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, 1998
Commission file number: 33-18888
ORRSTOWN FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2530374
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
77 East King Street
P. O. Box 250, Shippensburg, Pennsylvania 17257
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including
area code: (717) 532-6114
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, No Par Value The Common Stock is not
registered on any
exchange.
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X
No
As of February 28, 1999, 2,057,799 shares of the
registrant's common stock were outstanding. The aggregate
market value of such shares held by nonaffiliates on that
date was $ 72,022,965.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual shareholders report for the year
ended December 31, 1998 are incorporated by reference into
Parts I and II. Portions of the Proxy Statement for 1998
Annual Meeting of Security Holders are incorporated by
reference in Part III of this Form 10-K.
- -1-
Item 1. Business.
History and Business
Orrstown Financial Services, Inc. (OFS) is a bank holding
company registered under the Bank Holding Company Act of 1956, as
amended. Orrstown Financial Services, Inc. was organized on November
17, 1987, under the laws of the Commonwealth of Pennsylvania for the
purpose of acquiring Orrstown Bank ("Orrstown"), Shippensburg,
Pennsylvania, and such other banks and bank related activities as are
permitted by law and desirable. On March 8, 1988, Orrstown Financial
Services, Inc. acquired 100% ownership of Orrstown, issuing 131,455
shares of Orrstown Financial Services, Inc.'s common stock to the
former Orrstown shareholders.
Orrstown Financial Services, Inc.'s primary activity
consists of owning and supervising its subsidiary, Orrstown Bank, which
is engaged in providing banking and bank related services in South
Central Pennsylvania, principally Franklin and Cumberland Counties,
where its seven branches are located in Shippensburg (2), Carlisle (2),
Spring Run, Orrstown, and Chambersburg, 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, 1998, Orrstown had 76 full-time and 36
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.
- -2-
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 5 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.
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.
- -3-
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, 1998, Orrstown had total assets of
approximately $ 236 million, total shareholders' equity of
approximately $ 21 million and total deposits of approximately $ 184
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.
- -4-
The operations of Orrstown are subject to federal and state
statutes applicable to banks chartered under the banking laws of the
United States, and to banks whose deposits are insured by the Federal
Deposit Insurance Corporation. Bank operations are also subject to
regulations of the Pennsylvania Department of Banking, the Federal
Reserve Board and the Federal Deposit Insurance Corporation.
The primary supervisory authority of Orrstown is the
Pennsylvania Department of Banking, who regularly examines such areas
as reserves, loans, investments, management practices and other aspects
of bank operations. These examinations are designed primarily for the
protection of the Bank depositors.
Federal and state banking laws and regulations govern,
among other things, the scope of a bank's business, the investments a
bank may make, the reserves against deposits a bank must maintain, the
loans a bank makes and collateral it takes, the maximum interest rates
a bank may pay on deposits, the 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.
- -5-
Regulatory authorities have issued guidelines that establish
risk-based capital and leverage standards. These capital requirements
of bank regulators, are discussed on page 21 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,
- -6-
the primary federal banking regulator may prohibit such institution
from paying dividends or may require such institution to take other
steps to become adequately capitalized.
The earnings of Orrstown Bank, and therefore the earnings
of Orrstown Financial Services, are affected by general economic
conditions, management policies, and the legislative and governmental
actions of various regulatory authorities including the FRB, the FDIC
and the Pennsylvania Department of Banking. In addition, there are
numerous governmental requirements and regulations that affect the
activities of Orrstown Financial Services.
Competition
Orrstown's principal market area consists of 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 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 does not operate as a
branch, but rather as an accounting office. The bank also
- -7-
owns properties adjacent to the Orrstown and downtown Shippensburg
offices 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.
<TABLE>
<S> <C> <C> <C>
Age
Held Bank Employee as of
Name/Office Held Since Since 3/15/99
Joel R. Zullinger, Chairman
of the Board 1991 (1) 50
Jeffrey W. Coy, Vice Chairman of
The board 1988 (1) 47
Kenneth R. Shoemaker, President & CEO 1987 1986 51
Bradley S. Everly, Senior Vice President
Senior Loan Officer 1997 1997 47
Stephen C. Oldt, Executive
Vice President, Chief Operating
Officer 1987 1987 56
Philip E. Fague, Vice President,
Senior Trust Officer 1990 1988 39
Robert T. Henry, Secretary 1988 (1) 70
Benjamin Stoops, Vice President, Senior
Operations Officer 1998 1998 47
</TABLE>
(1) Mr. Henry, Mr. Zullinger and Mr. Coy are not employees
of the Bank.
- -8-
Senior Operating Officers of the Bank
<TABLE>
<S> <C> <C> <C> <C>
Held Bank Employee Age
Name/Office Held Since Since as of
3/15/99
Kenneth R. Shoemaker, President &
Chief Executive Officer 1987 1988 51
Stephen C. Oldt, Executive Vice
President & Chief Operating
Officer 1987 1987 56
Philip E. Fague, Vice President/ 1990/
Senior Trust Officer 1993 1988 39
Bradley S. Everly, Senior Vice 1997/
President/Senior Loan Officer 1997 1997 47
Benjamin Stoops, Vice President,
Senior Operations Officer 1998 1998 47
</TABLE>
Part II
Item 5. Market for Registrant's Common Stock and Related Security
Holder Matters.
Orrstown Financial Services, Inc.'s common stock is not
traded on a national securities exchange, but is traded inactively
through the local and over the counter local markets. At December 31,
1998, the approximate number of shareholders of record was
approximately
1,666. 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.
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Market Cash Market Cash
Price Dividend Price Dividend
Dividend (1) 1998 1997
High Low High Low
First Quarter $ 24.00 $ 22.50 $ .115 $ 17.15 $ 16.19 $ .09
Second Quarter 26.00 22.13 .115 20.00 17.15 .095
Third Quarter 30.00 26.00 .12 21.00 20.00 .10
Fourth Quarter 32.00 27.50 .13 22.50 21.00 .155
</TABLE>
(1) Note: Cash dividends per share have been restated after
giving retroactive recognition to a 2 for 1 stock split effective
November 21, 1998 and 5% stock dividend paid May 15, 1997.
See Note 14 to the financial statements for restrictions on
the payment of dividends.
- -9-
Item 6. Selected Financial Data.
The selected five-year financial data on page 22 of the
annual shareholders' report for the year ended December 31, 1998 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 17 through 22 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 5 through 22 of the annual
shareholders report for the year ended December 31, 1998 and are
incorporated herein by reference. Additional schedules required in
addition to those included in the annual shareholders report are
submitted herewith.
- -10-
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CHANGES IN NET INTEREST INCOME TAX EQUIVALENT YIELDS
1998 Versus 1997
Increase (Decrease)
Due to Change in
<TABLE>
<S> <C> <C> <C>
Total
Average Average Increase
Volume Rate (Decrease)
(000 omitted)
Interest Income
Loans (net of unearned discounts) $ 2,429 ($ 252) $ 2,177
Taxable investment securities 390 ( 80) 310
Nontaxable investment securities 170 ( 17) 153
Other short-term investments 131 ( 17) 114
Total interest income 3,120 ( 366) 2,754
Interest Expense
Interest bearing demand 503 156 659
Savings deposits ( 35) ( 16) ( 51)
Time deposits 344 32 376
Short-term borrowings 221 ( 29) 192
Long-term borrowings 379 ( 29) 350
Total interest expense 1,412 114 1,526
Net interest income $ 1,228
</TABLE>
- -11-
1997 Versus 1996
Increase (Decrease)
Due to Change in
<TABLE>
<S> <C> <C> <C>
Total
Average Average Increase
Volume Rate (Decrease)
(000 omitted)
Interest Income
Loans (net of unearned discounts) $ 1,062 ($ 12) $ 1,050
Taxable investment securities 285 6 291
Nontaxable investment securities 563 ( 57) 506
Other short-term investments ( 229) 9 ( 220)
Total interest income 1,681 ( 54) 1,627
Interest Expense
Interest bearing demand 245 130 375
Savings deposits ( 41) ( 4) ( 45)
Time deposits 207 ( 23) 184
Short-term borrowings 12 0 12
Long-term borrowings 180 ( 23) 157
Total interest expense 603 80 683
Net interest income $ 944
</TABLE>
Changes which are attributed in part to volume
and in part to rate are allocated in proportion to their
relationships to the amounts of changes.
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
The following table shows the maturities of investment
securities at book value as of December 31, 1998, and weighted
average yields of such securities. Yields are shown on a tax
equivalent basis, assuming a 34% federal income tax rate.
<TABLE>
<S> <C> <C> <C> <C> <C>
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 $ 2,511 $ 5,504 $ 1,056 $ 0 $ 9,071
Yield 5.89% 6.41% 6.06% 0% 6.22%
U. S. Government
agencies
Book value 0 0 2,500 0 2,500
Yield 0% 0% 6.63% 0% 6.63%
State and municipal
Book value 0 1,139 0 16,836 17,975
Yield 0% 9.98% 0% 8.67% 8.74%
Total book
value $ 2,511 $ 6,643 $ 3,556 $ 16,836 $ 29,546
Yield 5.89% 7.02% 6.46% 8.67% 7.79%
Mortgage-backed
securities:
Total book value $ 17,306
Yield 6.52%
Equity Securities:
Total book value $ 686
Yield 3.87%
Total Investment Securities $ 47,538
Yield 7.27%
</TABLE>
- -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:
<TABLE>
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
(000 omitted)
Commercial, financial
and agricultural $ 18,732 $ 10,275 $ 8,401 $ 8,211 $ 6,970
Real estate -
Construction 11,182 5,961 4,304 5,706 5,038
Real estate - Mortgage 116,030 97,074 82,687 75,731 68,458
Installment and other
personal loans (net of
unearned discount) 12,688 15,021 13,534 13,209
10,373
Total loans $ 158,632 $ 128,331 $ 108,926 $ 102,857 $ 90,839
</TABLE>
Presented below are the approximate maturities of the loan
portfolio (excluding real estate mortgages, installments and credit
cards) at December 31, 1998:
<TABLE>
<S> <C> <C> <C> <C>
Under One One to Over Five
Year Five Years Years Total
(000 omitted)
Commercial, financial
and agricultural $ 2,968 $ 3,560 $ 12,204 $ 18,732
Real estate - Construction 1,522 1,822 7,838 11,182
Total $ 4,490 $ 5,382 $ 20,042 $ 29,914
</TABLE>
The following table presents the approximate amount of
fixed rate loans and variable rate loans due as of December 31, 1998:
<TABLE>
<S> <C> <C>
Fixed Rate Variable
Loans Rate Loans
(000 omitted)
Due within one year $ 15,292 $ 68,150
Due after one but within
five years 27,666 0
Due after five years 47,524 0
Total $ 90,482 $ 68,150
</TABLE>
- -13-
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<S> <C> <C> <C> <C> <C>
Years Ended December 31
1998 1997 1996 1995 1994
(000 omitted)
Average total loans
outstanding (net of
unearned income) $ 144,013 $ 117,403 $ 105,779 $ 97,662 $ 81,740
Allowance for loan
losses, beginning
of period $ 1,767 $ 1,620 $ 1,433 $ 1,200 $ 1,125
Additions to provision
for loan losses
charged to operations 270 215 240 270 71
Loans charged off
during the year
Commercial 15 1 20 0 0
Personal credit lines 23 32 17 3 1
Installment 46 50 31 48 7
Total charge-off's 84 83 68 51 8
Recoveries of loans
previously charged off:
Commercial 3 2 3 0 0
Installment 10 12 12 14 12
Personal credit lines 5 1 0 0 0
Total recoveries 18 15 15 14 12
Net loans charged off
(recovered) 66 68 53 37 ( 4)
Allowance for loan
losses, end of
period $ 1,971 $ 1,767 $ 1,620 $ 1,433 $ 1,200
Ratio of net loans
charged off to
average loans
outstanding .06% .06% .05% .04% 0.0%
</TABLE>
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.
<TABLE>
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
(000 omitted)
Nonaccrual loans $ 486 $ 473 $ 14 $ 132 $ 27
Accrual loans:
Restructured $ 0 $ 0 $ 0 $ 0 $ 0
30 through 89
days past due 823 2,398 1,976 1,949 1,553
90 days or
more past due 284 657 203 417 155
Total accrual
loans $ 1,107 $ 3,055 $ 2,179 $ 2,366 $ 1,708
</TABLE>
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, 1998.
- -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:
<TABLE>
<S> <C> <C> <C> <C>
Years Ended December 31
1998 1997
Percentage Percentage
Allowance of Loans to Allowance of Loans to
Amount Total Loans Amount Total Loans
(000 omitted)
Commercial, financial
and agricultural $ 255 9.93% $ 31 8.00%
Commercial, real estate
secured 416 19.43 354 35.00
Real estate -
Construction 0 7.05 0 4.64
Real estate -
Mortgage 111 53.77 188 40.64
Installment 34 9.82 12 11.72
Unallocated 1,155 0.00 1,182 0.00
Total $ 1,971 100.00% $ 1,767 100.00%
Years Ended December 31
1996 1995
Percentage Percentage
Allowance of Loans to Allowance of Loans to
Amount Total Loans Amount Total Loans
(000 omitted)
Commercial, financial
and agricultural $ 125 7.71% $ 114 7.98%
Commercial - Real estate
secured 0 0.00 0 0.0
Real estate -
Construction 64 3.95 80 5.55
Real estate -
Mortgage 1,229 75.91 1,055 73.63
Installment 202 12.43 184 12.84
Unallocated 0 0.00 0 0.00
Total $ 1,620 100.00% $ 1,433 100.00%
</TABLE>
- -16-
Year Ended December 31
1994
<TABLE>
<S> <C> <C>
Percentage
Allowance of Loans to
Amount Total Loans
(000 omitted)
Commercial, financial
and agricultural $ 113 9.42%
Commercial - Real estate
secured 0 0.00
Real estate -
Construction 67 5.58
Real estate -
Mortgage 844 70.33
Installment 176 14.67
Unallocated 0 0.00
Total $ 1,200 100.00%
</TABLE>
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
DEPOSITS
The average amounts of deposits are summarized below:
<TABLE>
<S> <C> <C> <C>
Years Ended December 31
1998 1997 1996
(000 omitted)
Demand deposits $ 20,433 $ 17,665 $ 16,078
Interest bearing demand
deposits 55,454 37,535 27,601
Savings deposits 23,394 24,568 26,555
Time deposits 74,488 68,161 63,767
Total deposits $ 173,769 $ 147,929 $ 134,001
</TABLE>
The following is a breakdown of maturities of time deposits
of $ 100,000 or more as of December 31, 1998:
<TABLE>
<S> <C> <C>
Maturity (000 omitted)
Certificates of Deposit
Three months or less $ 2,605
Over three months through
six months 6,178
Over six months through
twelve months 1,241
Over twelve months 200
$ 10,224
</TABLE>
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)
<TABLE>
<S> <C> <C> <C>
1998 1997 1996
Average assets $ 212,149 $ 172,366 $ 153,145
Net income $ 3,119 $ 2,606 $ 2,248
Average equity $ 19,523 $ 16,956 $ 15,076
Cash dividends paid $ 986 $ 903 $ 694
Return on assets 1.47% 1.51% 1.47%
Return on equity 15.97% 15.37% 14.90%
Dividend payout ratio 31.59% 34.65% 30.87%
Equity to asset ratio 9.2% 9.84% 9.8%
</TABLE>
- -17-
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED SUMMARY OF OPERATIONS
<TABLE>
<S> <C> <C> <C> <C> <C>
Years Ended December 31
1998 1997 1996 1995 1994
(000 omitted)
Interest income $ 16,109 $ 13,450 $ 12,018 $ 10,829 $ 8,571
Interest expense 7,348 5,822 5,139 4,542 3,241
Net interest income 8,761 7,628 6,879 6,287 5,330
Provision for loan
losses 270 215 240 270 71
Net interest
income after
provision for
loan losses 8,491 7,413 6,639 6,017 5,259
Other income:
Trust and brokerage
services 818 490 384 297 185
Service charges -
Deposits 646 601 477 375 349
Other service charges,
collection and
exchange, charges,
commission fees 667 341 258 218 180
Other operating
income (loss) 122 119 121 45 146
Total other
income 2,253 1,551 1,240 935 860
Income before
operating expense 10,744 8,964 7,879 6,952 6,119
Operating expenses:
Salaries and
employees benefits 3,491 2,901 2,621 2,326 2,115
Occupancy and
equipment expense 859 764 665 559 486
Other operating
expenses 2,095 1,719 1,507 1,371 1,363
Total operating
expenses 6,445 5,384 4,793 4,256 3,964
Income before income
taxes 4,299 3,580 3,086 2,696 2,155
Income tax 1,180 974 838 742 520
Net income
applicable to
common stock $ 3,119 $ 2,606 $ 2,248 $ 1,954 $ 1,635
Per share data:
Earnings per common
share $ 1.52 $ 1.27 $ 1.10 $ .95 $ .80
Cash dividend -
Common $ .48 $ .44 $ .34 $ .29 $ .25
Weighted average
number of common
shares 2,051,831 2,050,646 2,051,412 2,052,614 2,052,614
</TABLE>
- -18-
Item 9. Disagreements on Accounting and Financial Disclosures.
Not applicable.
- -19-
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 1999
Annual Meeting of Shareholders filed pursuant to Regulation
14A.
- -20-
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, 1998, are incorporated by reference
in Item 8:
Consolidated balance sheets - December 31,
1998 and 1997
Consolidated statements of income - Years
ended December 31, 1998, 1997 and 1996
Consolidated statements of stockholders'
equity - Years ended December 31, 1998, 1997,
and 1996
Consolidated statements of cash flows - Years
ended December 31, 1998, 1997, and 1996
Notes to consolidated financial statements -
December 31, 1998
(2) List of Financial Statement Schedules
Schedule I - Changes in net interest income
tax equivalent yields
Schedule II - Investment portfolio
Schedule III - Loan portfolio
- -21-
Schedule IV - Summary of loan loss experience
Schedule V - Nonaccrual, delinquent and
impaired loans
Schedule VI - Allocation of allowance for loan
losses
Schedule VII - Deposits and return on equity
and assets
Schedule VIII - Consolidated summary of
operations
All other schedules for which provision is made in
the applicable accounting regulation 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 regulation of the
Securities and Exchange Commission are not
required under the related instructions or are
inapplicable and therefore have been omitted.
- -22-
(b) Reports on Form 8-K filed
None.
(c) Exhibits
(3)(i) Articles of incorporation. Filed herewith.
(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., filed herewith.
(ii) By-laws of Orrstown Financial
Services, Inc., filed as Exhibit 3.2
to the Registrant's Registration
Statement on Form S-4 (Registration
No. 33-18888).
(10) 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.
(13) Annual report to security holders - filed
herewith
- -23-
(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
The following financial statement schedules
required under Article 9 Industry Guide 3 have
been included on pages 11 to 18 under Item 8
of this report:
Schedule I - Changes in net interest income
tax equivalent yields.
Schedule II - Investment portfolio
Schedule III - Loan portfolio
Schedule IV - Summary of loan loss experience
Schedule V - Nonaccrual delinquent and
impaired loans
Schedule VI - Allocation of allowance for loan
losses
Schedule VII - Deposits and return on equity
and assets
Schedule VIII - Consolidated summary of
operations
- -24-
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 26, 1999 (Duly authorized officer)
By /s/ Robert B. Russell
Robert B. Russell, Controller
(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 and March 26 , 1999
Kenneth R. Shoemaker Director
/s/ Anthony F. Ceddia Director March 26 , 1999
Dr. Anthony F. Ceddia
/s/ Robert T. Henry Secretary and
Robert T. Henry Director March 26 , 1999
/s/ Gregory A. Rosenberry Director March 26 , 1999
Gregory A. Rosenberry
/s/ Joel R. Zullinger Chairman of the March 26 , 1999
Joel R. Zullinger Board and Director
/s/ Jeffrey W. Coy Vice Chairman March 26 , 1999
Jeffrey W. Coy of the Board
and Director
Director Deceased January
Ned R. Fogelsonger 20, 1999
/s/ Denver L. Tuckey________ Director March 26 , 1999
Denver L. Tuckey
/s/ Andrea Pugh_____________ Director March 26 , 1999
Andrea Pugh
- -25-
Exhibit 3(i)
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF STATE
CORPORATION BUREAU
The undersigned desiring to incorporate a business
corporation under the provisions of the Business
Corporation Law of the Commonwealth of Pennsylvania (Act of
May 5, 1933, P.L. 364, as amended) does hereby certify:
ARTICLES OF INCORPORATION:
1. The name of the Corporation is:
Orrstown Financial Services, Inc.
2. The location and post office address of its
initial registered office in the Commonwealth of
Pennsylvania is:
3580 Orrstown Road
Orrstown, Franklin County, Pennsylvania 17244
3. The purpose or purposes for which the
Corporation is incorporated are:
To have unlimited power to engage in and do any
lawful acts concerning any or all lawful business for which
corporations may be incorporated under the provisions of
the Business Corporation Law of the Commonwealth of
Pennsylvania. The Corporation is incorporated under the
provisions of the Business Corporation Law of the
Commonwealth of Pennsylvania (Act of May 5, 1933, P.L. 364,
as amended).
4. The term for which the Corporation is to exist is
perpetual.
5. The shareholders of the Corporation shall not
have the right to cumulate their shares in voting for the
election of directors.
6. (a) The aggregate number of shares which the
Corporation shall have authority to issue is:
(i) 10,000,000 shares of Common Stock with no par
value; and (*)
(ii) 500,000 shares of Preferred Stock with a par
value of $1.25 per share.
(b) The relative rights, preferences and
designations of the Preferred stock shall be as follows:
The Board of Directors may issue, in one or more
series, the shares of Preferred Stock, with full,
limited, multiple, fractional or no voting
rights, and with such designations, preferences,
qualifications, privileges, limitations,
restrictions, options, conversion rights or other
special or relative rights as shall be fixed from
time to time by resolution of the Board of
Directors.
7. A. The Board of Directors may, if it deems
advisable, recommend or oppose a tender or other offer for
the Corporation's securities, whether the offer is in cash
or in the securities of a corporation or otherwise. When
considering whether to recommend or oppose an offer, the
Board of Directors may, but is not legally obligated to,
consider any pertinent issue. By way of illustration, but
not limitation, the Board of Directors may, but shall not
be legally obligated to, consider any or all of the
following:
(1) whether the offer price is acceptable
based on the historical and present operating results or
financial condition of the Corporation;
(2) whether a more favorable price could be
obtained for the Corporation's securities in the future;
(3) the impact which an acquisition of the
Corporation would have on the employees, depositors and
customers of the Corporation and its subsidiaries and the
community which they serve;
(4) the reputation and business practices
of the offeror and its management and affiliates as they
would affect the employees, depositors and customers of the
Corporation and its subsidiaries and the future value of
the Corporation's stock;
(5) the value of the securities (if any)
which the offeror is offering in exchange for the
Corporation's securities, based on an analysis of the worth
of the Corporation as compared to the corporation or other
entity whose securities are being offered;
(6) any antitrust or other legal and
regulatory issues that are raised by the offer.
- -2-
(B) If the Board of Directors determines that an
offer should be opposed, it may take any lawful action for
that purpose, including, but not limited to, any, or all of
the following: advising shareholders not to accept the
offer; litigation against the offeror; filing complaints
with all governmental and regulatory authorities; acquiring
the Corporation's securities; selling or otherwise issuing
authorized but unissued securities or treasury stock or
granting options, warrants or rights with respect thereto;
making defensive acquisitions; and obtaining a more
favorable offer from another individual or entity.
8. Any business combination (including a plan of
merger or consolidation) or sale or transfer of all or
substantially all of the assets of the Corporation with or
to a shareholder of the Corporation who, directly or
indirectly, has voting control over 10% or more of any
class of shares of the Corporation or with or to an entity
which, directly or indirectly, is controlled by such a
shareholder, shall require the approval by the Board of
Directors of the Corporation and approval by shareholders
entitled to cast at least three-fourths of the votes which
all shareholders are entitled to cast thereon; provided,
however, if such business combination or sale or transfer
is approved by at least three-fourths of the Directors of
the Corporation, then approval by shareholders entitled to
cast a majority of the votes which all shareholders are
entitled to cast shall be sufficient.
9. If any person (including any individual,
corporation, partnership or other entity) directly or
indirectly acquires shares of the Corporation entitling
the owner to cast at least 10% of the votes which all
shareholders would be entitled to cast in the election of
Directors of the Corporation, then any business
combination (including a plan of merger or consolidation)
with such person or an entity directly or indirectly
controlled by such person shall require such person to
offer to pay the other shareholders of the Corporation at
least the highest price paid directly or indirectly by
such person for any of the shares then directly or
indirectly owned by such person. For purposes of this
provision "price" shall mean the sum of any cash and the
fair value of any other consideration paid for any of such
shares.
10. These Articles of Incorporation may be
amended by the affirmative vote of shareholders entitled
to cast at least three-fourths of the votes which all
shareholders are entitled to cast unless approved by
three-fourths of the Directors of the Corporation, in
which case approval by shareholders entitled to cast a
majority of the votes which all shareholders are entitled
to cast shall be sufficient.
- -3-
11. Section 910 of the Pennsylvania Business
Corporation Law shall not be applicable to the Corporation.
12. The name and post office address of the
incorporator and the number and class of shares subscribed
by him are:
Name Address Number & Class of
Share
Michael A. Budin, 12th Floor Packard
Esq. Bldg. One share of
Philadelphia, PA 19102 common stock
IN TESTIMONY WHEREOF, the incorporator has signed and
sealed these Articles of Incorporation this 12th day of
November, 1987.
/s/ Michael A. Budin(SEAL)
Incorporator
Filed this 17th day of November A.D. 1987
Commonwealth of Pennsylvania
Department of State
/s/ James J. Hagerty
Secretary of the Commonwealth
(*) Amended May 24, 1989 to eliminate par value as to
shares of common stock; amended May 27, 1998 to
increase number of authorized shares of common stock
from 2,000,000 shares to 10,000,000 shares.
- -4-
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
1. Orrstown Bank, Orrstown, Pennsylvania; a state-chartered
bank organized under the Pennsylvania Banking Code of 1965.
Exhibit 23.1
Independent Auditor's Consent
Board of Directors and Shareholders
Orrstown Financial Services, Inc.
We consent to the incorporation by reference in
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 29, 1999, appearing in this annual report on Form
10-K of Orrstown Financial Services, Inc. for the year ended
December 31, 1998.
SMITH ELLIOTT KEARNS & COMPANY, LLC
Chambersburg, Pennsylvania
March 24, 1999
It is our mission to be the premier financial institution in the markets
we serve. We will seek to maximize shareholder value by achieving
superior financial performance.
Our focus is to provide unmatched customer service and quality products
that meet the credit, investment, and associated needs of our customers.
We will be an active corporate citizen that is committed to employing
the resources and leadership needed to enhance the quality of life of
all our constituents.
LETTER TO SHAREHOLDERS t
Some years ago there was a popular song that included the words:
"You've got to accentuate the positive. Eliminate the negative. Latch on
to the affirmative. Don't mess with Mr. In-between." How true. How true.
They have become words to live by!
During the last year, we continued to accentuate our positive
position as a strong, local, independent bank, through stellar financial
performance, sound operations, and superior customer service. Mergers of
some of our major competitors into large national and regional con-
glomerates facilitated our ability to compete, and we latched on to the
affirmative message that hometown banking offers big advantages.
1998 was a landmark year for financial performance at Orrstown
Financial Services, Inc. Our strong relationships with shareholders,
customers, and employees enabled the company to achieve record earnings
for the 11th consecutive year. Net income increased 19.7% to a record
$3,119,000 or $1.52 per share. These results represent a return on
average assets of 1.47% and a return on average shareholder's equity of
15.97%. Both of these important ratios exemplify that Orrstown Financial
Services, Inc., is outperforming its peer groups by a wide margin.
Accentuate the Positive!
The primary reasons for our record-setting performance were stellar
growth in loans and deposits, pristine asset quality, and substantial
improvement in fee income. At year end, total assets had grown to
$235,822,000-an increase of 24% over the previous year end totals. Loan
demand was very strong throughout the year, with total outstandings
reaching $158,632,000-an increase of 23.6% over figures reported at the
end of 1997.
Deposit growth was strong as well, increasing 14.4% to $183,764,000.
We were extremely pleased that the majority of this growth occurred in
core accounts, with non-interest bearing deposits increasing 24.8%. Lead
by the tremendous popularity of our Hometown Investment Account,
interest bearing transaction accounts advanced 29.2% over the previous
year for a total increase of nearly $18,000,000.
Shareholders' equity grew 15.4% or $2,816,000, increasing the
corporation's total capital to $21,080,000. Even though the company grew
significantly during 1998, the 8.94% equity to assets ratio continues to
exceed regulatory guidelines by a comfortable margin. The book value per
share of our stock grew 15.2%, from $8.91 on December 31, 1997 to $10.26
on December 31, 1998.
Orrstown Financial Services, Inc. shareholders enjoyed a superior
return on their investment in 1998! Based upon the excellent financial
performance achieved during the year, the cash dividend was increased on
several occasions which resulted in a gain of 9.1% over the amount
distributed in 1997. On November 21, 1997, a two-for-one stock split was
effected to bring the market price into a more favorable trading range.
The corporation's stock closed the year at $28.00 per share, compared to
the 1997 year end price of $22.50. In other words, the market value of
Orrstown Financial Services, Inc. stock increased 24.4% in 1998!
Latch on to the affirmative.
Taking an historical look at the company, Orrstown's consistent
payment of stock dividends and periodic stock splits have produced an
exceptional return for shareholders. On December 31, 1981, 100 shares of
Orrstown common stock were valued at $12,000. An investor who simply
held onto those shares would, as of December 31, 1998, own 9,916 shares
valued at $277,648.00-a compounded annual rate of return of 19% over the
17-year period. And that's without counting the cash dividends! Not too
bad for a little bank with its roots in Orrstown!
Our Asset Management and Trust division continues to surpass our
expectations. Assets under management at year end stood at more than
$150,000,000. Unlike trust departments of many financial institutions,
ours is making a substantial contribution to the company's bottom line.
Headed by Philip Fague, Senior Vice President, this division is
positioned to enjoy stellar growth in the years ahead. The officer staff
of this important department was made even stronger during 1998 with the
addition of Bradley Gerlach, Vice President, who transferred from
another area of the bank, and Joseph Bowden, Trust Officer. Both of
these individuals share a deep commitment to providing quality service
to their clients, and we are pleased that they are a part of our Trust
team.
Sound operations will play a key role in the years ahead as we strive
to maintain our record of success. In November of 1998, we were
fortunate to add a quality individual to our senior management team in
the person of Benjamin Stoops. Ben is responsible for the management of
various areas of bank operations, and is charged with evaluating and
implementing computer hardware and software. During the first quarter of
1999, new equipment will be installed that will provide a more efficient
operating environment for all data processing requirements.
Eliminate the negative.
Under the leadership of Stephen Oldt, Executive Vice President, our
company has been working diligently to make sure that all mission
critical systems of our operation are compliant for the year 2000 issue.
Our bank has taken the Y2K situation very seriously and is implementing
remedial action where necessary. The new computer equipment mentioned
previously will assist us in preparing for this century-ending event. We
are confident in our ability to address this issue and every measure
will be taken to prevent interruption of services.
Going forward, the corporation will take advantage of technological
opportunities to improve service to our clients and gain operating
efficiencies. We were among the first banks in this area to enhance
customer service by providing access to account information through
telephone banking. Our company "homepage" provides bank information to
anyone seeking it through the internet. We also anticipate being able to
offer internet banking to interested customers before year end. Contact
us at www.orrstown.com to learn more about your company!
Don't mess with Mr. In-between.
In July of 1998, we had the opportunity to purchase a building
adjacent to our King Street facilities in Shippens-burg. Over the
ensuing months, detailed plans were developed and evaluated that called
for the demolition of this building to allow for the construction of a
new customer support center. While this will be a major project for our
company, it is necessary to accommodate the anticipated growth over the
next decade. The new structure will allow our company to finally house
most operational and administrative personnel at the same location,
creating a much more efficient work environment. The building will also
provide much needed space, including a dividable conference room for
training and employee meetings. In addition, customer parking will be
improved with the creation of approximately 40 additional spaces. We
expect construction to begin in early spring.
We have come a long way in the past two decades. But in my view, it's
just the beginning. We have in place a company prepared to build on the
momentum it has created. With increased emphasis on innovative products,
superior service, consultative selling, and enhanced delivery channels,
I believe our company has incredible potential.
Opportunities for growth have never been better due to the
competitive edge we've gained through other bank mergers. We have the
unique distinction of being able to offer our customers the very best in
banking products, along with friendly, hometown service. However, we
can't just be competitive. We have to be the best at everything that is
important to the customer. Focus on the things we know how to do well.
Relentlessly. That's how we will achieve our maximum potential!
It is important that we pay tribute to Galen L. Myers who retired
from our Board of Directors in April after 20 years of dedicated
service. Galen provided valuable guidance as a Director and was
instrumental in helping our company achieve success by serving as
Chairman of the Board for nine years. Galen continues to be a positive
influence on our company through his role as Director Emeritus.
With tremendous sadness, we note the passing of Director Ned
Fogelsonger, who died on January 20, 1999. Ned's insight, energetic
support, and sense of humor will be missed by everyone associated with
our company. As a local businessman, he was a pillar
of the community and gave selflessly of his time to many
organizations. Ned was also a close friend and in many ways, my personal
hero. I salute his contributions to our success.
I also want to acknowledge the support and encouragement of our
current Board of Directors. Their guidance and strong business acumen is
extremely valuable in charting the strategic course for our company.
Being a strong proponent of a team management style, it is fitting that
I commend and thank our senior officers for their contributions during
the past year. These committed professionals work together to constantly
raise the bar, and that's what it's all about!
Accentuate the positive.
There is nothing more positive to accentuate than the dedication of
our entire staff. None of our success would be possible without their
effort. I am proud to extend my sincere appreciation to them for making
it happen!
Kenneth R. Shoemaker
President and Chief Executive Officer
t CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
ASSETS Dec. 31, 1998
Dec. 31, 1997
(000 omitted)
(000 omitted)
Cash and due from banks $7,028
$5,963
Interest bearing deposits with banks 27
16
Federal funds sold 8,072
2,858
Securities available for sale 49,852
46,208
Federal Home Loan Bank, Federal Reserve and Atlantic Central Bankers
Bank stock, at cost which approximates market value
1,285 983
66,264
56,028
Loans
Commercial, financial and agricultural 18,732
10,275
Real estate-Mortgages 116,030
97,074
Real estate-Construction and land development 11,182
5,961
Consumer 12,688
15,021
158,632
128,331
Less:Allowance for loan losses ( 1,971)
(1,767)
156,661
126,564
Bank premises and equipment, net 5,224
5,130
Accrued interest receivable 1,235
1,299
Cash surrender value of life insurance 5,099
258
Other assets 1,339
963
Total assets $235,822
$190,242
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $22,020
$17,649
Interest bearing 161,744
142,931
183,764
160,580
Federal funds purchased and securities sold under agreements to
repurchase 6,234
235
Other borrowed funds 20,828
8,334
Accrued interest and other liabilities 3,916
2,828
Total liabilities 214,742
171,977
Shareholders' equity
Common stock:No par value-$.1041 stated value per share, 1998;
and $.2083 stated value per share, 1997; 10,000,000 shares
authorized with 2,055,315 shares issued at December 31, 1998; 1,025,094
shares issued at December 31, 1997
214 214
Additional paid-in capital 12,476
12,352
Retained earnings 6,863
4,730
Accumulated other comprehensive income 1,527
969
Total shareholders' equity 21,080
18,265
Total liabilities and shareholders' equity $ 235,822
$ 190,242
Consolidated Statements of Income
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31,
1998 1997
1996
(000 omitted)
Interest and Dividend Income
Interest and fees on loans $ 12,836 $ 10,702
$ 9,675
Interest and dividends on investment securities
U.S. Government and agencies 1,840 1,548
1,265
Exempt from federal income tax 1,036 935
601
Other investment income 397 265
477
Total interest and dividend income 16,109 13,450
12,018
Interest Expense
Interest on deposits 6,479 5,495
4,981
Interest on borrowed money 869 327
158
Total interest expense 7,348 5,822
5,139
Net interest income 8,761 7,628
6,879
Provision for loan losses 270 215
240
Net interest income after provision for loan losses 8,491
7,413 6,639
Other Income
Service charges on deposit accounts 646 601
477
Other service charges, commissions, and fees 667 341
258
Trust department income 656 490
384
Brokerage income 162 59
64
Securities gains (losses) ( 9) 3
(5)
Other income 131 57
62
Total other income 2,253 1,551
1,240
Net interest income and other income 10,744 8,964
7,879
Other Expenses
Salaries and employee benefits 3,491 2,901
2,621
Occupancy expense of bank premises, net, and furniture and equipment
expenses
859 764 665
FDIC insurance premiums 20 17
2
Other operating expenses 2,075 1,702
1,505
Total other expenses 6,445 5,384
4,793
Income before income tax 4,299 3,580
3,086
Applicable income tax 1,180 974
838
Net income $ 3,119 $ 2,606
$ 2,248
Per share data
Net income $1.52 $ 1.27
$ 1.10
Dividends $.48 $ .44
$ .34
Weighted average shares outstanding 2,051,831 2,050,646
2,051,412
Consolidated Statements of Changes in Shareholders' Equity
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31, 1998, 1997, and 1996
(000 omitted)
Balance, December 31, 1995 $ 204 $10,625 $3,232 $572
$ 14,633
Comprehensive Income
Net income 0 0 2,248 0
2,248
Change in unrealized loss on investment securities available for sale,
net of tax of $171
0 0 0 (331) (331)
Total comprehensive income 0 0 0 0
1,917
Cash dividends ($ .34 per share) 0 0 ( 694) 0
(694)
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 $375
0 0 0 728 728
Total comprehensive income 0 0 0 0
3,334
Cash dividends ($.44 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 $287
0 0 0 558 558
Total comprehensive income 0 0 0 0
3,677
Cash dividends ($.48 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
Consolidated Statements of Cash Flows
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
Years Ended December 31,
1998 1997
1996
(000 omitted)
Cash flows from operating activities:
Net income $3,119 $2,606
$2,248
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 438 364
329
Provision for loan losses 270 215
240
Deferred income taxes 27 (7)
(62)
(Gain) loss on disposal of other real estate 0 0
5
(Gain) loss on disposal of bank premises and equipment 0
0 (20)
Securities (gains) losses 9 (3)
5
(Increase) decrease in accrued interest receivable 64
(370) 64
Increase (decrease) in accrued interest payable 483
480 278
Other net (152) (59)
64
Net cash provided by operating activities 4,258 3,226
3,151
Cash flows from investing activities:
Net (increase) decrease in interest bearing deposits with banks
( 11) 1,538 (265)
Sales of available for sale securities 8,923 15
2,392
Maturities of available for sale securities 2,390 3,114
3,508
Purchases of available for sale securities ( 14,120) ( 14,811)
(9,134)
Purchases of FHLB stock ( 302) (49)
( 65)
Net (increase) in loans (30,367) ( 19,473)
( 6,291)
Proceeds from sale of bank premises and equipment 0
0 36
Proceeds from disposal of other real estate 0 0
142
Purchases of bank premises and equipment ( 491) ( 1,537)
(1,178)
Investment in cash surrender value of life insurance (4,816)
0 0
Net cash (used) by investing activities (38,794) (31,203)
(10,855)
Cash flows from financing activities:
Net increase in deposits 23,184 23,321
9,929
Net increase in federal funds purchased and securities sold
under agreements to repurchase
5,999 235 0
Proceeds from debt 12,500 6,000
0
Payment on debt (6) (5)
( 6)
Cash dividends paid (986) ( 903)
( 694)
Cash paid in lieu of fractional stock dividends 0
(22) 0
Proceeds from sale of stock 124 0
0
Net cash provided by financing activities 40,815 28,626
9,229
Net increase in cash and cash equivalents 6,279 649
1,525
Cash and cash equivalents, beginning balance 8,821 8,172
6,647
Cash and cash equivalents, ending balance $15,100 $8,821
$8,172
Supplemental disclosure of cash flows information:
Cash paid during the year for:Interest
$6,865 $5,343 $5,418
Income taxes 1,200 974
892
Supplemental schedule of noncash investing and financing activities:
Other real estate acquired in settlement of loans 264
0 169
Unrealized gain (loss) on investment securities available for
sale (net of tax effects)
558 728 (331)
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 seven
branches are located in Shippensburg (2), Carlisle (2), Spring Run,
Orrstown, and Chambersburg, Pennsylvania.
Principles of consolidation
The consolidated financial statements include the accounts of the
corporation and its wholly-owned subsidiary, Orrstown Bank. All
significant intercompany transactions and accounts have been eliminated.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for losses on loans
and the valuation of real estate acquired in connection with
foreclosures or in satisfaction of loans. In connection with the
determination of the allowances for losses on loans and foreclosed real
estate, management obtains independent appraisals for significant
properties.
While management uses available information to recognize losses on
loans and foreclosed real estate, future additions to the allowances may
be necessary based on changes in local economic conditions. In addition,
regulatory agencies, as an integral part of their examination process,
periodically review the corporation's allowances for losses on loans and
foreclosed real estate. Such agencies may require the corporation to
recognize additions to the allowances based on their judgments about
information available to them at the time of their examination. Because
of these factors, management's estimate of credit losses inherent in the
loan portfolio and the related allowance may change in the near term.
Investment securities
In accordance with Statement of Financial Accounting Standards No.
115 (SFAS 115) the Bank may segregate their investment portfolio into
three specific categories: "securities held to maturity", "trading
securities" and "securities available for sale". Securities held to
maturity are to be accounted for at their amortized cost; securities
classified as trading securities are to be accounted for at their
current market value with unrealized gains and losses on such securities
included in current period earnings; and securities classified as
available for sale are to be accounted for at their current market value
with unrealized gains and losses on such securities to be excluded from
earnings and reported 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.
Advertising
The corporation follows the policy of charging costs of advertising
to expense as incurred. Advertising expenses were $154,000, $149,000,
and $87,000 for 1998, 1997 and 1996, respectively.
Loans and allowance for loan losses
Loans are stated at the amount of unpaid principal, reduced by an
allowance for loan losses. Interest on loans is calculated by using the
simple interest method on daily balances of the principal amount
outstanding. Loan origination and commitment fees
and certain direct costs are deferred and the net amount amortized
over the contractual life of the loan as an adjustment of the loan's
yield. If a loan is sold, any deferred fees not yet amortized are
recognized as an adjustment to the gain or loss on sale. The allowance
for loan losses is established through a provision for loan losses
charged to expenses. Loans are charged against the allowance when
management believes that the collectibility of the principal is
unlikely. The allowance is an amount that management believes will be
adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of loans and
prior loan loss experience. The evaluations take into consideration such
factors as changes in the nature and volume of the loan portfolio,
overall portfolio quality, review of specific problem loans, and current
economic conditions that may affect the borrowers' ability to pay.
Nonaccrual loans
The accrual of interest income on loans ceases when principal or
interest is past due 90 days or more and collateral is inadequate to
cover principal and interest or immediately if, in the opinion of
management, full collection is unlikely. Interest accrued but not
collected as of the date of placement on nonaccrual status is reversed
and charged against current income unless fully collater-alized.
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 2,051,831 in 1998;
2,050,646 in 1997; and 2,051,412 in 1996 after giving retroactive
recognition to 5% stock dividend issued in May 1997, and 2 for-1 stock
split in November 1998.
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
Note10 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.
The components of the change in net unrealized gains (losses) on
securities were as follows:
1998 1997
1996
(000 omitted)
Gross unrealized holding gains (losses) arising during the year
$ 836 $1,106
($
507)
Reclassification adjustment for (gains) losses realized in net
income
9 ( 3) 5
Net unrealized holding gains (losses) before taxes 845
1,103 (502)
Tax effect ( 287) ( 375)
171
Net change $ 558 $ 728
($ 331)
NOTE 2.INVESTMENTS
At December 31, 1998 and 1997 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 December31 were:
(000 omitted)
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
1997
U. S. Treasury securities and obligations of U. S. Government
corporations and agencies $12,837 $174 $1
$13,010
Obligations of states and political subdivisions 17,611 961
0 18,572
Mortgage-backed securities 13,812 122 34
13,900
Equity securities 480 246 0
726
Totals $44,740 $ 1,503 $35
$46,208
The amortized cost and fair values of investment securities available
for sale at December31, 1998, by expected maturity are shown below.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Amortized
Cost Fair Value
(000 omitted)
Due in one year or less $2,511 $ 2,524
Due after one year through five years 7,700 8,038
Due after five years through ten years 10,218 10,603
Due after ten years 12,054 12,694
Mortgage-backed securities 14,369 14,524
Equity securities 686 1,469
$47,538 $ 49,852
Proceeds from sales of securities available for sale during 1998,
1997 and 1996 were $8,923,000, $15,000 and $2,392,000, 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. Gross gains and losses on 1996 sales were $16,440
and $21,455, respectively.
The bank owns $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 at December 31, 1998. At December31, 1997 the bank's stock
ownership was $739,800 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 $27,254,000 and $19,198,000 at December31,
1998 and 1997, respectively, were pledged to secure public funds and for
other purposes as required or permitted by law.
NOTE 3.CONCENTRATION OF CREDIT RISK
The bank grants agribusiness, commercial, residential and consumer
loans to customers in South Central Pennsylvania, principally Franklin
and Cumberland Counties. The concentrations of credit by type of loan
are set forth on the face of the balance sheet. The bank maintains a
diversified loan portfolio and evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the bank upon the extension of credit,
is based on management's credit evaluation of the customer. Collateral
held varies but generally includes equipment and real estate.
NOTE 4.ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is summarized as follows:
1998 1997
1996
(000 omitted)
Balance at beginning of period $1,767 $1,620
$1,433
Recoveries 18 15
15
Provision for loan losses charged to income 270 215
240
Total 2,055 1,850
1,688
Losses 84 83
68
Balance at the end of period $1,971 $1,767
$1,620
NOTE 5.BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment is as follows:
1998 1997
(000 omitted)
Land $ 606 $ 606
Buildings and improvements 3,785 3,749
Leasehold improvements 173 173
Furniture and equipment 3,050 2,840
Construction in progress 236 0
Total 7,850 7,368
Less accumulated depreciation and amortization 2,626
2,238
Bank premises and equipment, net $5,224 $5,130
Depreciation expense amounted to $397,246 in 1998, $323,652 in
1997, and $287,624 in 1996.
NOTE 6.LOANS TO RELATED PARTIES
The bank has granted loans to the officers and directors of the
corporation and its subsidiary and to their associates. Related party
loans are made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable
transactions with unrelated persons and do not involve more than normal
risk of collectibility. The aggregate dollar amount of these loans was
$1,888,000 at December31, 1998 and $1,507,000 at December 31, 1997.
During 1998, 1,159,000 of new loans were made and repayments totaled
$778,000.
Outstanding loans to bank employees totaled $1,424,000 at December
31, 1998.
NOTE 7.NONACCRUAL LOANS
The following table shows the principal balances of nonaccrual loans
as of December31:
1998 1997
1996
Nonaccrual loans $486,000 $473,000
$ 14,000
Interest income that would have been accrued at original contract
rates $39,878 $30,835
$560
Amount recognized as interest income 5,579 5,829
0
Foregone revenue $34,299 $25,006
$560
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.
The corporation had no impairment of loans during 1996 as defined by
Statement of Financial Accounting Standard No. 114.
NOTE 8.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financial needs of its
customers and to reduce its own exposure to fluctuations in interest
rates. These financial instruments include commitments to extend credit
and standby letters of credit. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the
amount recognized in the balance sheets. The contract amounts of those
instruments reflect the extent of involvement the bank has in particular
classes of financial instruments.
The bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend
credit and standby letters of credit and financial guarantees written is
represented by the contractual amount of those instruments. The bank
uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
Contract or
National Amount
1998 1997
(000 omitted)
Financial instruments whose contract amounts represent credit risk at
December 31:
Commitments to extend credit $36,653 $23,852
Standby letters of credit and financial guarantees written 3,863
2,811
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash
requirements. The bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained if deemed
necessary by the bank upon extension of credit is based on management's
credit evaluation of the customer. Collateral held varies but may
include accounts receivable, inventory, real estate, equipment, and
income-producing commercial properties.
Standby letters of credit and financial guarantees written are
conditional commitments issued by the bank to guarantee the performance
of a customer to a third party. Those guarantees are primarily issued to
support public and private borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that
involved in extending loans to customers. The bank holds collateral
supporting those commitments when deemed necessary by management.
NOTE 9.EMPLOYEE BENEFIT PLANS
The bank maintains a 401(k) profit-sharing plan for those employees
who meet the eligibility requirements set forth in the plan. Employer
contributions to the plan are based on bank performance and are at the
discretion of the bank's Board of Directors. In addition, there is a
provision for an employer match of 50 cents on the dollar for employee
contributions up to 6% of the employees' eligible compensation.
Substantially all of the bank's employees are covered by the plan and
the contributions charged to operations were $371,621, $319,182 and
$306,379 for 1998, 1997, and 1996, respectively.
The bank has a deferred compensation arrangement with certain present
and former board directors whereby a director or his beneficiaries will
receive a monthly retirement benefit at age 65. The arrangement is
funded by an amount of life insurance on the participating director
calculated to meet the bank's obligations under the compensation
agreement. The cash value of the life insurance policies is an
unrestricted asset of the bank. The estimated present value of future
benefits to be paid, which is included in other liabilities, amounted to
$166,214 and $166,237 at December31, 1998 and 1997, respectively. Total
annual expense for this deferred compensation plan was $19,064 for 1998
and 1997, and $20,153 for 1996.
The bank 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 Bank's trust department. Total amount contributed to the
plan was $30,725, $46,425 and $55,950 for 1998, 1997 and 1996,
respectively.
During 1998 the bank 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 bank. The estimated present value of future
benefits to be paid totaled $41,151 at December 31, 1998 which is
included in other liabilities. Total annual expense for these plans
amounted to $41,151 for 1998.
NOTE 10.INCOME TAXES
The components of federal income tax expense are summarized as
follows:
1998 1997
1996
(000 omitted)
Current year provision $1,153 $981
$900
Deferred income taxes (benefits) 27 ( 7)
( 62)
Net federal income tax expense $1,180 $974
$838
Federal income taxes were computed after reducing pretax accounting
income for non-taxable income in the amount of $1,154,199, $969,000, and
$661,000 for 1998, 1997, and 1996, respectively.
A reconciliation of the effective applicable income tax rate to the
federal statutory rate is as follows:
1998 1997
1996
Federal income tax rate 34.0% 34.0%
34.0%
Reduction resulting from:
Nontaxable interest income 6.5 6.8
6.8
Effective income tax rate 27.5% 27.2%
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
:
1998 1997
Total deferred tax assets $723,000 $625,000
Total deferred tax liabilities (1,108,000) (696,000)
Net deferred tax asset (liability) ($385,000) ($71,000)
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 December31 are NOW and
Super NOW account balances totaling $28,844,000 and $22,721,000 for 1998
and 1997, respectively. Also included in interest bearing deposits at
December31, 1998 and 1997 are money market account balances totaling
$35,299,000 and $23,423,000, respectively.
At December31, 1998 and 1997 time deposits of $100,000 and over
aggregated $10,224,000 and $10,235,000, respectively.
Interest expense on time deposits of $100,000 and over was $572,000;
$497,000; and $ 373,000 for 1998, 1997 and 1996, respectively.
At December 31, 1998 the scheduled maturities of certificates of
deposit are as follows:
1999 153,416,000
2000 14,481,000
2001 2,484,000
2002 1,123,000
2003 1,650,000
2004 and thereafter 901,000
$74,055,000
The bank accepts deposits of the officers and directors of the
corporation and its subsidiary on the same terms, including interest
rates, as those prevailing at the time for comparable transactions with
unrelated persons. The aggregate dollar amount of deposits of officers
and directors totaled $888,000 and $965,000 at December31, 1998 and
1997, 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:
1998 1997
Average balance during the year $4,139,000 $49,400
Average interest rate during the year 4.81% 4.94%
Maximum month-end balance during the year $6,234,000 $500,000
Securities underlying the agreements at year-end:
Carrying value $6,182,000 $485,280
Estimated fair value $6,303,000 $515,600
At December 31, the corporation had long-term notes outstanding with
the Federal Home Loan Bank of Pittsburgh as follows:
Amount
1998 1997 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 5.51%
3,000,000 3,000,000 10/02 5.73%
7,500,000 0 9/08 5.06%
5,000,000 0 10/08 4.66%
$20,500,000 $8,000,000
Interest rates are fixed and interest only is paid on a monthly
basis. The notes contain prepayment penalty charges, but management has
no intention to pay off early.
In addition to the aforementioned long-term notes the bank obtained a
term loan in 1994 totaling $350,000 with the Federal Home Loan Bank of
Pittsburgh. The maturity dates and applicable fixed interest rates on
the remaining balance at December 31 are as follows:
Amount
1998 1997 Maturity Date Rate
$ 0 $5,863 2/98 5.00%
6,173 6,173 2/99 5.21%
6,498 6,498 2/00 5.48%
315,579 315,579 2/01 5.58%
$328,250 $334,113
In addition, the bank has available a $ 10 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 $70,480,000 at
December31, 1998. The corporation also has available an unused line of
credit with Atlantic Central Bankers Bank of $3.5 million at
December31, 1998.
Total interest on the aforementioned borrowings charged to operations
was $655,025, $308,405 and $148,859 for 1998, 1997 and 1996,
respectively.
NOTE 13.ORRSTOWN FINANCIAL SERVICES, INC. (PARENT COMPANY ONLY) FINANCIAL
INFORMATION
The following are the condensed balance sheets, income statements and
statements of cash flows for the parent company:
Balance Sheets
December 31
Assets 1998 1997
(000 omitted)
Cash $ 109 $ 115
Securities available for sale 1,469 726
Investment in Orrstown Bank 19,740 17,507
Furniture and equipment (net of depreciation) 2 0
Other assets 26 0
Total assets $21,346 $18,348
Liabilities
Deferred taxes $ 266 $ 83
Total liabilities 266 83
Shareholders' Equity
Common stock: No par value-$ .1041 stated value per share, 1998; and $
.2083 stated value per share, 1997; 10,000,000 shares authorized with
2,055,315 shares issued at December 31, 1998; 1,025,094 shares issued at
December 31, 1997 214 214
Additional paid-in capital 12,476 12,352
Retained earnings 6,863 4,730
Accumulated other comprehensive income 1,527 969
Total shareholders' equity 21,080 18,265
Total liabilities and shareholders' equity $21,346 $18,348
Income Statements
Years Ended December 31
1998 1997
1996
(000 omitted)
Interest and dividend income $ 23 $ 16
$ 17
Net gain on sale of investment 0 10
0
Cash dividends from wholly-owned subsidiary 1,110 1,064
796
Equity in undistributed income of subsidiary 2,030 1,570
1,531
3,163 2,660
2,344
Less: Operating expenses 44 54
96
Net income $3,119 $2,606
$2,248
Statements of Cash Flows
Years Ended December 31
1998 1997
1996
(000 omitted)
Cash flows from operating activities:
Net income $3,119 $2,606
$2,248
Adjustments to reconcile net income to cash provided by operating
activities:
Security (gains) 0 (10)
0
Equity in undistributed income of subsidiary (2,030) ( 1,570)
( 1,531)
Increase (decrease) in other liabilities 0 (40)
0
(Increase) decrease in other assets ( 26) 0
0
Net cash provided by operating activities 1,063 986
717
Cash flows from investing activities:
Purchase of available for sale securities (207) (75)
(102)
Sales of available for sale securities 0 22
0
Net cash (used) by investing activities ( 207) ( 53)
( 102)
Cash flows from financing activities:
Cash dividends paid ($986) ($903)
($694)
Cash paid in lieu of fractional stock dividends 0
(22) 0
Proceeds from sale of stock 124 0
0
Net cash (used) by financing activities ( 862) ( 925)
( 694)
Net increase (decrease) in cash (6) 8
( 79)
Cash, beginning balance 115 107
186
Cash, ending balance $ 109 $ 115
$ 107
Supplemental disclosure of cash flows information:
Cash paid during the year for: Income taxes $ 0 $ 0
$ 8
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 $12,431,000 in its retained earnings at December31, 1998
is fully available for cash dividends. Orrstown Financial Services'
balance of retained earnings at December31, 1998 is $6,863,000 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.
Regulatory authorities have established capital guidelines in the
form of the "leverage ratio" and "risk-based capital ratios." The
leverage ratio compares capital to total balance sheet assets, while the
risk-based ratios compare capital to risk-weighted assets and off-
balance-sheet activity in order to make capital levels more sensitive to
risk profiles of individual banks. A comparison of Orrstown Financial
Services' capital ratios to regulatory minimums at December 31 is as
follows:
Orrstown Financial Services
Regulatory Minimum
1998 1997
Requirements
Leverage ratio 8.9% 9.7%
3%
Risk-based capital ratio
Tier I (core capital) 11.8% 12.7%
4%
Combined Tier I and Tier II (core capital plus allowance for
loan losses) 12.9% 14.0%
8%
NOTE 15.LEASES
The bank leases land and building space associated with its downtown
Carlisle office and various remote automated teller machines under
agreements which expire at various times from 1999 through 2003. Total
rent expense charged to operations in connection with these leases was
$24,803, $22,350 and $14,260 for 1998, 1997, and 1996, respectively.
The total minimum rental commitment under operating leases at
December31, 1998 is as follows:
Due in the year ending December 31:
1999 $24,866
2000 25,828
2001 26,990
2002 24,113
2003 22,123
NOTE 16.COMPENSATING BALANCE ARRANGEMENTS
Required deposit balances at the Federal Reserve were $168,000 and
$65,000 at December31, 1998 and 1997, respectively. Required deposit
balances at Atlantic Central Bankers Bank were $585,000 at December31,
1998 and 1997. These balances are maintained to cover processing costs
and service charges. An additional $28,080 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
During 1998 the bank entered into a construction contract for the
renovation of a property acquired in 1998 that is adjacent to its
downtown Shippensburg office. The total amount of the contract is
$252,000, of which $232,000 remained open at December 31, 1998.
NOTE 18.FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the corporation's financial instruments
were as follows at December31:
1998 1997
Carrying Fair Carrying
Fair
Amount Value Amount
Value
(000 omitted)
Financial Assets
Cash and short-term investments $15,127 $15,127 $8,837
$8,837
Securities available for sale 49,852 49,852 46,208
46,208
Restricted bank stocks 1,285 1,285 983
983
Loans 158,632 128,331
Allowance for loan loses (1,971) (1,767)
Net loans 156,661 157,486 126,564
128,164
Accrued interest receivable 1,235 1,235 1,299
1,299
Total financial assets $224,160 $224,985 $183,891
$185,491
Financial Liabilities
Deposits $183,764 $184,131 $160,580
$160,807
Short-term borrowed funds 6,234 6,234 235
235
Long-term borrowed funds 20,828 20,903 8,334
8,369
Accrued interest payable 2,129 2,129 1,645
1,645
Total financial liabilities $212,955 $213,397 $170,794
$171,056
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
December31, 1998 and 1997 and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the
three years ended December31, 1998. 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 December31, 1998 and 1997, and the results of their operations and
their cash flows for each of the three years ended December31, 1998 in
conformity with generally accepted accounting principles.
Smith Elliott Kearns &
Company, LLC
Certified Public
Accountants &
Consultants
Chambersburg,
Pennsylvania
January 29, 1999
Management's Discussion and Analysis
of Consolidated Financial Condition and Results of Operations
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
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, 1998, Orrstown Financial Services,
Inc. (the Corporation) and its wholly owned subsidiary Orrstown Bank
(the Bank) recorded net income of $3,119,000, an increase of 19.7% over
1997 earnings of $2,606.000, which was a 15.9% increase over net income
of $2,248,000 in 1996. Net income per share (EPS) has increased over
this time period from $1.10 in 1996 to $1.27 in 1997 and $1.52 in 1998.
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
1.47% in 1998, 1.51% in 1997 and 1.47% in 1996. The return on average
equity has steadily increased from 14.90% in 1996, to 15.37% in 1997 and
15.97% in 1998.
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, 1998, net interest income totaled $
8,761,000, an increase of $1,133,000, or 14.9%, over 1997. The 1997
total was $7,628,000, or 10.9%, over 1996. On a taxable equivalent
basis, net interest income increased by 15.1% in 1998 and 13.1% in 1997.
The use of tax exempt assets increased significantly in 1997 and 1998
enhancing taxable equivalent gains. 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 4.28% in
1996, 4.32% in 1997, and 4.05% in 1998. The net interest margin, which
factors in noninterest bearing funds sources, has moved from 4.98% to
5.01% to 4.70%, respectively. Earning assets represented 94.1% of total
assets in 1997, 94.2% in 1996 and 93.6% in 1995. The allocation of
growth dollars to interest bearing categories has been maintained at a
steady pace even while opening two new branch banking offices during
1997 and purchasing a property in 1998 that will be refurbished to act
as an operations center during 1999.
Volume factors were responsible for essentially all net interest
income growth during 1997 and 1998. On an average daily basis assets
grew 23.1% during 1998 and 12.6% during 1997. Earning assets grew 22.8%
and 12.4% during 1998 and 1997, respectively. Average daily loan growth
of 22.7% in 1998 and 11.0% in 1997 was achieved without lowering credit
standards and allowed net interest margins to hold at above peer group
levels despite increased rate competition for good credits and lowering
rates. The declining interest rate environment, highlighted by three 25
basis point cuts in the prime lending rate during 1998's fourth quarter,
served to lower net interest margins from 1997 levels. The net interest
spread generated in 1998 declined 27 basis points from 1997 levels.
Similarly, net interest margin tightened by 31 basis points. Planned
investment securities purchases funded by Federal Home Loan Bank
borrowings contributed approximately 12 basis points of this tightening
but generated earnings and EPS
while enhancing ROE. The remaining tightening was caused by lowered
asset yields (31 basis points) in a declining rate environment and an
increased cost of funds (10 basis points) due to mix. Liability side
rate cuts in certain transaction accounts and a continued shifting of
the loan portfolio mix toward a heavier commercial loan weighting helped
increase spread and margin during late November and December 1998. The
heavier emphasis on commercial lending has also afforded opportunities
to record noninterest bearing deposit balances that also enhance
spreads. Management is poised to keep a very close eye on margins moving
into 1999. Increased asset yields fueled by loan growth helped generate
a 4 basis point increase in net interest spread and the 3 basis point
increase in net interest margin for 1997 over 1996 levels.
ANALYSIS OF NET INTEREST INCOME
Average Balances and Interest Rates
Taxable Equivalent Basis
(Dollars In Thousands)
1998 1997 1996
ASSETS:
Interest Earning Assets:
Federal funds sold and interest-bearing bank balances $
5,706 $ 303 5.31% $3,372 $ 189 5.60% $7,637 $
409 5.36%
Investment securities:
Taxable investment securities 31,450 1,934 6.15 25,360 1,624
6.40
20,899
1,333 6.38
Tax-exempt investment securities 17,890 1,570 8.77 15,983 1,417
8.86 9,881 911 9.22
Total investment securities 49,340 3,504 7.10 41,343 3,041 7.35
30,780 2,244 7.29
Loans:
Taxable loans 142,019 12,717 8.96 116,811 10,669 9.13 104,783 9,578
9.14
Tax-exempt loans 1,994 179 8.97 592 50 8.45 996
91 9.13
Total loans 144,013 12,896 8.96 117,403 10,719 9.13 105,779 9,669
9.14
Total interest-earning assets 199,059 16,703 8.39 162,118 13,949
8.60
144,196 12,322 8.55
Non-interest Earning Assets:
Cash and due from banks 5,699 5,008 4,520
Bank premises and equipment 5,148 4,443 3,486
Other assets 4,158 2,486 2,471
Less allowance for loan losses ( 1,915) (1,689) (1,528
)
TOTAL $212,149 $172,366
$153,145
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest Bearing Liabilities:
Interest-bearing demand deposits $55,454 1,715 3.09 $37,535 1,056
2.81
$27,601 681 2.47
Savings deposits 23,394 677 2.89 24,568 728 2.96 25,934 773 2.98
Time deposits 74,488 4,087 5.49 68,161 3,711 5.44 64,388 3,527
5.48
Short term borrowings 4,237 204 4.81 218 12 5.50 0 0 0
Long term borrowings 11,726 665 5.67 5,322 315 5.92 2,486
158 6.36
Total interest-bearing liabilities 169,299 7,348 4.34 135,804 5,822
4.28 120,409 5,139 4.27
Non-interest Bearing Liabilities:
Demand deposits 20,433 17,665 16,078
Other 2,894 1,941 1,582
Total liabilities 192,626 155,410 138,069
Shareholders' Equity 19,523 16,956 15,076
TOTAL/Cost of funds $212,149 3.69 $172,366 3.59
$153,145 3.57
Net interest income/net interest spread $9,355 4.05% $8,127
4.32% $7,183
4.28%
Net interest margin 4.70% 5.01% 4.98%
Noninterest Income and Expenses
Other income increased $702,000,or 45.3% in 1998 due primarily to
significant increases in fees from trust department services and retail
brokerage activities, service charges on lending activities, fees
generated from merchant services, ATM activity fees and revenue
generated from debit card usage. Service charges on deposit accounts
rose modestly during 1998 because service charge schedules were not
modified. The corporation typically has very little securities gain or
loss activity. Management has made a concerted effort, in recent years,
to locate new sources of noninterest income and price them accordingly.
Deposit service charge schedules were being reviewed as 1998 drew to a
close with revisions during 1999 likely.
Other expenses rose $1,061,000,or 19.7% in 1998. With commercial bank
totals growing at a 20% plus pace over each of the last two years and
trust department totals growing at a 30% plus pace during the same
period, some growth in operating expenses is to be expected. In
addition, two new branches were opened during 1997, a second Carlisle
branch in late January and a Chambersburg branch in November. Additional
personnel were needed to staff those branches which operated for their
first full year in 1998. In addition, the robust growth has created the
need for additional operations personnel. Computer networks have been
expanded with further expansion slated for 1999. Management has been
acutely aware of the pressure to increase overhead expenditures but has
managed to improve (lower) the Corporation's efficiency ratio annually
from 56.4% in 1996 to 55.2% in 1997 and, finally, to 55.0% in 1998. The
maintenance of efficiency ratios below 60% in a banking company with
less than $500 million in assets places the Corporation well above peer
averages.
The Corporation has been in the midst of Year 2000 (Y2K) preparedness
for data processing issues for approximately two years and has completed
the assessment stage. The renovation and testing stage is currently in
process with the last mission critical installation set to be addressed
with the installation of a new check processing solution scheduled for
April, 1999. This project addresses more than Y2K issues as many
backroom efficiencies will be gained via the installation of an IBM AS-
400 minicomputer and the addition of image capabilities for our backroom
operation. The addition of an image ready reader/sorter will add
efficiency to the research and check clearing operations and enable the
Bank to easily handle the growth that has recently been experienced.
Most of the original $100,000 that was budgeted for Y2K efforts has been
expended to date and approximately $500,000 of primarily capitalized
costs will be expended on the AS-400/image project but these outlays
will replace costs incurred during 1998 under systems that were less
efficient. Thus, the Corporation does not expect Y2K expenses recorded
in 1999 to have a material effect on its liquidity. capital position or
results of operations.
The table that follows provides additional information regarding
noninterest income and noninterest expense increases over the past three
years:
ANALYSES OF NONINTEREST INCOME AND EXPENSES
Year Ended December 31 % Change
(in thousands)
Other income:
Service charges on deposit accounts $ 646 $ 601 $ 477 7.5% 26.0%
Loan service charges and fees 275 137 138 100.7% -0.7%
Other service charges, commissions and fees 392 204 120 92.2% 70.0%
Trust department income 656 490 384 33.9% 27.6%
Brokerage income 162 59 64 174.6% -7.8%
Securities gains (losses) (9) 3 (5) -400.0% -160.0%
Other operating income 131 57 62 129.8% -8.1%
$2,253 $1,551 $1,240 45.3% 25.1%
Other expenses:
Salaries $2,478 $2,076 $1,847 19.4% 12.4%
Employee benefits 1,013 825 774 22.8% 6.6%
Occupancy and equipment expenses 859 764 665 12.4% 14.9%
Data processing expenses 493 390 324 26.4% 20.4%
Printing and supplies 178 161 149 10.6% 8.1%
Directors Fees 154 151 154 2.0% -1.9%
Advertising 154 149 87 3.4% 71.3%
Pennsylvania shares tax 145 132 119 9.8% 10.9%
Other operating expenses 971 736 674 31.9% 9.2%
$6,445 $5,384 $4,793 19.7% 12.3%
Noninterest income as a % of noninterest expense 35.0% 28.8% 25.9%
Federal Income Taxes
The Corporation's effective federal income tax rate for 1998 was
27.5%, as compared to 27.2% in 1997 and 1996. Corporate income tax rates
for 1998 are forecast to stay near 1998 levels. The Corporation is
firmly entrenched in the 34% bracket so all taxable income will be taxed
at 34% in 1999. This, along with anticipated growth, is expected to
increase the Corporation's effective federal income tax rate to
approximately 28% in 1999, assuming no retroactive change in rates
during 1999.
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 minimi-
zation 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 non-domestic
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
1998 and .06% of average 1997 loans. Nonperforming loans, as represented
by nonaccrual and restructured items, were only .31% and .37% of
outstanding loans at December 31, 1998 and 1997, respectively. Loans 90
days or more past due and still accruing represented .18% and .51% of
outstanding loans at December 31, 1998 and 1997, 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 $270,000, $215,000 and $240,000 for 1998, 1997 and
1996, respectively. These provisions compared to net charge-offs of
$66,000, $68,000 and $53,000 for 1998, 1997 and 1996, respectively. The
allowance for loan losses was increased 11.5% during 1998 while loans
increased 23.6%. The reserve at December 31, 1998 represented 1.24% of
loans outstanding. Net charge-offs for 1997 represented only .05% of
average loans outstanding. The reserve at December 31,
1998 represented 29.9 years of coverage based upon 1998 net charge-
offs and 405.6% of nonaccrual loans. In addition, approximately 58% of
the allowance was unallocated under internal evaluation procedures as of
December 31, 1998.
SUMMARY OF LOAN LOSS EXPERIENCE
Year Ended December 31
1998 1997 1996 1995 1994
Amount of loans outstanding at end of period $158,632 $128,331 $108,926
$102,857 $90,839
Daily average loans outstanding $144,013 $117,403 $105,779 $97,662
$81,740
Balance of allowance for possible loan losses at beginning of period $1,767
$1,620 $1,433 $1,200 $1,125
Loans charged off 84 83 68 51 8
Recoveries of loans previously charged off 18 15 15
14 12
Net loans charged off (recovered) 66 68 53 37 (4)
Additions to allowance charged to expense 270 215 240
270 71
Balance at end of period $1,971 $1,767 $1,620 $1,433 $1,200
Ratio of net charge-offs to average loans outstanding 0.05% 0.06% 0.05%
0.04% -0.01%
Ratio of reserve to gross loans outstanding at year end 1.24% 1.38%
1.49%
1.39% 1.32%
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 ample given the current composition of
the loan portfolio and adequately covers the credit risk management sees
under present economic conditions. Approximately 58% of the reserve
balance is unallocated under current procedures with 32% allocated to
credit risk and 10% allocated to Year 2000 (Y2K) risk. Management is
prepared to make any reserve adjustments that may become necessary as
economic conditions change.
NONPERFORMING ASSETS
December 31
1998 1997 1996 1995 1994
(in thousands)
Loans on nonaccrual (cash) basis $486 $473 $14 $132 $1
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 311 49 49 27 27
Total nonperforming loans and OREO $797 $522 $63 $159 $28
Ratio of nonperforming assets to total loans and OREO 0.50% 0.41% 0.06%
0.15%
0.03%
Ratio of nonperforming assets to total assets 0.34% 0.27% 0.04%
0.11%
0.02%
OTHER CREDIT RISK ELEMENTS
Loans past due 90 or more days and still accruing $284 $657 $203
$417 $262
Ratio of other credit risk elements to total loans and OREO 0.18% 0.51%
0.19%
0.41% 0.29%
Ratio of other credit risk elements to total assets 0.12% 0.35% 0.13%
0.29%
0.21%
TOTAL NONPERFORMING AND OTHER RISK ASSETS $ 1,081 $ 1,179 $266 $576
$290
Ratio of total risk assets to total loans and OREO 0.68% 0.92% 0.24%
0.56% 0.32%
Ratio of total risk assets to total assets 0.46% 0.50% 0.11% 0.24%
0.12%
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". This Statement establishes accounting and reporting
standards for derivatives and hedging activities. In October 1998, the
FASB issued SFAS No. 134-"Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a
Mortgage Banking Enterprise". This statement requires entities that are
engaged in mortgage banking activities to classify mortgage-backed
securities as trading securities following the securitization of
mortgage loans held for sale. The Corporation has no derivative
instruments and does not engage in hedging activities. The Corporation
has no loans held for sale nor does it engage in securitization of
loans. Therefore, the adoption of either of the aforementioned standards
is not expected to have a material impact on the Corporation's operating
results or capital resources.
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.
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, 1998
(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 $51,002 $11,245 $19,273 $36,266 $40,846 $158,632
Investment securities 5,525 1,685 1,460 2,409 40,057 51,136
Other earning assets 8,099 0 0 0 0 8,099
Total RSA 64,626 12,930 20,733 38,675 80,903 217,867
RATE SENSITIVE LIABILITIES (RSL):
Interest bearing deposits 38,639 10,771 15,092 15,996 81,246
161,
744
Short term borrowed funds 6,234 0 0 0 0 6,234
Long term borrowed funds 0 6,006 0 0 14,822 20,828
Total RSL 44,873 16,777 15,092 15,996 96,068 188,806
RATE SENSITIVITY GAP:
Period $19,753 $ (3,847) $5,641 $22,679 $ (15,165) $ 29,061
Cumulative 19,753 15,906 21,547 44,226 29,061
GAP AS A PERCENT OF TOTAL ASSETS:
Period 8.38% -1.63% 2.39% 9.62%
Cumulative 8.38% 6.74% 9.14% 18.75%
RSA/RSL Cumulative 1.44 1.26 1.28 1.48
The asset biased, or positive, gap position indicates that earnings
are naturally enhanced, or more easily maintained, in a rising rate
environment but the position is balanced closely enough to react to a
declining rate environment. This conclusion is further supported by 200
basis point rate shock tests projecting a 2% or less contraction in net
interest income on a downward shock, the riskiest direction for this
balance sheet.
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 $2,815,000
during 1998, an increase of 15.4% for the year. This followed growth of
15.2% and 8.4% during 1997 and 1996, respectively. The increasing
earnings stream during this period has allowed the Corporation to
steadily increase cash dividends paid to stockholders. In 1998 cash
dividends rose $81,000, or 9.0% over 1997 levels while net income rose
19.7% during the period. This followed a 30.1% increase in dividend
payout for 1997 versus 1996. The Bank enjoyed rapid asset growth during
1998 which caused a moderation in the Corporation's dividend increase
for the year in order to assure an adequate capital base to accommodate
such growth in the future. Dividends per share have moved from .34 to
.44 to .48 for 1996 through 1998, respectively.
CAPITAL AND DIVIDEND RATIOS
1998 1997 1996
At December 31: (amounts in thousands)
Shareholders' Equity $21,080 $18,265 $15,856
Equity/Assets 8.94% 9.60% 10.06%
For the Year:
Average Equity/Average Assets 9.20% 9.84% 9.84%
Dividend payout 31.59% 34.65% 30.87%
Return on Average Equity 15.97% 15.37% 14.90%
Dividends paid $984 $903 $694
Regulatory
Regulatory Capital Measures:
Minimums
Tier I Capital Ratio 11.8% 12.7% 13.2%
4.0%
Total (Tier II) Capital Ratio 12.9% 14.0% 14.6%
8.0%
Leverage Ratio 8.9% 10.0% 10.0%
3.0%
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 forsees no problem in
maintaining capital ratios well 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 1998, two
examinations were conducted that included, but were not limited to,
procedures designed to review Year 2000 (Y2K) preparedness and transfer
agent operations. 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 1998 and 1997 are as follows:
1998 1997
($000 omitted except per share) Quarter Ended Quarter Ended
March June September December March June
September December
Interest income $3,715 $3,979 $4,138 $4,277 $3,103 $3,316
$3,474 $3,557
Interest expense 1,707 1,800 1,857 1,984 1,300 1,418
1,504
1,600
Net interest income 2,008 2,179 2,281 2,293 1,803 1,898
1,970
1,957
Provisions for loan losses 75 75 75 45 45 45
45 80
Net interest income after provision for loan losses 1,933 2,104 2,206
2,248 1,758 1,853 1,925 1,877
Securities gains (losses) ( 10) ( 2) 11 ( 8) (
5) 9 5 ( 6)
Other income 491 535 550 686 345 381 351
471
Other expenses 1,527 1,556 1,567 1,795 1,307 1,254
1,297
1,526
Operating income before income taxes 887 1,081 1,200 1,131 791
989 984 816
Applicable income taxes 245 296 335 304 232 270 256
216
Net income $ 642 $ 785 $ 865 $ 827 $ 559 $ 719
$ 728 $ 600
*Per common share data:
Net income $.32 $.38 $.42 $.40 $.27 $.35
$.36 $.29
Dividends .115 .115 .12 .13 .09 .095 .10
.155
Performance Statistics:
Return on Average Assets 1.33% 1.51% 1.60% 1.42% 1.42%
1.70%
1.63% 1.30%
Return on Average Equity 13.99% 16.61% 17.42% 15.77% 14.03%
17.69% 16.78% 13.21%
Average Equity/Average Assets 9.52% 9.11% 9.19% 9.04% 10.15%
9.61% 9.73% 9.81%
Selected Five-Year Financial Data
ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY
1998 1997 1996 1995 1994
Income (000 omitted)
Interest income $16,109 $13,450 $12,018 $10,829 $8,571
Interest expense 7,348 5,822 5,139 4,542 3,241
Provision for loan losses 270 215 240 270 71
Net interest income after provision for loan losses 8,491 7,413 6,639
6,017
5,259
Securities gains (losses) (9) 3 (5) ( 45) 95
Other operating income 2,262 1,548 1,245 980 765
Other operating expenses 6,445 5,384 4,793 4,256 3,964
Income before income taxes 4,299 3,580 3,086 2,696 2,155
Applicable income tax 1,180 974 838 742 520
Net income $3,119 $2,606 $2,248 $1,954 $1,635
*Per share amounts are based on following weighted averages:
1998-2,051,831 1996-2,051,412 1994-2,052,614
1997-2,050,646 19952,052,614
Income before income taxes $2.09 $1.75 $1.51 $1.31 $1.05
Applicable income taxes .57 .48 .41 .36 .25
Net income 1.52 1.27 1.10 .95 .80
Cash dividend paid .48 .44 .34 .29 .25
Book value 10.26 8.91 7.73 7.14 6.02
Year-End Balance Sheet Figures (000 omitted)
Total assets $235,822 $190,242 $157,556 $145,998 $123,004
Total loans 158,632 128,331 108,926 102,857 90,839
Total investment securities 51,137 47,191 34,355 31,563 24,318
Deposits-noninterest bearing 22,020 17,649 16,322 13,962 13,262
Deposits-interest bearing 161,744 142,931 120,937 113,368 93,103
Total deposits 183,764 160,580 137,259 127,330 106,365
Liabilities for borrowed money 27,062 8,569 2,339 2,345 2,350
Total shareholders' equity 21,080 18,265 15,856 14,633 12,353
Trust assets under management-market value 152,000 108,000 83,000 66,000
50,000
Ratios
Average equity/average assets 9.20% 9.84% 9.84% 10.00% 10.34%
Return on average equity 15.97% 15.37% 14.90% 14.40% 13.36%
Return on average assets 1.47% 1.51% 1.47% 1.44% 1.38%
*Per share amounts have been restated to reflect:
The 2 for 1 stock split effective November 21, 1998. The 5% stock
dividend paid May 15, 1997. The 5% stock dividend paid July 21, 1995.
t BANK DIRECTORY
From left to right: Benjamin Stoops, Philip Fague, Bradley Everly,
Kenneth Shoemaker, and Stephen Oldt
Executive Officers
Kenneth R. Shoemaker
President and Chief Executive Officer
Officer since January 1986
Stephen C. Oldt
Executive Vice President and Chief Operating Officer
Officer since August 1987
Bradley S. Everly
Senior Vice President and Chief Financial Officer
Officer since July 1997
Philip E. Fague
Senior Vice President and Senior Trust Officer
Officer since October 1988
Benjamin S. Stoops
Vice President and Senior Operations Officer
Officer since November 1998
Operating Officers
Barbara E. Brobst
Vice President and Trust Officer
Patricia A. Corwell
Vice President and Assistant Secretary/Shareholder Relations Officer
James B. Dubbs
Vice President and Cashier, Branch Executive Officer, King Street
Office
Jeffrey W. Embly
Vice President and Commercial Loan Officer
Charles E. Ferguson
Vice President and Human Resources Manager
Bradley S. Gerlach
Vice President and Trust Officer
Robert B. Russell
Vice President and Chief Accounting Officer
Frank E. Koser II
Assistant Vice President and Branch Executive Officer, Stonehedge
Office
Ann E. McCrae
Assistant Vice President and Data/Deposit Operations Manager
Karen J. Shearer
Assistant Vice President and Branch Executive Officer, Chambersburg
Office
Wilma M. Rosenberry
Assistant to the President
Jeffrey S. Gayman
Branch Executive Officer, South Hanover Street Office
Phyllis A. Nye
Trust Officer
Anita L. Ocker
Branch Executive Officer, Orrstown Office
Teresa F. Ott
Branch Executive Officer, Fannett-Metal Office
Debra A. Ramsey
Assistant Secretary and Branch Executive Officer, Lurgan Avenue
Office
Judith L. Clayton
Customer Service Officer, Fannett-Metal Office
Alice A. Dubbs
Loan Processing Supervisor
Lisa D. Gutshall
EFT Processing Supervisor
Sondra K. Mellinger
Auditor
Marie A. Mitchell
Deposit Processing Supervisor
Sheryl E. Perkins
Customer Service Officer, Chambersburg Office
Albert H. Shuller, Jr.
Security Officer
Jennifer A. Zullinger
Management Information Systems Officer
Directors Emeriti
Richard M. Diffenbaugh
Stoey W. Forrester
Eldon E. Funk
Frank S. Heberlig
William O. Hykes
Raymond C. Martin
Galen L. Myers
Raymond I. Pugh
Glenn C. Rosenberry
Kenneth M. Upperman
President's Advisory Council
Frances M. Banks
Karen L. Bender Benedict
John E. Clinton
Thomas Colley
Duaine A. Collier
Kathy J. Frazer
Lester E. Funk
Bonnie L. Hoffman
Paul E. Hornbaker
Dale F. Kuhn
Jerry S. Lyons
William E. Naugle
Kathryn E. Poe
Jean C. Ritchie
Glenn W. Snoke
Carlisle Advisory Council
Robert Davis
Robert G. Frey
John W. Gleim, Jr.
Zane R. Highlands
William M. Kronenberg
Gilmore B. Seavers
Dale F. Shughart, Jr.
Patricia H. Vance
Chambersburg Advisory Council
Thomas J. Barra
Thomas G. Burkey
Robert K. Gonder
Shirley U. Lehman
Richard W. Mackey, Jr.
Adrian Simpson
William C. Stake
Todd Stonesifer
This report is dedicated in honor of Ned R. Fogelsonger who passed away
January 20, 1999. He was appointed to the Board of Orrstown Bank on June
24, 1986.
t BOARD OF DIRECTORS
From left to right: Gregory Rosenberry, Denver Tuckey, Andrea Pugh,
Jeffrey Coy, Kenneth Shoemaker, Joel Zullinger, Anthony Ceddia, and
Robert Henry
Absent from photo: Ned R. Fogelsonger
Joel R. Zullinger
Attorney-at-Law
Chairman of the Board
Board Committees: Audit Committee Executive Committee Trust Committee
Jeffrey W. Coy
State Representative
Vice Chairman of the Board
Board Committees: Executive Committee, Chairman Property Committee
Kenneth R. Shoemaker
President and CEO, Orrstown Bank Board Committees: ALCO Committee,
Chairman Executive Committee
Robert T. Henry
Retired Pharmacist and Businessman
Secretary
Board Committees: Credit Administration Committee, Chairman Executive
Committee Property Committee
Anthony F. Ceddia
President, Shippensburg University Board Committees: Credit
Administration Committee Trust Committee
Ned R. Fogelsonger
President, Fogelsonger Agency, Inc. Board Committees: Trust Committee,
Chairman ALCO Committee Audit Committee
Andrea Pugh
Self-employed, PharmCare Consultant Board Committees: Audit Committee,
Chairperson Credit Administration Committee
Gregory A. Rosenberry
President and Owner, Tri-Valley Forestry Board Committees: ALCO
Committee Property Committee
Denver L. Tuckey
Retired Businessman Board Committees: Property Committee, Chairman ALCO
Committee Credit Administration Committee
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<PERIOD-END> DEC-31-1998
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