-----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, VUKvEtBYKh4G/AbDrLPW/E5hof8FyhVSv8nTWib1lgIMi8DlQq1uBd0FO6EuEhyC pxsiZvEDY0H4hgGpOQhYLw== 0000950115-00-000406.txt : 20000329 0000950115-00-000406.hdr.sgml : 20000329 ACCESSION NUMBER: 0000950115-00-000406 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 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: SEC FILE NUMBER: 033-18888 FILM NUMBER: 580848 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: STREET 1: 77 EAST KING STREET CITY: SHIPPANSBURG STATE: PA ZIP: 17257 10-K 1 ANNUAL REPORT 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, 1999 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 Identification No.) incorporation or organization) 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 December 31, 1999, 2,218,291 shares of the registrant's common stock were outstanding. The aggregate market value of such shares held by nonaffiliates on that date was $ 88,731,640. DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholders report for the year ended December 31, 1999 are incorporated by reference into Parts I and II. Portions of the Proxy Statement for 2000 Annual Meeting of Security Holders are incorporated by reference in Part III of this Form 10-K. ORRSTOWN FINANCIAL SERVICES, INC. FORM 10-K INDEX
Page ---- Part I Item 1. Business ............................................................................ 2 Item 2. Properties .......................................................................... 7 Item 3. Legal Proceedings ................................................................... 8 Item 4. Submission of Matters to a Vote of Security Holders ................................. 8 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ............... 10 Item 6. Selected Financial Data ............................................................. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..................................................................... 10 Item 8. Financial Statements and Supplementary Data ......................................... 10 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .............................................................. 19 Part III Item 10. Directors and Executive Officers of the Registrant .................................. 19 Item 11. Executive Compensation .............................................................. 19 Item 12. Security Ownership of Certain Beneficial Owners and Management ...................... 19 Item 13. Certain Relationships and Related Transactions ...................................... 19 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .................... 19 Signatures ..................................................................................... 21
Part I 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 eight branches are located in Shippensburg (2), Carlisle (2), Spring Run, Orrstown, and Chambersburg (2), 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, 1999, Orrstown had 84 full-time and 48 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 Pennsylvania, principally Franklin and Cumberland Counties. The concentrations of credit by type of loan are set forth on the face of the balance sheet (page 2 of the annual report to shareholders). 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. -2- 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. As of December 31, 1999, Orrstown had total assets of approximately $ 265 million, total shareholders' equity of approximately $ 22 million and total deposits of approximately $ 204 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. -3- 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 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 14 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 12 of the annual report to shareholders under "Capital Adequacy and Regulatory Matters". 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. FDICIA 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 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. -4- FDICIA establishes five capital tiers, ranging from "well capitalized", to "critically undercapitalized". A depository institution is well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure. Under FDICIA, an institution that is not well capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market; in addition, "pass through" insurance coverage may not be available for certain employee benefit accounts. FDICIA also requires an undercapitalized depository institution to submit an acceptable capital restoration plan to the appropriate federal bank regulatory agency. One requisite element of such a plan is that the institution's parent holding company must guarantee compliance by the institution with the plan, subject to certain limitations. In the event of the parent holding company's bankruptcy, the guarantee, and any other commitments that the parent holding company has made to federal bank regulators to maintain the capital of its depository institution subsidiaries, would be assumed by the bankruptcy trustee and entitled to priority in payment. Based on their respective regulatory capital ratios at December 31, 1999, the corporation is considered well capitalized, based on the definitions in the regulations issued by the Federal Reserve Board and the other federal bank regulatory agencies setting forth the general capital requirements mandated by FDICIA. See "Capital Adequacy and Regulatory Matters" in management's discussion and analysis in the corporation's annual report as shown in Exhibit 13. A federal depositor preference statute was enacted in 1993 providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999, federal legislation intended to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial services providers. As a result of the legislation, bank holding companies will be permitted to engage in a wider variety of financial activities than permitted under prior law, particularly with regard to insurance and securities activities. Moreover, to the extent that it permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This could result in a growing number of larger financial institutions that offer a wider variety of financial services than we currently offer and that can aggressively compete in the markets we serve. This could adversely impact our profitability. In addition, a bank holding company, which does not qualify or does not elect to become a financial holding company under the Gramm-Leach-Bliley Act, is generally prohibited from engaging in, or acquiring direct or indirect control of any company engaged in nonbanking activities, except for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The principal activities that the Federal Reserve Board has determined by regulation to be so closely related to banking as to be a proper incident thereto are set forth in Federal Reserve Board Regulation Y. -5- Bank holding companies that do qualify as a financial holding company may engage in activities that are of a financial nature or incidental thereto. This will include activities such as securities and insurance underwriting which are not permitted nonbanking activities under Regulation Y. A bank holding company may qualify to become a financial holding company if each of its depository institution subsidiaries is "well capitalized", "well managed", has at least a "satisfactory" CRA rating in its most recent examination and the bank holding company has filed a certification with the Federal Reserve Bank that it elects to become a financial holding company. 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 to banking and securities laws, regulations and regulatory agencies, the Corporation also is subject to various other laws, regulations and regulatory agencies. Furthermore, various proposals, bills and regulations have been and are being considered in the United States Congress, and various other governmental regulatory and legislative bodies, which could result in changes in the profitability and governance of the Corporation. It cannot be predicted whether new legislation or regulations will be adopted and, if so, how they would affect the Corporation. References under the caption "Supervision and Regulation" to applicable statutes, regulations and orders are brief summaries of portions thereof which do not purport to be complete and which are qualified in their entirety by reference thereto. Important Factors Relating to Forward Looking Statements The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. In connection with certain statements made in this report and those that may be made in the future by or on behalf of the Corporation which are identified as forward-looking statements, the Corporation notes that the following important factors, among others, could cause actual results to differ materially from those set forth in any such forward-looking statements. Further, such forward-looking statements speak only as of the date on which such statement or statements are made, and the Corporation undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. The business and profitability of a financial services organization such as the Corporation is influenced by prevailing economic conditions and governmental policies. The actions and policy directives of the Federal Reserve Board determine to a significant degree the cost and the availability of funds obtained from money market sources for lending and investing. Federal Reserve Board policies and regulations also influence, directly and indirectly, the rates of interest paid by commercial banks on their interest-bearing deposits and may also impact the value of financial instruments held by the Corporation. The nature and -6- impact on the Corporation of future changes in economic and market conditions and monetary and fiscal policies are not predictable and are beyond the Corporation's control. In addition, these conditions and policies can impact the Corporation's customers and counterparties which may increase the risk of default on their obligations to the Corporation and its affiliates. They can also affect the competitive conditions in the markets and products within which the Corporation operates, which can have an adverse impact on the Corporation's ability to maintain its revenue streams. As part of its ongoing business, the Corporation assumes financial exposures to interest rates, currencies, equities and other financial products. In doing so, the Corporation is subject to unforeseen events which may not have been anticipated or which may have effects which exceed those assumed within its risk management processes. This risk can be accentuated by volatility and reduction in liquidity in those markets which in turn can impact the Corporation's ability to hedge and trade the positions concerned. In addition, the Corporation is dependent on its ability to access the financial markets for its funding needs. As noted in "Supervision and Regulation", the Corporation is regulated by and subject to various regulators. The actions of these regulators can have an impact on the profitability and governance of the Corporation. Increases by regulatory authorities of minimum capital, reserve, deposit insurance and other financial viability requirements can also affect the Corporation's profitability. The Corporation is subject to operational and control risk which is the potential for loss caused by a breakdown in communication, information, processing and settlement systems or processes or a lack of compliance with the procedures on which they rely either within the Corporation or within the broader financial systems infrastructure. As with any financial institution, the Corporation is also subject to the risk of litigation and to an unexpected or adverse outcome in such litigation. Competitive pressures in the marketplace and unfavorable or adverse publicity and news coverage can have the effect of lessening customer demand for the Corporation's services. Ultimately, the Corporation's businesses and their success are dependent on the Corporation's ability to attract and retain high quality employees. Competition Orrstown's principal market area consists of Franklin County and Cumberland County, Pennsylvania. It services a substantial number of depositors in this market area, with the greatest concentration within a radius of Chambersburg, 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, Spring Run, Pennsylvania and Chambersburg, Pennsylvania. Offices of the bank are located in each of these buildings. One of the offices located in Shippensburg is an "Operations Center" which -7- does not operate as a branch, but rather as an accounting office. The corporation is in the process of expanding its main offices located on King Street in Shippensburg, PA and has acquired property in Mechanicsburg, PA to be the site of its ninth branch. Both projects are expected to be completed in 2000. The bank also owns a 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. -8-
Age Held Bank Employee as of Name/Office Held Since Since 3/15/00 ---------------- ----- ----- ------- Joel R. Zullinger, Chairman of the Board 1991 (1) 51 Jeffrey W. Coy, Vice Chairman of The board 1988 (1) 48 Kenneth R. Shoemaker, President & CEO 1987 1986 52 Bradley S. Everly, Senior Vice President Chief Financial Officer 1997 1997 48 Stephen C. Oldt, Executive Vice President, Chief Operating Officer 1987 1987 57 Philip E. Fague, Senior Vice President, Senior Trust Officer 1990 1988 40 Denver L. Tuckey, Secretary 1999 (1) 65 Benjamin Stoops, Vice President, Senior Operations Officer 1998 1998 48 Jeffrey W. Embly, Vice President Senior Loan Officer 1999 1997 29 (1) These officers are not employees of the Bank. Senior Operating Officers of the Bank Age Held Bank Employee as of Name/Office Held Since Since 3/15/00 ---------------- ----- ----- ------- Kenneth R. Shoemaker, President & Chief Executive Officer 1987 1988 52 Stephen C. Oldt, Executive Vice President & Chief Operating Officer 1987 1987 57 Philip E. Fague, Vice President/ 1990/ Senior Trust Officer 1993 1988 40 Bradley S. Everly, Senior Vice 1997/ President/Chief Financial Officer 1997 1997 48 Benjamin Stoops, Vice President, Senior Operations Officer 1998 1998 48 Jeffrey W. Embly, Vice President, Senior Loan Officer 1999 1997 29
-9- 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 through the local and over the counter local markets. At December 31, 1999, the approximate number of shareholders of record was approximately 1,848. 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 ------------------ --------- -------------------- -------- Dividend (1) 1998 1997 --------------------------------- --------------------------------- High Low High Low First Quarter $ 32.56 $ 25.58 $ .121 $ 22.33 $ 20.93 $ .107 Second Quarter 37.21 25.12 .121 24.19 20.59 .107 Third Quarter 37.21 32.56 .130 27.91 24.19 .112 Fourth Quarter 40.0 32.56 .140 29.77 25.58 .112
- ---------- (1) Note: All per share data has been restated after giving retroactive recognition to a 7-1/2% stock dividend paid November 19, 1999 and a 2 for 1 stock split effective November 21, 1998. See Note 14 to the financial statements for restrictions on the payment of dividends. Item 6. Selected Financial Data. The selected five-year financial data on page 20 of the annual shareholders' report for the year ended December 31, 1999 is incorporated herein by reference. 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 14 through 18 of the annual shareholders' report are incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. The financial statements and supplementary data, some of which is required under Guide 3 (statistical disclosures by bank holding companies) are shown on pages 2 through 20 of the annual shareholders report for the year ended December 31, 1999 and are incorporated herein by reference. Certain statistical information required in addition to those included in the annual shareholders report are submitted herewith as follows. Description of Statistical Information Page -------------------------------------- ---- Changes in net interest income tax equivalent yields 11 Investment portfolio 12 Loan portfolio 13 Summary of loan loss experience 14 Nonaccrual, delinquent and impaired loans 15 Allocation of allowances for loan losses 16 Deposits and return on equity and assets 17 Consolidated summary of operations 18 -10- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CHANGES IN NET INTEREST INCOME TAX EQUIVALENT YIELDS
1999 Versus 1998 1998 Versus 1997 Increase (Decrease) Increase (Decrease) Due to Change in Due to Change in ------------------------------------ -------------------------------- Total Total ------------------------------------ -------------------------------- Average Average Increase Average Average Increase Volume Rate (Decrease) Volume Rate (Decrease) ------ ---- --------- ------ ---- ---------- (000 omitted) Interest Income Loans (net of unearned discounts) $ 2,280 ($ 469) $ 1,811 $ 2,429 ($ 252) $ 2,177 Taxable investment securities 456 7 463 390 (80) 310 Nontaxable investment securities (3) (3) (6) 170 (17) 153 Other short-term investments 7 (27) (20) 131 (17) 114 ------- -------- ------- ------- ------ ------- Total interest income 2,740 (492) 2,248 3,120 (366) 2,754 ------- -------- ------- ------- ------ ------- Interest Expense Interest bearing demand 486 (113) 373 503 156 659 Savings deposits (15) (82) (97) (35) (16) (51) Time deposits 75 (312) (237) 344 32 376 Short-term borrowings 263 (29) 234 221 (29) 192 Long-term borrowings 501 (48) 453 379 (29) 350 ------- ------- ------- ------- ------- ------- Total interest expense 1,310 (584) 726 1,412 114 1,526 ------- ------- ------- ------- ------ ------- Net interest income $ 1,522 $ 1,228 ======= =======
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. -11- 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, 1999, 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 $ 2,999 $ 3,549 $ 0 $ 0 $ 6,548 Yield 6.31% 6.37% 0% 0% 6.35% U.S. Government agencies Book value 0 9,500 12,960 1,982 24,442 Yield 0% 6.15% 6.84% 6.72% 6.56% State and municipal Book value 0 1,139 500 15,359 16,998 Yield 0% 9.98% 10.0% 8.67% 8.76% Total book value $ 2,999 $ 14,188 $ 13,460 $ 17,341 $47,988 ======= ======== ======== ======== ======= Yield 6.31% 6.51% 6.96% 8.45% 7.31% ====== ====== ====== ======= ======= Mortgage-backed securities: Total book value $12,603 ======= Yield 6.97% ======= Equity Securities: Total book value $ 739 ======= Yield 3.87% ======= Total Investment Securities $61,330 ======= Yield 7.20% =======
-12- 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:
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (000 omitted) Commercial, financial and agricultural $ 21,503 $ 18,732 $ 10,275 $ 8,401 $ 8,211 Real estate - Construction 15,580 11,182 5,961 4,304 5,706 Real estate - Mortgage 134,046 116,030 97,074 82,687 75,731 Installment and other personal loans (net of unearned discount) 9,562 12,688 15,021 13,534 13,209 --------- --------- --------- --------- --------- Total loans $ 180,691 $ 158,632 $ 128,331 $ 108,926 $ 102,857 ========= ========= ========= ========= =========
Presented below are the approximate maturities of the loan portfolio (excluding real estate mortgages, installments and credit cards) at December 31, 1999:
Under One One to Over Five Year Five Years Years Total ---- ---------- ----- ----- (000 omitted) Commercial, financial and agricultural $ 3,407 $ 4,087 $ 14,009 $ 21,503 Real estate - Construction 2,159 2,585 10,836 15,580 ------- ------- -------- -------- Total $ 5,566 $ 6,672 $ 24,845 $ 37,083 ======= ======= ======== ========
The following table presents the approximate amount of fixed rate loans and variable rate loans due as of December 31, 1999: Fixed Rate Variable Loans Rate Loans ----- ---------- (000 omitted) Due within one year $ 1,932 $ 63,710 Due after one but within five years 32,602 27,806 Due after five years 54,162 479 -------- -------- Total $ 88,696 $ 91,995 ======== ======== -13- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY SUMMARY OF LOAN LOSS EXPERIENCE
Years Ended December 31 -------------------------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (000 omitted) Average total loans outstanding (net of unearned income) $ 169,458 $ 144,013 $ 117,403 $ 105,779 $ 97,662 ========= ========= ========= ========= ======== Allowance for loan losses, beginning of period $ 1,971 $ 1,767 $ 1,620 $ 1,433 $ 1,200 Additions to provision for loan losses charged to operations 547 270 215 240 270 Loans charged off during the year Commercial 97 15 1 20 0 Personal credit lines 7 23 32 17 3 Installment 24 46 50 31 48 --------- --------- --------- ---------- -------- Total charge-off's 128 84 83 68 51 --------- --------- --------- --------- -------- Recoveries of loans previously charged off: Commercial 59 3 2 3 0 Installment 1 10 12 12 14 Personal credit lines 5 5 1 0 0 --------- --------- ---------- --------- ---------- Total recoveries 65 18 15 15 14 --------- --------- --------- --------- -------- Net loans charged off (recovered) 63 66 68 53 37 --------- --------- --------- --------- -------- Allowance for loan losses, end of period $ 2,455 $ 1,971 $ 1,767 $ 1,620 $ 1,433 ========= ========= ========= ========= ========= Ratio of net loans charged off to average loans outstanding .04% .06% .06% .05% .04% ========= ========= ========= ========= ==========
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. -14- 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.
1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (000 omitted) Nonaccrual loans $ 0 $ 486 $ 473 $ 14 $ 132 ========== ======== ======== ======== ======== Accrual loans: Restructured $ 0 $ 0 $ 0 $ 0 $ 0 30 through 89 days past due 3,420 823 2,398 1,976 1,949 90 days or more past due 97 284 657 203 417 ---------- -------- -------- -------- -------- Total accrual loans $ 3,517 $ 1,107 $ 3,055 $ 2,179 $ 2,366 ========== ======== ======== ======== ========
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, and discussion concerning impaired loans at December 31, 1999. -15- 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 --------------------------------------------------------------------- 1999 1998 ---------------------------- ------------------------------- Percentage Percentage Allowance of Loans to Allowance of Loans to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (000 omitted) Commercial, financial and agricultural $ 45 11.90% $ 255 9.93% Commercial, real estate secured 609 18.03 416 19.43 Real estate - Construction 0 8.62 0 7.05 Real estate - Mortgage 93 56.16 111 53.77 Installment 27 5.29 34 9.82 Unallocated 1,681 0.00 1,155 0.00 ------- ------ ------- ------ Total $ 2,455 100.00% $ 1,971 100.00% ======= ====== ======= ======
Years Ended December 31 --------------------------------------------------------------------- 1999 1998 ---------------------------- ------------------------------- Percentage Percentage Allowance of Loans to Allowance of Loans to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (000 omitted) Commercial, financial and agricultural $ 31 8.00% $ 125 7.71% Commercial - Real estate secured 354 35.00 0 0.00 Real estate - Construction 0 4.64 64 3.95 Real estate - Mortgage 188 40.64 1,229 75.91 Installment 12 11.72 202 12.43 Unallocated 1,182 0.00 0 0.00 ------- ------ ------- ------ Total $ 1,767 100.00% $ 1,620 100.00% ======= ====== ======= ======
Year Ended December 31 1995 ------------------------------ Percentage Allowance of Loans to Amount Total Loans ------ ----------- (000 omitted) Commercial, financial and agricultural $ 114 7.98% Commercial - Real estate secured 0 0.00 Real estate - Construction 80 5.55 Real estate - Mortgage 1,055 73.63 Installment 184 12.84 Unallocated 0 0.00 ------- ------ Total $ 1,433 100.00% ======= ====== -16- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY DEPOSITS The average amounts of deposits are summarized below:
Years Ended December 31 ------------------------------------------------------ 1999 1998 1997 ---- ---- ---- (000 omitted) Demand deposits $ 25,365 $ 20,433 $ 17,665 Interest bearing demand deposits 71,176 55,454 37,535 Savings deposits 22,888 23,394 24,568 Time deposits 75,859 74,488 68,161 --------- --------- --------- Total deposits $ 195,288 $ 173,769 $ 147,929 ========= ========= =========
The following is a breakdown of maturities of time deposits of $ 100,000 or more as of December 31, 1999: Maturity (000 omitted) -------- ------------- Certificates of Deposit Three months or less $ 3,858 Over three months through twelve months 2,245 Over one year through three years 4,349 Over three years 403 -------- $ 10,855 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) 1999 1998 1997 ---- ---- ---- Average assets $ 250,529 $ 212,149 $ 172,366 Net income $ 3,755 $ 3,119 $ 2,606 Average equity $ 22,067 $ 19,523 $ 16,956 Cash dividends paid $ 1,134 $ 986 $ 903 Return on assets 1.50% 1.47% 1.51% Return on equity 17.02% 15.97% 15.37% Dividend payout ratio 30.20% 31.61% 34.65% Equity to asset ratio 8.81% 9.2% 9.84% -17- ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY CONSOLIDATED SUMMARY OF OPERATIONS
Years Ended December 31 --------------------------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (000 omitted) Interest income $ 18,324 $ 16,109 $ 13,450 $ 12,018 $ 10,829 Interest expense 8,074 7,348 5,822 5,139 4,542 -------- -------- -------- -------- -------- Net interest income 10,250 8,761 7,628 6,879 6,287 Provision for loan losses 547 270 215 240 270 -------- -------- -------- -------- -------- Net interest income after provision for loan losses 9,703 8,491 7,413 6,639 6,017 Other income: Trust and brokerage services 1,230 818 490 384 297 Service charges - Deposits 779 646 601 477 375 Other service charges, collection and exchange, charges, commission fees 844 667 341 258 218 Other operating income (loss) 728 122 119 121 45 -------- -------- -------- -------- -------- Total other income 3,581 2,253 1,551 1,240 935 -------- -------- -------- -------- -------- Income before operating expense 13,284 10,744 8,964 7,879 6,952 Operating expenses: Salaries and employees benefits 4,297 3,491 2,901 2,621 2,326 Occupancy and equipment expense 1,099 859 764 665 559 Other operating expenses 2,822 2,095 1,719 1,507 1,371 -------- -------- -------- -------- -------- Total operating expenses 8,218 6,445 5,384 4,793 4,256 -------- -------- -------- -------- -------- Income before income taxes 5,066 4,299 3,580 3,086 2,696 Income tax 1,311 1,180 974 838 742 -------- -------- -------- -------- -------- Net income applicable to common stock $ 3,755 $ 3,119 $ 2,606 $ 2,248 $ 1,954 ======== ======== ======== ======== ======== Per share data: Earnings per common share $ 1.70 $ 1.41 $ 1.18 $ 1.02 $ .88 Cash dividend - Common $ .51 $ .45 $ .41 $ .32 $ .27 Weighted average number of common shares 2,214,951 2,205,718 2,204,444 2,205,268 2,206,560
-18- Item 9. Disagreements on Accounting and Financial Disclosures. Not applicable. PART III The information required by Items 10, 11, 12 and 13 is incorporated by reference from Orrstown Financial Services, Inc.'s definitive proxy statement for the 2000 Annual Meeting of Shareholders filed pursuant to Regulation 14A. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports of Form 8-K. (a) (1) - List of Financial Statements The following consolidated financial statements of Orrstown Financial Services, Inc. and its subsidiary, included in the annual report of the registrant to its shareholders for the year ended December 31, 1999, are incorporated by reference in Item 8: Consolidated balance sheets - December 31, 1999 and 1998 Consolidated statements of income - Years ended December 31, 1999, 1998 and 1997 Consolidated statements of shareholders' equity - Years ended December 31, 1999, 1998, and 1997 Consolidated statements of cash flows - Years ended December 31, 1999, 1998, and 1997 Notes to consolidated financial statements - December 31, 1999 (2) List of Financial Statement Schedules All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (3) Listing of Exhibits Exhibit (3) (i) Articles of incorporation Exhibit (3) (ii) Bylaws Exhibit (4) Instruments defining the rights of security holders including indentures Exhibit (10) Material contracts Exhibit (13) Annual report to security holders Exhibit (21) Subsidiaries of the registrant Exhibit (23) Consent of independent auditors Exhibit (27) Financial data schedule All other exhibits for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. -19- (b) Reports on Form 8-K filed None. (c) Exhibits (3)(i) Articles of incorporation. Incorporated by reference to Exhibit 3(i) of the registrant's Form 10-K filed March 26, 1999 for the year ended December 31, 1998. (ii) 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., incorporated by reference to Exhibit 3(i) of the registrant's Form 10-K filed March 26, 1999 for the year ended December 31, 1998. (ii) By-laws of Orrstown Financial Services, Inc., incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-4 (Registration No. 33-18888). (10.1) Change in control agreement between Orrstown Financial Services, Inc. and its chief executive officer. Incorporated by reference to Exhibit 99 of the registrant's Form 10-K filed March 17, 1997 for the year ended December 31, 1996. (10.2) Salary continuation plan for selected officers - filed herewith (10.3) Officer group term replacement plan for selected officers - filed herewith (10.4) Director retirement plan - filed herewith (10.5) Revenue neutral retirement plan - filed herewith (13) Annual report to security holders - filed herewith (21) Subsidiaries of the registrant - filed herewith (23.1) Consent of independent auditors filed herewith (27) Financial data schedule - filed herewith (d) Financial statement schedules None -20- 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 /s/ Kenneth R. Shoemaker ----------------------------- Kenneth R. Shoemaker, President Dated: March 15, 2000 (Duly authorized officer) By /s/ Bradley S. Everly ----------------------------- Bradley S. Everly, Chief Financial Officer (Principal Accounting 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 --------- ----- ---- /s/ Kenneth R. Shoemaker President, CEO and March 15, 2000 - ------------------------------------- Director Kenneth R. Shoemaker /s/ Anthony F. Ceddia Director March 15, 2000 - ------------------------------------- Dr. Anthony F. Ceddia /s/ Glenn W. Snoke Director March 15, 2000 - ------------------------------------- Glenn W. Snoke /s/ Gregory A. Rosenberry Director March 15, 2000 - ------------------------------------- Gregory A. Rosenberry /s/ Joel R. Zullinger Chairman of the March 15, 2000 - ------------------------------------- Board and Director Joel R. Zullinger /s/ Jeffrey W. Coy Vice Chairman March 15, 2000 - ------------------------------------- of the Board Jeffrey W. Coy and Director /s/ John S. Ward Director March 15, 2000 - ------------------------------------- John S. Ward /s/ Denver L. Tuckey - ------------------------------------- Secretary and March 15, 2000 Denver L. Tuckey Director /s/ Andrea Pugh - ------------------------------------- Director March 15, 2000 Andrea Pugh
-21- EX-10.2 2 SALARY CONTINUATION AGREEMENT EXHIBIT 10.2 ORRSTOWN BANK SALARY CONTINUATION AGREEMENT THIS AGREEMENT is made this lst day of October 1998, by and between ORRSTOWN BANK, a Pennsylvania corporation located in Orrstown, Pennsylvania (the "Company") and Kenneth R. Shoemaker (the "Executive"). INTRODUCTION To encourage the Executive to remain an employee of the Company, the Company is willing to provide salary continuation benefits to the Executive. The Company will pay the benefits from its general assets. AGREEMENT The Executive and the Company agree as follows: Article 1 Definitions 1.1 Definitions. Whenever used in this Agreement, the following words and phrases shall have the meanings specified: 1.1.1 "Change of Control" shall mean any of the following: (A) 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 (B) the liquidation or dissolution of the Corporation or the Company 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 Company to an entity which is not a direct or indirect subsidiary of the Corporation; or (C) 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 (D) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation, or similar transaction of the Corporation, or before any connected series of such transactions, 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 (E) any other event which is at any time designated as a "Change of 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 of 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. Notwithstanding anything else to the contrary set forth in this Agreement, if (i) an agreement is executed by the Corporation or the Company providing for any of the transactions or events constituting a Change of Control as defined herein, and the agreement subsequently expires or is terminated without the transaction or event being consummated, and (ii) Executive's employment did not terminate during the period after the agreement and prior to such expiration or termination, for purposes of this Agreement it shall be as though such agreement was never executed and no Change of Control event shall be deemed to have occurred as a result of the execution of such agreement. 1.1.2 "Code" means the Internal Revenue Code of 1986, as amended. 1.1.3 "Corporation" means 0rrstown Financial Services, Inc. 1.1.4 "Disability" means the Executive suffering a sickness, accident or injury which, in the judgment of a physician satisfactory to the Company, prevents the Executive from performing substantially all of the Executive's normal duties for the Company. As a condition to any benefits, the Company may require the Executive to submit to such physical or mental evaluations and tests as the Company's Board of Directors deems appropriate 1.1.5 "Early Termination" means the Termination of Employment before Normal Retirement Age for reasons other than death, disability, termination for cause or following a change of control. 1.1.6 "Early Termination Date" means the month, day and year which early termination occurs. 1.1.7 "Norma1 Retirement Age" means the Executive's 62nd birthday. 1.1.8 "Normal Retirement Date" means the later of the Normal Retirement Age or Termination of Employment. 1 1.1.9 "Plan Year" means a twelve-month period commencing on October 1 and ending on September 30 of each year. The initial Plan Year shall commence on the effective date of this Agreement. 1.1.0 "Termination for Cause" See Section 5.2. 1.1.11 "Termination of Employment" means that the Executive ceases to be employed by the Company for any reason whatsoever other than by reason of a leave of absence which is approved by the Company. For purposes of this Agreement, if there is a dispute over the employment status of the Executive or the date of the Executive's Termination of Employment, the Company shall have the sole and absolute right to decide the dispute. Article 2 Lifetime Benefits 2.1 Normal Retirement Benefit. Upon Termination of Employment on or after the Normal Retirement Age for reasons other than death, the Company shall pay to the Executive the benefit described in this Section 2.1 in lieu of any other benefit under this Agreement. 2.1.1 Amount of Benefit. The annual Normal Retirement Benefit under this section 2.1 is $80,000 (eighty thousand dollars). The Company may increase the annual benefit under this Section 2.1 at the sole and absolute discretion of the Company's Board of Directors. Any increase in the annual benefit shall require the recalculation of all the amounts on Schedule A attached hereto. The annual benefit amounts on Schedule A are calculated by amortizing the annual normal retirement benefit using the interest method of accounting, a 7.50% discount rate, monthly compounding and monthly payments. 2.1.2 Payment of Benefit. The Company shall pay the annual benefit to the Executive in 12 equal monthly installments payable on the first day of each month commencing with the month following the Executive's Normal Retirement Date and continuing for 179 additional months. 2.1.3 Benefit Increases. Commencing on the first anniversary of the first benefit payment, and continuing on each subsequent anniversary, the Company's Board of Directors, in its sole discretion, may increase the benefit. 2.2 Early Termination Benefit. Upon Early Termination, the Company shall pay to the Executive the benefit described in this Section 2.2 in lieu of any other benefit under this Agreement. 2.2.1 Amount of Benefit. The annual benefit under this Section 2.2 is the Early Termination Annual Benefit set forth in Schedule A for the Plan Year ending immediately prior to the Early Termination Date. 2.2.2 Payment of Benefit. The Company shall pay the annual benefit to the Executive in 12 equal monthly installments payable on the first day of each month commencing with the month following the Executive's Normal Retirement Age and continuing for 179 additional months. 2.2.3 Benefit Increases. Benefit payments may be increased as provided in Section 2.1.3. 2.3 Disability Benefit. If the Executive terminates employment due to Disability prior to Normal Retirement Age, the Company shall pay to the Executive the benefit described in this section 2.3 in lieu of any other benefit under this Agreement. 2.3.1 Amount of Benefit. The annual benefit under this Section 2.3 is the Disability Benefit amount set forth in Schedule A for the Plan Year ending immediately prior to the date in which Termination of Employment occurs. 2.3.2 Payment of Benefit. The Company shall pay the benefit to the Executive in 12 equal monthly installments commencing within 90 days after the date of the Executive's Termination of Employment and continuing for 179 additional months. 2.3.3 Benefit Increases. Benefit payments may be increased as provided in Section 2.1.3. 2.4 Change of Control Benefit. If the Executive is in the active service of the Company at the time of a Change of Control, the Company shall pay to the Executive the benefit described in this Section 2.4 in lieu of any other benefit under this Agreement. 2.4.1 Amount of Benefit. The annual benefit under this Section 2.4 is the Normal Retirement Benefit described in Section 2.1.1. 2.4.2 Payment of Benefit. The Company shall pay the annual benefit amount to the Executive in 12 equal monthly installments payable on the first day of each month commencing with the month following the Executive's Normal Retirement Date and continuing for 179 additional months. 2.4.3 Benefit Increases. Benefit payments may be increased as provided in Section 2.1.3 Article 3 Death Benefits 3.1 Death During Active Service. If the Executive dies while in the active service of the Company, the Company shall pay to the Executive's beneficiary the benefit described in this Section 3. 1. This benefit shall be paid in lieu of the Lifetime Benefits of Article 2. 3.1.1 Amount of Benefit. The annual benefit under this Section 3.1 is the Normal Retirement Benefit described Section 2.1.1. 3.1.2 Payment of Benefit. The Company shall pay the annual benefit to the beneficiary in 12 equal monthly installments payable on the first day of each month commencing with the month following the Executive's death and continuing for 179 additional months. 2 3.2 Death During Benefit Period. If the Executive dies after the benefit payments have commenced under this Agreement but before receiving all such payments, the Company shall pay the remaining benefits to the Executive's beneficiary at the same time and in the sameamounts they would have been paid to the Executive had the Executive survived. 3.3 Death Following Termination of Employment But Before Benefits Commence. If the Executive is entitled to benefits under this Agreement, but dies prior to receiving said benefits, the Company shall pay to the Executive's beneficiary the same benefits, in the same manner, they would have been paid to the Executive had the Executive survived; however, said benefit payments will commence upon the Executive's death. Article 4 Beneficiaries 4.1 Beneficiary Designations. The Executive shall designate a beneficiary by filing a written designation with the Company. The Executive may revoke or modify the designation at any time by filing a new designation. However, designations will only be effective if signed by the Executive and accepted by the Company during the Executive's lifetime. The Executive's beneficiary designation shall be deemed automatically revoked if the beneficiary predeceases the Executive, or if the Executive names a spouse as beneficiary and the marriage is subsequently dissolved. If the Executive dies without a valid beneficiary designation, all payments shall made to the Executive's estate. 4.2 Facility of Payment. If a benefit is payable to a minor, to a person declared incapacitated, or to a person incapable of handling the disposition of his or her property, the Company may pay such benefit to the guardian , legal representative or person having the care or custody of such minor, incapacitated person or incapable person. The Company may require proof of incapacity, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit. Article 5 General Limitations Notwithstanding any provision of this Agreement to the contrary, the Company shall not pay any benefit under this Agreement: 5.1 Excess Parachute Payment. To the extent the benefit would be an excess parachute payment under Section 280G of the Code. 5.2 Termination for Cause. If the Company terminates the Executive's employment for: 5.2.1 Gross negligence or gross neglect of duties; 5.2.2 Commission of a felony or of a gross misdemeanor involving moral turpitude; or 5.2.3 Fraud, disloyalty, dishonesty or willful violation of any law or significant Company policy committed in connection with the Executive's employment and resulting in an adverse effect on the Company. 5.3 Competition After Termination of Employment. If the Executive, without the prior written consent of the Company, engages in, becomes interested in, directly or indirectly, as a sole proprietor, as a partner in a partnership, or as a substantial shareholder in a corporation, or becomes associated with, in the capacity of employee, director, officer, principal, agent, trustee or in any other capacity whatsoever, any enterprise conducted in the trading area (a 50 mile radius of the main office of the Company at the comer of King and Penn Streets), which enterprise is, or may deemed to be, competitive with any business carried on by the Company as of the date of termination of the Executive's employment or his retirement. This section shall not apply following a Change of Control. 5.4 Suicide or Misstatement. If the Executive commits suicide within two years after the date of this Agreement, or if the Executive has made any material misstatement of fact on any application for life insurance purchased by the Company. Article 6 Claims and Review Procedures 6.1 Claims Procedure. The Company shall notify any person or entity that makes a claim against the Agreement (the "Claimant") in writing, within ninety (90) days of Claimant's written application for benefits, of his or her eligibility or noneligibility for benefits under the Agreement. If the Company determines that the Claimant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of the Agreement on which the denial is based, (3) a description of any additional information or material necessary for the Claimant to perfect his or her claim, and a description of why it is needed, and (4) explanation of the Agreement's claims review procedure and other appropriate information as to the steps to be taken if the Claimant wishes to have the claim reviewed. If the Company determines that there are special circumstances requiring additional time to make a decision, the Company shall notify the Claimant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional ninety-day period. 6.2 Review Procedure. If the Claimant is determined by the Company not to be eligible for benefits, or if the Claimant believes that he or she is entitled to greater or different benefits, the Claimant shall have the opportunity to have such claim reviewed by the Company by filing a petition for review with the Company within sixty (60) days after receipt of the notice issued by the Company. Said petition shall state the specific reasons which the Claimant believes entitle him or her to benefits or to greater or different benefits. Within sixty (60) days after receipt by the Company of the petition, the Company shall afford the Claimant (and counsel, if any) an opportunity to present his or her position to the Company orally or in writing, and the Claimant (or counsel) shall have the right to review the pertinent documents. The Company shall notify the Claimant of its decision in writing within the sixty-day period, stating specifically the basis of its decision, written a manner calculated to be understood by the Claimant and the specific provisions of the Agreement on which the decision is based. If, because of the need for a hearing, the sixty-day period is not sufficient, the decision may be deferred for up to another sixty-day period at the election of the Company, but notice of this deferral shall be given to the Claimant. 3 Article 7 Amendments and Termination This Agreement may be amended or terminated only by a written agreement signed by the Company and the Executive. Article 8 Miscellaneous 8.1 Binding Effect. This Agreement shall bind the Executive and the Company, and their beneficiaries, survivors, executors, successors, administrators and transferees. 8.2 No Guarantee of Employment. This Agreement is not an employment policy or contract. It does not give the Executive the right to remain an employee of the Company, nor does it interfere with the Company's right to discharge the Executive. It also does not require the Executive to remain an employee nor interfere with the Executive's right to terminate employment at any time. 8.3 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached or encumbered in any manner. 8.4 Tax Withholding. The Company shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement. 8.5 Applicable Law. The Agreement and all rights hereunder shall be governed by the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America. 8.6 Unfunded Arrangement. The Executive and beneficiary are general unsecured creditors of the Company for the payment of benefits under this Agreement. The benefits represent the mere promise by the Company to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Executive's life is a general asset of the Company to which the Executive and beneficiary have no preferred or secured claim. 8.7 Recovery of Estate Taxes. If the Executive's gross estate for federal estate tax purposes includes any amount determined by reference to and on account of this Agreement, and if the beneficiary is other than the Executive's estate, then the Executive's estate shall be entitled to recover from the beneficiary receiving such benefit under the terms of the Agreement, an amount by which the total estate tax due by the Executive's estate, exceeds the total estate tax which would have been payable if the value of such benefit had not been included in the Executive's gross estate. If there is more than one person receiving such benefit, the right of recovery shall be against each such person. In the event the beneficiary has a liability hereunder, the beneficiary may petition the Company for a lump sum payment in an amount not to exceed the beneficiary's liability hereunder. 8.8 Entire Agreement. This Agreement constitutes the entire agreement between the Company and the Executive as to the subject matter hereof. No rights are granted to the Executive by virtue of this Agreement other than those specifically set forth herein. 8.9 Administration. The Company shall have powers which are necessary to administer this Agreement, including but not limited to: 8.9.1 Interpreting the provisions of the Agreement; 8.9.2 Establishing and revising the method of accounting for the Agreement; 8.9.3 Maintaining a record of benefit payments; and 8.9.4 Establishing rules and prescribing any forms necessary or desirable to administer the Agreement, IN WITNESS WHEREOF, the Executive and a duly authorized Company officer have signed this Agreement. EXECUTIVE: COMPANY: ORRSTOWN BANK _____________________________ By _______________________________ Kenneth R. Shoemaker Title ____________________________ By execution hereof, Orrstown Financial Services, Inc. consents to and agrees to be bound by the terms and condition of this Agreement. ATTEST: CORPORATION: ORRSTOWN FINANCIAL SERVICES, INC. _____________________________ By ______________________________ Title ___________________________ 4 EX-10.3 3 GROUP TERM REPLACEMENT PLAN EXHIBIT 10.3 ORRSTOWN BANK GROUP TERM REPLACEMENT PLAN THIS PLAN, hereby made and entered into this 19 day of November, 1998, by and between the ORRSTOWN BANK, a state commercial located in Orrstown, Pennsylvania (the "Company") and the Participant selected to participate in this Plan (the "Participant"). INTRODUCTION The Company wishes to attract and retain highly qualified executives. To further this objective, the Company is willing to divide the death proceeds of certain life insurance policies which are owned by the Company on the lives of the participating executives with the designated beneficiary of each insured participating executive. The Company will pay the life insurance premiums from its general assets. Article I General Definitions The following terms shall have the meanings specified: 1.1.l "Change of Control" shall mean any of the following: (A) 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 (B) the liquidation or dissolution of the Corporation or the Company 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 Company to an entity which is not a direct or indirect subsidiary of the Corporation; or (C) 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, follow 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 (D) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation, or similar transaction of the Corporation, or before any connected series of such transactions, 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 (E) any other event which is at any time designated as a "Change of 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 adopted, the Change of 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 Participant. Notwithstanding anything else to the contrary set forth in this Agreement, if (i) an agreement is executed by the Corporation or the Company providing for any of the transactions or events constituting a Change of Control as defined herein, and the agreement subsequently expires or is terminated without the transaction or event being consummated, and (ii) Participant's employment did not terminate during the period after the agreement and prior to such expiration or termination, for purposes of this Agreement it shall be as though such agreement was never executed and no Change of Control event shall deemed to have occurred as a result of the execution of such agreement. 1.2 "Compensation Committee" means either the Compensation Committee designated from time to time by the Company's Board of Directors or a majority of the Company's Board of Directors, either of which shall hereinafter be referred to as the Compensation Committee. 1.3 "Corporation" means Orrstown Financial Services, Inc. 1.4 "Disability" means the Participant's inability to perform substantially all normal duties of a employee, as determined by the Company's Board of Directors in its sole discretion. As a condition to any benefits, the Company may require the Participant to submit to such physical or mental evaluations and tests as the Board of Directors deems appropriate. 1.5 "Insured" means the individual whose life is insured. 1.6 "Insurer" means the insurance company issuing the life insurance policy on the life of the insured. 1.7 "Normal Retirement Age" means the Participant attaining age 65 while employed with the Company or after reaching a total of 70 or more when age and Years of Service are combined. 1.8 "Normal Retirement Date" means the later of the Normal Retirement Age or the date that the Participant terminates or is terminated for any reason other than being Terminated for Cause. 1 1.9 "Participant" means the employee who is designated by the Compensation Committee as eligible to participate in the Plan, elects in writing to participate in the Plan using the form attached hereto as Exhibit A, and signs a Split Dollar Endorsement for the Policy in which he or she is the Insured. 1.10 "Policy" or "Policies" means the individual insurance policy (or policies) adopted by the Compensation Committee for purposes of insuring a Participant's life under this Plan. 1.11 "Plan" means this instrument, including all amendments thereto. 1.12 "Terminated for Cause" means that the Company has terminated the Participant's employment for any of the following reasons: 1.11.1 Gross negligence or gross neglect of duties; 1.11.2 Commission of a felony or of a gross misdemeanor involving moral turpitude; or 1.11.3 Fraud, disloyalty , dishonesty or willful violation of any law or significant Company policy committed in connection with the Participant's employment and resulting in an adverse effect on the Company. 1.12 "Two Times Base Annual Salary" means the current base annual salary of the Participant at the earliest of: (1) the date of the Participant's death; (2) the date of the Participant's Disability; or (3) the Participant's Normal Retirement Date, multiplied by a factor of two (2) but not in excess of the maximum benefit amount specified Exhibit B. 1.13 "Years of Service" means total years of employment with the Company including any approved leaves of absences. Article 2 Participation 2.1 Eligibility to Participate. The Compensation Committee in its sole discretion shall designate from time to time Participants that are eligible to participate in this Plan. The Compensation Committee will not designate a Participant as eligible unless he or she either is a participant in the Company's group term insurance plan as of this date or has been employed by the Company for at least one year. 2.2 Participation. The eligible executive may participate in this Plan by executing an Election to Participate and a Split Dollar Endorsement. The Split Dollar Endorsement shall bind the Participant and his or her beneficiaries, assigns and transferees, to the terms and conditions of this Plan. An executive's participation is limited to only Policies where he or she is the Insured. Exhibit B attached hereto sets forth the original Insured participants and the Policies on their lives. 2.3 Termination of Participation. A Participant's rights under this Plan shall cease and his or her participation in this Plan shall terminate if any of the following events occur: (i) the Participant's employment with the Company is Terminated for Cause; (ii) the Participant's employment with the Company is terminated prior to Normal Retirement Age for reasons other than Disability; or (iii) the Plan or any Participant's rights under the Plan are terminated in accordance with Article 8. In the event that the Company decides to maintain the Policy after the Participant's termination of his or her participation in the Plan, the Company shall be the direct beneficiary of the entire death proceeds of the Policy. 2.4 Disability. (A) Except as otherwise provided in paragraph (B) of this section 2.4, if the Participant's employment with the Company is terminated because of the Participant's Disability, the Company shall maintain the Policy in full force and effect and, in no event, shall the Company amend, terminate or otherwise abrogate the Participant's interest in the Policy, provided, however, that at all times the Policy shall be subject to the claims of the Company's creditors. (B) Notwithstanding the provisions of paragraph (A) of this section 2.4, upon the Disabled Participant's gainful employment with an entity other than the Company, the Company shall have no farther obligation to the Disabled Participant, and the Disabled Participant's rights pursuant to the Plan shall cease. In the event the Disabled Participant's rights are terminated hereunder, the Company shall be the direct beneficiary of the entire death proceeds of the Policy upon the death of the Disabled Participant. 2.5 Retirement. Upon the Participant reaching Normal Retirement Date, the Company shall maintain the Policy in full force and effect and in no event shall the Company amend, terminate or otherwise abrogate a retired Participant's interest in the Policy, provided, however that at all times the Policy shall be subject to the claims of the Company's creditors. Article 3 Policy Ownership/Interests 3.1 Company Ownership. The Company shall own one or more Policies on each Participant's life and shall have the right to exercise all incidents of ownership and, except as provided in sections 2.3, 2.4, 2.5 and 8.2, the Company may terminate a Policy without the consent of the Insured. With respect to each Policy, the Company shall be the direct beneficiary of an amount of death proceeds equal to the greatest of: (1) the cash surrender value of the policy; (2) the aggregate premiums paid on the Policy by the Company less any outstanding indebtedness to the Insurer; or (3) the amount in excess of Two Times Base Annual Salary of the Insured/Participant. If the Company owns more than one policy on a Participant, the Policies shall be aggregated with respect to item (3). 3.2 Participant's Interest. Each Participant, or the Participant's assignee, shall have the right to designate the beneficiary of the death proceeds of the Policy remaining after the payment to the Company of its interests. The Participant shall also have the right to elect and change settlement options with the consent of the Company and the Insurer. 2 Article 4 Premiums 4.1 Premium Payment. The Company shall pay all premiums due on all Policies. 4.2 Imputed Income. The Company shall impute income to the Participant in an amount equal to the current term rate for the Participant's age multiplied by the aggregate death benefit payable to the Participant's beneficiary. The "current term rate" is the minimum amount required to be imputed under Revenue Rulings 64-328 and 66-110, or any subsequent applicable authority. The Company will provide each participant with an annual statement of the amount of income reportable by the participant for federal and state income purposes as a result of such imputed income. Article 5 Assignment Any Participant may assign without consideration all interests in his or her Policy and in this Plan to any person, entity or trust. In the event a Participant shall transfer all of his/her interest in the Policy, then all of that Participant's interest in his or her Policy and in the Plan shall be vested in his/her transferee, subject to such transferee executing agreements binding them to the provisions of this Plan, who shall be substituted as a party hereunder, and that Participant shall have no further interest in his or her Policy or in this Plan. Article 6 Insurer The Insurers shall be bound only by the terms of their corresponding Policies. Any payments an Insurer makes or actions it takes in accordance with a Policy shall fully discharge it from all claims, suits and demands of all persons relating to that Policy. The Insurer shall not be bound by the provisions of this Plan, except to the extent of any endorsement filed with the Insurer. The Insurer shall have the right to rely on the Company's representations with regard to any definitions, interpretations, or Policy interests as specified under this Plan. Article 7 Claims Procedure 7.1 Claims Procedure. The Company shall notify any person or entity that makes a claim against this Plan (the "Claimant"), in writing, within ninety (90) days of Claimant's written application for benefits, of Claimant's eligibility or ineligibility for benefits under this Plan. If the Company determines that Claimant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of this Plan on which the denial is based, (3) a description of any additional information or material necessary for the Claimant to perfect Claimant's claim, and a description of why it is needed, and (4) an explanation of this Plan's claim review procedure and other appropriate information as to the steps to be taken if the Claimant wishes to have the claim reviewed. If the Company determines that there are special circumstances requiring additional time to make a decision, the Company shall notify the Claimant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional ninety-day period. Upon resolution of all open issues, the Company shall receive the proceeds and upon recovering the share of the proceeds to which it is entitled, shall distribute the Claimant's proceeds. 7.2 Review Procedure. If a Claimant is determined by the Company not to be eligible for benefits, or if the Claimant believes that Claimant is entitled to greater or different benefits, the Claimant shall have the opportunity to have such claim reviewed by the Company by filing a petition for review with the Company within sixty (60) days after receipt of the notice issued by the Company. Said petition shall state the specific reasons which the Claimant believes entitle Claimant to benefits or to greater or different benefits. Within sixty (60) days after receipt by the Company of the petition, the Company shall afford the Claimant (and counsel, if any) an opportunity to present Claimant's position to the Company verbally or in writing, and the Claimant (or counsel) shall have the right to review the pertinent documents. The Company shall notify the Claimant of its decision in writing within the sixty-day period, stating specifically the basis of its decision, written in a manner calculated to be understood by the Claimant and the specific provisions of this Plan on which the decision is based. If, because of the need for a hearing, the sixty-day period is not sufficient, the decision may be deferred for up to another sixty-day period at the election of the Company, but notice of this deferral shall be given to the Claimant. Article 8 Amendments and Termination 8.1 Amendment or Termination of Plan. Except as otherwise provided in sections 2.3, 2.4, 2.5 and 8.2: (i) the Company may amend or terminate the Plan at any time, and (ii) the Company may amend or terminate a Participant's rights under the Plan at any time prior to a Participant's death by written notice to the Participant. 8.2 Amendment or Termination of Plan Upon Change of Control. Notwithstanding the provisions of section 8. 1, in the event of a Change of Control, the Company or its successor shall maintain in full force and effect each Policy that is in existence on the date the Change of Control occurs and, in no event shall the Company or its successor terminate or otherwise abrogate a Participant's interest in the Policy, provided, however, that at all times the Policy shall be subject to the claims of the Company's creditors, provided further, however, that the Policy shall be canceled, terminated or replaced if deemed by the Company to be reasonably prudent to do so and if agreed to by Participant. This section 8.2 shall apply to all Participants in the Plan on the date the Change of Control occurs, including but not limited to (i) a retired Participant who has an interest in the Policy pursuant to section 2.5; (ii) a Disabled Participant who has an interest in the Policy pursuant to section 2.4; and (iii) a Participant whose Employment is terminated as a result of a Change of Control. 8.3 Participant's Waiver. A Participant may, in the Participant's sole and absolute discretion, waive his or her rights under the Plan at any time. Any waiver permitted under this section 8.3 shall be in writing and delivered to the Board of Directors of the Company. 3 Article 9 Miscellaneous 9.1 Competition After Termination of Employment. No benefits shall be payable if the Participant, without the prior written consent of the Company, engages in, becomes interested in, directly or indirectly, as a sole proprietor, as a partner in a partnership, or as a substantial shareholder in a corporation, or becomes associated with, in the capacity of employee, director, officer, principal, agent, trustee or in any other capacity whatsoever, any enterprise conducted in the trading area (a 50 mile radius of the main office of the Company at the corner of King and Penn Streets), which enterprise is, or may deemed to be, competitive with any business carried on by the Company as of the date of termination of the Participant's employment or his retirement. This section shall not apply following a Change of Control. 9.2 Suicide or Misstatement. No benefits shall be payable if the Participant commits suicide within two years after the date of this Agreement, or if the Participant has made any material misstatement of fact on any application for life insurance purchased by the Company. Article 10 Miscellaneous 10.1 Binding Effect. This Plan in conjunction with each Split Dollar Endorsement shall bind each Participant and the Company, their beneficiaries, survivors, executors, administrators and transferees and any Policy beneficiary. 10.2 No Guarantee of Employment. This Plan is not an employment policy or contract. It does not give a Participant the right to remain an employee of the Company, nor does it interfere with the Company's right to discharge a Participant. It also does not require a Participant to remain an employee nor interfere with a Participant's right to terminate employment at any time. 10.3 Named Fiduciary. For purposes of the Employee Retirement Income Security Act of 1974, if applicable, the Company shall be the named fiduciary and plan administrator under the Plan. The named fiduciary may delegate to others certain aspects of the management and operation responsibilities of the plan including the employment of advisors and the delegation of ministerial duties to qualified individuals. 10.4 Applicable Law. The Plan and all rights hereunder shall be governed by and construed according to the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America. 10.5 Notice. Any notice, consent or demand required or permitted to be given under the provisions of this Plan by one party to another shall be in writing, shall be signed by the party giving or making the same, and may be given either by delivering the same to such other party personally, or by mailing the same, by United States certified mail, postage prepaid, to such party, addressed to his/her last known address as shown on the records of the Company. The date of such mailing shall be deemed the date of such mailed notice, consent or demand. 10.6 Entire Agreement. This Plan constitutes the entire agreement between the Company and the Participant to the subject matter hereof. No rights are granted to the Participant by virtue of this Plan other those specifically set forth herein. 10.7 Administration. The Company shall have powers which are necessary to administer this Plan, including but not limited to: 10.7.1 Interpreting the provisions of the Plan; 10.7.2 Establishing and revising the method of accounting for the Plan; 10.7.3 Maintaining a record of benefit payments; and 10.7.4 Establishing rules and prescribing any forms necessary or desirable to administer the Plan. 10.7 Designated Fiduciary. For purposes of the Employee Retirement Income Security Act of 1974, if applicable, the Company shall be the named fiduciary and plan administrator under the Agreement. The named fiduciary may delegate to others certain aspects of the management and operation responsibilities of the plan 'including the employment of advisors and the delegation of ministerial duties to qualified individuals. IN WITNESS WHEREOF, the Company executes this Plan as of the date indicated above. COMPANY; ORRSTOWN BANK By _______________________________ Title ____________________________ By execution hereof, 0rrstown Financial Services, Inc., consents to and agrees to be bound by the terms and condition of this Agreement. ATTEST: CORPORATION: ORRSTOWN FINANCIAL SERVICES, INC. ___________________________________ By _______________________________ Title ____________________________ 4 EX-10.4 4 DIRECTOR RETIREMENT AGREEMENT EXHIBIT 10.4 ORRSTOWN BANK DIRECTOR RETIREMENT AGREEMENT THIS AGREEMENT is made this 1st day of October 1998, by and between ORRSTOWN BANK, a state commercial bank located in Orrstown, Pennsylvania (the "Company"), and Kenneth R. Shoemaker (the "Director"). INTRODUCTION To encourage the Director to remain a member of the Company's Board of Directors, the Company is willing to provide retirement benefits to the Director. The Company will pay the retirement benefits from its general assets according to the terms of this Agreement. AGREEMENT The Director and the Company agree as follows: Article 1 Definitions 1.1 Definitions. Whenever used in this Agreement, the following words and phrases shall have the meanings specified: 1.1.1 "Change of Control" shall mean any of the following: (A) any person (as such term is used in Section 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 (B) the liquidation or dissolution of the Corporation or the Company 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 Company to entity which is not a direct or indirect subsidiary of the Corporation; or (C) 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 (D) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation, or similar transaction of the Corporation, or before any connected series of such transactions, 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, 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 (E) any other event which is at any time designated as a "Change of 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 of 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 Director. Notwithstanding anything else to the contrary set forth in this Agreement, if (i) an agreement is executed by the Corporation or the Company providing for any of the transactions or events constituting a Change of Control as defined herein, and the agreement subsequently expires or is terminated without the transaction or event being consummated, and (ii) Director's service did not terminate during the period after the agreement and prior to such expiration or termination, for purposes of this Agreement it shall as though such agreement was never executed and no Change of Control event shall be deemed to have occurred as a result of the execution of such agreement. 1.1.2 "Code" means the Internal Revenue Code of 1986, as amended. 1.1.3 "Corporation" means 0rrstown Financial Services, Inc. 1.1.4 "Disability" means the Director suffering a sickness, accident or injury which, in the judgment of a physician satisfactory to the Company, prevents the Director from performing substantially all of the Director's normal duties for the Company. As a condition to any benefits, the Company may require the Director to submit to such physical or mental evaluations and tests as the Company's Board of Directors deems appropriate. 1.1.5 "Early Termination" means the Termination of Service before Normal Retirement Age for reasons other than death, Disability, Termination for Cause or following a Change of Control. 1.1.6 "Early Termination Date" means the month, day and year which Early Termination occurs. 1.1.7 "Normal Retirement Age" means the Director's 65th birthday. 1.1. 8 "Normal Retirement Date" means the later of the Normal Retirement Age or Termination of Service. 1.1.9 "Plan Year" means a twelve-month period commencing on October 1 and ending on September 30 of each year. The initial Plan Year shall commence on the effective date of this Agreement. 1 1.1.10 "Termination for Cause" See Section 5.2. 1.1.11 "Termination of Service" means that the Director ceases to be employed by the company for any reason whatsoever other than by reason of a leave of absence which is approved by the company. For purposes of this Agreement, if there is a dispute over the service status of the Director or the date of the Director's Termination of Service, the Company shall have the sole and absolute right to decide the dispute. Article 2 Lifetime Benefits 2.1 Normal Retirement Benefit. Upon Termination of Service on or after the Normal Retirement Age for reasons other than death, the Company shall pay to the Director the benefit described in this Section 2.1 in lieu of any other benefit under this Agreement. 2.1.1 Amount of Benefit. The annual Normal Retirement Benefit under this Section 2.1 is $24,308 (twenty-four thousand three hundred eight dollars). The Company may increase the annual benefit under this Section 2.1 at the sole and absolute discretion of the Company's Board of Directors. Any increase in the annual benefit shall require the recalculation of all the amounts on Schedule A attached hereto. The annual benefit amounts on Schedule A are calculated by amortizing the annual normal retirement benefit using the interest method of accounting, a 7.50% discount rate, monthly compounding and monthly payments. 2.1.2 Payment of Benefit. The Company shall pay the annual benefit to the Director in 12 equal monthly installments payable on the first day of each month commencing with the month following the Director's Normal Retirement Date and continuing for 119 additional months. 2.1.3 Benefit Increases. Commencing on the first anniversary of the first benefit payment, and continuing on each subsequent anniversary, the Company's Board of Directors, in its sole discretion, may increase the benefit. 2.2 Early Termination Benefit. Upon Early Termination, the Company shall pay to the Director the benefit described in this Section 2.2 in lieu of any other benefit under this Agreement. 2.2.1 Amount of Benefit. The annual benefit under this Section 2.2 is the Early Termination Annual Benefit set forth in Schedule A for the Plan Year ending immediately prior to the Early Termination Date. 2.2.2 Payment of Benefit. The Company shall pay the annual benefit to the Director in 12 equal monthly installments payable on the first day of each month commencing with the month following the Director's Normal Retirement Age and continuing for 119 additional months. 2.2.3 Benefit Increases. Benefit payments may be increased as provided in Section 2.1.3. 2.3 Disability Benefit. If the Director terminates service due to Disability prior to Normal Retirement Age, the Company shall pay to the Director the benefit described in this Section 2.3 in lieu of any other benefit under this Agreement. 2.3.1 Amount of Benefit. The annual benefit under this Section 2.3 is the Disability Benefit amount set forth in Schedule A for the Plan Year ending immediately prior to the date in which Termination of Service occurs. 2.3.2 Payment of Benefit. The Company shall pay the benefit to the Director in 12 equal monthly installments commencing within 90 days after the date of the Director's Termination of Service and continuing for 119 additional months. 2.3.3 Benefit Increases. Benefit payments may be increased as provided in Section 2.1.3. 2.4 Change of Control Benefit. If the Director is in the active service of the Company at the time of a Change of Control, the Company shall pay to the Director the benefit described in this Section 2.4 in lieu of any other benefit under this Agreement. 2.4.1 Amount of Benefit. The annual benefit under this Section 2.4 is the Normal Retirement Benefit described in Section 2.1.1. 2.4.2 Payment of Benefit. The Company shall pay the annual benefit amount to the Director in 12 equal monthly installments payable on the first day of each month commencing with the month following the Director's Normal Retirement Date and continuing for 119 additional months. 2.4.3 Benefit Increases. Benefit payments may be increased provided in Section 2.1.3 Article 3 Death Benefits 3.1 Death During Active Service. If the Director dies while in the active service of the Company, the Company shall pay to the Director's beneficiary the benefit described this Section 3. 1. This benefit shall be paid in lieu of the Lifetime Benefits of Article 2. 3.1.1 Amount of Benefit. The annual benefit under this Section 3. 1 is the Normal Retirement Benefit described in Section 2.1.1. 3.1.2 Payment of Benefit. The Company shall pay the annual benefit to the beneficiary in 12 equal monthly installments payable on the first day of each month commencing with the month following the Director's death and continuing for 119 additional months. 3.2 Death During Benefit Period. If the Director dies after the benefit payments have commenced under this Agreement but before receiving all such payments, the Company shall pay the remaining benefits to the Director's beneficiary at the same time and in the same amounts they would have been paid to the Director had the Director survived. 3.3 Death Following Termination of Service But Before Benefits Commence. If the Director is entitled to benefits under this Agreement, but dies prior to receiving said benefits, the Company shall pay to the Director's beneficiary the same benefits, in the same manner, they would have been paid to the Director had the Director survived; however, said benefit payments will commence upon the Director's death. 2 Article 4 Beneficiaries 4.1 Beneficiary Designations. The Director shall designate a beneficiary by filing a written designation with the Company. The Director may revoke or modify the designation at any time by filing a new designation. However, designations will only be effective if signed by the Director and accepted by the Company during the Director's lifetime. The Director's beneficiary designation shall be deemed automatically revoked if the beneficiary predeceases the Director, or if the Director names a spouse as beneficiary and the marriage is subsequently dissolved. If the Director dies without a valid beneficiary designation, all payments shall be made to the Director's estate. 4.2 Facility of Payment. If a benefit is payable to a minor, to a person declared incapacitated, or to a person incapable of handling the disposition of his or her property, the Company may pay such benefit to the guardian, legal representative or person having the care or custody of such minor, incapacitated person or incapable person. The Company may require proof of incapacity, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit. Article 5 General Limitations Notwithstanding any provision of this Agreement to the contrary, the Company shall not pay any benefit under this Agreement: 5.1 Excess Parachute Payment. To the extent the benefit would be an excess parachute payment under Section 280G of the Code. 5.2 Termination for Cause. If the Company terminates the Director's service for: 5.2.1 Gross negligence or gross neglect of duties; 5.2.2 Commission of a felony or of a gross misdemeanor involving moral turpitude; or 5.2.3 Fraud, disloyalty, dishonesty or willful violation of any law or significant Company policy committed in connection with the Director's service and resulting in an adverse effect on the Company. 5.3 Competition After Termination of Service. If the Director, without the prior written consent of the Company, engages in, becomes interested in, directly or indirectly, as a sole proprietor, as a partner in a partnership, or as a substantial shareholder in a corporation, or becomes associated with, in the capacity of employee, director, officer, principal, agent, trustee or in any other capacity whatsoever, any enterprise conducted in the trading area (a 50 mile radius of the main office of the Company at the comer of King and Penn Streets), which enterpise is, or may deemed to be, competitive with any business carried on by the Company as of the date of termination of the Director's service or his retirement. This section shall not apply following a Change of Control. 5.4 Suicide or Misstatement. If the Director commits suicide within two years after the date of this Agreement, or if the Director has made any material misstatement of fact on any application for life insurance purchased by the Company. Article 6 Claims and Review Procedures 6.1 Claims Procedure. The Company shall notify any person or entity that makes a claim against the Agreement (the "Claimant") in writing, within ninety (90) days of Claimant's written application for benefits, of his or her eligibility or noneligibility for benefits under the Agreement. If the Company determines that the Claimant is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of the Agreement on which the denial is based, (3) a description of any additional information or material necessary for the Claimant to perfect his or her claim, and a description of why it is needed, and (4) an explanation of the Agreement's claims review procedure and other appropriate information as to the steps to be taken if the Claimant wishes to have the claim reviewed. If the Company determines that there are special circumstances requiring additional time to make a decision, the Company shall notify the Claimant of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional ninety-day period. 6.2 Review Procedure. If the Claimant is determined by the Company not to be eligible for benefits, or if the Claimant believes that he or she is entitled to greater or different benefits, the Claimant shall have the opportunity to have such claim reviewed by the Company by filing a petition for review with the Company within sixty (60) days after receipt of the notice issued by the Company. Said petition shall state the specific reasons which the Claimant believes entitle him or her to benefits or to greater or different benefits. Within sixty (60) days after receipt by the Company of the petition, the Company shall afford the Claimant (and counsel, if any) an opportunity to present his or her position to the Company orally or in writing, and the Claimant (or counsel) shall have the right to review the pertinent documents. The Company shall notify the Claimant of its decision in writing within the sixty-day period, stating specifically the basis of its decision, written in a manner calculated to be understood by the Claimant and the specific provisions of the Agreement on which the decision is based. If, because of the need for a hearing, the sixty-day period is not sufficient, the decision may be deferred for up to another sixty-day period at the election of the Company, but notice of this deferral shall be given to the Claimant. Article 7 Amendments and Termination This Agreement may be amended or terminated only by a written agreement signed by the Company and the Director. Article 8 Miscellaneous 8.1 Binding Effect. This Agreement shall bind the Director and the Company, and their beneficiaries, survivors, executors, successors, administrators and transferees. 8.1 No Guarantee of Service. This Agreement does not give the Director the right to remain a member of the Company's Board of Directors, nor does it interfere with the Company's right to terminate the service of the Director. It also does not interfere with the Director's right. to terminate his or her service at any time. 3 8.3 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached or encumbered in any manner. 8.4 Tax Withholding. The Company shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement. 8.5 Applicable Law. The Agreement and all rights hereunder shall be governed by the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America. 8.6 Unfunded Arrangement. The Director and beneficiary are general unsecured creditors of the Company for the payment of benefits under this Agreement. The benefits represent the mere promise by the Company to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Director's life is a general asset of the Company to which the Director and beneficiary have no preferred or secured claim. 8.7 Recovery of Estate Taxes. If the Director's gross estate for federal estate tax purposes includes any amount determined by reference to and on account of this Agreement, and if the beneficiary is other than the Director's estate, then the Director's estate shall be entitled to recover from the beneficiary receiving such benefit under the terms of the Agreement, an amount by which the total estate tax due by the Director's estate, exceeds the total estate tax which would have been payable if the value of such benefit had not been included in the Director's gross estate. If there is more than one person receiving such benefit, the right of recovery shall be against each such person. In the event the beneficiary has a liability hereunder, the beneficiary may petition the Company for a lump sum payment in an amount not to exceed the beneficiary's liability hereunder. 8.8 Entire Agreement. This Agreement constitutes the entire agreement between the Company and the Director as to the subject matter hereof. No rights are granted to the Director by virtue of this Agreement other than those specifically set forth herein. 8.9 Administration. The Company shall have powers which are necessary to administer this Agreement, including but not limited to: 8.9.1 Interpreting the provisions of the Agreement; 8.9.2 Establishing and revising the method of accounting for the Agreement; 8.9.3 Maintaining a record of benefit payments; and 8.9.4 Establishing rules and prescribing any forms necessary or desirable to administer the Agreement IN WITNESS WHEREOF, the Director and a duly authorized Company officer have signed this Agreement. DIRECTOR: COMPANY: ORRSTOWN BANK __________________________ By ___________________________ Kenneth R. Shoemaker Title ________________________ By execution hereof, Orrstown Financial Services, Inc. consents to and agrees to be bound by the terms and condition of this Agreement. ATTEST: CORPORATION: ORRSTOWN FINANCIAL SERVICES, INC. __________________________ By ___________________________ Title ________________________ 4 EX-10.5 5 DIRECTOR REV. NEUTRAL RETIREMENT AGREEMENT EXHIBIT 10.5 ORRSTOWN BANK DIRECTOR REVENUE NEUTRAL RETIREMENT AGREEMENT THIS AGREEMENT is made this 11th day of November 1998 by and between ORRSTOWN BANK (the "Company"), and ROBERT HENRY (the "Director"). INTRODUCTION To help promote orderly succession of its Board of Directors, the Company is willing to provide the Director with an opportunity for retirement income. The Company will pay the benefits from its general assets. AGREEMENT The Director and the Company agree as follows: Article I Definitions Whenever used in this Agreement, the following words and phrases shall have the meanings specified: 1.1.1 "Change of Control" shall mean any of the following: (A) 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 (B) the liquidation or dissolution of the Corporation or the Company 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 Company to an entity which is not a direct or indirect subsidiary of the Corporation; or (C) 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 (D) the occurrence of, or execution of an agreement providing for, a reorganization, merger, consolidation, or similar transaction of the Corporation, or before any connected series of such transactions, 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 (E) any other event which is at any time designated as a "Change of 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 of 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. Notwithstanding anything else to the contrary set forth in this Agreement, if an agreement is executed by the Corporation or the Company providing for any of the transactions or events constituting a Change of Control as defined herein, and the agreement subsequently expires or is terminated without the transaction or event being consummated, for purposes of this Agreement it shall be as though such agreement was never executed and no Change of Control event shall be deemed to have occurred as a result of the execution of such agreement. 1.1.2 "Corporation" means Orrstown Financial Services, Inc. 1.1.3 "Normal Retirement Date" means the benefit described in Article 3. 1.1.4 "Normal Retirement Date" means the Date of the Director's Termination of Service on or after attaining age 70. 1.1.5 "Plan Anniversary" means each twelve month period from the date set forth in Section 2.1. 1.1.6 "Retirement Account" means the account maintained on the books of the Company as described in Section 2.2. 1.1.7 "Simulated Investments" means investments specified by the Company for use in measuring the Retirement Benefit. Subject to Article 2, the Company can change the Simulated Investments only with the Director's written agreement. The Simulated Investments shall be of equal initial amounts. 1.1.8 "Simulated Investment Rate" means the after-tax rate of return on a Simulated Investment. If the Simulated Investment is a life insurance policy, the Simulated Investment Rate shall track cash surrender value and not include receipt of the policy's death benefits. 1.1.9 "Termination of Service" means the Director's ceasing to serve on the Board of the Company or its successor for any reason other than death. 1 Article 2 Retirement Account 2.1 SimuLated Investments. The Company shall establish two Simulated Investments, in the amount of $655,000 as of October 1, 1998 as follows: 2.1.1 Simulated Investment Number One shall be equal to the cash surrender value of one or more life insurance policies, as described in Appendix A. 2.1.2 Simulated Investment Number Two shall be equal to the principal and the accumulated net after-tax interest earnings on an alternative investment. For purpose of this Agreement, Simulated Investment Number Two assumes an investment in one year U.S. Treasury Bills, assumes the applicable income rate to be the Company's highest marginal tax rate for the previous calendar year, assumes that after-tax interest shall accrue monthly and be compounded at each Plan Anniversary Date, and assumes that the accumulated balance shall be reinvested in one year U.S. Treasury Bills at each Plan Anniversary Date. 2.2 Retirement Account. The Company shall establish a Retirement Account on its books for the Director. The Retirement Account as of any date shall be determined by: (1) subtracting the value of Simulated Investment Number Two from the value of Simulated Investment Number One, (2) dividing the difference by the "adjustment rate", and (3) subtracting the sum of all previous distributions. For purposes of this Section 2.2 the term "adjustment rate" shall mean the figure equal to one minus the Company's highest marginal tax rate for the previous calendar year. 2.3 Statement of Accounts. The Company shall provide to the Director, within 90 days after each Plan Anniversary, a statement setting forth the Retirement Account balance. 2.4 Accounting Device Only. The Retirement Account and Simulated Investments are solely devices for measuring amounts to be paid under this Agreement. They are not a trust fund of any kind. The Director is a general unsecured creditor of the Company for the payment of benefits. The benefits represent the mere Company promise to pay such benefits. The Director's rights not subject in any manner to anticipation, alienation, transfer, assignment, pledge, encumbrance, attachment, or garnishment by the Director's creditors. Article 3 Lifetime Benefits 3.1 Retirement Benefit. Subject to the general limitations of Article 6, the Company shall pay to the Director the Normal Retirement Benefit described in Section 3.1.1. 3.1.1 Normal Retirement Benefit. Commencing on April 15, 2000 and continuing each April 15 until the earlier of (1) the Director's death or (2) the date the Director has received total payments of $120,000, the Company shall pay a Normal Retirement Benefit to the Director. The Normal Retirement Benefit shall be paid annually in an amount equal to the hypothetical growth, if any, of the Director's Retirement Account from the immediately preceding Plan Anniversary Date, determined pursuant to the method set forth in Section 2.1 and 2.2 hereof. 3.2 Change of Control Benefit. Following a Change of Control, the Director shall continue to receive the Normal Retirement Benefit payable in accordance with Article 3 herein until the Director or his beneficiary has received total payments of $120,000. Article 4 Death Benefits Upon the Director's death prior to termination of this Agreement, the Company shall pay to the Director's beneficiary a benefit equal to the difference between $120,000 and the total payments previously distributed to the Director under this Agreement. The Company shall pay the benefit to the beneficiary in a lump sum within 60 days following the Director's death. This shall terminate any further obligations the Company has to the Director or his beneficiary. Article 5 Beneficiaries 5.1 Beneficiary Designations. The Director shall designate a beneficiary by filing a written designation with the Company. The Director may revoke or modify the designation at any time by filing a new designation. However, designations will only be effective if signed by the Director and accepted by the Company during the Director's lifetime. The Director's beneficiary designation shall be deemed automatically revoked if the beneficiary predeceases the Director, or if the Director names a spouse as beneficiary and the marriage is subsequently dissolved. If the Director dies without a valid beneficiary designation, all payments shall be made to the Director's surviving spouse, if any, and if none, to the Director's surviving children and the descendants of any deceased child by right of representation, and if no children or descendants survive, to the Director's estate. 5.2 Facility of Payment. If a benefit is payable to a minor, to a person declared incompetent, or to a person incapable of handling the disposition of his or her property the Company may pay such benefit to the guardian, legal representative or person having the care or custody of such minor, incompetent person or incapable person. The Company may require proof of incompetence, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit. Article 6 General Limitations Notwithstanding any provision of this Agreement to the contrary, the Company shall not pay any benefit under this Agreement: 6.1 Termination for Cause. If the Company terminates the Director's service for: 6.1.1 Gross negligence or gross neglect of duties; 6.1.2 Commission of a felony or of a gross misdemeanor involving moral turpitude; or 2 6.1.3 Fraud, disloyalty, dishonesty or willful violation of any law or significant Company policy resulting in an adverse effect on the Company. 6.2 Suicide. If the Director commits suicide within two years after the date of this Agreement, or if the Director has made any material misstatement of fact on any application for life insurance purchased by the Company. 6.3 Competition After Termination of Service. If the Director, without the prior written consent of the Company, engages in, becomes interested in, directly or indirectly, a sole proprietor, as a partner in a partnership, or as a substantial shareholder in a corporation, or becomes associated with, in the capacity of employee, director, officer, principal, agent, trustee or in any other capacity whatsoever, any enterprise conducted in the trading area (a 50 mile radius of the main office of the Company at the comer of King and Penn Streets), which enterprise is, or may deemed to be competitive with any business carried on by the Company as of the date of the Director's termination of service. This Section 6.3 shall not apply following a Change of Control. Article 7 Claims and Review Procedures 7.1 Claims Procedure. The Company shall notify the Director's beneficiary in writing, within ninety (90) days of his or her written application for benefits, of his or her eligibility or noneligibility for benefits under the Agreement. If the Company determines that the beneficiary is not eligible for benefits or full benefits, the notice shall set forth (1) the specific reasons for such denial, (2) a specific reference to the provisions of the Agreement on which the denial is based, (3) a description of any additional information or material necessary for the claimant to perfect his or her claim, and a description of why it is needed, and (4) an explanation of the Agreement's claims review procedure and other appropriate information as to the steps to be taken if the beneficiary wishes to have the claim reviewed. If the Company determines that there are special circumstances requiring additional time to make a decision, the Company shall notify the beneficiary of the special circumstances and the date by which a decision is expected to be made, and may extend the time for up to an additional 90-day period. 7.2 Review Procedure. If the beneficiary is determined by the Company not to be eligible for benefits, or if the beneficiary believes that he or she is entitled to greater or different benefits, the beneficiary shall have the opportunity to have such claim reviewed by the Company by filing a petition for review with the Company within sixty (60) days after receipt of the notice issued by the Company. Said petition shall state the specific reasons which the beneficiary believes entitle or her to benefits or to greater or different benefits. Within sixty (60) days after receipt by the Company of the petition, the Company shall afford the beneficiary (and counsel, if any) an opportunity to present his or her position to the Company orally or in writing, and the beneficiary (or counsel) shall have the right to review the pertinent documents. The Company shall notify the beneficiary of its decision in writing within the 60-day period, stating specifically the basis of its decision, written in a manner calculated to understood by the beneficiary and the specific provisions of the Agreement on which the decision is based. If, because of the need for a hearing, the 60-day period is not sufficient, the decision may be deferred for up to another 60-day period at the election of the Company, but notice of this deferral shall be given to the beneficiary. Article 8 Amendments and Termination This Agreement may be amended or terminated only by a written agreement signed by the Company and the Director. Article 9 Administration 9.1 Administration. Unless otherwise determined by the Company's Board of Directors ("Board"), the Board or its designee shall be the named fiduciary and shall act for the Company under this Agreement. 9.2 Powers of the Company. The Company shall have all powers necessary to administer this Agreement, including, without limitation, powers: 9.2.1 to interpret the provisions of the Agreement; and 9.2.2 to establish rules for the administration of the Agreement and to prescribe any forms required to administer the Agreement. 9.3 Actions of the Company. All determinations, interpretations, rules, and decisions of the Company shall be conclusive and binding upon all persons having or claiming to have any interest or right under this Agreement. Article 10 Miscellaneous 10.1 Binding Effect. This Agreement shall bind the Director and the Company, and their beneficiaries, survivors, executors, administrators and transferees. 10.2 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged. attached or encumbered in any manner. 10.3 Tax Withholding. The Company shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement. 10.4 Applicable Law. The Agreement and all rights hereunder shall be governed by the laws of the Commonwealth of Pennsylvania except to the extent preempted by the laws of the United States of America. 3 10. 5 Unfunded Arrangement. The Director is a general unsecured creditor of the Company for the payment of benefits under this Agreement. The benefits represent the mere promise by the Company to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Director's life or any other asset held in connection with this Agreement is a general asset of the Company to which the Director has no preferred or secured claim. IN WITNESS WHEREOF, the Director and a duly authorized Company officer have signed this Agreement. DIRECTOR: COMPANY: ORRSTOWN BANK _____________________________ By ______________________________ Title ___________________________ By execution hereof, 0rrstown Financial Services, Inc. consents to and agrees to be bound by the terms and conditions of this Agreement. ATTEST: CORPORATION: ORRSTOWN FINANCIAL SERVICES, INC. _____________________________ By ______________________________ Title ___________________________ 4 EX-13 6 1999 ANNUAL REPORT EXHIBIT 13 Orrstown Financial Services, Inc. 1999 Annual Financial Report CONTENTS Page INDEPENDENT AUDITOR'S REPORT ....................................... 1 CONSOLIDATED FINANCIAL STATEMENTS Balance sheets ................................................ 2 Statements of income .......................................... 3 Statements of changes in shareholders' equity ................. 4 Statements of cash flows ...................................... 5 Notes to consolidated financial statements .................... 6 - 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS .................... 14 - 19 SUMMARY OF QUARTERLY FINANCIAL DATA ................................ 19 SELECTED FIVE-YEAR FINANCIAL DATA .................................. 20 MARKET, DIVIDEND AND INVESTOR INFORMATION .......................... 21 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, 1999 and 1998 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years ended December 31, 1999. 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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years ended December 31, 1999 in conformity with generally accepted accounting principles. /s/ Smith Elliott Kearns & Company, LLC Chambersburg, Pennsylvania January 31, 2000 Consolidated Balance Sheets ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
ASSETS Dec. 31, 1999 Dec. 31, 1998 (000 omitted) (000 omitted) ------------- ------------- Cash and due from banks $ 8,585 $ 7,028 Interest bearing deposits with banks 115 27 Federal funds sold 0 8,072 Securities available for sale 60,455 49,852 Federal Home Loan Bank, Federal Reserve and Atlantic Central Bankers Bank stock, at cost which approximates market value 1,509 1,285 ------------ ----------- 70,664 66,264 ------------ ----------- Loans Commercial, financial and agricultural 21,503 18,732 Real estate - Mortgages 134,046 116,030 Real estate - Construction and land development 15,580 11,182 Consumer 9,562 12,688 ------------ ----------- 180,691 158,632 Less: Allowance for loan losses (2,455) (1,971) ------------ ----------- 178,236 156,661 ------------ ----------- Premises and equipment, net 6,809 5,224 Accrued interest receivable 1,599 1,235 Cash surrender value of life insurance 5,384 5,099 Other assets 2,361 1,339 ------------ ----------- Total assets $ 265,053 $ 235,822 ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Non-interest bearing $ 25,264 $ 22,020 Interest bearing 179,125 161,744 ------------ ----------- 204,389 183,764 ------------ ----------- Federal funds purchased and securities sold under agreements to repurchase 15,406 6,234 Other borrowed funds 20,822 20,828 Accrued interest and other liabilities 2,568 3,916 ------------ ----------- Total liabilities 243,185 214,742 ------------ ----------- Shareholders' equity Common stock: No par value - $ .1041 stated value per share, 10,000,000 shares authorized with 2,218,291 shares issued at December 31, 1999; 2,055,315 shares issued at December 31, 1998 231 214 Additional paid-in capital 18,498 12,476 Retained earnings 3,717 6,863 Accumulated other comprehensive income (578) 1,527 ------------ ----------- Total shareholders' equity 21,868 21,080 ------------ ----------- Total liabilities and shareholders' equity $ 265,053 $ 235,822 ============ ===========
THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 2 Consolidated Statements of Income ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31, ----------------------------------------------- 1999 1998 1997 ---- ---- ---- (000 omitted) Interest and Dividend Income Interest and fees on loans $ 14,613 $ 12,836 $ 10,702 Interest and dividends on investment securities U.S. Government and agencies 2,289 1,840 1,548 Exempt from federal income tax 1,032 1,036 935 Other investment income 390 397 265 -------- -------- -------- Total interest and dividend income 18,324 16,109 13,450 -------- -------- -------- Interest Expense Interest on deposits 6,519 6,479 5,495 Interest on borrowed money 1,555 869 327 -------- -------- -------- Total interest expense 8,074 7,348 5,822 -------- -------- -------- Net interest income 10,250 8,761 7,628 -------- -------- -------- Provision for loan losses 547 270 215 -------- -------- -------- Net interest income after provision for loan losses 9,703 8,491 7,413 -------- -------- -------- Other Income Service charges on deposit accounts 779 646 601 Other service charges, commissions, and fees 844 667 341 Trust department income 861 656 490 Brokerage income 369 162 59 Securities gains (losses) 423 (9) 3 Other income 305 131 57 -------- -------- -------- Total other income 3,581 2,253 1,551 -------- -------- -------- Net interest income and other income 13,284 10,744 8,964 -------- -------- -------- Other Expenses Salaries and employee benefits 4,297 3,491 2,901 Occupancy expense of bank premises, net, and furniture and equipment expenses 1,099 859 764 FDIC insurance premiums 22 20 17 Other operating expenses 2,800 2,075 1,702 -------- -------- -------- Total other expenses 8,218 6,445 5,384 -------- -------- -------- Income before income tax 5,066 4,299 3,580 Applicable income tax 1,311 1,180 974 -------- -------- -------- Net income $ 3,755 $ 3,119 $ 2,606 ======== ======== ======== Per share data Net income $ 1.70 $ 1.41 $ 1.18 Dividends .51 .45 .41 Weighted average shares outstanding 2,214,951 2,205,718 2,204,444
THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 3 Consolidated Statements of Changes in Shareholders' Equity ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31, 1999, 1998 and 1997 ------------------------------------------------------------------------------ Accumulated Additional Other Total Common Paid-In Retained Comprehensive Shareholders' Stock Capital Earnings Income Equity ----- ------- -------- ------ ------ (000 omitted) Balance, December 31, 1996 $ 204 $ 10,625 $ 4,786 $ 241 $ 15,856 Comprehensive income Net income 0 0 2,606 0 2,606 Change in unrealized gain on investment securities available for sale, net of tax of $ 375 0 0 0 728 728 -------- Total comprehensive income 3,334 Cash dividends ($ .41 per share) 0 0 (903) 0 (903) Stock dividends issued 10 1,727 (1,737) 0 0 Cash paid in lieu of fractional stock dividends 0 0 (22) 0 (22) ------ -------- ------- ----- -------- Balance, December 31, 1997 214 12,352 4,730 969 18,265 Comprehensive income Net income 0 0 3,119 0 3,119 Change in unrealized gain on investment securities available for sale, net of tax of $ 287 0 0 0 558 558 -------- Total comprehensive income 3,677 Cash dividends ($ .45 per share) 0 0 (986) 0 (986) Issuance of stock through dividend reinvestment plan 0 124 0 0 124 ------ -------- ------- ----- -------- Balance, December 31, 1998 214 12,476 6,863 1,527 21,080 Comprehensive income Net income 0 0 3,755 0 3,755 Change in unrealized (loss) on investment securities available for sale, net of tax of $ 1,084 0 0 0 (2,105) (2,105) -------- Total comprehensive income 1,650 Cash dividends ($ .51 per share) 0 0 (1,134) 0 (1,134) Stock dividends issued 16 5,720 (5,736) 0 0 Cash paid in lieu of fractional stock dividends 0 0 (31) 0 (31) Issuance of stock through dividend reinvestment plan 1 302 0 0 303 ------ -------- ------- ----- -------- Balance, December 31, 1999 $ 231 $ 18,498 $ 3,717 ($ 578) $ 21,868 ====== ======== ======= ====== ========
THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 4 Consolidated Statements of Cash Flows ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31, 1999, 1998 and 1997 ---------------------------------------------- 1999 1998 1997 ---- ---- ---- (000 omitted) Cash flows from operating activities: Net income $ 3,755 $ 3,119 $ 2,606 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 528 438 364 Provision for loan losses 547 270 215 Loss on sale of other real estate owned 54 0 0 Deferred income taxes ( 103) 27 ( 7) Securities (gains) losses ( 423) 9 ( 3) Increase in cash surrender value of life insurance ( 285) 0 0 (Increase) decrease in accrued interest receivable ( 364) 64 ( 370) Increase (decrease) in accrued interest payable ( 1,707) 483 480 Other net 143 ( 152) ( 59) ------- ------- ------- Net cash provided by operating activities 2,145 4,258 3,226 ------- ------- ------- Cash flows from investing activities: Net (increase) decrease in interest bearing deposits with banks ( 88) ( 11) 1,538 Sales of available for sale securities 6,895 8,923 15 Maturities of available for sale securities 2,500 2,390 3,114 Purchases of available for sale securities (22,763) (14,120) (14,811) Purchases of FHLB stock ( 225) ( 302) ( 49) Net (increase) in loans (22,130) (30,367) (19,473) Purchases of bank premises and equipment ( 2,071) ( 491) ( 1,537) Investment in cash surrender value of life insurance 0 ( 4,816) 0 Proceeds from sale of other real estate owned 286 0 0 ------- ------- ------- Net cash (used) by investing activities (37,596) (38,794) (31,203) ------- ------- ------- Cash flows from financing activities: Net increase in deposits 20,631 23,184 23,321 Net increase in federal funds purchased and securities sold under agreements to repurchase 9,173 5,999 235 Proceeds from debt 0 12,500 6,000 Payment on debt ( 6) ( 6) ( 5) Cash dividends paid ( 1,134) ( 986) ( 903) Cash paid in lieu of fractional stock dividends ( 31) 0 ( 22) Proceeds from sale of stock 303 124 0 ------- ------- ------- Net cash provided by financing activities 28,936 40,815 28,626 ------- ------- ------- Net increase (decrease) in cash and cash equivalents ( 6,515) 6,279 649 Cash and cash equivalents, beginning balance 15,100 8,821 8,172 ------- ------- ------- Cash and cash equivalents, ending balance $ 8,585 $15,100 $ 8,821 ======= ======= ======= Supplemental disclosure of cash flows information: Cash paid during the year for: Interest $ 9,781 $ 6,865 $ 5,343 Income taxes 1,385 1,200 974 Supplemental schedule of noncash investing and financing activities: Other real estate acquired in settlement of loans 0 264 0 Unrealized gain (loss) on investment securities available for sale (net of tax effects) ( 2,105) 558 728
THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 5 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 eight branches are located in Shippensburg (2), Carlisle (2), Spring Run, Orrstown, and Chambersburg (2), 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 Corporation 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 as a net amount in other comprehensive income. 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 other comprehensive income, 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 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. Intangibles Intangible costs are amortized on a straight-line basis over fifteen years. Advertising The corporation follows the policy of charging costs of advertising to expense as incurred. Advertising expense was $ 138,000, $ 154,000, and $149,000 for 1999, 1998 and 1997, 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. The allowance for loan losses is established through a provision for loan losses charged to expenses. 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. 6 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. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of loan principal balance. Interest income on other impaired loans is recognized only to the extent of interest payments received. 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 less cost to sell 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 shares of common stock outstanding of 2,214,951 in 1999; 2,205,718 in 1998; and 2,204,444 in 1997 after giving retroactive recognition to a 7-1/2% stock dividend issued in November 1999, a 2-for-1 stock split in November 1998, and a 5% stock dividend issued in May 1997. 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 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. Comprehensive income In 1998 the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 130 - Reporting Comprehensive Income. Under SFAS No. 130, comprehensive income is defined as the change in equity from transactions and other events from nonowner sources. It includes all changes in equity except those resulting from investments by shareholders and distributions to shareholders. Comprehensive income includes net income and certain elements of "other comprehensive income" such as foreign currency transactions; accounting for futures contracts; employers accounting for pensions; and accounting for certain investments in debt and equity securities. The Corporation has elected to report its comprehensive income in the statement of shareholders' equity. The only element of "other comprehensive income" that the Corporation has is the unrealized gain or loss on available for sale securities. The 1997 financial statements have been reclassified to reflect these changes in reporting format. 7 The components of the change in net unrealized gains (losses) on securities were as follows:
1999 1998 1997 ---- ---- ---- (000 Omitted) Gross unrealized holding gains (losses) arising during the year ($ 2,766) $ 836 $ 1,106 Reclassification adjustment for (gains) losses realized in net income ( 423) 9 ( 3) ------- ----- ------ Net unrealized holding gains (losses) before taxes ( 3,189) 845 1,103 Tax effect 1,084 ( 287) ( 375) ------- ----- ------ Net change ($ 2,105) $ 558 $ 728 ======= ===== ======
NOTE 2. INVESTMENTS At December 31, 1999 and 1998 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) 1999 ---- U.S. Treasury securities and obligations of U. S. Government corporations and agencies $ 30,990 $ 22 $ 653 $ 30,359 Obligations of states and political subdivisions 16,998 306 120 17,184 Mortgage-backed securities 12,603 0 526 12,077 Equity securities 739 156 60 835 -------- --------- ------- -------- Totals $ 61,330 $ 484 $ 1,359 $ 60,455 ======== ========= ======= ======== 1998 ---- U.S. Treasury securities and obligations of U. S. Government corporations and agencies $ 14,508 $ 311 $ 22 $ 14,797 Obligations of states and political subdivisions 17,975 1,087 0 19,062 Mortgage-backed securities 14,369 166 11 14,524 Equity securities 686 804 21 1,469 -------- --------- ------- -------- Totals $ 47,538 $ 2,368 $ 54 $ 49,852 ======== ========= ======= ========
The amortized cost and fair values of investment securities available for sale at December 31, 1999, by contractual maturity are shown below. Contractual maturities will differ from expected 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 $ 2,999 $ 3,004 Due after one year through five years 14,188 13,896 Due after five years through ten years 13,460 13,227 Due after ten years 17,341 17,416 Mortgage-backed securities 12,603 12,077 Equity securities 739 835 -------- -------- $ 61,330 $ 60,455 ======== ======== Proceeds from sales of securities available for sale during 1999, 1998 and 1997 were $ 6,895,000, $ 8,923,000 and $ 15,000, respectively. Gross gains and losses on 1999 sales were $ 425,864 and $ 2,340, respectively. Gross gains and losses on 1998 sales were $ 14,386 and $ 23,779, respectively. Gross gains and losses on 1997 sales were $ 10,045 and $ 6,660, respectively. The corporation owns $ 1,266,200 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, 1999. At December 31, 1998 the corporation's stock ownership was $ 1,041,500 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 $ 43,138,000 and $ 33,436,000 at December 31, 1999 and 1998, respectively, were pledged to secure public funds and for other purposes as required or permitted by law. NOTE 3. CONCENTRATION OF CREDIT RISK The corporation 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 corporation 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 corporation 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. The corporation maintains deposit balances at several correspondent banks, which provide check collection and item processing services to the corporation. The balances with these correspondent banks, at times, exceed federally insured limits, which management considers to be a normal business risk. 8 NOTE 4. ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses is summarized as follows:
1999 1998 1997 -------- -------- --------- (000 omitted) Balance at beginning of period $ 1,971 $ 1,767 $ 1,620 Recoveries 65 18 15 Provision for loan losses charged to income 547 270 215 ------- ------- ------- Total 2,583 2,055 1,850 Losses 128 84 83 ------- ------- ------- Balance at the end of period $ 2,455 $ 1,971 $ 1,767 ======= ======= =======
NOTE 5. PREMISES AND EQUIPMENT A summary of bank premises and equipment is as follows: 1999 1998 ---- ---- (000 omitted) Land $ 606 $ 606 Buildings and improvements 3,805 3,785 Leasehold improvements 189 173 Furniture and equipment 4,306 3,050 Construction in progress 1,002 236 ------- -------- Total 9,908 7,850 Less accumulated depreciation and amortization 3,099 2,626 ------- -------- Bank premises and equipment, net $ 6,809 $ 5,224 ======= ======== Depreciation expense amounted to $ 485,477 in 1999, $ 397,246 in 1998, and $323,652 in 1997. NOTE 6. LOANS TO RELATED PARTIES The corporation 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 $ 2,189,000 at December 31, 1999 and $ 1,888,000 at December 31, 1998. During 1999, $ 781,000 of new loans were made and repayments totaled $ 480,000. Outstanding loans to employees totaled $810,353 and $ 1,424,000 at December 31, 1999 and 1998, respectively. NOTE 7. NONACCRUAL LOANS The following table shows the principal balances of nonaccrual loans as of December 31:
1999 1998 1997 ---- ---- ---- Nonaccrual loans $ 64,000 $486,000 $ 473,000 ======== ======== ========= Interest income that would have been accrued at original contract rates $ 6,608 $ 39,878 $ 30,835 Amount recognized as interest income 0 5,579 5,829 -------- -------- --------- Foregone revenue $ 6,608 $ 34,299 $ 25,006 ======== ======== =========
Impairment of loans having recorded investments of $ 404,678 at December 31, 1998 and 1997 has been recognized in accordance with Statements of Financial Accounting Standards No. 114 and 118. The average recorded investment in impaired loans during 1998 and 1997 was $ 404,678 and $ 405,262, respectively. Total allowance for loan losses related to impaired loans was $ 60,702 and $60,750 at December 31, 1998 and 1997. Interest income on impaired loans of $ 0 and $ 5,829 was recognized for cash payments received in 1998 and 1997. During 1999 foreclosure proceedings were concluded on impaired loans resulting in a loss of $ 39,000 charged to the allowance for loan losses. The corporation had no impairment of loans as of December 31, 1999 as defined by Statements of Financial Accounting Standard No. 114 and 118. NOTE 8. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The corporation 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 corporation has in particular classes of financial instruments. The corporation'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 corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Contract or Notional Amount --------------------- 1999 1998 ---- ---- (000 omitted) Financial instruments whose contract amounts represent credit risk at December 31: Commitments to extend credit $32,464 $36,653 Standby letters of credit and financial guarantees written 4,688 3,863
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 corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the corporation 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. 9 Standby letters of credit and financial guarantees written are conditional commitments issued by the corporation 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 corporation holds collateral supporting those commitments when deemed necessary by management. NOTE 9. BENEFIT PLANS The corporation 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 corporate performance and are at the discretion of the corporation'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 corporation's employees are covered by the plan and the contributions charged to operations were $ 439,957, $ 371,621 and $ 319,182 for 1999, 1998, and 1997, respectively. The corporation 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 corporation's obligations under the compensation agreement. The cash value of the life insurance policies is an unrestricted asset of the corporation. The estimated present value of future benefits to be paid, which is included in other liabilities, amounted to $ 166,191 and $ 166,214 at December 31, 1999 and 1998, respectively. Total annual expense for this deferred compensation plan was $ 19,064 for 1999, 1998 and 1997. The corporation also has a supplemental discretionary deferred compensation plan for executive officers and directors. The plan is funded annually with salary and fee reductions which are placed in a trust account invested by the corporation's trust department. Total amount contributed to the plan was $ 42,308, $ 31,975 and $ 46,425 for 1999, 1998 and 1997, respectively. During 1998 the corporation adopted four new supplemental retirement and salary continuation plans for directors and executive officers. These plans are funded with single premium life insurance on the plan participants. The cash value of the life insurance policies is an unrestricted asset of the corporation. The estimated present value of future benefits to be paid totaled $196,625 and $ 41,151 at December 31, 1999 and 1998, respectively which is included in other liabilities. Total annual expense for these plans amounted to $155,474 and $41,151 for 1999 and 1998, respectively. NOTE 10. INCOME TAXES The components of federal income tax expense are summarized as follows:
1999 1998 1997 ---- ---- ---- (000 omitted) Current year provision $ 1,599 $ 1,153 $ 981 Deferred income taxes (benefits) (288) 27 (7) ------- ------- ----- Net federal income tax expense $ 1,311 $ 1,180 $ 974 ======= ======= =====
Federal income taxes were computed after reducing pretax accounting income for non-taxable income in the amount of $ 1,515,383, $ 1,154,199, and $ 969,000 for 1999, 1998, and 1997, respectively. A reconciliation of the effective applicable income tax rate to the federal statutory rate is as follows:
1999 1998 1997 ---- ---- ---- Federal income tax rate 34.0% 34.0% 34.0% Reduction resulting from: Nontaxable income 8.1 6.5 6.8 ----- ----- ----- Effective income tax rate 25.9% 27.5% 27.2% ===== ==== ====
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 (liabilities) included in the accompanying consolidated balance sheets include the following components:
1999 1998 ---- ----- Total deferred tax assets $ 1,262,000 $ 723,000 Total deferred tax liabilities (275,000) (1,108,000) ----------- ----------- Net deferred tax asset (liability) $ 987,000 $ (385,000) =========== ===========
The corporation has not recorded a valuation allowance for 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 totaling $ 31,663,000 and $ 28,844,000 for 1999 and 1998, respectively. Also included in interest bearing deposits at December 31, 1999 and 1998 are money market account balances totaling $ 45,444,000 and $35,299,000, respectively. At December 31, 1999 and 1998 time deposits of $ 100,000 and over aggregated $ 10,855,000 and $ 10,224,000, respectively. Interest expense on time deposits of $ 100,000 and over was $ 484,000; $ 572,000; and $ 497,000 for 1999, 1998 and 1997, respectively. At December 31, 1999 the scheduled maturities of certificates of deposit are as follows: 2000 $ 22,179 2001 35,746 2002 11,790 2003 2,588 2004 6,346 2005 and thereafter 1,932 -------- $ 80,581 ======== 10 The corporation 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 $1,081,000 and $ 888,000 at December 31, 1999 and 1998, respectively. NOTE 12. LIABILITIES FOR BORROWED MONEY Federal funds purchased and securities sold under agreements to repurchase generally mature within one day from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows:
1999 1998 ---- ---- Average balance during the year $ 8,894,000 $ 4,139,000 Average interest rate during the year 4.61% 4.81% Maximum month-end balance during the year $ 13,683,000 $ 6,234,000 Securities underlying the agreements at year-end: Carrying value $ 25,247,000 $ 6,182,000 Estimated fair value $ 24,909,000 $ 6,303,000
At December 31, the corporation had long-term notes outstanding with the Federal Home Loan Bank of Pittsburgh as follows: - - - - - - - Amount - - - - - 1999 1998 Maturity Date Interest Rate ---- ---- ------------- ------------- $ 1,000,000 $ 1,000,000 1/04 6.42% 1,000,000 1,000,000 4/03 6.58% 3,000,000 3,000,000 3/02 6.26% 3,000,000 3,000,000 10/02 5.73% 7,500,000 7,500,000 9/08 5.06% 5,000,000 5,000,000 10/08 4.66% ------------ ------------ $ 20,500,000 $ 20,500,000 ============ ============ 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 corporation 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 are as follows: - - - - - - Amount - - - - - 1999 1998 Maturity Date Rate ---- ---- ------------- ---- $ 0 $ 6,173 2/99 5.21% 6,498 6,498 2/00 5.48% 315,579 315,579 2/01 5.58% --------- --------- $ 322,077 $ 328,250 ========= ========= In addition, the corporation has available a $ 5 million line of credit with the Federal Home Loan Bank of Pittsburgh. Collateral for outstanding advances and the line consists of certain securities and the corporation's 1-4 family mortgage loans totaling $ 100,207,000 at December 31, 1999. The corporation also has available an unused line of credit with Atlantic Central Bankers Bank of $ 6 million at December 31, 1999. Total interest on the aforementioned borrowings charged to operations was $1,106,695, $655,025 and $308,405 for 1999, 1998 and 1997, 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
1999 1998 ---- ---- (000 omitted) Assets Cash $ 641 $ 109 Securities available for sale 835 1,469 Investment in Orrstown Bank 20,811 19,740 Furniture and equipment (net of depreciation) 4 2 Other assets 19 26 -------- -------- Total assets $ 22,310 $ 21,346 ======== ======== Liabilities Accrued expenses $ 409 $ 0 Deferred taxes 33 266 -------- -------- Total liabilities 442 266 ======== ========
11
Shareholders' Equity 1999 1998 ---- ---- (000 Omitted) Common stock, no par value - $ .1041 stated value per share, 10,000,000 shares authorized with 2,218,291 shares issued at December 31, 1999; 2,055,315 shares issued at December 31, 1998 $ 231 $ 214 Additional paid-in capital 18,498 12,476 Retained earnings 3,717 6,863 Accumulated other comprehensive income (578) 1,527 -------- -------- Total shareholders' equity 21,868 21,080 -------- -------- Total liabilities and shareholders' equity $ 22,310 $ 21,346 ======== ========
Income Statements Years Ended December 31 1999 1998 1997 ---- ----- ----- (000 omitted) Interest and dividend income $ 38 $ 23 $ 16 Net gain on sale of investment 421 0 10 Cash dividends from wholly-owned subsidiary 910 1,110 1,064 Equity in undistributed income of subsidiary 2,723 2,030 1,570 ------- ------- ------- 4,092 3,163 2,660 Less: Operating expenses and income tax 337 44 54 ------- ------- ------- Net income $ 3,755 $ 3,119 $ 2,606 ======= ======= =======
Statements of Cash Flows Years Ended December 31 1999 1998 1997 ---- ---- ---- (000 Omitted) Cash flows from operating activities: Net income $ 3,755 $ 3,119 $ 2,606 Adjustments to reconcile net income to cash provided by operating activities: Security (gains) (421) 0 (10) Equity in undistributed income of subsidiary (2,723) (2,030) (1,570) Increase (decrease) in other liabilities 409 0 (40) (Increase) decrease in other assets 5 (26) 0 ------- ------- ------- Net cash provided by operating activities 1,025 1,063 986 ------- ------- ------- Cash flows from investing activities: Purchase of available for sale securities (255) (207) (75) Sales of available for sale securities 624 0 22 ------- ------- ------- Net cash provided (used) by investing activities 369 (207) (53) ------- ------- ------- Cash flows from financing activities: Cash dividends paid (1,134) (986) (903) Cash paid in lieu of fractional stock dividends (31) 0 (22) Proceeds from sale of stock 303 124 0 ------- ------- ------- Net cash (used) by financing activities (862) (862) (925) ------- ------- ------- Net increase (decrease) in cash 532 (6) 8 Cash, beginning balance 109 115 107 ------- ------- ------- Cash, ending balance $ 641 $ 109 $ 115 ======= ======= =======
NOTE 14. REGULATORY MATTERS 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 $ 15,153,000 in its retained earnings at December 31, 1999 is fully available for cash dividends. Orrstown Financial Services' balance of retained earnings at December 31, 1999 is $ 3,717,000 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. The corporation is also subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the corporation's financial statements. Under capital adequacy guidelines, the corporation is required to maintain minimum 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: 12
Orrstown Financial Services Regulatory Minimum 1999 1998 Requirements ---- ---- ------------------ Leverage ratio 8.2% 8.9% 3% Risk-based capital ratio Tier I (core capital) 10.5% 11.8% 4% Combined Tier I and Tier II (core capital plus allowance for loan losses) 11.8% 12.9% 8%
As of December 31, 1999 the most recent notification from the Federal Reserve Bank categorized the corporation as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the corporation's category. NOTE 15. LEASES The bank leases land and building space associated with certain branch offices, remote automated teller machines, and certain data processing equipment under agreements which expire at various times from 2001 through 2004. Total rent expense charged to operations in connection with these leases was $118,342, $24,803 and $22,350 for 1999, 1998, and 1997, respectively. The total minimum rental commitment under operating leases at December 31, 1999 is as follows: Due in the year ending December 31: 2000 $ 186,452 2001 174,189 2002 60,480 2003 14,326 2004 11,076 NOTE 16. COMPENSATING BALANCE ARRANGEMENTS Required deposit balance at the Federal Reserve was $ 65,000 at December 31, 1999 and 1998, respectively. Required deposit balance at Atlantic Central Bankers Bank was $ 585,000 at December 31, 1999 and 1998. These balances are maintained to cover processing costs and service charges. An additional $ 30,240 is on deposit with First Union National Bank of Florida as a reserve for potential clearing losses related to the credit card operations. NOTE 17. COMMITMENTS The corporation has entered into contracts for the renovation of a property acquired in 1998 that is adjacent to its downtown Shippensburg office and for the construction of a new branch office. The total amount of the contracts is $362,000, of which $ 107,000 remained open at December 31, 1999. NOTE 18. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the corporation's financial instruments were as follows at December 31:
- - - - - 1999 - - - - - - - - - - - - 1998 - - - - - Carrying Fair Carrying Fair Amount Value Amount Value --------- --------- --------- -------- (000 Omitted) FINANCIAL ASSETS Cash and short-term investments $ 8,700 $ 8,700 $ 15,127 $ 15,127 Securities available for sale 60,455 60,455 49,852 49,852 Restricted bank stocks 1,509 1,509 1,285 1,285 Loans 180,691 158,632 Allowance for loan loses (2,455) (1,971) --------- --------- Net loans 178,236 177,742 156,661 157,486 Accrued interest receivable 1,599 1,599 1,235 1,235 --------- --------- --------- --------- Total financial assets $ 250,499 $ 250,005 $ 224,160 $ 224,985 ========= ========= ========= ========= FINANCIAL LIABILITIES Deposits $ 204,389 $ 205,177 $ 183,764 $ 184,131 Short-term borrowed funds 15,406 15,406 6,234 6,234 Long-term borrowed funds 20,822 17,822 20,828 20,903 Accrued interest payable 422 422 2,129 2,129 --------- --------- --------- --------- Total financial liabilities $ 241,039 $ 238,827 $ 212,955 $ 213,397 ========= ========= ========= =========
13 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. Summary For the year ended December 31, 1999, Orrstown Financial Services, Inc. (the Corporation), and its wholly owned subsidiary, Orrstown Bank (the Bank), recorded net income of $ 3,755,000, an increase of 20.4% over 1998 earnings of $3,119,000, which was a 19.7% increase over net income of $2,606,000 in 1997. Net income per share (EPS) has increased over this time period from $1.18 in 1997 to $1.41 in 1998 and $1.70 in 1999. The Corporation's earnings performance continues to be well above peer group averages as measured by various ratio analyses. Two widely recognized performance indicators are the return on average assets (ROA) and the return on average equity (ROE). The return on average assets was 1.50% in 1999, 1.47% in 1998 and 1.51% in 1997. The return on average equity has steadily increased from 15.37% in 1997, to 15.97% in 1998 and 17.02% in 1999. Net Interest Income Net interest income is the amount by which interest income on earning assets exceeds interest paid on interest bearing liabilities. The amount of net interest income is affected by changes in interest rates, account balances or volume and the mix of earning assets and interest bearing liabilities. Net interest income is still the primary source of commercial bank profits despite the continued industry wide push to build noninterest income streams. For the year ended December 31, 1999, net interest income totaled $10,250,000, an increase of $1,489,000, or 17.0%, over 1998. The 1998 total was $8,761,000, or 14.9%, over 1997. On a taxable equivalent basis, net interest income increased by 16.3% in 1999 and 15.1% in 1998. Marginal tax rates used in the taxable equivalent equation were 34% for all three years presented. The Corporation's taxable equivalent net interest spread was 4.32% in 1997, 4.05% in 1998, and 4.14% in 1999. The net interest margin, which factors in noninterest bearing funds sources, has moved from 5.01% to 4.70% to 4.69%, respectively. Earning assets represented 94.1% of total assets in 1997, 93.8% in 1998 and 92.6% in 1999. Volume factors were responsible for essentially all net interest income growth during 1998 and 1999. On an average daily basis, assets grew 18.1% during 1999 and 23.1% during 1998. Earning assets grew 16.5% and 22.8% during 1999 and 1998, respectively. Average daily loan growth of 17.7% in 1999 and 22.7% in 1998 was achieved without lowering credit standards and allowed net interest margins to hold at above peer group levels despite pressure on margins generally throughout the banking industry. The net interest margin generated in 1999 declined by only one basis point from 1998 levels and remained well above peer averages while net interest spread actually increased by nine basis points. Continued shifting of the loan portfolio mix toward a heavier commercial loan weighting helped maintain spreads by affording opportunities to record noninterest bearing deposit balances along with variable loan balances tied primarily to prime during a period that saw three 25 basis point increases in the prime rate over the last half of the year. Management is poised to keep a very close eye on margins moving into 2000. 14 ANALYSIS OF NET INTEREST INCOME Average Balances and Interest Rates Taxable Equivalent Basis (Dollars In Thousands)
- - - - - - - 1999 - - - - - - - - - - - - 1998 - - - - - - - - Tax Tax Tax Tax Average Equivalent Equivalent Average Equivalent Equivalent Balance Interest Rate Balance Interest Rate ASSETS: Interest Earning Assets: Federal funds sold & interest- bearing bank balances $ 5,834 $ 283 4.85% $ 5,706 $ 303 5.31% -------- ------- ---- -------- ------- ---- Investment securities: Taxable investment securities 38,877 2,397 6.17 31,450 1,934 6.15 Tax-exempt investment securities 17,852 1,564 8.76 17,890 1,570 8.77 -------- ------- ---- -------- ------- ---- Total investment securities 56,729 3,961 6.98 49,340 3,504 7.10 -------- ------- ---- -------- ------- ---- Loans: Taxable loans 166,498 14,433 8.67 142,019 12,717 8.96 Tax-exempt loans 2,960 274 9.26 1,994 179 8.97 -------- ------- ---- -------- ------- ---- Total loans 169,458 14,707 8.68 144,013 12,896 8.96 -------- ------- ---- -------- ------- ---- Total interest- earning assets 232,021 18,951 8.17 199,059 16,703 8.39 Non-Interest Earning Assets: Cash and due from banks 6,515 5,699 Bank premises and equipment 14,110 5,148 Other assets 0 4,158 Less allowance for loan losses (2,117) (1,915) -------- -------- Total $250,529 $212,149 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest Bearing Liabilities: Interest-bearing demand deposits $ 71,176 $ 2,088 2.93 $ 55,454 $ 1,715 3.09 Savings deposits 22,888 580 2.53 23,394 677 2.89 Time deposits 75,859 3,850 5.08 74,488 4,087 5.49 Short term borrowings 9,713 438 4.51 4,237 204 4.81 Long term borrowings 20,560 1,118 5.44 11,726 665 5.67 -------- ------- ---- -------- ------- ---- Total interest- bearing liabilities 200,196 8,074 4.03 169,299 7,348 4.34 Non-Interest Bearing Liabilities: Demand deposits 25,365 20,433 Other 2,901 2,894 -------- -------- Total liabilities 228,462 192,626 Shareholders' equity 22,067 19,523 -------- -------- Total cost of funds $250,529 3.48 $212,149 3.69 ======== ---- ======== ---- Net interest income/net interest spread $10,877 4.14% $ 9,355 4.05% ======= ==== ======= ==== Net interest margin 4.69% 4.70% ==== ====
- - - - - - 1997 -- - - - - - Tax Tax Average Equivalent Equivalent Balance Interest Rate ASSETS: Interest Earning Assets: Federal funds sold & interest- bearing bank balances $ 3,372 $ 189 5.60% -------- ------- Investment securities: Taxable investment securities 25,360 1,624 6.40 Tax-exempt investment securities 15,983 1,417 8.86 -------- ------- Total investment securities 41,343 3,041 7.35 -------- ------- ---- Loans: Taxable loans 116,811 10,669 9.13 Tax-exempt loans 592 50 8.45 -------- ------- Total loans 117,403 10,719 9.13 -------- ------- ---- Total interest- earning assets 162,118 13,949 8.60 Non-Interest Earning Assets: Cash and due from banks 5,008 Bank premises and equipment 4,443 Other assets 2,486 Less allowance for loan losses (1,689) -------- Total $172,366 ======== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest Bearing Liabilities: Interest-bearing demand deposits $ 37,535 $ 1,056 2.81 Savings deposits 24,568 728 2.96 Time deposits 68,161 3,711 5.44 Short term borrowings 218 12 5.50 Long term borrowings 5,322 315 5.92 -------- ------- ---- Total interest- bearing liabilities 135,804 5,822 4.28 Non-Interest Bearing Liabilities: Demand deposits 17,665 Other 1,941 -------- Total liabilities 155,410 Shareholders' equity 16,956 -------- Total cost of funds $172,366 3.59 ======== ---- Net interest income/net interest spread $ 8,127 4.32% ======= ==== Net interest margin 5.01% ====
Noninterest Income and Expenses Other income increased $ 1,328,000, or 59.0% during 1999 due to significant increases in all noninterest income areas that, at least, mirrored the 18.1% growth in the Corporation's average daily assets. Growth of 27.7% in deposit related charges contributed $ 234,000 additional revenue. These gains arose due to a 12.4% increase in average daily deposits plus an upgrade in various service charge schedules. Trust and brokerage revenue grew $ 412,000, or 50.4%, as investment management services continue to grow at a phenomenal rate as measured by both assets under management and profitability. Securities gains increased $ 432,000 due, almost solely, to one transaction. One of the companies held in the parent's bank stock portfolio was acquired and the resultant sale of the stock generated a large gain. Other income increased $ 175,000 due to growth in cash surrender values of life insurance policies used to provide benefits under various plans. Management has made a concerted effort, in recent years, to locate new sources of noninterest income and to offer them to the customer base profitably. 15 Other expenses rose $1,773,000, or 27.7% in 1999. With commercial bank totals growing at a 20% plus annualized pace over the past two years and trust department totals growing at a 30% plus annualized pace during the same period, some growth in operating expenses is to be expected. In addition, a second Chambersburg branch was opened during 1999 via acquisition of a $5,000,000 deposit base and the assumption of an existing leased facility located in a Wal-Mart. Additional personnel were added to staff that branch which came under our control in September. In addition, the robust growth has created the need for additional operations personnel. Every major data processing system was converted during 1999 with one-time charges exceeding $300,000 being funded through operations. The resultant improvements in backroom efficiency and enhancements to customer service should set the stage for improved efficiency and ability to handle growth moving forward. Management has been able to generate across the board improvements in operating systems while still maintaining an efficiency ratio below 60%, an enviable number for a community bank with less than $ 500 million of assets. The efficiency ratio increased to 58.2% for 1999, following 55.0% in 1998 and 55.2% in 1997, but the backroom should be properly positioned to allow improvement of this ratio in 2000. The Corporation handled the year 2000 date turnover with no incidents and did not suffer material costs associated with that issue. The ability to focus the attention of operations personnel totally on customers and products will be a great relief moving forward however. The table that follows provides additional information regarding noninterest income and noninterest expense increases over the past three years: ANALYSIS OF NONINTEREST INCOME AND EXPENSES
- - Year Ended December 31 - - - - - - - % Change - - - - 1999 1998 1997 1999-1998 1998-1997 (In Thousands) Other income: Service charges on deposit accounts $ 1,080 $ 846 $ 679 27.7% 24.6% Loan service charges and fees 285 243 100 17.3% 143.0% Other service charges, commissions and fees 258 224 163 15.2% 37.4% Trust department income 862 656 490 31.4% 33.9% Brokerage income 368 162 59 127.2% 174.6% Securities gains (losses) 423 (9) 3 NM NM Other operating income 305 131 57 133.6% 129.8% ------- ------- ------- ----- ----- $ 3,581 $ 2,253 $ 1,551 59.0% 45.3% ------- ------- ------- ----- ------ Other expenses: Salaries $ 2,945 $ 2,478 $ 2,076 18.8% 19.4% Employee benefits 1,351 1,013 825 33.4% 22.8% Occupancy and equipment expenses 1,100 859 764 28.1% 12.4% Data processing expenses 671 493 390 36.1% 26.4% ATM expenses 151 113 59 33.6% 91.5% Telephone 143 96 77 49.0% 24.7% Printing and supplies 249 178 161 39.9% 10.6% Postage 128 117 108 9.4% 8.3% Directors fees 185 154 151 20.1% 2.0% Advertising 138 154 149 (10.4)% 3.4% Pennsylvania shares tax 171 145 132 17.9% 9.8% Other operating expenses 986 645 492 53.0% 31.1% ------- ------- ------- ----- ----- $ 8,218 $ 6,445 $ 5,384 27.5% 19.7% ------- ------- ------- ----- ----- Noninterest income as a % of noninterest expense 43.6% 35.0% 28.8%
Federal Income Taxes The Corporation's effective federal income tax rate for 1999 was 25.9%, as compared to 27.5% in 1998 and 27.2% in 1997. Corporate income tax rates for 2000 are forecast to stay near 1999 levels. The Corporation is firmly entrenched in the 34% bracket so all taxable income will be taxed at 34% in 2000. This, along with anticipated growth, is expected to increase the Corporation's effective federal income tax rate to approximately 27% in 2000, assuming no retroactive change in rates during 2000. Asset Quality and Credit Risk Analysis The quality of the Corporation's asset structure continues to be strong. A substantial amount of time is devoted by management to overseeing the investment of funds in loans and securities and the formulation of policies directed toward the profitability and minimization of risk associated with the investments. Credit Risk Analysis The Bank follows generally conservative lending practices and continues to carry a high quality loan portfolio with no unusual or undue concentrations of credit. No loans are extended to nondomestic borrowers or governments, consistent with past practice and policy. Net charge-offs historically have been quite low, when compared to industry standards, and represented only .05% of average outstanding loans during 1999 and .05% of average 1998 loans. Nonperforming loans, as represented by nonaccrual and restructed items, were only .04% and .31% of outstanding loans at December 31, 1999 and 1998, respectively. Loans 90 days or more past due and still accruing represented .05% and .18% of outstanding loans at December 31, 1999 and 1998, respectively. Allowance for Loan Losses Historically, the Corporation has had an enviable record regarding its control of loan losses, but lending is a banking service that inherently contains elements of risk. In order to assess this risk, an ongoing loan review process continually evaluates the current financial condition of commercial borrowers, local and national economic conditions, and the current level of delinquencies. Through this process, an amount deemed adequate to meet current growth and future loss expectations is charged to operations. The provision for loan losses amounted to $ 547,000, $ 270,000 and $ 215,000 for 1999, 1998 and 1997, respectively. These provisions compared to net charge-offs of $ 63,000, $ 66,000 and $ 68,000 for 1999, 1998 and 1997, respectively. The allowance for loan losses was increased 24.6% during 1999 while loans increased 13.9%. The reserve at December 31, 1999 represented 1.36% of loans outstanding. Net charge-offs for 1999 represented only .04% of average loans outstanding. The reserve at December 31, 1999 represented 39 years of coverage based upon 1999 net charge-offs and 3,836% of nonaccrual loans. In addition, approximately 68% of the allowance was unallocated under internal evaluation procedures as of December 31, 1999. 16 SUMMARY OF LOAN LOSS EXPERIENCE
- - - - - - - - - - - - Year Ended December 31 - - - - - - - - - 1999 1998 1997 1996 1995 --------- -------- -------- --------- -------- Amount of loans outstanding at end of period $ 180,691 $158,632 $128,331 $ 108,926 $102,857 ========= ======== ======== ========= ======== Daily average loans outstanding $ 169,458 $144,013 $117,403 $ 105,779 $ 97,662 ========= ======== ======== ========= ========= Balance of allowance for possible loan losses at beginning of period $ 1,971 $ 1,767 $ 1,620 $ 1,433 $ 1,200 Loans charged off 128 84 83 68 51 Recoveries of loans previously charged off 65 18 15 15 14 --------- -------- Net loans charged off (recovered) 63 66 68 53 37 Additions to allowance charged to expense 547 270 215 240 270 --------- -------- -------- --------- -------- Balance at end of period $ 2,455 $ 1,971 $ 1,767 $ 1,620 $ 1,433 ========= ======== ======== ========= ======== Ratio of net charge-offs to average loans outstanding 0.04% 0.05% 0.06% 0.05% 0.04% ========= ======== ======== ========= ======== Ratio of reserve to gross loans outstanding at December 31 1.36% 1.24% 1.38% 1.49% 1.39% ========= ======== ======== ========= ========
Risk Elements Nonperforming assets are comprised of nonaccrual and restructured loans and real estate owned other than bank premises (OREO). OREO represents property acquired through foreclosure or settlements of loans and is carried at the lower of the principal amount of the loan outstanding at the time acquired or the estimated fair value of the property. The excess, if any, of the principal balance at the time acquired over the carrying amount is charged against the reserve for loan losses. The Bank's loan loss history has been much better than peer standards and analysis of the current credit risk position is favorable. The allowance for loan losses is adequate given the current composition of the loan portfolio and adequately covers the credit risk management sees under present economic conditions. Approximately 68% of the reserve balance is unallocated under current procedures. Management is prepared to make any reserve adjustments that may become necessary as economic conditions change. NONPERFORMING ASSETS
- - - - - - - - - - - -December 31 - - - - - - - - - - - - - 1999 1998 1997 1996 1995 ----- -------- -------- ----- ----- (In Thousands) Loans on nonaccrual (cash) basis $ 64 $ 486 $ 473 $ 14 $ 132 Loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower 0 0 0 0 0 OREO 0 311 49 49 27 ----- -------- -------- ----- ----- Total nonperforming loans and OREO $ 64 $ 797 $ 522 $ 63 $ 159 ===== ======== ======== ===== ===== Ratio of nonperforming assets to total loans and OREO 0.04% 0.50% 0.41% 0.06% 0.15% ==== ======== ======== ==== ==== Ratio of nonperforming assets to total assets 0.02% 0.34% 0.27% 0.04% 0.11% ==== ======== ======== ==== ==== OTHER CREDIT RISK ELEMENTS Loans past due 90 or more days and still accruing $ 97 $ 284 $ 657 $ 203 $ 417 ----- -------- -------- ----- ----- Ratio of other credit risk elements to total loans and OREO 0.05% 0.18% 0.51% 0.19% 0.41% ==== ======== ======== ==== ==== Ratio of other credit risk elements to total assets 0.04% 0.12% 0.35% 0.13% 0.29% ==== ======== ======== ==== ==== TOTAL NONPERFORMING AND OTHER RISK ASSETS $ 161 $ 1,081 $ 1,179 $ 266 $ 576 ----- ------- ------- ----- ----- Ratio of total risk assets to total loans and OREO 0.09% 0.68% 0.92% 0.24% 0.56% ==== ======== ======== ==== ==== Ratio of total risk assets to total assets 0.06% 0.46% 0.62% 0.17% 0.39% ==== ======== ======== ==== ====
Future Impact of Recently Issued Accounting Standards In June, 1998 the Financial Accounting Standards Board (FASB) issued SFAS No. 133 - "Accounting for Derivative Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 1999. This Statement establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other contracts, and requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them at fair value. If certain conditions are met, an entity may elect to designate a derivative as follows: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of an unrecognized firm commitment, an available-for-sale security, a foreign currency denominated forecasted transaction, or a net investment in a foreign operation. The statement generally provides for matching the timing of the recognition of the gain or loss on derivatives designated as hedging instruments with the recognition of the changes in the fair value of the item being hedged. Depending on the type of hedge, such recognition will be in either net income or other comprehensive income. For a derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in the period of change. Management is currently evaluating the impact of adopting this Statement on the consolidated financial statements, but does not anticipate that it will have a material impact. Liquidity, Rate Sensitivity and Interest Rate Risk Analysis The primary function of asset/liability management is to assure adequate liquidity and rate sensitivity. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management requires the maintenance of an appropriate balance between interest sensitive assets and liabilities. Interest bearing assets and liabilities that are maturing or repricing should be adequately balanced to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. 17 The Corporation has consistently followed a strategy of pricing assets and liabilities according to prevailing market rates while largely matching maturities, within the guidelines of sound marketing and competitive practices. The goal is to maintain a predominantly matched position with very few planned mismatches. Rate spreads will be sacrificed at times in order to enable the overall rate sensitivity position to stay within the guidelines called for by asset/liability management policy. Rate sensitivity is measured by monthly gap analysis, quarterly rate shocks and periodic simulation. Investment and pricing decisions are made using both liquidity and sensitivity analyses as tools. The schedule that follows reflects the degree to which the Corporation can adjust its various portfolios to meet interest rate changes. Additionally, the Bank is a Federal Home Loan Bank (FHLB) member, and standard credit arrangements available to FHLB members provide increased liquidity. RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 1999 (Dollars in Thousands)
- - - - - - - - - - - - - - - - Interest Sensitivity Period - - - - - - - - - - - - - - - - - After 1 After 3 After 6 Within Within 3 Within 6 Within 12 After 1 Month Months Months Months 1 Year Total RATE SENSITIVE ASSETS (RSA): Loans $ 49,060 $ 12,492 $ 20,411 $ 36,551 $ 62,177 $ 180,691 Investment securities 4,576 1,248 4,930 6,460 44,750 61,964 Other earning assets 115 0 0 0 0 115 ----------- ------------ ------------- ------------- -------------- ------------- Total RSA 53,751 13,740 25,341 43,011 106,927 242,770 --------- -------- --------- -------- --------- ---------- RATE SENSITIVE LIABILITIES (RSL): Interest bearing deposits 41,001 17,163 11,602 13,715 95,644 179,125 Short term borrowed funds 15,406 0 0 0 0 15,406 Long term borrowed funds 0 6,000 6 0 14,816 20,822 ------------ --------- ------------ ------------ ---------- ----------- Total RSL 56,407 23,163 11,608 13,715 110,460 215,353 -------- -------- -------- -------- --------- ---------- RATE SENSITIVE GAP: Period (2,656) (9,423) 13,733 29,296 (3,533) 27,417 Cumulative (2,656) (12,079) 1,654 30,950 27,417 GAP AS A PERCENT OF TOTAL ASSETS: Period (1.13)% (4.00)% 5.82% 12.42% Cumulative (1.13)% (5.12)% 0.70% 13.12% RSA/RSL Cumulative 0.95 0.85 1.02 1.30
The liability biased, or negative, gap position during the first three months indicates that earnings would be naturally enhanced, or more easily maintained, in a falling rate environment. The gap position becomes asset biased, or positive, by the sixth month. This indicates that the position is balanced adequately to react to a rate movement in either direction without material damage to earnings. Capital Adequacy and Regulatory Matters The Corporation maintains a strong capital base which provides adequate resources to absorb both normal and unusual risks inherent to the banking business. Internal capital generation, net income retained after the declaration of dividends, has been the primary method employed to increase capital accounts. Total stockholders' equity rose $ 788,000 during 1999, an increase of 3.7% for the year. This followed growth of 15.4% and 15.2% during 1998 and 1997, respectively. The 1999 increase was tempered by an equity writedown of $ 2,105,000 attributable to the available for sale debt securities portfolio. This writedown was due simply to the rising interest rate environment during the second half of the year and was not attributable to portfolio quality issues. The increasing earnings stream during this period has allowed the Corporation to steadily increase cash dividends paid to stockholders. In 1999 cash dividends rose $ 148,000, or 15.0% over 1998 levels while net income rose 20.4% during the period. This followed a 9.0% increase in dividend payout for 1998 versus 1997. The Bank enjoyed rapid asset growth during 1999 which caused a moderation in the Corporation's dividend payout percentage for the year in order to assure an adequate capital base to accommodate such growth in the future. Dividends per share have moved from .41 to .45 to .51 for 1997 through 1999, respectively. CAPITAL AND DIVIDEND RATIOS
1999 1998 1997 (Amounts in Thousands) At December 31: Shareholders' equity $ 21,868 $21,080 $ 18,265 Equity/assets 8.25% 8.94% 9.60% For the Year: Average equity/average assets 8.81% 9.20% 9.84% Dividend payout 30.20% 31.61% 34.65% Return on average equity 17.02% 15.97% 15.37% Dividends paid $ 1,134 $ 986 $ 903 Regulatory Regulatory Capital Measures: Minimums Tier I Capital Ratio 10.5% 11.8% 12.7% 4.0% Total (Tier II) Capital Ratio 11.8% 12.9% 14.0% 8.0% Leverage Ratio 8.2% 8.9% 10.0% 3.0%
18 The maintenance of a strong capital base, above regulatory risk based minimums and industry averages, has been an integral part of the Corporation's operating philosophy. Management foresees no problem in maintaining capital ratios in excess of regulatory requirements. Capital has been purposely leveraged in recent years by the use of matched investment securities transactions approximating $8 million. These transactions are generating approximately $100,000 of annual net income while still maintaining a comfortable capital base. The Corporation and the Bank are subject to periodic examinations by one or more of the various regulatory agencies. During 1999, four examinations were conducted that included, but were not limited to, procedures designed to review Year 2000 (Y2K) preparedness, trust operations, compliance Community Reinvestment Act (CRA) activities. No comments were received from regulatory bodies which, if implemented, would have a material effect on the Corporation's liquidity, capital resources or operations. SUMMARY OF QUARTERLY FINANCIAL DATA The unaudited quarterly results of operations for the years ended December 31, 1999 and 1998 are as follows:
1999 1998 - - - - - - - - - Quarter Ended - - - - - - - - - - - - - - - Quarter Ended - - - - - - - - - March June September December March June September December Interest income $ 4,309 $ 4,433 $ 4,672 $ 4,910 $ 3,715 $ 3,979 $ 4,138 $ 4,277 Interest expense 1,922 1,941 2,033 2,178 1,707 1,800 1,857 1,984 ------- ------- ------- -------- ------- ------- ------- ------- Net interest income 2,387 2,492 2,639 2,732 2,008 2,179 2,281 2,293 Provision for loan losses 90 90 90 277 75 75 75 45 ------- ------- ------- -------- ------- ------- ------- ------- Net interest income after provision for loan losses 2,297 2,402 2,549 2,455 1,933 2,104 2,206 2,248 Securities gains (losses) (9) (6) 271 167 (10) (2) 11 (8) Other income 713 862 801 782 491 535 550 686 Other expenses 1,829 1,920 2,302 2,167 1,527 1,556 1,567 1,795 ------- ------- ------- -------- ------- ------- ------- ------- Other income before income taxes 1,172 1,338 1,319 1,237 887 1,081 1,200 1,131 Applicable income taxes 323 349 345 294 245 296 335 304 ------- ------- ------- -------- ------- ------- ------- ------- Net income $ 849 $ 989 $ 974 $ 943 $ 642 $ 785 $ 865 $ 827 ======= ======= ======= ======== ======= ======= ======= ======= Per common share data: Net income $ 0.38 $ 0.45 $ 0.44 $ 0.43 $ 0.30 $ 0.35 $ 0.39 $ 0.37 Dividends 0.12 0.12 0.13 0.14 0.11 0.11 0.11 0.12 Performance statistics: Return on average assets 1.45% 1.62% 1.52% 1.41% 1.33% 1.51% 1.60% 1.42% Return on average equity 15.95% 17.92% 17.38% 16.78% 13.99% 16.61% 17.42% 15.77% Average equity/average assets 9.09% 9.04% 8.73% 8.41% 9.52% 9.11% 9.19% 9.04%
19 Selected Five-Year Financial Data ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Year Ended December 31 1999 1998 1997 1996 1995 Summary of Operations (000 omitted) Interest income ................................... $ 18,324 $ 16,109 $ 13,450 $ 12,018 $ 10,829 Interest expense .................................. 8,074 7,348 5,822 5,139 4,542 ----------- ----------- ----------- ----------- ----------- Net interest income ............................... 10,250 8,761 7,628 6,879 6,287 Provision for loan losses ......................... 547 270 215 240 270 ----------- ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 9,703 8,491 7,413 6,639 6,017 Securities gains (losses) ......................... 423 (9) 3 (5) (45) Other operating income ............................ 3,158 2,262 1,548 1,245 980 Other operating expenses .......................... 8,218 6,445 5,384 4,793 4,256 ----------- ----------- ----------- ----------- ----------- Income before income taxes ........................ 5,066 4,299 3,580 3,086 2,696 Applicable income tax ............................. 1,311 1,180 974 838 742 ----------- ----------- ----------- ----------- ----------- Net income ................................... $ 3,755 $ 3,119 $ 2,606 $ 2,248 $ 1,954 =========== =========== =========== =========== =========== Per Common Share Data* Income before taxes ............................... $ 2.29 $ 1.94 $ 1.63 $ 1.40 $ 1.22 Applicable income taxes ........................... 0.59 0.53 0.45 0.38 0.34 Net income ........................................ 1.70 1.41 1.18 1.02 0.88 Cash dividend paid ................................ 0.51 0.45 0.41 0.32 0.27 Book value ........................................ 9.85 9.54 8.29 7.19 6.64 Average shares outstanding ........................ 2,214,951 2,205,718 2,204,444 2,205,268 2,206,560 Stock Price Statistics* Close ............................................. $ 38.00 $ 26.05 $ 20.93 $ 15.06 $ 13.29 High .............................................. 40.00 29.77 20.93 15.06 13.29 Low ............................................... 25.12 20.59 15.06 13.29 11.96 Price earnings ratio at close ..................... 22.4 18.5 17.7 14.8 15.1 Year-End Balance Sheet Data (000 omitted) Total assets ...................................... $ 265,053 $ 235,822 $ 190,242 $ 157,556 $ 145,998 Total loans ....................................... 180,691 158,632 128,331 108,926 102,857 Total investment securities ....................... 61,964 51,137 47,191 34,355 31,563 Deposits - noninterest bearing .................... 25,264 22,020 17,649 16,322 13,962 Deposits - interest bearing ....................... 179,125 161,744 142,931 120,937 113,368 Total deposits .................................... 204,389 183,764 160,580 137,259 127,330 Liabilities for borrowed money .................... 36,228 27,062 8,569 2,339 2,345 Total shareholders' equity ........................ 21,868 21,080 18,265 15,856 14,633 Trust assets under management - market value ...... 182,000 152,000 108,000 83,000 66,000 Performance Statistics Average equity/average assets ..................... 8.81% 9.20% 9.84% 9.84% 10.00% Return on average equity .......................... 17.02% 15.97% 15.37% 14.90% 14.40% Return on average assets .......................... 1.50% 1.47% 1.51% 1.47% 1.44%
* Per share amounts have been restated to reflect: The 7 1/2% stock dividend effective November 19, 1999. The 2 for 1 stock split effective November 21, 1998. The 5% stock dividend effective May 15, 1997. The 5% stock dividend effective July 21, 1995. 20 Market, Dividend & Investor Information Market and Dividend Information The common stock of Orrstown Financial Services, Inc. is traded in the over-the-counter market under the symbol ORRF. At the close of business December 31, 1999, there were approximately 1,848 shareholders of record, with a total of 2,218,291 shares outstanding. The table below sets forth the range of high and low quarterly sales prices and dividends declared per common share. All per share data has been restated to reflect the 7 1/2% stock dividend paid November 19, 1999 to shareholders of record November 1, 1999.
1999 1998 Market Price Market Price Quarterly Quarterly High Low Dividend High Low Dividend ------- ------- ------- ------- ------- ------- First quarter $ 32.56 $ 25.58 $ 0.121 $ 22.33 $ 20.93 $ 0.107 Second quarter $ 37.21 $ 25.12 $ 0.121 $ 24.19 $ 20.59 $ 0.107 Third quarter $ 37.21 $ 32.56 $ 0.130 $ 27.91 $ 24.19 $ 0.112 Fourth quarter $ 40.00 $ 32.56 $ 0.140 $ 29.77 $ 25.58 $ 0.121 ------- ------- $ 0.512 $ 0.447
Investor Information Annual Meeting The annual meeting of Orrstown Financial Services, Inc. stockholders is scheduled for April 11, 2000 at 9:00 a.m. at Shippen Place Hotel and Restaurant, 32 East King Street, Shippensburg, PA 17257. All stockholders are cordially invited to attend. Annual and Quarterly Reports Copies of the annual and quarterly reports may be obtained at any office of Orrstown Bank, or by writing to Patricia A. Corwell, Vice President & Assistant Secretary, Orrstown Bank, P. O. Box 250, Shippensburg, PA 17257. Form 10-K A copy of the corporation's Form 10-K, as filed with the Securities and Exchange Commission, may be obtained by writing to Orrstown Bank, P. O. Box 250, Shippensburg, PA 17257. Transfer Agent The transfer agent for Orrstown Financial Services, Inc. is Orrstown Bank, 77 East King Street, P.O. Box 250, Shippensburg, PA 17257. Market Makers E.E. Powell & Co., Inc. Janney Montgomery Scott F.J. Morrissey & Co., Inc. 1100 Gulf Tower 1 North Church Street 1700 Market Street - Suite 1420 Pittsburgh, PA 15219 P. O. Box 3129 Philadelphia, PA 19103 1-800-289-7865 West Chester, PA 19380 1-800-842-8928 1-800-777-0131
21 EX-21 7 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT 1. Orrstown Bank, Orrstown, Pennsylvania; a state-chartered bank organized under the Pennsylvania Banking Code of 1965. EX-23.1 8 INDEPENDENT AUDITOR'S CONSENT EXHIBIT 23.1 Independent Auditor's Consent Board of Directors and Shareholders Orrstown Financial Services, Inc. We consent to the incorporation by reference in to previously filed Registration Statements (Form S-4 No. 33-18888 and Form S-3 No. 333-53405) of Orrstown Financial Services, Inc. of our report dated January 31, 2000, appearing in the 1999 annual report to shareholders incorporated by reference in this Form 10-K of Orrstown Financial Services, Inc. for the year ended December 31, 1999. SMITH ELLIOTT KEARNS & COMPANY, LLC Chambersburg, Pennsylvania March 15, 2000 EX-27 9 FDS --
9 12-MOS DEC-31-1999 DEC-31-1999 8,585 115 0 0 61,330 61,330 60,455 180,691 2,455 265,053 204,389 15,406 2,568 20,822 0 0 231 21,637 265,053 14,613 3,321 390 18,324 6,519 8,074 10,250 547 423 8,218 5,066 3,755 0 0 3,755 1.70 1.70 4.69 64 97 0 0 1,971 128 65 2,455 2,455 0 0
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