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UNITED STATES
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
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
For the transition period from _____ to _____
Commission file number: 001-34292
ORRSTOWN FINANCIAL SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania
(State or Other Jurisdiction of Incorporation or Organization)
77 East King Street, P. O. Box 250, Shippensburg, Pennsylvania
(Address of Principal Executive Offices)
23-2530374
(I.R.S. Employer Identification No.)
17257
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (717) 532-6114
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading symbol(s)
Name of Each Exchange on Which Registered
Common Stock, no par value
ORRF
NASDAQ Stock Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Securities registered pursuant to Section 12(g) of the Act: None
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 ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth
company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
¨
¨
Accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.). Yes ☐ No x
x
☒
☐
¨
Securities registered pursuant to Section 12(b) of the Act: No x
The aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the common stock was last sold as of the last business day of
the Registrant’s most recently completed second fiscal quarter, was approximately $238.3 million. For purposes of this calculation, the term “affiliate” refers to all directors and
executive officers of the registrant, and all persons beneficially owning more than 5% of the registrant’s common stock.
Number of shares outstanding of the Registrant’s common stock as of February 28, 2020: 11,256,603.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2020 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.
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ORRSTOWN FINANCIAL SERVICES, INC.
FORM 10-K
INDEX
Part I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Part III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Part IV
Item 15.
Item 16.
Signatures
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
Form 10-K Summary
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Page
4
12
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24
24
24
25
27
28
55
58
118
118
118
118
118
119
119
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Glossary of Defined Terms
The following terms may be used throughout this Report, including the consolidated financial statements and related notes.
Term
Definition
ALL
AFS
AOCI
ASC
ASU
Bank
BHC Act
CDI
CET1
CMO
Company
CFPB
CRA
Dodd-Frank Act
EPS
ERM
Exchange Act
FASB
FDIA
FDIC
FHC
FHLB
FRB
GAAP
GLB Act
GSE
Hamilton
IRC
LHFS
MBS
Mercersburg
MPF Program
MSR
NIM
OCI
OFA
OREO
Orrstown
OTTI
Parent Company
2011 Plan
PCI loans
Repurchase Agreements
SEC
Securities Act
TDR
U.S.
Wheatland
Allowance for loan losses
Available for sale
Accumulated other comprehensive income (loss)
Accounting Standards Codification
Accounting Standards Update
Orrstown Bank, the commercial banking subsidiary of Orrstown Financial Services, Inc.
Bank Holding Company Act of 1965
Core deposit intangible
Common Equity Tier 1
Collateralized mortgage obligation
Orrstown Financial Services, Inc. and subsidiaries (interchangeable with "Orrstown” below)
Consumer Financial Protection Bureau
Community Reinvestment Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
Earnings per common share
Enterprise risk management
Securities Exchange Act of 1934, as amended
Financial Accounting Standards Board
Federal Deposit Insurance Act
Federal Deposit Insurance Corporation
Financial holding company
Federal Home Loan Bank
Board of Governors of the Federal Reserve System
Accounting principles generally accepted in the United States of America
Gramm-Leach-Bliley Act
United States government-sponsored enterprise
Hamilton Bancorp, Inc., and its wholly-owned banking subsidiary, Hamilton Bank (acquired May 1, 2019)
Internal Revenue Code of 1986, as amended
Loans held for sale
Mortgage-backed securities
Mercersburg Financial Corporation and its wholly-owned banking subsidiary, First Community Bank of Mercersburg (acquired October 1, 2018)
Mortgage Partnership Finance Program
Mortgage servicing right
Net interest margin
Other comprehensive income (loss)
Orrstown Financial Advisors, a division of the Bank that provides investment and brokerage services
Other real estate owned (foreclosed real estate)
Orrstown Financial Services, Inc. and subsidiaries
Other-than-temporary impairment
Orrstown Financial Services, Inc., the parent company of Orrstown Bank and Wheatland Advisors, Inc.
2011 Orrstown Financial Services, Inc. Stock Incentive Plan
Purchased credit impaired loans
Securities sold under agreements to repurchase
Securities and Exchange Commission
Securities Act of 1933, as amended
Troubled debt restructuring
United States of America
Wheatland Advisors, Inc., the Registered Investment Advisor subsidiary of Orrstown Financial Services, Inc.
Unless the context otherwise requires, the terms “Orrstown,” “we,” “us,” “our,” and “Company” refer to Orrstown Financial Services, Inc. and its subsidiaries.
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PART I
Caution About Forward-Looking Statements:
Certain statements appearing herein, which are not historical in nature, are forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, we may make other written and oral communications,
from time to time, that contain such statements. Forward-looking statements reflect the current views of the Company's management with respect to, among other
things, future events and the Company's financial performance. These statements are often, but not always, made through the use of words or phrases such as
“may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,”
“project,” “forecast,” “goal,” “target,” “would” and “outlook,” or the negative variations of those words or other comparable words of a future or forward-looking
nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about the Company's industry,
management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company's control.
Accordingly, the Company cautions you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions
and uncertainties that are difficult to predict. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable as
of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements and there can be no
assurances that the Company will be able to continue to successfully execute on our strategic growth plan into Dauphin, Lancaster, York and Berks counties,
Pennsylvania, and the greater Baltimore market in Maryland, with newer markets continuing to be receptive to our community banking model; to take advantage of
market disruption; to experience sustained growth in loans and deposits or maintain the momentum experienced to date from these actions; and to realize cost
savings from our branch consolidation efforts. Factors which could cause the actual results of the Company's operations to differ materially from expectations
include, but are not limited to: ineffectiveness of the Company's strategic growth plan due to changes in current or future market conditions; the effects of
competition and how it may impact our community banking model, including industry consolidation and development of competing financial products and
services; the integration of the Company's strategic acquisitions; the inability to fully achieve expected savings, efficiencies or synergies from mergers and
acquisitions, or taking longer than estimated for such savings, efficiencies and synergies to be realized; changes in laws and regulations; interest rate movements;
changes in credit quality; inability to raise capital, if necessary, under favorable conditions; volatilities in the securities markets; deteriorating economic conditions;
expenses associated with pending litigation and legal proceedings; and other risks and uncertainties. The foregoing list of factors is not exhaustive.
For a description of factors that we believe could cause actual results to differ materially from such forward-looking statements, you should review our Risk
Factors discussion in Item 1A, our Critical Accounting Policies section included in Item 7, and Note 22, Contingencies, in the Notes To Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K. We encourage readers of this report to understand forward-looking statements to be strategic
objectives rather than absolute targets of future performance. If one or more events related to these or other risks or uncertainties materialize, or if the Company's
underlying assumptions prove to be incorrect, actual results may differ materially from what the Company anticipates. Accordingly, you should not place undue
reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company does not
undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
New risks and uncertainties arise from time to time, and it is not possible for the Company to predict those events or how they may affect it. In addition, the
Company cannot assess the impact of each factor on its business or the extent to which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements. All forward-looking statements, expressed or implied, included in this Annual report on Form
10-K are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent
written or oral forward-looking statements that the Company or persons acting on the Company's behalf may issue.
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ITEM 1 – BUSINESS
Orrstown Financial Services, Inc., a Pennsylvania corporation, is the holding company for its wholly-owned subsidiaries Orrstown Bank and Wheatland
Advisors, Inc. The Company’s principal executive offices are located at 77 East King Street, Shippensburg, Pennsylvania, with additional executive and
administrative offices at 4750 Lindle Road, Harrisburg, Pennsylvania. The Parent Company was organized on November 17, 1987, for the purpose of acquiring the
Bank and such other banks and bank-related activities as are permitted by law and desirable. The Company provides banking and bank-related services through
branches located in south central Pennsylvania, principally in Berks, Cumberland, Dauphin, Franklin, Lancaster, Perry and York Counties, Pennsylvania, and in
Anne Arundel, Baltimore, Howard and Washington Counties, Maryland, as well as Baltimore City, Maryland. Wheatland was acquired in December 2016 and
provides services as a registered investment advisor through its office in Lancaster County, Pennsylvania.
The Company files periodic reports with the SEC in the form of quarterly reports on Form 10-Q, annual reports on Form 10-K, annual proxy statements and
current reports on Form 8-K for any significant events that may arise during the year. Copies of these reports, and any amendments to such reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), may be obtained free of charge through the
SEC’s Internet site at www.sec.gov or by accessing the Company’s website at www.orrstown.com as soon as reasonably practicable after such reports are
electronically filed with, or furnished to, the SEC. Information on our website shall not be considered a part of this Annual Report on Form 10-K.
Recent Merger and Acquisition Activity
On October 1, 2018, Orrstown expanded its presence in Franklin County, Pennsylvania, with the completion of its acquisition of Mercersburg Financial
Corporation and the merger of its banking subsidiary, First Community Bank of Mercersburg, with and into Orrstown Bank.
On May 1, 2019, Orrstown expanded its presence into the greater Baltimore, Maryland, market with the completion of its acquisition of Hamilton Bancorp,
Inc., and the merger of its banking subsidiary, Hamilton Bank, with and into Orrstown Bank.
Business
The Bank was organized in 1919 as a state-chartered bank. On March 8, 1988, in a bank holding company reorganization transaction, the Parent Company
acquired 100% ownership of the Bank.
The Parent Company’s primary activity consists of owning and supervising its subsidiaries, the Bank and Wheatland. Day-to-day management is conducted
by its officers, who are also Bank officers. The Parent Company has historically derived most of its income through dividends from the Bank. At December 31,
2019, the Company had total assets of $2.4 billion, total deposits of $1.9 billion and total shareholders’ equity of $223.2 million.
The Parent Company has no employees. Its 12 officers are employees of the Bank. On December 31, 2019, the Bank and Wheatland combined had 439 full-
time and 21 part-time employees.
The Bank is engaged in the 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 holds commercial, residential, consumer and agribusiness loans primarily in its market areas of in
south central Pennsylvania, in the greater Baltimore region, and in Washington County, Maryland, and in contiguous counties. The concentrations of credit by type
of loan are included in Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and
Supplementary Data." The Bank maintains a diversified loan portfolio and evaluates each client’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 client pursuant to collateral
standards established in the Bank’s credit policies and procedures.
Wheatland supplements the Bank's trust and wealth management group and is anticipated to provide opportunities for future growth in these areas.
Lending
Federal bank regulatory agencies have adopted uniform regulations prescribing standards for extensions of credit that are secured by liens or interests in real
estate or made for the purpose of financing permanent improvements to real estate. Under these regulations, all insured depository institutions, such as the Bank,
must adopt and maintain written policies establishing appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or
are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification
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standards, prudent underwriting standards (including loan-to-value limits) that are clear and measurable, loan administration procedures, and documentation,
approval and reporting requirements. The real estate lending policies must reflect consideration of the federal bank regulatory agencies’ Interagency Guidelines for
Real Estate Lending Policies.
All secured loans are supported with appraisals or evaluations of collateral. Business equipment and machinery, inventories, accounts receivable, and farm
equipment are considered appropriate security, provided borrowers meet acceptable standards for liquidity and marketability. Loans secured by real estate
generally do not exceed 90% of the appraised value of the property. Loan to collateral values are monitored as part of the loan review process, and appraisals are
updated as deemed appropriate under the circumstances.
Commercial Lending
The Bank makes commercial real estate, equipment, construction, working capital and other commercial purpose loans as required by commercial customers
throughout the Bank’s various markets. The Bank has significant market share in south central Pennsylvania and has been expanding its presence geographically in
recent years. Currently, growth markets include the Harrisburg region, Lancaster County and Maryland markets. The Bank's commercial lending is focused in
these geographic regions or with borrowers headquartered in these geographic regions.
The Bank’s credit policy dictates the underwriting requirements for the various types of commercial loans the Bank makes available to borrowers. The policy
covers such requirements as debt coverage ratios, advance rates against different forms of collateral, loan-to-value ratios and maximum term.
A majority of the Company’s loan assets are loans for business purposes. At December 31, 2019, approximately 63% of the loan portfolio was comprised of
commercial loans.
Consumer Lending
The Bank provides home equity loans, home equity lines of credit and other consumer loans primarily through its branch network and client call center. A
large majority of the consumer loans are secured by either a first or second lien position on the borrower’s primary residential real estate. The Bank requires a loan-
to-value ratio of no greater than 90% of the value of the real estate being taken as collateral. The Bank also, at times, purchases consumer loans to help diversify
credit risk in our loan portfolio.
Residential Lending
The Bank provides residential mortgages throughout its various markets referred from retail branches and through a network of mortgage loan officers. A
majority of the residential mortgages originated are sold to secondary market investors, primarily Wells Fargo and Fannie Mae. All mortgages, regardless of being
sold or held in the Bank’s portfolio, are generally underwritten to secondary market industry standards for prime mortgages. The Bank generally requires a loan-to-
value ratio of no greater than 80% of the value of the real estate being taken as collateral, without the borrower obtaining private mortgage insurance.
Loan Review
The Company has a loan review policy and program which is designed to identify and monitor risk in the lending function. The Management ERM
Committee, comprised of executive officers and loan department personnel, is charged with the oversight of overall credit quality and risk exposure of the
Company's loan portfolio. This includes the monitoring of the lending activities of all Company personnel with respect to underwriting and processing new loans
and the timely follow-up and corrective action for loans showing signs of deterioration in quality. A loan review program provides the Company with an
independent review of the commercial loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories
unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible
credit event.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $500 thousand, which includes
confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of $1.0 million. In addition, all commercial
relationships greater than $500 thousand rated substandard, doubtful or loss are reviewed quarterly and corresponding risk ratings are reaffirmed by the Company's
Problem Loan Committee, with subsequent reporting to the Management ERM Committee and the Board of Directors.
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The Bank outsources its independent loan review to a third-party provider, which monitors and evaluates loan clients on a quarterly basis utilizing risk-rating
criteria established in the credit policy in order to identify deteriorating trends and detect conditions which might indicate potential problem loans. The results of
the third-party loan review are reported quarterly to the Management and Board ERM Committees for review. The loan ratings provide the basis for evaluating the
adequacy of the ALL.
Deposit Products
The Bank offers deposit products to retail, commercial, non-profit and government clients through its retail branch network. Product offerings for retail
clients include checking accounts, money market, savings and certificates of deposit. The Company offers numerous products and treasury management solutions
for commercial clients, including account analysis for demand deposit accounts, certificates of deposit, sweep accounts, money market accounts and other treasury
services such as merchant banking, foreign exchange, remote deposit capture, lockbox and others. The Bank further provides various deposit solutions for
government agencies and non-profits, such as demand deposit accounts, sweeps and certificates of deposit.
Investment Services
Through its trust department, the Bank renders services as trustee, executor, administrator, guardian, managing agent, custodian, investment advisor, and
other fiduciary activities authorized by law under the trade name Orrstown Financial Advisors. OFA offers retail brokerage services through a third-party
broker/dealer arrangement with Cetera Advisor Networks LLC. Wheatland also offers investment advisor services as a registered investment advisor. At
December 31, 2019, assets under management by OFA and Wheatland totaled $1.6 billion.
Competition
The Bank’s principal market area consists of south central Pennsylvania, the greater Baltimore region, and Washington County, Maryland. The Bank serves a
substantial number of depositors in this market area and its contiguous counties.
We compete with other banks and less heavily regulated financial services companies such as credit unions and finance and trust companies, as well as
mortgage banking companies, mutual funds, investment advisors, and brokerage firms, both within and outside of our primary market areas. Financial technology
companies, or FinTechs, are also providing nontraditional, but increasingly strong, competition for our borrowers, depositors, and other clients.
We compete for loans primarily on the basis of a combination of value and service by building client relationships as a result of addressing our clients’
banking needs, demonstrating expertise, and providing convenience to our clients.
We compete for deposits similarly on the basis of a combination of value and service and by providing convenience through a banking network of branches
and ATMs within our markets and our website at www.orrstown.com.
We implement strategic initiatives focused on expanding our core businesses and explore, on an ongoing basis, acquisition, divestiture, and joint venture
opportunities to the extent permitted by our regulators. We analyze each of our products and businesses in the context of shareholder return, client demands,
competitive advantages, industry dynamics, and growth potential. We believe our market area will support growth in assets and deposits in the future, which we
expect to contribute to our ability to maintain or grow profitability.
Regulation and Supervision
The Parent Company is a bank holding company registered with the FRB and has elected status as a financial holding company. The Bank is a Pennsylvania-
chartered commercial bank and a member of the FRB. Wheatland is a registered investment advisor.
Regulatory Environment
The banking industry is highly regulated. Orrstown is subject to supervision, regulation, and examination by various federal and state regulators, including
the FRB, SEC, CFPB, FDIC, and various state regulatory agencies. The statutory and regulatory framework that governs us is generally intended to protect
depositors and clients, the FDIC's Deposit Insurance Fund, the U.S. banking and financial system, and financial markets as a whole by ensuring the safety and
soundness of Bank Holding Companies ("BHCs") and banks. Bank regulators regularly examine the operations of BHCs and banks. Regulators have broad
supervisory and enforcement authority over BHCs and banks, including the power to impose nonpublic supervisory agreements, issue cease and desist orders,
impose fines and other civil and criminal penalties, terminate deposit insurance, and appoint a conservator or receiver.
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Engaging in unsafe or unsound practices or failing to comply with applicable laws, regulations, and supervisory agreements could subject Orrstown, its
subsidiaries, and their respective officers, directors, and institution-affiliated parties to the remedies described above, and other sanctions. In addition, the FDIC
may terminate a bank’s deposit insurance upon a finding that the bank’s financial condition is unsafe or unsound or that the bank has engaged in unsafe or unsound
practices or has violated an applicable rule, regulation, order, or condition enacted or imposed by the bank’s regulatory agency.
Banking statutes, regulations, and policies are continually under review by Congress, state legislatures, and federal and state regulatory agencies. In addition
to laws and regulations, state and federal bank regulatory agencies may issue policy statements, interpretive letters, and similar written guidance applicable to
Orrstown. Any change in statutes, regulations, or regulatory policies applicable to us, including changes in their interpretation or implementation, could have a
material effect on our business or organization.
In May 2018, the Economic Growth Act was signed into law. Among other regulatory changes, the Economic Growth Act amended various sections of the
Dodd-Frank Act, including section 165 of the Dodd-Frank Act, which was revised to raise the asset thresholds for determining the application of enhanced
prudential standards for BHCs. Under the Economic Growth Act, BHCs with consolidated assets below $100.0 billion were immediately exempted from all of the
enhanced prudential standards, except risk committee requirements, which now apply to publicly-traded BHCs with $50.0 billion or more of consolidated assets.
In October 2019, the Federal Reserve adopted the EPS Tailoring Rule pursuant to the Economic Growth Act, which adjusted the thresholds at which certain
enhanced prudential standards apply to U.S. BHCs with $100.0 billion or more in total consolidated assets. Also in October 2019, the Federal Reserve and FDIC
adopted the Capital and Liquidity Tailoring Rule, which similarly adjusted the thresholds at which certain other capital and liquidity standards apply to U.S. BHCs
and banks with $100.0 billion or more in total consolidated assets.
We are also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, both as administered by the SEC, as well as the rules of Nasdaq that apply to companies with securities listed on the Nasdaq Capital Market. Wheatland
is subject to periodic examination by the SEC.
Several of the more significant regulatory provisions applicable to bank holding companies and banks to which Orrstown and the Bank are subject are
discussed below, along with certain regulatory matters concerning Orrstown and the Bank. To the extent that the following information describes statutory or
regulatory provisions, such information is qualified in its entirety by reference to the particular statutes or regulations. Any change in applicable law or regulation
may have a material effect on the business and prospects of the Company and the Bank.
Financial and Bank Holding Company Activities
As an FHC, we are permitted to engage, directly or through subsidiaries, in a wide variety of activities that are financial in nature or are incidental or
complementary to a financial activity, in addition to all of the activities otherwise allowed to us.
As an FHC, Orrstown is generally subject to the same regulation as other bank holding companies, including the reporting, examination, supervision and
consolidated capital requirements of the FRB. To preserve our FHC status, we must remain well-capitalized and well-managed and ensure that the Bank remains
well-capitalized and well-managed for regulatory purposes and earns “satisfactory” or better ratings on our periodic Community Reinvestment Act examinations.
An FHC ceasing to meet these standards is subject to a variety of restrictions, depending on the circumstances.
If the Parent Company or the Bank are either not well-capitalized or not well-managed, the Parent Company or the Bank must promptly notify the FRB. Until
compliance is restored, the FRB has broad discretion to impose appropriate limitations on an FHC’s activities. If compliance is not restored within 180 days, the
FRB may ultimately require the FHC to divest its depository institutions or in the alternative, to discontinue or divest any activities that are permitted only to non-
FHC bank holding companies.
If the FRB determines that an FHC or its subsidiaries do not satisfy the CRA requirements, the potential restrictions are different. In that case, until all the
subsidiary institutions are restored to at least “satisfactory” CRA rating status, the FHC may not engage, directly or through a subsidiary, in any of the additional
activities permissible under the BHC Act nor make additional acquisitions of companies engaged in the additional activities. However, completed acquisitions and
additional activities and affiliations previously begun are left undisturbed, as the BHC Act does not require divestiture for this type of situation.
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Federal Deposit Insurance
The FDIC's Deposit Insurance Fund provides insurance coverage for certain deposits, up to a standard maximum deposit insurance amount of $250,000 per
depositor and is funded through assessments on insured depository institutions, based on the risk each institution poses to the Deposit Insurance Fund. The Bank
accepts client deposits that are insured by the Deposit Insurance Fund and, therefore, must pay insurance premiums. The FDIC may increase the Bank’s insurance
premiums based on various factors, including the FDIC’s assessment of its risk profile.
If the FDIC is appointed conservator or receiver of a bank upon the bank’s insolvency or the occurrence of other events, the FDIC may sell some, part or all
of a bank’s assets and liabilities to another bank or repudiate or disaffirm most types of contracts to which the bank was a party if the FDIC believes such contracts
are burdensome. In resolving the estate of a failed bank, the FDIC as receiver will first satisfy its own administrative expenses, and the claims of holders of U.S.
deposit liabilities also have priority over those of other general unsecured creditors.
Liability for Banking Subsidiaries
Orrstown is required to serve as a source of financial and managerial strength to the Bank and, under appropriate conditions, to commit resources to support
the Bank. This support may be required by the Federal Reserve at times when we might otherwise determine not to provide it or when doing so is not otherwise in
the interests of Orrstown or our shareholders or creditors. The Federal Reserve may require a BHC to make capital injections into a troubled subsidiary bank and
may charge the BHC with engaging in unsafe and unsound practices if the BHC fails to commit resources to such a subsidiary bank or if it undertakes actions that
the Federal Reserve believes might jeopardize the BHC’s ability to commit resources to such subsidiary bank.
Under these requirements, Orrstown may in the future be required to provide financial assistance to the Bank should it experience financial distress. Capital
loans by Orrstown to the Bank would be subordinate in right of payment to deposits and certain other debts of the Bank. In the event of Orrstown's bankruptcy, any
commitment by Orrstown to a federal bank regulatory agency to maintain the capital of the Bank would be assumed by the bankruptcy trustee and entitled to a
priority of payment.
Pennsylvania Banking Law
The Pennsylvania Banking Code contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers,
and employees, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Pennsylvania Banking Code
delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking so that the supervision and regulation of state
chartered banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.
The FDIA, however, prohibits state chartered banks from making new investments, loans, or becoming involved in activities as principal and equity
investments which are not permitted for national banks unless the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit
Insurance Fund, and the bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the Pennsylvania
Banking Code is significantly restricted by the FDIA.
Dividend Restrictions
The Parent Company is a legal entity separate and distinct from its banking and non-banking subsidiaries. Since our consolidated net income consists largely
of net income of Orrstown's subsidiaries, our ability to make capital distributions, including paying dividends and repurchasing shares, depends upon our receipt of
dividends from these subsidiaries. Under federal law, there are various limitations on the extent to which the Bank can declare and pay dividends to the Parent
Company, including those related to regulatory capital requirements, general regulatory oversight to prevent unsafe or unsound practices, and federal banking law
requirements concerning the payment of dividends out of net profits, surplus, and available earnings. Certain contractual restrictions also may limit the ability of
the Bank to pay dividends to the Parent Company. No assurances can be given that the Bank will, in any circumstances, pay dividends to the Parent Company.
Orrstown's ability to declare and pay dividends to our shareholders is similarly limited by federal banking law and Federal Reserve regulations and policy.
The Bank must maintain the applicable CET1 Capital Conservation Buffer to avoid becoming subject to restrictions on capital distributions, including dividends.
As of January 1, 2019, the fully phased in Capital Conservation Buffer was 2.5%.
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Federal Reserve policy provides that a BHC should not pay dividends unless (1) the BHC’s net income over the last four quarters (net of dividends paid) is
sufficient to fully fund the dividends, (2) the prospective rate of earnings retention appears consistent with the capital needs, asset quality, and overall financial
condition of the BHC and its subsidiaries, and (3) the BHC will continue to meet minimum required capital adequacy ratios. Accordingly, a BHC should not pay
cash dividends that can only be funded in ways that weaken the BHC’s financial health, such as by borrowing. The policy also provides that a BHC should inform
the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could
result in a material adverse change to the BHC’s capital structure. BHCs also are required to consult with the Federal Reserve before increasing dividends or
redeeming or repurchasing capital instruments. Additionally, the Federal Reserve could prohibit or limit the payment of dividends by a BHC if it determines that
payment of the dividend would constitute an unsafe or unsound practice.
Transactions between a Bank and its Affiliates
Federal banking laws and regulations impose qualitative standards and quantitative limitations upon certain transactions between a bank and its affiliates,
including between a bank and its holding company and companies that the BHC may be deemed to control for these purposes. Transactions covered by these
provisions must be on arm’s-length terms and cannot exceed certain amounts which are determined with reference to the bank’s regulatory capital. Moreover, if the
transaction is a loan or other extension of credit, it must be secured by collateral in an amount and quality expressly prescribed by statute, and if the affiliate is
unable to pledge sufficient collateral, the BHC may be required to provide it. The Dodd-Frank Act expanded the coverage and scope of these regulations, including
by applying them to the credit exposure arising under derivative transactions, repurchase and reverse repurchase agreements, and securities borrowing and lending
transactions. Federal banking laws also place similar restrictions on loans and other extensions of credit by FDIC-insured banks, such as the Bank, and their
subsidiaries to their directors, executive officers, and principal shareholders.
Regulatory Capital Requirements
Compliance with respect to capital requirements is incorporated by reference from Note 16, Shareholders' Equity and Regulatory Capital, to the Consolidated
Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," and from the Capital Adequacy and Regulatory Matters section of
Item 7, “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations.”
The Bank is subject to certain risk-based capital and leverage ratio requirements under the U.S. Basel III capital rules adopted by the Federal Reserve. These
rules implement the Basel III international regulatory capital standards in the U.S., as well as certain provisions of the Dodd-Frank Act. These quantitative
calculations are minimums, and the Federal Reserve may determine that a banking organization, based on its size, complexity, or risk profile, must maintain a
higher level of capital in order to operate in a safe and sound manner. In May 2018, the Federal Reserve raised the asset-sized reporting threshold for a BHC to
$3.0 billion and a company with consolidated assets under the revised limit is not subject to the FRB consolidated capital rules. A company with consolidated
assets under the revised limits may continue to file reports that include capital amounts and ratios. Orrstown has elected to continue to file those reports.
Under the U.S. Basel III capital rules, Orrstown's and the Bank’s assets, exposures, and certain off-balance sheet items are subject to risk weights used to
determine the institutions’ risk-weighted assets. These risk-weighted assets are used to calculate the following minimum capital ratios for Orrstown and the Bank:
• CET1 Risk-Based Capital Ratio, equal to the ratio of CET1 capital to risk-weighted assets. CET1 capital primarily includes common shareholders’ equity
subject to certain regulatory adjustments and deductions, including goodwill, intangible assets, certain deferred tax assets, and AOCI.
• Tier 1 Risk-Based Capital Ratio, equal to the ratio of Tier 1 capital to risk-weighted assets. Tier 1 capital is primarily comprised of CET1 capital, perpetual
preferred stock, and certain qualifying capital instruments.
• Total Risk-Based Capital Ratio, equal to the ratio of total capital, including CET1 capital, Tier 1 capital, and Tier 2 capital, to risk-weighted assets. Tier 2
capital primarily includes qualifying subordinated debt and qualifying ALL.
• Tier 1 Leverage Ratio, equal to the ratio of Tier 1 capital to quarterly average assets (net of goodwill, certain other intangible assets, and certain other
deductions).
Failure to be well-capitalized or to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have an adverse material effect on our operations or
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financial condition. Failure to be well-capitalized or to meet minimum capital requirements could also result in restrictions on the Bank’s ability to pay dividends
or otherwise distribute capital or to receive regulatory approval of applications.
In addition to meeting the minimum capital requirements, under the U.S. Basel III capital rules, the Bank must also maintain the required Capital
Conservation Buffer to avoid becoming subject to restrictions on capital distributions and certain discretionary bonus payments to management. The Capital
Conservation Buffer is calculated as a ratio of CET1 capital to risk-weighted assets, and it effectively increases the required minimum risk-based capital ratios. The
Capital Conservation Buffer requirement was phased in over a three-year period that began on January 1, 2016. The phase-in period ended on January 1, 2019, and
the Capital Conservation Buffer was at its fully phased-in level of 2.5% throughout 2019. The Tier 1 Leverage Ratio is not impacted by the Capital Conservation
Buffer, and a banking institution may be considered well-capitalized while remaining out of compliance with the Capital Conservation Buffer.
Orrstown has the ability to provide additional capital to the Bank to maintain the Bank’s risk-based capital ratios at levels which would be considered well-
capitalized.
At December 31, 2019, Orrstown's and the Bank’s regulatory capital ratios were above the well-capitalized standards and met the Capital Conservation
Buffer on a fully phased-in basis.
Bank Acquisitions by Orrstown
BHCs must obtain prior approval of the Federal Reserve in connection with any acquisition that results in the BHC owning or controlling 5% or more of any
class of voting securities of a bank or another BHC.
Acquisitions of Ownership of Orrstown
Acquisitions of Orrstown's voting stock above certain thresholds are subject to prior regulatory notice or approval under federal banking laws, including the
BHC Act and the Change in Bank Control Act of 1978. Under the Change in Bank Control Act, a person or entity generally must provide prior notice to the
Federal Reserve before acquiring the power to vote 10% or more of our outstanding common stock. Investors should be aware of these requirements when
acquiring shares in our stock.
Data Privacy
Federal and state law contains extensive consumer privacy protection provisions. The GLB Act requires financial institutions to periodically disclose their
privacy policies and practices relating to sharing such information and enables retail clients to opt out of our ability to share information with unaffiliated third
parties under certain circumstances. Other federal and state laws and regulations impact our ability to share certain information with affiliates and non-affiliates for
marketing and/or non-marketing purposes, or to contact clients with marketing offers. These security and privacy policies and procedures for the protection of
personal and confidential information are in effect across all businesses and geographic locations as applicable. Federal law also makes it a criminal offense, except
in limited circumstances, to obtain or attempt to obtain client information of a financial nature by fraudulent or deceptive means. Data privacy and data protection
are areas of increasing federal and state legislative focus.
Like other lenders, the Bank uses credit bureau data in its underwriting activities. Use of such data is regulated under the Fair Credit Reporting Act, which
also regulates reporting information to credit bureaus, prescreening individuals for credit offers, sharing of information between affiliates, and using affiliate data
for marketing purposes. Similar state laws may impose additional requirements on us.
Cybersecurity
The GLB Act requires financial institutions to implement a comprehensive information security program that includes administrative, technical, and physical
safeguards to ensure the security and confidentiality of client records and information.
The Cybersecurity Information Sharing Act is intended to improve cybersecurity in the U.S. by enhanced sharing of information about security threats among
the U.S. government and private sector entities, including financial institutions. The Cybersecurity Information Sharing Act also authorizes companies to monitor
their own systems notwithstanding any other provision of law and allows companies to carry out defensive measures on their own systems from cyber attacks. The
law includes liability protections for companies that share cyber threat information with third parties so long as such sharing activity is conducted in accordance
with Cybersecurity Information Sharing Act.
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In October 2016, the federal bank regulatory agencies issued an Advanced Notice of Proposed Rulemaking regarding enhanced cyber risk management
standards which would apply to a wide range of large financial institutions and their third-party service providers. The proposed rules would expand existing
cybersecurity regulations and guidance to focus on cyber risk governance and management, management of internal and external dependencies, and incident
response, cyber resilience, and situational awareness. In addition, the proposal contemplates more stringent standards for institutions with systems that are critical
to the financial sector. The Federal Reserve announced in May 2019 that it would revisit the Advanced Notice of Proposed Rulemaking in the future.
Community Reinvestment Act
The CRA is intended to encourage banks to help meet the credit needs of their service areas, including low- and moderate-income neighborhoods, consistent
with safe and soundness practices. The relevant federal bank regulatory agency, the FRB in the Bank’s case, examines each bank and assigns it a public CRA
rating. A bank’s record of fair lending compliance is part of the resulting CRA examination report.
The CRA requires the relevant federal bank regulatory agency to consider a bank’s CRA assessment when considering the bank’s application to conduct
certain mergers or acquisitions or to open or relocate a branch office. The Federal Reserve also must consider the CRA record of each subsidiary bank of a BHC in
connection with any acquisition or merger application filed by the BHC. An unsatisfactory CRA record could substantially delay or result in the denial of an
approval or application by Orrstown or the Bank. The Bank received a CRA rating of “Satisfactory” in its most recent examination.
Leaders of the federal banking agencies recently have indicated their support for modernizing the CRA regulatory framework to address changing delivery
systems and consumer preferences, and, in December 2019, the Office of the Comptroller of the Currency and FDIC issued a joint proposed rule that would amend
the CRA regulatory framework. It is too early to tell whether and to what extent any changes will be made to applicable CRA requirements.
Anti-Money Laundering
The Bank Secrecy Act and the PATRIOT Act contain anti-money laundering and financial transparency provisions intended to detect and prevent the use of
the U.S. financial system for money laundering and terrorist financing activities. The Bank Secrecy Act, as amended by the PATRIOT Act, requires depository
institutions and their holding companies to undertake activities including maintaining an anti-money laundering program, verifying the identity of clients, verifying
the identity of certain beneficial owners for legal entity clients, monitoring for and reporting suspicious transactions, reporting on cash transactions exceeding
specified thresholds, and responding to requests for information by regulatory authorities and law enforcement agencies. The Bank is subject to the Bank Secrecy
Act and, therefore, is required to provide its employees with anti-money laundering training, designate an anti-money laundering compliance officer, and undergo
an annual, independent audit to assess the effectiveness of its anti-money laundering program. The Bank has implemented policies, procedures, and internal
controls that are designed to comply with these anti-money laundering requirements. Bank regulators are focusing their examinations on anti-money laundering
compliance, and we will continue to monitor and augment, where necessary, our anti-money laundering compliance programs. The federal banking agencies are
required, when reviewing bank and BHC acquisition or merger applications, to take into account the effectiveness of the anti-money laundering activities of the
applicant.
Office of Foreign Assets Control Regulation
The Office of Foreign Assets Control is responsible for administering economic sanctions that affect transactions with designated foreign countries, nationals,
and others, as defined by various Executive Orders and in various legislation. Office of Foreign Assets Control-administered sanctions take many different forms.
For example, sanctions may include: (1) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports
from and exports to a sanctioned country and prohibitions on U.S. persons engaging in financial transactions relating to, making investments in, or providing
investment-related advice or assistance to, a sanctioned country; and (2) a blocking of assets in which the government or “specially designated nationals” of the
sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction, including property in the possession or control of U.S. persons.
The Office of Foreign Assets Control also publishes lists of persons, organizations, and countries suspected of aiding, harboring, or engaging in terrorist acts,
known as Specially Designated Nationals and Blocked Persons. Blocked assets, for example property and bank deposits, cannot be paid out, withdrawn, set off, or
transferred in any manner without a license from the Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and
reputational consequences.
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Transaction Account Reserves
Federal Reserve rules require depository institutions to maintain reserves against their transaction accounts, primarily NOW and regular checking accounts.
For 2020, the first $16.9 million of covered balances are exempt from the reserve requirement, aggregate balances between $16.9 million and $127.5 million are
subject to a 3% reserve requirement, and aggregate balances above $127.5 million are subject to a 10% reserve requirement. These reserve requirements are subject
to annual adjustment by the Federal Reserve. The Bank was in compliance with these requirements as of December 31, 2019.
Consumer Protection Regulation and Supervision
We are subject to supervision and regulation by the CFPB with respect to federal consumer protection laws. We are also subject to certain state consumer
protection laws, and under the Dodd-Frank Act, state attorneys general and other state officials are empowered to enforce certain federal consumer protection laws
and regulations. State authorities have increased their focus on and enforcement of consumer protection rules. These federal and state consumer protection laws
apply to a broad range of our activities and to various aspects of our business and include laws relating to interest rates, fair lending, disclosures of credit terms and
estimated transaction costs to consumer borrowers, debt collection practices, the use of and the provision of information to consumer reporting agencies, and the
prohibition of unfair, deceptive, or abusive acts or practices in connection with the offer, sale, or provision of consumer financial products and services.
The CFPB has promulgated many mortgage-related final rules since it was established under the Dodd-Frank Act, including rules related to the ability to
repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, high-cost mortgage requirements, Home Mortgage
Disclosure Act requirements, and appraisal and escrow standards for higher priced mortgages. The mortgage-related final rules issued by the CFPB have materially
restructured the origination, servicing, and securitization of residential mortgages in the U.S. These rules have impacted, and will continue to impact, the business
practices of mortgage lenders, including the Bank.
Future Legislation and Regulation
Changes in federal laws and regulations, as well as laws and regulations in states where the Parent Company, the Bank, and Wheatland do business, can
affect the operating environment of Orrstown in substantial ways. We cannot predict whether those changes in laws and regulations will occur, and, if they occur,
the ultimate effect they would have upon the financial condition or results of operations of the Company.
Nasdaq Capital Market
The Company’s common stock is listed on the Nasdaq Capital Market under the trading symbol “ORRF” and is subject to Nasdaq’s rules for listed
companies.
Available Information
We are subject to the informational requirements of the Exchange Act and, in accordance with the Exchange Act, we file annual, quarterly, and current
reports, proxy statements, and other information with the SEC. The SEC maintains an Internet web site that contains reports, proxy statements, and other
information about issuers, like us, who file electronically with the SEC. The address of the site is www.sec.gov. The reports and other information, including any
related amendments, filed by us with, or furnished by us to, the SEC are also available free of charge at our Internet web site as soon as reasonably practicable after
such material is electronically filed with, or furnished to, the SEC. The address of the site is www.orrstown.com. Except as specifically incorporated by reference
into this Annual Report on Form 10-K, information on those web sites is not part of this report.
ITEM 1A – RISK FACTORS
An investment in our common stock is subject to risks inherent in our business. The material risks and uncertainties that management believes affect us are
described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other
information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing us. Additional risks and
uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report
is qualified in its entirety by these risk factors.
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If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. If this were
to happen, the market price of our common stock could decline significantly, and you could lose all or part of your investment.
Risks Related to Credit
If our allowance for loan losses is not sufficient to cover actual losses, our earnings would decrease.
There is no precise method of predicting loan losses. The required level of reserves, and the related provision for loan losses, can fluctuate from year to year,
based on charge-offs and/or recoveries, loan volume, credit administration practices, and local and national economic conditions, among other factors. The ALL,
which is a reserve established through a provision for loan losses charged to expense, represents management’s best estimate of probable incurred losses within the
existing portfolio of loans. The level of the allowance reflects management’s evaluation of, among other factors, the status of specific impaired loans, historical
loss experience, delinquency, credit concentrations and economic conditions within our market area. The determination of the appropriate level of the ALL
inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which
may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional
problem loans and other factors, both within and outside of our control, may require us to increase our ALL.
In addition, bank regulatory agencies periodically review our ALL and may require us to increase the provision for loan losses or to recognize further loan
charge-offs, based on judgments that differ from those of, or information not available to, management. If loan charge-offs in future periods exceed the ALL, there
would be a need to record additional provisions to increase our ALL. Furthermore, growth in the loan portfolio would generally lead to an increase in the provision
for loan losses. Generally, increases in our ALL will result in a decrease in net income and stockholders’ equity, and may have a material adverse effect on our
financial condition and results of operations.
The deterioration of one or more of our significant lending relationships could result in a significant increase in the nonperforming loans and the provisions
for loan losses, which would negatively impact our results of operations.
Further, as a "smaller reporting company" as defined by the FASB, we have elected to delay implementation of ASU 2016-13, Measurement of Credit Losses
on Financial Instruments, under the three year delay permitted by the FASB in 2019. For a more complete description of the potential impact ASU 2016-13 may
have on our financial statements and ALL, please refer to the "Changes in our accounting policies or in accounting standards could materially affect how we
report our financial results and condition" risk factor below and Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements
under Part II, Item 8, "Financial Statements and Supplementary Data" appearing elsewhere in this Form 10-K.
Commercial real estate lending may expose us to a greater risk of loss and impact our earnings and profitability.
Our business strategy includes making loans secured by commercial real estate. These types of loans generally have higher risk-adjusted returns and shorter
maturities than other loans. Loans secured by commercial real estate properties are generally for larger amounts and may involve a greater degree of risk than other
loans. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the
successful operation and management of the properties. Accordingly, repayment of these loans is subject to conditions in the real estate market or the local
economy. In challenging economic conditions, these loans represent higher risk and could result in an increase in our total net charge-offs, requiring us to increase
our ALL, which could have a material adverse effect on our financial condition or results of operations. While we seek to minimize these risks in a variety of ways,
there can be no assurance that these measures will protect against credit-related losses.
The credit risk related to commercial and industrial loans is greater than the risk related to residential loans.
Commercial and industrial loans generally carry larger loan balances and involve a greater degree of risk of nonpayment or late payment than home equity
loans or residential mortgage loans.
Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term
working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may
be unsecured to our highest rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and
equipment. In a significant number of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets.
Commercial and industrial loans are more susceptible to risk of loss during a downturn in the economy, as borrowers may have greater difficulty in meeting their
debt service requirements and the value of the collateral may decline. We attempt to mitigate this risk through our underwriting standards, including evaluating the
creditworthiness of the borrower
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and, to the extent available, credit ratings on the business. Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are
typical. However, these procedures cannot eliminate the risk of loss associated with commercial and industrial lending.
Our commercial and industrial lending operations are located c Our borrowers’ ability to repay these loans depends largely on economic conditions in these
and surrounding areas. A deterioration in the economic conditions in these market areas could materially adversely affect our operations and increase loan
delinquencies, increase problem assets and foreclosures, increase claims and lawsuits, decrease the demand for our products and services and decrease the value of
collateral securing loans.
Risks Related to Interest Rates and Investments
Changes in interest rates could adversely impact the Company’s financial condition and results of operations.
Our operations are subject to risks and uncertainties surrounding our exposure to changes in the interest rate environment. Operating income, net income and
liquidity depend to a great extent on our net interest margin, i.e., the difference between the interest yields we receive on interest-earning assets, such as loans and
securities, and the interest rates we pay on interest-bearing liabilities, such as deposits and borrowings. These rates are highly sensitive to many factors beyond our
control, including competition, general economic conditions, and monetary and fiscal policies of various governmental and regulatory authorities, including the
FRB. If the rate of interest we pay on our interest-bearing liabilities increases more than the rate of interest we receive on our interest-earning assets, our net
interest income, and therefore our earnings and liquidity could be materially adversely affected. Our earnings and liquidity could also be materially adversely
affected if the rates on interest-earning assets fall more quickly than those on our interest-bearing liabilities.
Changes in interest rates also can affect our ability to originate loans; the ability of borrowers to repay adjustable or variable rate loans; our ability to obtain
and retain deposits in competition with other available investment alternatives; and the value of interest-earning assets, which would negatively impact
stockholders’ equity, and the ability to realize gains from the sale of such assets. Based on our interest rate sensitivity analyses, an increase in the general level of
interest rates will negatively affect the market value of the investment portfolio because of the relatively higher duration of certain securities included in the
investment portfolio.
Our subordinated notes, issued in December 2018, have a 6.0% fixed interest rate through December 2023, after which the interest rate will convert to a
variable rate of the London Interbank Offered Rate (“LIBOR”) plus 3.16% through maturity in December 2028. Depending on our financial condition at the time
of the rate changing from fixed to variable, an increase in the interest rate on our subordinated debt could have a material adverse effect on our liquidity and results
of operations.
The expected discontinuance of LIBOR presents risks to the financial instruments originated, issued or held by us that use LIBOR as a reference rate.
LIBOR is used as a reference rate for many of our transactions, which means it is the base on which relevant interest rates are determined. Transactions
include those in which we lend and borrow money and issue, purchase and sell securities. LIBOR is the subject of recent national and international regulatory
guidance and proposals for reform. The United Kingdom Financial Conduct Authority, which regulates the process for setting LIBOR, announced in July 2017 that
it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021.
While there are ongoing efforts to establish an alternative reference rate to LIBOR, such as the Secured Overnight Financing Rate or SOFR, as of the date of
this report, no such rate has been accepted or is considered ready to be widely implemented.
If another rate does not achieve wide acceptance as the alternative to LIBOR, there likely will be disruption to all of the markets relying on the availability of
a broadly accepted reference rate. Even if another reference rate ultimately replaces LIBOR, risks will remain for us with respect to outstanding loans, or other
instruments using LIBOR. Those risks arise in connection with transitioning those instruments to a new reference rate and the corresponding value transfer that
may occur in connection with that transition. Risks related to transitioning instruments to a new reference rate or to how LIBOR is calculated and its availability
include impacts on the yield on loans or securities held by us and amounts paid on securities we have issued. The value of loans, securities, or borrowings tied to
LIBOR and the trading market for LIBOR-based securities could also be impacted upon its discontinuance or if it is limited.
Further, it is possible that LIBOR quotes will become unavailable prior to 2021 if a sufficient number of banks decline to make submissions to the LIBOR
administrator. In that case, the risks associated with the transition to an alternative reference rate would be accelerated and magnified. These risks may also be
increased due to the shorter time frame for preparing for the transition.
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Risks Related to Competition and to Our Business Strategy
Difficult economic and market conditions can adversely affect the financial services industry and may materially and adversely affect the Company.
Our operations are sensitive to general business and economic conditions in the U.S. If the growth of the U.S. economy slows, or if the economy worsens or
enters into a recession, our growth and profitability could be constrained. In addition, economic conditions in foreign countries can affect the stability of global
financial markets, which could impact the U.S. economy and financial markets. Weak economic conditions are characterized by deflation, fluctuations in debt and
equity capital markets, including a lack of liquidity and/or depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage,
consumer and commercial loans, residential and commercial real estate price declines and lower home sales and commercial activity. All of these factors are
detrimental to our business. Our business is significantly affected by monetary and related policies of the U.S. federal government, its agencies and government-
sponsored entities. Changes in any of these policies could have a material adverse effect on our business, financial position, results of operations and cash flows.
In particular, we may face the following risks in connection with volatility in the economic environment:
•
•
•
•
Loan delinquencies could increase;
Problem assets and foreclosures could increase;
Demand for our products and services could decline; and
Collateral for loans made by us, especially real estate, could decline in value, reducing client borrowing power, and reducing the value of the assets and
collateral associated with our loans.
Because our business is concentrated in south central Pennsylvania, in the greater Baltimore region, and Washington County, Maryland, our financial
performance could be materially adversely affected by economic conditions and real estate values in these market areas.
Our operations and the properties securing our loans are primarily located in south central Pennsylvania, in the greater Baltimore region, and Washington
County, Maryland. Our operating results depend largely on economic conditions and real estate valuations in these and surrounding areas. A deterioration in the
economic conditions in these market areas could materially adversely affect our operations and increase loan delinquencies, increase problem assets and
foreclosures, increase claims and lawsuits, decrease the demand for our products and services and decrease the value of collateral securing loans, especially real
estate, in turn reducing clients’ borrowing power, the value of assets associated with nonperforming loans and collateral coverage.
Competition from other banks and financial institutions in originating loans, attracting deposits and providing other financial services may adversely affect
our profitability and liquidity.
We experience substantial competition in originating both commercial and consumer loans in our market area. This competition comes principally from other
banks, savings institutions, credit unions, mortgage banking companies and other lenders. Some of our competitors enjoy advantages, including greater financial
resources, and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more
favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income and liquidity by decreasing the
number and size of loans that we originate and the interest rates we are able to charge on these loans.
As we expand our on-line lending capabilities, we will face competition, particularly in residential mortgage lending, from non-bank lenders (financial
institutions that only make loans and do not offer deposit accounts such as a savings account or checking account) and financial technology companies that use
new technology and innovation with available resources in order to compete in the marketplace of traditional financial institutions and intermediaries in the
delivery of financial services. This competition could similarly reduce our net income and liquidity.
In attracting business and consumer deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions
and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Some of our competitors enjoy advantages,
including more expansive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do,
which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition
could materially adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that
may be more expensive to obtain and could increase our cost of funds.
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The Company’s business strategy includes the continuation of moderate growth plans, and our financial condition and results of operations could be
negatively affected if we fail to grow or fail to manage our growth effectively.
Over the long term, we expect to continue to experience organic growth in loans and total assets, the level of our deposits and the scale of our operations.
Achieving our growth targets requires us to successfully execute our business strategies, which includes continuing to grow our loan portfolio. Our ability to
successfully grow will also depend on the continued availability of loan opportunities that meet underwriting standards. In addition, we may consider the
acquisition of other financial institutions and branches within or outside of our market area to the extent permitted by our regulators. The success of any such
acquisition will depend on a number of factors, including our ability to integrate the acquired institutions or branches into the current operations of the Company;
our ability to limit the outflow of deposits held by clients of the acquired institution or branch locations; our ability to control the incremental increase in
noninterest expense arising from any acquisition; and our ability to retain and integrate the appropriate personnel of the acquired institution or branches. We
believe we have the resources and internal systems in place to successfully achieve and manage our future growth. If we do not manage our growth effectively, we
may not be able to achieve our business plan goals and our business and prospects could be harmed.
The Company may be adversely affected by technological advances.
Technological advances impact our business. The banking industry undergoes technological change with frequent introductions of new technology-driven
products and services. In addition to improving client services, the effective use of technology increases efficiency and enables financial institutions to reduce
costs. Our future success may depend, in part, on our ability to address the needs of our current and prospective clients by using technology to provide products and
services that will satisfy demands for convenience, as well as to create additional efficiencies in operations.
The Company may not be able to attract and retain skilled people.
Competition for the best people in most activities engaged in by us can be intense, and we may not be able to attract and hire sufficiently skilled people to fill
open and newly created positions or to retain current or future employees. An inability to attract and retain individuals with the necessary skills to fill open
positions, or the unexpected loss of services of one or more of our key personnel, could have a material adverse impact on our business due to the loss of their
skills, knowledge of our markets, years of industry experience or the difficulty of promptly finding qualified replacement personnel.
We believe that our continued growth and future success will depend in large part on the skills of our management team and our ability to motivate and retain
these individuals and other key personnel. The loss of service of one or more of our executive officers or key personnel could reduce our ability to successfully
implement our long-term business strategy, our business could suffer, and the value of our stock could be materially adversely affected. Leadership changes will
occur from time to time, and we cannot predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel. We
believe our management team possesses valuable knowledge about the banking industry and that their knowledge and relationships could be very difficult to
replicate. Our success also depends on the experience of our branch managers and lending officers and on their relationships with the clients and communities they
serve. The loss of these key personnel could negatively impact our banking operations. The loss of key personnel, or the inability to recruit and retain qualified
personnel in the future, could have an adverse effect on our business, financial condition, or operating results.
We face security risks, including denial of service attacks, hacking, social engineering attacks targeting our colleagues and clients, malware intrusion or data
corruption attempts, and identity theft that could result in the disclosure of confidential information, adversely affect our business or reputation, and create
significant legal and financial exposure.
Our computer systems and network infrastructure and those of third parties, on which we are highly dependent, are subject to security risks and could be
susceptible to cyber attacks, such as denial of service attacks, hacking, terrorist activities, or identity theft. Our business relies on the secure processing,
transmission, storage, and retrieval of confidential, proprietary, and other information in our computer and data management systems and networks, and in the
computer and data management systems and networks of third parties. In addition, to access our network, products, and services, our clients and other third parties
may use personal mobile devices or computing devices that are outside of our network environment and are subject to their own cybersecurity risks.
We, our clients, regulators, and other third parties, including other financial services institutions and companies engaged in data processing, have been
subject to, and are likely to continue to be the target of, cyber attacks. These cyber attacks include computer viruses, malicious or destructive code, phishing
attacks, denial of service or information, ransomware, improper access by employees or vendors, attacks on personal email of employees, ransom demands to not
expose security vulnerabilities in our systems or the systems of third parties or other security breaches that could result in the unauthorized release, gathering,
monitoring, misuse, loss, or destruction of confidential, proprietary, and other information of ours, our employees, our clients,
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or of third parties, damage our systems or otherwise materially disrupt our or our clients’ or other third parties’ network access or business operations. As cyber
threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to
investigate and remediate any information security vulnerabilities or incidents. Despite efforts to ensure the integrity of our systems and implement controls,
processes, policies, and other protective measures, we may not be able to anticipate all security breaches, nor may we be able to implement sufficient preventive
measures against such security breaches, which may result in material losses or consequences for us.
Cybersecurity risks for banking organizations have significantly increased in recent years in part because of the proliferation of new technologies, and the use
of the internet and telecommunications technologies to conduct financial transactions. For example, cybersecurity risks may increase in the future as we continue to
increase our mobile-payment and other internet-based product offerings and expand our internal usage of web-based products and applications. In addition,
cybersecurity risks have significantly increased in recent years in part due to the increased sophistication and activities of organized crime affiliates, terrorist
organizations, hostile foreign governments, disgruntled employees or vendors, activists, and other external parties, including those involved in corporate espionage.
Even the most advanced internal control environment may be vulnerable to compromise. Due to increasing geopolitical tensions, nation state cyber attacks and
ransomware are both increasing in sophistication and prevalence. Targeted social engineering and email attacks (i.e. “spear phishing” attacks) are becoming more
sophisticated and are extremely difficult to prevent. In such an attack, an attacker will attempt to fraudulently induce colleagues, clients, or other users of our
systems to disclose sensitive information in order to gain access to its data or that of its clients. Persistent attackers may succeed in penetrating defenses given
enough resources, time, and motive. The techniques used by cyber criminals change frequently, may not be recognized until launched, and may not be recognized
until well after a breach has occurred. The speed at which new vulnerabilities are discovered and exploited often before security patches are published continues to
rise. The risk of a security breach caused by a cyber attack at a vendor or by unauthorized vendor access has also increased in recent years. Additionally, the
existence of cyber attacks or security breaches at third-party vendors with access to our data may not be disclosed to us in a timely manner.
We also face indirect technology, cybersecurity, and operational risks relating to the clients and other third parties with whom we do business or upon whom
we rely to facilitate or enable our business activities, including, for example, financial counterparties, regulators, and providers of critical infrastructure such as
internet access and electrical power. As a result of increasing consolidation, interdependence, and complexity of financial entities and technology systems, a
technology failure, cyber attack, or other information or security breach that significantly degrades, deletes, or compromises the systems or data of one or more
financial entities could have a material impact on counterparties or other market participants, including us. This consolidation, interconnectivity, and complexity
increases the risk of operational failure, on both individual and industry-wide bases, as disparate systems need to be integrated, often on an accelerated basis. Any
third-party technology failure, cyber attack, or other information or security breach, termination, or constraint could, among other things, adversely affect our
ability to effect transactions, service our clients, manage our exposure to risk, or expand our business.
Cyber attacks or other information or security breaches, whether directed at us or third parties, may result in a material loss or have material consequences.
Furthermore, the public perception that a cyber attack on our systems has been successful, whether or not this perception is correct, may damage our reputation
with clients and third parties with whom we do business. Hacking of personal information and identity theft risks, in particular, could cause serious reputational
harm. A successful penetration or circumvention of system security could cause us serious negative consequences, including our loss of clients and business
opportunities, costs associated with maintaining business relationships after an attack or breach; significant business disruption to our operations and business,
misappropriation, exposure, or destruction of our confidential information, intellectual property, funds, and/or those of our clients; or damage to our or our clients’
and/or third parties’ computers or systems, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties
or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and
could adversely impact our results of operations, liquidity and financial condition. In addition, we may not have adequate insurance coverage to compensate for
losses from a cybersecurity event.
Cybersecurity and data privacy are areas of heightened legislative and regulatory focus.
As cybersecurity and data privacy risks for banking organizations and the broader financial system have significantly increased in recent years, cybersecurity
and data privacy issues have become the subject of increasing legislative and regulatory focus. The federal bank regulatory agencies have proposed regulations that
would enhance cyber risk management standards, which would apply to a wide range of large financial institutions and their third-party service providers and
would focus on cyber risk governance and management, management of internal and external dependencies, and incident response, cyber resilience, and situational
awareness. Several states have also proposed or adopted cybersecurity legislation and regulations, which require, among other things, notification to affected
individuals when there has been a security breach of their personal data.
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We receive, maintain, and store non-public personal information of our clients and counterparties, including, but not limited to, personally identifiable
information and personal financial information. The sharing, use, disclosure, and protection of these types of information are governed by federal and state law.
Both personally identifiable information and personal financial information are increasingly subject to legislation and regulation, the intent of which is to protect
the privacy of personal information and personal financial information that is collected and handled.
We may become subject to new legislation or regulation concerning cybersecurity or the privacy of personally identifiable information and personal financial
information or of any other information we may store or maintain. We could be adversely affected if new legislation or regulations are adopted or if existing
legislation or regulations are modified such that we are required to alter our systems or require changes to our business practices or privacy policies. If
cybersecurity, data privacy, data protection, data transfer, or data retention laws are implemented, interpreted, or applied in a manner inconsistent with our current
practices, we may be subject to fines, litigation, or regulatory enforcement actions or ordered to change our business practices, policies, or systems in a manner that
adversely impacts our operating results.
We could be adversely affected by a failure in our internal controls.
We rely on our employees to design, manage, and operate our systems and controls to assure that we properly enter into, record and manage processes,
transactions and other relationships with clients, suppliers and other parties with whom we do business. In some cases, we rely on employees of third parties to
perform these tasks. We also depend on employees and the systems and controls for which they are responsible to assure that we identify and mitigate the risks that
are inherent in our relationships and activities. These concerns are increased when we change processes or procedures, introduce new products or services, or
implement new technologies, as we may fail to adequately identify or manage operational risks resulting from such changes.
As a result of our necessary reliance on employees, whether ours or those of third parties, to perform these tasks and manage resulting risks, we are subject to
human vulnerabilities. These range from innocent human error to misconduct or malfeasance, potentially leading to operational breakdowns or other failures. Our
controls may not be adequate to prevent problems resulting from human involvement in our business, including risks associated with the design, operation and
monitoring of automated systems.
Errors by our employees or others responsible for systems and controls on which we depend and any resulting failures of those systems and controls could
result in significant harm to us. This could include client remediation costs, regulatory fines or penalties, litigation or enforcement actions, or limitations on our
business activities. We could also suffer damage to our reputation, impacting our ability to attract and retain clients and employees.
We continue to devote a significant amount of effort and resources to constantly strengthening our controls and ensuring compliance with complex
accounting standards and regulations. However, these efforts may not be effective in preventing a breach in or failure of our controls.
Negative public opinion could damage our reputation and adversely affect our earnings.
Reputational risk, or the risk to the Company's earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can
result from the actual or perceived manner in which we conduct our business activities, including banking operations and trust and investment operations, our
management of actual or potential conflicts of interest and ethical issues, and our protection of confidential client information. Negative public opinion can
adversely affect the Company's ability to keep and attract clients and can expose the Company to litigation and regulatory action. Although we take steps to
minimize reputation risk in the way we conduct our business activities and deal with our clients, communities and vendors, these steps may not be effective.
We may become subject to claims and litigation pertaining to fiduciary responsibility.
We provide fiduciary services through OFA and Wheatland. From time to time, clients may make claims and take legal action with regard to the performance
of our fiduciary responsibilities. Whether such claims and legal actions are founded or unfounded, if such claims or legal actions are not resolved in a manner
favorable to us, the claims or related actions may result in significant financial expense and liability to us and/or adversely affect our reputation in the marketplace,
as well as adversely impact client demand for our products and services. Any financial liability or reputation damage could have a material adverse effect on our
business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
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Acts of terrorism, natural disasters, global climate change, pandemics and global conflicts may have a negative impact on our business and operations.
Acts of terrorism, natural disasters, global climate change, pandemics, global conflicts or other similar events could have a negative impact on our business
and operations. While we have in place business continuity plans, such events could still damage our facilities, disrupt or delay the normal operations of our
business (including communications and technology), result in harm to or cause travel limitations on our employees, and have a similar impact on our clients,
suppliers, third-party vendors and counterparties. These events also could impact us negatively to the extent that they result in reduced capital markets activity,
lower asset price levels, or disruptions in general economic activity in the U.S. or abroad, or in financial market settlement functions. In addition, these or similar
events may impact economic growth negatively, which could have an adverse effect on our business and operations, and may have other adverse effects on us in
ways that we are unable to predict.
Risks Related to Mergers and Acquisitions
On October 1, 2018, we completed the acquisition of Mercersburg, and on May 1, 2019, we completed the acquisition of Hamilton Bancorp, Inc.
Growing by acquisition involves risks.
We intend to pursue a growth plan consistent with our business strategy, including growth by acquisition, as well as leveraging our existing branch network
and adding new branch locations in current and future markets we choose to serve.
Our ability to manage growth successfully will depend on our ability to attract qualified personnel and maintain cost controls and asset quality while
attracting additional loans and deposits on favorable terms, as well as on factors beyond our control, such as economic conditions and competition. If we grow too
quickly and are not able to attract qualified personnel, control costs and maintain asset quality, this continued rapid growth could materially adversely affect our
financial performance.
Goodwill incurred in acquisitions may negatively affect our financial condition.
To the extent that merger consideration, consisting of cash and shares of our common stock, exceeds the fair value of the net assets acquired, including
identifiable intangibles, that amount will be reported as goodwill by us. In accordance with current accounting guidance, goodwill will not be amortized but will be
evaluated for impairment annually or more frequently if events or circumstances warrant. A failure to realize expected benefits of the mergers could adversely
impact the carrying value of the goodwill recognized in the mergers and, in turn, negatively affect our financial results.
We may be unable to successfully integrate the operations of acquired entities over time.
Acquisitions involve the integration with Orrstown of companies that previously operated independently. The difficulties of combining the operations of the
acquired companies with Orrstown include:
•
•
•
•
•
integrating personnel with diverse business backgrounds;
integrating departments, systems, operating procedures and information technologies;
combining different corporate cultures;
retaining existing clients and attracting new clients; and
retaining key employees.
The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the combined company and the loss of key
personnel. The diversion of management’s attention and any delays or difficulties encountered in connection with the merger and the integration process could
have a material adverse effect on the business and results of operations of the combined company.
The success of acquisitions depends, in part, on our ability to realize the anticipated benefits and cost savings from combining the businesses acquired with
Orrstown. If we are unable to successfully execute on integration, the anticipated earnings and cost savings to be derived from acquisitions may not be realized
fully or may take longer to realize than expected. In addition, as with regard to any acquisition, a significant change in interest rates or economic conditions or
decline in asset valuations may also cause us not to realize expected benefits and result in the acquisitions not meeting expectations.
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The market price of our common stock after acquisitions may be affected by factors different from those affecting our shares currently.
The businesses of the Company and acquired entities may differ and, accordingly, the results of operations of the combined company and the market price of
the shares of common stock of the combined company may be affected by factors different from those currently affecting the independent results of operations and
market prices of common stock of each separate entity. The market value of our common stock fluctuates based upon various factors, including changes in our
business, operations or prospects, market assessments of the merger, regulatory considerations, market and economic considerations, and other factors. Further, the
market price of our common stock after an acquisition may be affected by factors different from those currently affecting our common stock.
Additionally, future business acquisitions may result in the issuance and payment of additional shares of stock, which would dilute current shareholders’
ownership interests, and may involve the payment of a premium over book and market values. Therefore, dilution of our tangible book value and net income per
common share could occur in connection with any future transaction.
Risks Related to Regulatory Compliance and Legal Matters
Governmental regulation and regulatory actions against us may impair our operations or restrict our growth.
The Company is subject to regulation and supervision under federal and state laws and regulations. The requirements and limitations imposed by such laws
and regulations limit the manner in which we conduct our business, undertake new investments and activities and obtain financing. These regulations are designed
primarily for the promotion of the safety and soundness of financial institutions and the protection of the deposit insurance funds and consumers, and not to benefit
our shareholders.
Applicable laws and regulations impose capital adequacy requirements and restrict our ability to repurchase stock or to receive dividends from our
subsidiaries. Our ability to service our obligations and pay dividends to shareholders is largely dependent on the receipt of dividends from our subsidiaries,
primarily the Bank. The Federal Reserve requires a BHC to act as a source of financial and managerial strength for its subsidiary banks. The Federal Reserve could
require us to commit resources to the Bank when doing so is not otherwise in the interests of our shareholders or creditors.
We are subject to supervision and examination by numerous governmental bodies. The results of these supervisory or examination activities could result in
limitations on our ability to engage in new activities or expand geographically. These activities also could result in significant fines, penalties, or required
corrective actions, some of which could be expensive and difficult to implement. As we expand our product and service offerings into additional states, there could
be an increase in state regulation affecting our operations. Different approaches to regulation by different jurisdictions could increase our compliance costs or risks
of non-compliance.
Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the
future, none of which is within our control. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which
existing regulations are applied or enforced. The Company cannot predict the substance or impact of pending or future legislation, regulation or the application
thereof.
Compliance with such current and potential regulation and scrutiny may significantly increase our costs, impede the efficiency of our internal business
processes, require us to increase our regulatory capital and limit our ability to pursue business opportunities in an efficient manner. Bank regulations can hinder our
ability to compete with financial services companies that are not regulated in the same manner or are subject to less regulation. A failure to comply, or to have
adequate policies and procedures designed to comply, with regulatory requirements and expectations could expose us to damages, fines and regulatory penalties
and other regulatory or enforcement actions or consequences, such as limitations on activities otherwise permissible for us or additional requirements for engaging
in new activities, and could also injure our reputation with clients and others with whom we do business.
Increases in FDIC insurance premiums may have a material adverse effect on our results of operations.
We are generally unable to control the amount of premiums that are required to be paid for FDIC insurance. If there are bank or financial institution failures,
the Company may be required to pay significantly higher premiums than the levels currently imposed or additional special assessments or taxes that could
adversely affect earnings. Any future increases or required prepayments in FDIC insurance premiums may materially adversely affect the results of operations.
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Legislative, regulatory and legal developments involving income and other taxes could materially adversely affect the Company’s results of operations and
cash flows.
The Company is subject to U.S. federal and U.S. state income, payroll, property, sales and use, and other types of taxes including the Pennsylvania Bank
Shares Tax. Significant judgment is required in determining the Company's provisions for income taxes. Changes in tax rates, enactments of new tax laws,
revisions of tax regulations, and claims or litigation with taxing authorities could result in substantially higher taxes, and therefore, could have a significant adverse
effect on the Company's results of operations, financial condition and liquidity. Increases in the assessment rate for the Pennsylvania Bank Shares Tax, which is
calculated on the outstanding equity of the Bank, may also materially adversely affect results of operations.
The Company is required to use judgment in applying accounting policies and different estimates and assumptions in the application of these policies could
result in a decrease in capital and/or other material changes to the reports of financial condition and results of operations.
Material estimates that are particularly susceptible to significant change relate to the determination of the ALL, the fair value of certain financial instruments,
particularly securities, and goodwill and purchase accounting associated with acquisitions. While we have identified those accounting policies that we consider
critical and have procedures in place to facilitate the associated judgments, different assumptions in the application of these policies could have a material adverse
effect on our financial condition and results of operations.
Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.
From time to time, the FASB, SEC and other regulatory bodies change the financial accounting and reporting standards that govern the preparation of our
consolidated financial statements. These changes can be operationally complex to implement and can materially impact how we record and report our financial
condition and results of operations.
For example, in June 2016, the FASB issued Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments, that will, upon
adoption, substantially change the accounting for credit losses on loans and other financial assets held by banks, financial institutions and other organizations. The
update replaces existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost. Upon
adoption of ASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of credit losses over the full remaining expected
life. Companies must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and
reasonable and supportable forecasts.
The changes were effective for most publicly-held companies on January 1, 2020. However, in July 2019, the FASB approved permitting “smaller reporting
companies”, such as Orrstown, up to an additional 3 years to adopt ASU 2016-13. We elected not to adopt ASU 2016-13 on January 1, 2020, and have not yet
determined if we will adopt its provisions prior to the extended implementation date of January 1, 2023.
In December 2018, the Federal Reserve, OCC and FDIC released a final rule to revise their regulatory capital rules, in part to address the upcoming change to
the treatment of credit expense and allowances under ASC 2016-13. The final rule provides an optional three year phase-in period for the day-one adverse
regulatory capital effects upon adopting the standard. The impact of this final rule on the Company will depend on whether we elect to phase in the impact of ASU
2016-13 over a three year period. The standard is likely to have a negative impact, potentially materially, to the ALL and our capital position at adoption. When we
adopt ASU 2016-13, we will also determine whether we will elect the phase-in provisions for regulatory capital. It is possible that our ongoing reported earnings
and lending activity will be negatively impacted in periods following adoption of ASU 2016-13.
The short-term and long-term impact of changing regulatory capital requirements and new capital rules is uncertain.
The Basel III Capital Rules have targeted higher levels of base capital, certain capital buffers, and a migration toward common equity as the key source of
regulatory capital, as domestic and international bank regulatory agencies have sought to require financial institutions, including depository institutions, to
maintain generally higher levels of capital. The application of more stringent capital requirements to the Company and the Bank could, among other things, result
in lower returns on invested capital, result in the need for additional capital, and result in regulatory actions if we were to be unable to comply with such
requirements, including limitations on our ability to make distributions, including paying out dividends or buying back shares. Furthermore, the imposition of
liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business
models, and/or increase our holdings of liquid assets.
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Noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations could cause us material financial loss.
The Bank Secrecy Act and the PATRIOT Act contain anti-money laundering and financial transparency provisions intended to detect and prevent the use of
the U.S. financial system for money laundering and terrorist financing activities. The Bank Secrecy Act, as amended by the PATRIOT Act, requires depository
institutions and their holding companies to undertake activities including maintaining an anti-money laundering program, verifying the identity of clients,
monitoring for and reporting suspicious transactions, reporting on cash transactions exceeding specified thresholds, and responding to requests for information by
regulatory authorities and law enforcement agencies. FinCEN, a unit of the Treasury Department that administers the Bank Secrecy Act, is authorized to impose
significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the federal bank regulatory
agencies, as well as the U.S. Department of Justice, Drug Enforcement Administration, and IRS.
There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures, and systems are
deemed deficient or the policies, procedures, and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we
would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory
approvals to proceed with certain planned business activities, including acquisition plans, which would negatively impact our business, financial condition, and
results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious
reputational consequences for us.
Pending litigation and legal proceedings and the impact of any finding of liability or damages could adversely impact the Company and its financial condition
and results of operations.
As more fully described in Note 22, Contingencies, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statement and Supplementary
Data," of this Annual Report on Form 10-K, the Company believes that the allegations of the Southeastern Pennsylvania Transportation Authority's third amended
complaint are without merit and it intends to vigorously defend itself against those claims. It is not possible at this time to estimate reasonably possible losses, or
even a range of reasonably possible losses, in connection with the litigation. There can be no assurances, however, that the Company will not incur any losses
associated with this litigation or that any losses that are incurred will not be material.
Indemnification costs associated with litigation and legal proceedings could adversely impact the Company and its financial condition and results of
operations.
We are generally required, to the extent permitted by Pennsylvania law, to indemnify our current and former directors and officers who are named as
defendants in lawsuits. We also have certain contractual indemnification obligations to third parties regarding litigation. Generally, insurance coverage is not
available for such indemnification costs we could incur to third parties. Current or future litigation could result in indemnification expenses that could have a
materially adverse impact on our financial condition and results of operations.
Risks Related to Liquidity
The Parent Company is a holding company dependent for liquidity on payments from its bank subsidiary, which is subject to restrictions.
The Parent Company is a holding company and depends on dividends, distributions and other payments from the Bank to fund dividend payments and stock
repurchases, if permitted, and to fund all payments on obligations. The Bank is subject to laws that restrict dividend payments or authorize regulatory bodies to
prohibit or reduce the flow of funds from it to us. In addition, our right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is
subject to the prior claims of the Bank’s creditors, including its depositors.
The soundness of other financial institutions could adversely affect the Company.
Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial
institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even
rumors or questions about, one or more financial services institutions, or the financial services industry generally, have historically led to market-wide liquidity
problems, losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions. We could experience
increases in deposits and assets as a result of other banks’ difficulties or failure, which would increase the capital we are required to maintain to support such
growth.
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Risks Related to Owning our Stock
If the Company wants, or is compelled, to raise additional capital in the future, that capital may not be available when it is needed or on terms favorable to
current shareholders.
Federal banking regulators require us and our banking subsidiary to maintain adequate levels of capital to support our operations. These capital levels are
determined and dictated by law, regulation and banking regulatory agencies. In addition, capital levels are also determined by our management and board of
directors based on capital levels that they believe are necessary to support our business operations. At December 31, 2019, all four capital ratios for us and our
banking subsidiary were above regulatory minimum levels to be deemed “well capitalized” under current bank regulatory guidelines. To be “well capitalized,”
banks generally must maintain a tier 1 leverage ratio of at least 5.0%, CET1 capital ratio of 6.5%, Tier 1 risk-based capital ratio of at least 8.0%, and a total risk-
based capital ratio of at least 10.0%.
The Company’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside of our control, and on our
financial performance. Accordingly, we cannot provide assurance of our ability to raise additional capital on terms and time frames acceptable to us or to raise
additional capital at all. Additionally, the inability to raise capital in sufficient amounts may adversely affect our operations, financial condition and results of
operations. Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative news
and expectations about the prospects for the financial services industry as a whole. If we raise capital through the issuance of additional shares of our common
stock or other securities, we would likely dilute the ownership interests of current investors by diluting earnings per share of our common stock and potentially
dilute book value per share, depending on the issuance price. The price at which we issue additional shares of stock could be less than the current market price of
our common stock. Furthermore, a capital raise through the issuance of additional shares may have an adverse impact on our stock price.
The market price of our common stock is subject to volatility.
The market price of the Company’s common stock has been subject to fluctuations in response to numerous factors, many of which are beyond our control.
These factors include actual or anticipated variations in our operational results and cash flows, changes in financial estimates by securities analysts, trading
volume, large purchases or sales of our common stock, market conditions within the banking industry, the general state of the securities markets and the market for
stocks of financial institutions, as well as general economic conditions.
A reduction in our credit rating could adversely affect our access to capital and could increase our cost of funds.
A credit rating agency regularly evaluates Orrstown and the Bank, and credit ratings are based on a number of factors, including our financial strength and
ability to generate earnings, as well as factors not entirely within our control, including conditions affecting the financial services industry, the economy, and
changes in rating methodologies. There can be no assurance that we will maintain our current credit ratings. A downgrade of the credit ratings of Orrstown or the
Bank could adversely affect our access to liquidity and capital, and could significantly increase our cost of funds, trigger additional collateral or funding
requirements, and decrease the number of investors and counterparties willing to lend to us or purchase our securities. This could affect our growth, profitability,
and financial condition, including liquidity.
The Parent Company's primary source of income is dividends received from its bank subsidiary.
The Parent Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is
responsible for paying any dividends declared to its shareholders. The Company also has repurchased shares of its common stock. The Company’s primary source
of income is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid from the Bank to the Company without prior
approval of regulatory agencies. Restrictions on the Bank’s ability to dividend funds to the Company are included in Note 16, Shareholders' Equity and Regulatory
Capital, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data."
ITEM 1B – UNRESOLVED STAFF COMMENTS
None.
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ITEM 2 – PROPERTIES
Our principal executive offices are located at 77 East King Street, Shippensburg, Pennsylvania, with additional executive and administrative offices at 4750
Lindle Road, Harrisburg, Pennsylvania. These facilities are owned by the Bank, which also maintains its principal and additional executive and administrative
offices at those locations.
We own or lease other premises for use in conducting our business activities, including bank branches, an operations center, and offices in Berks,
Cumberland, Dauphin, Franklin, Lancaster, Perry, and York Counties, Pennsylvania and Anne Arundel, Baltimore, Howard, and Washington Counties, Maryland,
as well as Baltimore City, Maryland. We believe that the properties currently owned and leased are adequate for present levels of operation. We are constantly
evaluating the best and most efficient mix of branch locations to service our clients due to evolving trends in our industry and increased engagement through digital
channels.
In October 2019, we announced the consolidation of five Pennsylvania branches in Franklin and Perry Counties, that average less than $20.0 million in
deposits per location, into other, larger Orrstown Bank branches, as well as the sale of an operations center facility. We expect that these efforts will improve the
profitability of the remaining branch locations and eliminate close to 50,000 square feet of excess back office space. The branch consolidations were completed in
January 2020, and the sale of the operations center facility is anticipated to be completed in the second quarter of 2020.
ITEM 3 – LEGAL PROCEEDINGS
Information regarding legal proceedings is included in Note 22, Contingencies, to the Consolidated Financial Statements under Part II, Item 8, "Financial
Statement and Supplementary Data."
On March 5, 2019, Paul Parshall, a purported individual stockholder of Hamilton, filed, on behalf of himself and all of Hamilton’s stockholders other than the
named defendants and their affiliates (the “Purported Class”), a derivative and putative class action complaint in the Circuit Court for Baltimore City, Maryland,
captioned Paul Parshall v. Carol Coughlin et. al., naming each Hamilton director, Orrstown, and Hamilton as defendants (the “Action”). The Action alleges, among
other things, that Hamilton’s directors breached their fiduciary duties to the Purported Class in connection with the merger, and that the Proxy
Statement/Prospectus omitted certain material information regarding the merger. Orrstown is alleged to have aided and abetted the Hamilton directors’ alleged
breaches of their fiduciary duties. The Action seeks, among other remedies, to enjoin the merger or, in the event the merger is completed, rescission of the merger
or rescissory damages; unspecified damages; and costs of the lawsuit, including attorneys’ and experts’ fees. Orrstown believes that the lawsuit is without merit as
there are substantial legal and factual defenses to the claims asserted and intends to vigorously defend the lawsuit. It is not possible at this time to estimate
reasonably possible losses, or even a range of reasonably possible losses, in connection with the litigation.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
24
Table of Contents
PART II
ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market Information
Our common stock is traded on the NASDAQ Capital Market under the symbol “ORRF.” At the close of business on February 28, 2020, there were 2,984
shareholders of record.
The Board declared cash dividends of $0.60 and $0.51 per common share in 2019 and 2018, respectively. Our management is currently committed to
continuing to pay regular cash dividends; however, there can be no assurance as to future dividends because they are dependent on our future earnings, capital
requirements and financial condition. Restrictions on the payment of dividends are discussed in Note 16, Shareholders' Equity and Regulatory Capital, to the
Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data." On January 21, 2020, the Board declared a cash dividend
of $0.17 per common share, which was paid on February 10, 2020, to shareholders of record as of February 3, 2020.
Securities Authorized for Issuance under Equity Compensation Plans
Information regarding the Company's equity compensation plans is included in Part III, Item 12, Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.
Issuer Purchases of Equity Securities
In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of
the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including
Rule 10b-18 of the Securities Exchange Act of 1934, as amended. When and if appropriate, repurchases may be made in open market or privately negotiated
transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may
not occur and the share repurchase program may be discontinued at any time.
No shares were repurchased from October 1, 2019 to December 31, 2019. As of December 31, 2019, 82,725 shares had been repurchased under the program
at a total cost of $1.4 million, or $17.38 per share and the maximum number of shares that may yet be purchased under the plan is 333,275 shares.
25
Table of Contents
PERFORMANCE GRAPH
The performance graph below compares the cumulative total shareholder return on our common stock with other indexes: the SNL index of banks with assets
between $1.0 billion and $5.0 billion, the S&P 500 Index, and the NASDAQ Composite index. The graph assumes an investment of $100 on December 31, 2014
and reinvestment of dividends on the date of payment without commissions. Shareholder returns on our common stock are based on trades on the NASDAQ Stock
Market. The performance graph represents past performance and should not be considered to be an indication of future performance.
Index
Orrstown Financial Services, Inc.
SNL Bank $1B-$5B Index
S&P 500 Index
NASDAQ Composite Index
Source : S&P Global Market Intelligence © 2020
Period Ending
12/31/14
12/31/15
12/31/16
12/31/17
12/31/18
12/31/19
100.00
100.00
100.00
100.00
106.28
111.94
101.38
106.96
135.98
161.04
113.51
116.45
156.03
171.69
138.29
150.96
114.89
150.42
132.23
146.67
146.90
182.85
173.86
200.49
In accordance with the rules of the SEC, this section captioned “Performance Graph” shall not be incorporated by reference into any of our future filings
made under the Exchange Act or the Securities Act. The Performance Graph and its accompanying table are not deemed to be soliciting material or to be filed
under the Exchange Act or the Securities Act.
Recent Sales of Unregistered Securities
The Company has not sold any equity securities within the past three years which were not registered under the Securities Act.
26
Table of Contents
ITEM 6 – SELECTED FINANCIAL DATA
Summary of Operations
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Investment securities gains
Noninterest income
Noninterest expenses
Income before income tax expense
Income tax expense
Net income
Per Share Information
Basic earning per share
Diluted earnings per share
Dividends paid per share
Book value per share
Weighted average shares outstanding – basic
Weighted average shares outstanding – diluted
Stock Price Statistics
Close
High
Low
Price earnings ratio at close
Diluted price earnings ratio at close
Price to book at close
Year-End Information
Total assets
Loans
Total investment securities
Deposits – noninterest-bearing
Deposits – interest-bearing
Total deposits
Repurchase agreements
Borrowed money
Total shareholders’ equity
Assets under management – market value
Financial Ratios
Average equity / average assets
Return on average equity
Return on average assets
$
$
$
$
$
2019
2018
2017
2016
2015
At or For The Year Ended December 31,
$
92,994
23,699
69,295
900
68,395
4,749
23,792
77,302
19,634
2,710
$
65,667
13,511
52,156
800
51,356
1,006
20,018
57,935
14,445
1,640
$
51,453
7,644
43,809
1,000
42,809
1,190
18,759
50,330
12,428
4,338
$
42,276
5,417
36,859
250
36,609
1,420
18,005
48,140
7,894
1,266
16,924
$
12,805
$
8,090
$
6,628
$
$
$
$
1.53
1.50
0.51
18.39
8,360
8,537
18.21
27.05
18.10
11.9
12.1
1.0
1,934,388
1,247,657
476,686
204,843
1,353,913
1,558,756
9,069
170,309
173,433
1,330,595
$
$
$
1.00
0.98
0.42
17.34
8,070
8,226
25.25
26.95
19.05
25.3
25.8
1.5
1,558,849
1,010,012
425,305
162,343
1,057,172
1,219,515
43,576
133,815
144,765
1,370,950
$
$
$
0.82
0.81
0.35
16.28
8,059
8,145
22.40
23.75
16.60
27.3
27.7
1.4
1,414,504
883,391
408,124
150,747
1,001,705
1,152,452
35,864
76,163
134,859
1,174,143
8.75 %
8.56 %
0.75 %
9.49 %
5.73 %
0.54 %
10.41 %
4.80 %
0.50 %
10.66 %
5.99 %
0.64 %
$
$
$
1.63
1.61
0.60
19.93
10,362
10,514
22.62
23.48
17.30
13.9
14.0
1.1
2,383,274
1,644,330
506,570
249,450
1,626,072
1,875,522
8,269
241,514
223,249
1,613,223
9.26 %
8.21 %
0.76 %
27
39,013
4,301
34,712
(603)
35,315
1,924
16,876
44,607
9,508
1,634
7,874
0.97
0.97
0.22
16.08
8,106
8,142
17.84
18.45
15.10
18.4
18.4
1.1
1,292,816
781,713
402,844
131,390
900,777
1,032,167
29,156
84,495
133,061
966,362
Table of Contents
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of Orrstown
and should be read in conjunction with our Consolidated Financial Statements and notes thereto included in this Annual Report on Form 10-K. Certain prior period
amounts presented in this discussion and analysis have been reclassified to conform to current period classifications.
Overview
The results of our operations are highly dependent on economic conditions and market interest rates. Our profitability for the years ended December 31,
2019, 2018 and 2017 was influenced by our continued organic growth and ongoing expansion into targeted markets, the acquisitions of Mercersburg and Hamilton,
and a continued focus on maintaining strong asset quality. These and other matters are discussed more fully below.
Critical Accounting Estimates
The Company's consolidated financial statements are prepared in accordance with GAAP, and follow general practices within the financial services industry.
The most significant accounting policies followed by the Company are presented in Note 1, Summary of Significant Accounting Policies, to the Consolidated
Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data." In applying those accounting policies, the Company's management is
required to exercise judgment in determining many of the methodologies, assumptions and estimates to be utilized. Certain of the critical accounting estimates are
more dependent on such judgment and, in some cases, may contribute to volatility in our reported financial performance should the assumptions and estimates used
change over time due to changes in circumstances. Some of the more significant areas in which the Company's management applies critical assumptions and
estimates include the following.
Accounting for credit losses — The loan portfolio is the largest asset on the Company's consolidated balance sheets. The allowance for loan losses represents
the amount that, in management’s judgment, appropriately reflects credit losses inherent in the loan portfolio at the balance sheet date. A provision for credit losses
is recorded to adjust the level of the ALL as deemed necessary by management. In estimating losses inherent in the loan portfolio, assumptions and judgment are
applied to measure amounts and timing of expected future cash flows, collateral values and other factors used to determine the borrowers’ abilities to repay
obligations. Historical loss trends are also considered, as are economic conditions, industry trends, portfolio trends and borrower-specific financial data. Loans
acquired at a discount, that is, in part, attributable to credit quality, are initially recorded at fair value with no carry-over of an acquired entity’s previously
established ALL. Cash flows expected at acquisition, in excess of estimated fair value, are recognized as interest income over the remaining lives of the loans.
Subsequent decreases in the expected principal cash flows require the Company to evaluate the need for additions to the ALL. Subsequent improvements in
expected cash flows result, first, in the recovery of any applicable ALL and, then, in the recognition of additional interest income over the remaining lives of the
loans. Changes in the circumstances considered when determining management’s estimates and assumptions, could result in changes to those estimates and
assumptions, and also in adjustment of the ALL, or, in the case of loans acquired at a discount, increases in interest income in future periods.
Valuation methodologies — Management applies various valuation methodologies to assets and liabilities which often involve a significant degree of
judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for
certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant
estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit and other intangible assets,
other assets and liabilities obtained or assumed in business combinations, and capitalized servicing assets. These valuations require the use of various assumptions,
including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, costs of servicing and liquidation values. The use of
different assumptions could produce significantly different results, which could have material positive or negative effects on our results of operations, financial
condition or disclosures of fair value information. In addition to valuation, we must assess whether there are any declines in value below the carrying value of
assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statements
of income. Examples include investment securities, loan servicing rights, goodwill and core deposit and other intangible assets, among others.
Readers of our consolidated financial statements should be aware that the estimates and assumptions used in our current financial statements may need to be
updated in future financial presentations for changes in circumstances, business or economic conditions, in order to fairly represent the condition of the Company
at that time.
28
Table of Contents
Economic Climate, Inflation and Interest Rates
Preliminary annual real GDP growth for 2019 was 2.3%. The pace of U.S. economic growth weakened somewhat in 2019 versus 2018 and inflation pressures
declined. In response, the Federal Reserve reduced the Fed Funds rate three times in 2019 to the rate of 1.75%. Early in 2020, a novel coronavirus emerged and
spread, first in China and more recently, around the globe. The fast spread of the virus and the fear that has occurred has created a high level of uncertainty about
the near and intermediate future economic outlook. Because of this uncertainty, markets are pricing in a wide range of potential outcomes by buying sovereign
government bonds, especially U.S. Treasuries, and selling stocks. In reaction to the increase in uncertainty, the Federal Reserve took the step of cutting the Fed
Funds rates by 50 basis points between regularly scheduled meetings. Despite this action by the Federal Reserve, the outlook remains uncertain at this time.
The majority of the assets and liabilities of a financial institution are monetary in nature, and therefore, differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories. However, inflation does have an impact on the growth of total assets and on noninterest
expenses, which tend to rise during periods of general inflation. Inflationary pressures remain modest and there is great uncertainty about when, or if, inflation will
increase and pressure interest rates to move higher.
As the Company’s balance sheet consists primarily of financial instruments, interest income and interest expense are greatly influenced by the level of
interest rates and the slope of the yield curve. The Company has been able to grow its net interest income by $17.1 million from 2018 to 2019, through a
combination of organic growth and merger acquisitions. Competition for quality lending opportunities and deposits remains intense, which, together with a
flattening yield curve, will continue to challenge our ability to grow our net interest margin and to leverage our overhead expenses.
Results of Operations
Summary
Earnings in 2019 reflected continuing increased interest income from expanding loan and investment portfolios, partially offset by the impact of decreasing
interest rates and an overall increase in interest expense. In addition, the comparability of operating results for 2019 with 2018 has been impacted by the
Mercersburg and Hamilton acquisitions, which were completed on October 1, 2018 and May 1, 2019, respectively. Mercersburg added loans and deposits totaling
$141.1 million and $160.4 million, respectively, and Hamilton added loans and deposits totaling $347.4 million and $388.2 million, respectively.
The Company recorded net income of $16.9 million, $12.8 million and $8.1 million for 2019, 2018 and 2017, respectively. Diluted earnings per share totaled
$1.61, $1.50 and $0.98 for 2019, 2018 and 2017.
Net interest income totaled $69.3 million, $52.2 million and $43.8 million for 2019, 2018 and 2017, respectively, principally reflecting our expanded
geographic footprint, as well as organic growth in loans from an expanded sales force as we continued to take advantage of market opportunities. As previously
noted, interest rates increased throughout 2017 and 2018 and decreased throughout 2019, contributing to fluctuations in yields on loans and investments, and, to a
lesser extent, costs of interest-bearing liabilities.
Asset quality trends continue to exhibit low levels of charge-offs and non-performing loans. The provision for loan losses totaled $900 thousand, $800
thousand and $1.0 million in 2019, 2018 and 2017, respectively.
Noninterest expenses totaled $77.3 million, $57.9 million and $50.3 million for 2019, 2018 and 2017, respectively. The changes in certain components of
noninterest expenses between years reflect the Mercersburg and Hamilton acquisitions, and our continued focus on investing in additional talent and locations to
better serve the needs of our clients, particularly in Lancaster and Dauphin Counties, Pennsylvania, and in Maryland. Salaries and employee benefits expense
increased $2.4 million from 2017 to 2018 and $7.0 million from 2018 to 2019. Occupancy and furniture and fixture costs increased $923 thousand from 2017 to
2018 and $1.9 million from 2018 to 2019 as new and acquired branch locations were brought on line. In 2019, we incurred $9.0 million in pretax merger related
and branch consolidation expenses, with $3.2 million incurred in 2018 for pretax expense for merger related activity.
Income tax expense totaled $2.7 million, $1.6 million and $4.3 million for 2019, 2018 and 2017, or an effective tax rate of 13.8%, 11.4% and 34.9%
respectively. In 2017, we remeasured our net deferred tax asset due to the enactment of the Tax Act in December 2017. The Tax Act lowered our statutory tax rate
from 34% to 21% effective January 1, 2018. Remeasurement of our net deferred tax asset at the lower rate resulted in an expense of $2.6 million, which is included
in income tax expense for the year ended December 31, 2017.
29
Table of Contents
Net Interest Income
Net interest income is the primary component of Orrstown's revenue. Interest-earning assets include loans, securities and federal funds sold. Interest-bearing
liabilities include deposits and borrowed funds.
Net interest income is affected by changes in interest rates, volumes of interest-earning assets and interest-bearing liabilities, and the composition of those
assets and liabilities. “Net interest spread” and “net interest margin” are two common statistics related to changes in net interest income. Net interest spread
represents the difference between the yields earned on interest-earning assets and the rates paid for interest-bearing liabilities. Net interest margin is the ratio of net
interest income to average earning asset balances. Through the use of noninterest-bearing demand deposits and shareholders' equity, the net interest margin exceeds
the net interest spread, as these funding sources are noninterest-bearing.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan
portfolio is affected by changes in the prime interest rate. During 2017, the prime rate increased 25 basis points in each of March, June and December to end the
year at 4.50%. In 2018, the prime rate continued to rise with 25 point increases in each of March, June, September and December, ending the year at 5.50%. And in
2019, 25 basis point reductions occurred in August, September and October and the prime rate ended the year at 4.75%.
Core deposits are deposits that are stable, lower cost and generally reprice more slowly than other deposits when interest rates change. Core deposits are
typically funds of local clients who also have a borrowing or other relationship with the Bank. We are primarily funded by core deposits, with noninterest-bearing
demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and
net interest margin in a rising interest rate environment.
Net interest income totaled $69.3 million, $52.2 million and $43.8 million in 2019, 2018 and 2017, respectively. The following table presents net interest
income, net interest spread and net interest margin on a taxable-equivalent basis for 2019, 2018 and 2017. Taxable-equivalent adjustments are the result of
increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 21% federal
corporate tax rate for 2019 and 2018 and 34% for 2017, reflecting our statutory tax rates for those years.
30
Table of Contents
Assets
Federal funds sold and
interest-bearing bank
balances
Taxable securities
Tax-exempt securities (1)
Total securities
Taxable loans (2)(3)
Tax-exempt loans (1)(2)(3)
Total loans
Total interest-earning assets
Cash and due from banks
Bank premises and equipment
Other assets
Allowance for loan losses
Total
Liabilities and
Shareholders’ Equity
Interest-bearing demand
deposits
Savings deposits
Time deposits (4)
Short-term borrowings
Long-term debt
Subordinated notes
Total interest-bearing
liabilities
Noninterest-bearing demand
deposits
Other
Total Liabilities
Shareholders’ Equity
Total
Taxable-equivalent net
interest income / net
interest spread
Taxable-equivalent net
interest margin
Taxable-equivalent
adjustment
Net interest income
Ratio of average interest-
earning assets to average
interest-bearing liabilities
2019
Taxable-
Equivalent
Interest
Average
Balance
Taxable-
Equivalent
Rate
Average
Balance
2018
Taxable-
Equivalent
Interest
Taxable-
Equivalent
Rate
Average
Balance
2017
Taxable-
Equivalent
Interest
Taxable-
Equivalent
Rate
2.30 % $
3.33
4.10
16,442 $
359,852
119,665
1.99 % $
3.02
4.07
$
58,100 $
435,839
63,443
499,282
1,432,951
59,864
1,492,815
2,050,197
25,046
40,982
123,362
(14,466)
$ 2,225,121
$
920,025
138,761
549,937
32,001
80,636
31,842
1,339
14,530
2,600
17,130
73,201
2,367
75,568
94,037
8,253
261
10,796
623
1,779
1,987
1,753,202
23,699
234,354
31,544
2,019,100
206,021
$ 2,225,121
3.43
5.11
3.95
5.06
4.59
0.90
0.19
1.96
1.95
2.21
6.24
1.35
327
10,858
4,873
15,731
49,151
1,875
51,026
67,084
479,517
1,053,308
47,318
1,100,626
1,596,585
18,951
35,399
72,960
(13,298)
$ 1,710,597
$
767,863
102,189
324,118
81,172
83,640
1,139
4,968
159
5,102
1,577
1,632
73
1,360,121
13,511
183,387
17,427
1,560,935
149,662
$ 1,710,597
3.28
4.67
3.96
4.64
4.20
0.65
0.16
1.57
1.94
1.95
6.41
0.99
15,487 $
326,900
93,683
420,583
893,555
50,797
944,352
1,380,422
20,391
35,055
65,293
(12,738)
$ 1,488,423
$
648,174
94,815
292,616
97,814
36,336
—
218
7,478
4,748
12,226
39,006
2,450
41,456
53,900
2,148
150
3,836
784
726
—
1,169,755
7,644
161,917
15,450
1,347,122
141,301
$ 1,488,423
1.41 %
2.29
5.07
2.91
4.37
4.82
4.39
3.90
0.33
0.16
1.31
0.80
2.00
—
0.65
70,338
3.24 %
3.43 %
53,573
3.21 %
3.36 %
46,256
3.25 %
3.35 %
(1,043)
$
69,295
(1,417)
52,156
$
(2,447)
$
43,809
117 %
117 %
118 %
NOTES TO ANALYSIS OF NET INTEREST INCOME:
(1) Yields and interest income on tax-exempt assets have been computed on a taxable-equivalent basis assuming a 21% tax rate in 2019 and 2018, and 34% in 2017. For
yield calculation purposes, nonaccruing loans are included in the average loan balance.
(2) Average balances include nonaccrual loans.
(3) Interest income on loans includes prepayment and late fees. Where applicable, prior periods have been conformed to include these fees.
(4) In 2019, expenses associated with the early redemption of brokered time deposits totaled $215 thousand and increased the cost of funds by 3 basis points.
31
Table of Contents
The following table presents changes in net interest income on a taxable-equivalent basis for 2019, 2018 and 2017 by rate and volume components.
2019 Versus 2018 Increase (Decrease)
Due to Change in
2018 Versus 2017 Increase (Decrease)
Due to Change in
Average
Volume
Average
Rate
Total
Average
Volume
Average
Rate
Total
Interest Income
Federal funds sold and interest-bearing bank
balances
Taxable securities
Tax-exempt securities
Taxable loans
Tax-exempt loans
Total interest income
Interest Expense
Interest-bearing demand deposits
Savings deposits
Time deposits
Short-term borrowings
Long-term debt
Subordinated notes
Total interest expense
$
828 $
184 $
1,012 $
13 $
96 $
2,292
(2,289)
17,715
497
19,043
984
57
3,555
(955)
(59)
1,968
5,550
1,380
16
6,335
(5)
7,910
2,301
45
2,139
1
206
(54)
3,672
(2,273)
24,050
492
26,953
3,285
102
5,694
(954)
147
1,914
4,638
10,188
754
1,317
6,974
(168)
8,890
397
12
413
(133)
945
73
1,707
2,626
(1,192)
3,171
(407)
4,294
2,423
(3)
853
926
(39)
—
4,160
Taxable-Equivalent Net Interest Income
$
13,493 $
3,272 $
16,765 $
7,183 $
134 $
109
3,380
125
10,145
(575)
13,184
2,820
9
1,266
793
906
73
5,867
7,317
Note:
The change attributed to volume is calculated by taking the average change in average balance times the prior year's
average rate and the remainder is attributable to rate.
2019 versus 2018
In 2019, net interest income increased $17.1 million, or 32.9%, compared with 2018. Net interest income for 2019 on a taxable-equivalent basis increased
$16.8 million, or 31.3%, compared with 2018. The Company’s net interest spread increased three basis points to 3.24% for 2019 compared with 2018. Taxable-
equivalent yields on interest-earning assets and costs of interest-bearing liabilities both increased from 2018 to 2019, reflecting increased average balances from
organic growth and acquisitions, partially offset by changes in the interest rate environment between years. Other factors impacting the comparison of taxable-
equivalent yields between 2018 and 2019 include the effect of purchase accounting related to the Mercersburg and Hamilton acquisitions and the timing of our
adjustments to rates paid on interest-bearing deposits in response to market demand.
Interest income on a taxable-equivalent basis on loans increased $24.5 million, or 48.1%, from 2018 to 2019. The increase resulted from an increase in both
average loan volume and yield, with average loans increasing $392.2 million, or 35.6%, and yield increasing 42 basis points from 4.64% in 2018 to 5.06% in 2019.
The Company's geographic expansion and sales efforts with additional loan officers continued to drive loan growth in 2019 across most loan classes. Increases in
prime lending rates in 2018 contributed to an increased yield in the first half of 2019, but were partially offset by rate decreases in the second half. In addition, the
middle of the yield curve inverted for much of 2019, which lowered the rate on new loans more than the rate on new deposits, which pressured net interest margin.
Accretion of purchase accounting adjustments in connection with the acquisitions increased 2019 interest income by $3.8 million compared with $335 thousand in
2018.
Interest income earned on a taxable-equivalent basis on securities increased $1.4 million, or 8.9%, from 2018 to 2019, with both average volume and yield
increasing. Average securities increased $19.8 million, or 4.1%, and the taxable-equivalent yield increased from 3.28% in 2018 to 3.43% in 2019. Contributing to
the overall increase in interest income on securities was the purchase of higher yielding, longer maturity, tax-free state and political subdivisions investments in the
third quarter of 2018, that were subsequently sold in the third quarter of 2019. This was partially offset by declines in the yield of floating rate securities, which fell
as the Federal Reserve reduced short-term rates by 75 basis points in the second half of 2019.
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Table of Contents
Interest expense on deposits and borrowings increased $10.2 million from 2018 to 2019, as the average balance of interest-bearing liabilities increased $393.1
million, or 28.9%. Interest expense on interest-bearing deposits declined less than the decline in market rates due to competitive factors in the marketplace.
Our ability to attract new deposits in all categories, but in particular interest-bearing demand deposits, resulted in an increase in average interest-bearing
deposits totaling $152.2 million, or 19.8% in 2019, of which approximately $51.0 million was acquired in the Hamilton acquisition. Interest expense for these
deposits increased $3.3 million, with the cost of funds increasing from 0.65% in 2018 to 0.90% in 2019. The increase was driven by increasing market rates
throughout 2018, followed by falling short-term rates once the Fed began to ease in the second half of 2019. As noted, yields on interest-bearing deposits did not
fall as much as market rates due to competitive factors. As a result, interest was paid at higher rates on interest-bearing deposits in 2019 than in 2018.
We also decreased our average short-term borrowings in 2019 in favor of brokered deposits at more attractive rates in early 2019. In late 2018, we issued
$32.5 million in aggregate principal amount of subordinated notes, the proceeds of which were designated for the cash portion of merger and acquisition activity
and for general corporate purposes. Borrowings generally have higher interest rates associated with them than interest-bearing deposits. Interest expense on all
borrowings increased $1.1 million in 2019, with average balances decreasing $49.2 million for short-term borrowings while long-term borrowings also decreased
$3.0 million. The average rate paid on short-term borrowings increased from 1.94% in 2018 to 1.95% in 2019 and the average rate paid on long-term borrowings
increased from 1.95% in 2018 to 2.21% in 2019.
2018 versus 2017
In 2018, net interest income increased $8.0 million, or 18.4%, compared with 2017. Net interest income for 2018 on a taxable-equivalent basis increased $7.0
million, or 15.2%, compared with 2017. The Company’s net interest spread decreased six basis point to 3.16% for 2018 compared with 2017. Taxable-equivalent
yields on interest-earning assets and costs of interest-bearing liabilities both increased from 2017 to 2018, reflecting the increased interest rate environment
between years. Other factors impacting the comparison of taxable-equivalent yields between 2017 and 2018 included the effect of purchase accounting related to
the Mercersburg acquisition; the Company's gradual increase in rates paid on interest-bearing deposits in response to market demand; and the change in our
statutory tax rate.
Interest income on a taxable-equivalent basis on loans increased $9.2 million, or 22.4%, from 2017 to 2018. The increase resulted from an increase in both
average loan volume and yield, with average loans increasing $156.3 million, or 16.5%, and yield increasing 22 basis points from 4.34% in 2017 to 4.56% in 2018.
The Company's geographic expansion and sales efforts with additional loan officers continued to drive loan growth in 2018 across most loan classes. Increases in
prime lending rates during the year contributed to the increased yield, but a flattened yield curve partially offset the benefit of the rate increases. Accretion of
purchase accounting adjustments in connection with the Mercersburg acquisition increased 2018 interest income by $335 thousand.
Interest income earned on a taxable-equivalent basis on securities increased $3.5 million, or 28.7%, from 2017 to 2018, with both average volume and yield
increasing. Average securities increased $58.9 million, or 14.0%, and yield increased from 2.91% in 2017 to 3.28% in 2018. Contributing to the increase in interest
income on securities was the higher rate environment in 2018 and strategic moves within the portfolio as the interest rate environment changed.
Interest expense on deposits and borrowings increased $5.8 million from 2017 to 2018, as the average balance of interest-bearing liabilities increased $190.4
million, or 16.3%.
Our ability to attract and acquire new deposits in all categories, but in particular interest-bearing demand deposits, resulted in an increase in average interest-
bearing deposits totaling $119.7 million, or 18.5%, in 2018. Interest expense for these deposits increased $2.8 million, with the cost of funds increasing from
0.33% in 2017 to 0.64% in 2018. Generally, the Company increased rates paid on interest-bearing deposits in 2018 in response to market conditions, but at a
slower pace than yields earned on interest-earning assets.
We also increased our short-term and long-term borrowings in 2018 to partially fund loan and investment portfolio growth. In late 2018, we issued $32.5
million in aggregate principal amount of subordinated notes, the proceeds of which were designated for the cash portion of merger and acquisition activity and for
general corporate purposes. Borrowings generally have higher interest rates associated with them than interest-bearing deposits. Interest expense on all borrowings
increased $1.8 million in 2018, with average balances decreasing $16.6 million for short-term borrowings while long-term borrowings increased $47.3 million as
the Company responded to the changing interest rate environment. The average rate paid on short-term borrowings increased from 0.80% in 2017 to 1.94% in 2018
and the average rate paid on long-term borrowings decreased from 2.00% in 2017 to 1.95% in 2018.
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Table of Contents
Provision for Loan Losses
The Company recorded a provision for loan losses of $900 thousand, $800 thousand and $1.0 million in 2019, 2018, and 2017, respectively. In calculating
the provision for loan losses, both quantitative and qualitative factors, including the Company's favorable historical charge-off data and stable economic and
market conditions, were considered in the determination of the adequacy of the ALL. Net charge-offs and loan growth resulted in the determination that a provision
expense was required in 2019, 2018 and 2017.
See further discussion in the “Asset Quality” and “Credit Risk Management” sections of this Management’s Discussion and Analysis of Financial Condition
and Results of Operations.
Noninterest Income
The following table compares noninterest income for 2019, 2018 and 2017.
2019
2018
2017
2019-2018
2018-2017
2019-2018
2018-2017
$ Change
% Change
$
3,404 $
3,281
805
1,197
7,255
2,426
3,049
2,044
331
3,233 $
2,821
907
—
6,576
2,035
2,663
1,463
320
3,057 $
2,618
570
—
6,400
1,896
2,919
1,109
190
23,792
4,749
20,018
1,006
18,759
1,190
171 $
460
(102)
1,197
679
391
386
581
11
3,774
3,743
$
28,541 $
21,024 $
19,949 $
7,517 $
176
203
337
—
176
139
(256)
354
130
1,259
(184)
1,075
5.3 %
16.3 %
(11.2)%
— %
10.3 %
19.2 %
14.5 %
39.7 %
3.4 %
18.9 %
372.1 %
35.8 %
5.8 %
7.8 %
59.1 %
— %
2.8 %
7.3 %
(8.8) %
31.9 %
68.4 %
6.7 %
(15.5) %
5.4 %
Service charges on deposit accounts
Interchange income
Other service charges, commissions and fees
Loan swap referral fees
Trust and investment management income
Brokerage income
Mortgage banking activities
Income from life insurance
Other income
Subtotal before securities gains
Investment securities gains
Total noninterest income
2019 versus 2018
Noninterest income increased $7.5 million from 2018 to 2019. We continue to focus on growth in relationship fee-based revenue for commercial and retail
clients. In addition to the impact of the Mercersburg and Hamilton acquisitions, the following were significant factors in that net increase.
•
•
Service charges on deposit accounts and interchange on debit card income reflected an overall increase in our clients' activity and card usage from our
organic growth as well as the expanded client base from the acquisitions. These stable sources of fee revenue should grow over time as we add retail
and commercial clients.
Gains on SBA loan sales, which are included in other service charges, commissions and fees, decreased approximately $300 thousand from 2018 to
2019.
• We began offering interest rate hedging products through a third party in the second half of 2019, whereby we receive a fee at loan closing; this is
primarily used by commercial real estate borrowers. With our market expansion efforts and building of our experienced relationship manager team, we
added this product to better serve our clients. This fee revenue will fluctuate from quarter to quarter, but we continue to see client demand to fix loan
interest rates in the current rate environment.
•
•
Trust and brokerage income reflected increased revenue from generally improved market conditions, additional advisors and increased estate fees in
2019. We continue to look to build this business over the coming years and have recently begun efforts to offer wealth management products in our
acquired Baltimore market area.
The increase in mortgage banking activities reflects the increase in loans sold from $93.1 million in 2018 to $106.7 million in 2019. With interest rates
currently at low levels and recent market expansion efforts, we see opportunities to increase our market share with existing clients by increasing our
focus on branch referrals and local market outreach efforts.
34
Table of Contents
•
•
Income from life insurance included death benefit proceeds in both 2019 and 2018, with the increase between years principally attributable to life
insurance assets obtained through acquisitions.
In both 2019 and 2018, asset/liability management strategies resulted in net gains on sales of securities, as market conditions presented opportunities to
improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
2018 versus 2017
Noninterest income increased $1.1 million from 2017 to 2018. In addition to the impact of the Mercersburg acquisition, the following were significant factors
in that net increase.
•
•
•
•
•
•
Service charges on deposit accounts continued to increase in 2018 as a result of new product offerings and increased activity associated with deposit
growth.
Other service charges, commissions and fees in 2018 included additional gains on SBA loan sales and an increase in loan transaction fees.
Trust department income increased more modestly in 2018 than in 2017, reflecting a reduction in fee income in the latter part of 2018 as financial
markets declined.
The decrease in mortgage banking activities reflects a combination of overall decreased refinance activity as interest rates increased and a shortage of
available housing inventory during the year.
Income from life insurance increased principally due to death benefit proceeds.
In both 2018 and 2017, asset/liability management strategies resulted in net gains on sales of securities, as market conditions presented opportunities to
improve responsiveness of the portfolio to interest rate conditions, while also considering funding requirements of anticipated lending activity.
Noninterest Expenses
The following table compares noninterest expenses for 2019, 2018 and 2017.
2019
2018
2017
2019-2018
2018-2017
2019-2018
2018-2017
$ Change
% Change
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Automated teller machine and interchange fees
Advertising and bank promotions
FDIC insurance
Legal fees
Other professional services
Directors' compensation
Taxes other than income
Intangible asset amortization
Merger related and branch consolidation expenses
Insurance claim receivable write off
Other operating expenses
$
39,495 $
4,325
4,723
3,599
1,015
1,967
367
585
2,369
1,003
1,018
1,570
8,964
615
5,687
32,524 $
3,084
4,079
2,674
806
1,592
681
413
1,434
984
1,012
286
3,197
—
5,169
30,145 $
2,806
3,434
2,271
767
1,600
606
802
1,571
996
866
102
—
—
4,364
6,971 $
1,241
644
925
209
375
(314)
172
935
19
6
1,284
5,767
615
518
Total noninterest expenses
$
77,302 $
57,935 $
50,330 $
19,367 $
2,379
278
645
403
39
(8)
75
(389)
(137)
(12)
146
184
3,197
—
805
7,605
21.4 %
40.2 %
15.8 %
34.6 %
25.9 %
23.6 %
(46.1)%
41.6 %
65.2 %
1.9 %
0.6 %
449.0 %
180.4 %
— %
10.0 %
33.4 %
7.9 %
9.9 %
18.8 %
17.7 %
5.1 %
(0.5) %
12.4 %
(48.5) %
(8.7) %
(1.2) %
16.9 %
180.4 %
— %
— %
18.4 %
15.1 %
35
Table of Contents
2019 versus 2018
Noninterest expenses increased $19.4 million from 2018 to 2019. In addition to the impact of the Mercersburg and Hamilton acquisitions, the following were
significant factors in that net increase.
•
•
•
•
•
•
The salaries and employee benefits increase includes the impact in 2019 of additional employees, including new client-facing employees in new
branches in targeted expansion markets and others that were hired throughout 2018 and 2019, as well as additional new relationship managers. Higher
costs in 2019 also include annual merit and incentive compensation increases in 2019, increased stock compensation expense from additional share-
based awards granted in 2019, and higher medical costs for claims activity and the expanded workforce.
Occupancy and furniture and equipment expenses in 2019 reflect a full period of expense for our expanded presence in Lancaster County,
Pennsylvania, with two branch banking locations added in the third and fourth quarters of 2018 and two in the first quarter of 2019.
Increases in data processing reflect volume increases and physical growth and costs associated with more sophisticated product and service offerings.
Advertising and bank promotions expense includes additional costs incurred in 2019 for the celebration of the Bank's 100th anniversary year, as well as
marketing associated with the acquisitions.
FDIC insurance expense reflects credits received in the second half of 2019 under the FDIC's regulations to provide credits, when the reserve ratio
reaches 1.38%, to banks with consolidated assets below $10 billion. We expect FDIC insurance expense to increase after remaining credits are used to
partially offset first quarter 2020 expense.
Intangible asset amortization increased due to the core deposit intangibles recorded in the acquisitions.
• Merger related costs incurred in 2019 totaled $8.0 million and represented principally data processing contract termination costs, employee contract
termination costs and legal and consulting fees for the Hamilton acquisition and system conversion expenses for both the Mercersburg and Hamilton
acquisitions. In the fourth quarter of 2019, we recorded $988 thousand in expenses associated with the announced consolidation of five branches into
other, larger Bank branches, which was completed in January 2020. The expenses principally represented owned real estate write downs, lease
termination costs, severance benefits for impacted employees and other branch exit related expenses.
•
•
The insurance claim receivable write off relates to an expense recorded in 2019 to write off an insurance claim receivable from a 2018 cyber security
incident. In 2019, we received reimbursement totaling $59 thousand for the write off. In February 2020, we received an additional $486 thousand
reimbursement in a final settlement of the matter.
Other line items within noninterest expenses are generally attributable to normal fluctuations in the ordinary course of business.
2018 versus 2017
Noninterest expenses increased $7.6 million from 2017 to 2018. In addition to the impact of the Mercersburg acquisition, the following were significant
factors to that net increase.
•
•
•
•
The salaries and employee benefits increase includes the impact in 2018 of additional employees, including new client-facing employees in new
branches in targeted expansion markets and others that were hired throughout 2017 and 2018. Higher costs in 2018 also include annual merit increases
awarded in 2018 and incentive compensation increases, additional share-based awards granted in 2017, net of the benefit of forfeitures, and increased
medical costs for the expanded workforce. Medical costs in 2018 benefited from reduced claim activity from that experienced in 2017.
Occupancy and furniture and equipment expenses reflect a full period of expense for new facilities opened in 2017 and 2018, principally in Lancaster
County, Pennsylvania.
The Company incurred certain indemnification costs totaling $645 thousand, which are included in legal fees, to several professional service providers
in 2017 in connection with previously disclosed outstanding litigation. Indemnification costs incurred in 2018 were not material. Additional costs may
be incurred as the litigation progresses.
Intangible asset amortization increased due to the core deposit intangible recorded in the Mercersburg acquisition.
• Merger related costs were principally for investment banking and legal and consulting fees for the Mercersburg acquisition.
36
Table of Contents
•
Other line items within noninterest expenses are generally attributable to normal fluctuations in the conduct of business.
Income Taxes
Income tax expense totaled $2.7 million, $1.6 million and $4.3 million for 2019, 2018 and 2017, respectively. The effective tax rate for 2019 was 13.8%
compared with 11.4% for 2018 and 34.9% for 2017. Generally, our effective tax rate is lower than the federal statutory tax rate principally due to nontaxable
interest income earned on tax-free loans and securities and income from life insurance policies, offset partially by nondeductible expenses. In 2019, our effective
tax rate increased principally due to increased profitability, offset partially by benefits realized from a $185 thousand expense reduction related to a favorable tax
law clarification on the treatment of life insurance assets of an acquired entity, as well as a $334 thousand expense reduction related to an increase in deferred state
income taxes due to a state tax rate change resulting from the Hamilton acquisition. In 2017, our higher effective tax rate was principally impacted by the tax
expense incurred due to enacted tax reform. We were required to remeasure our net deferred tax asset and incurred a tax expense of $2.6 million, which was
included in income tax expense for the year ended December 31, 2017.
Our statutory federal tax rate was 21% in 2019 and 2018 and 34% in 2017. Note 8, Income Taxes, to the Consolidated Financial Statements under Part II,
Item 8, "Financial Statements and Supplementary Data," includes a reconciliation of our federal statutory tax rate to our effective tax rate, which is a meaningful
comparison between years and measures income tax expense as a percentage of pretax income.
Financial Condition
Management devotes substantial time to overseeing the investment of funds in loans and securities and the formulation of policies directed toward the
profitability and management of the risks associated with these investments.
Securities Available for Sale
The Company utilizes securities available for sale to manage interest rate risk, to enhance income through interest and dividend income, to provide liquidity
and to provide collateral for certain deposits and borrowings.
We have established investment policies and an asset management policy to assist in administering our investment portfolio. Decisions to purchase or sell
these securities are based on economic conditions and management’s strategy to respond to changes in interest rates, liquidity, pledges to secure deposits and
repurchase agreements and other factors while trying to maximize return on the investments. We may segregate our investment portfolio into three categories:
“securities held to maturity,” “trading securities” and “securities available for sale.” At December 31, 2019, management has classified the entire securities
portfolio as available for sale, which is accounted for at current market value with unrealized gains and losses excluded from earnings and reported in OCI, net of
income taxes.
Our securities available for sale portfolio includes debt investments that are subject to varying degrees of credit and market risks, which arise from general
market conditions, and factors impacting specific industries, as well as news that may impact specific issues. Management monitors its debt securities, using
various indicators in determining whether a debt security is other-than-temporarily impaired, including the amount of time the security has been in an unrealized
loss position, and the extent of the unrealized loss. In addition, management assesses whether it is likely we will have to sell the security prior to recovery, or if we
are able to hold the security until the price recovers. For those debt securities in which management concludes the security is other-than-temporarily impaired, it
recognizes the credit component of an OTTI impairment in earnings and the remaining portion in OCI. Given the strong asset quality of our debt security portfolio,
we did not record any OTTI expense in 2019, 2018 or 2017.
37
Table of Contents
The following table summarizes the fair value of securities available for sale at December 31, 2019, 2018 and 2017.
States and political subdivisions
GSE residential mortgage-backed securities
GSE residential CMOs
Non-agency CMOs
Private label residential CMOs
Private label commercial CMOs
Asset-backed and other
Total debt securities
2019
$
87,863 $
2018
145,004 $
—
68,154
17,087
—
86,629
230,653
—
108,064
—
143
75,045
137,588
2017
159,458
49,530
111,119
—
1,003
7,653
86,545
$
490,386 $
465,844 $
415,308
We modestly increased our investment portfolio in 2019, with the average balance of securities increasing from $479.5 million for the year ended
December 31, 2018 to $499.3 million for the year ended December 31, 2019.
In late 2018, we increased our holdings of longer maturity state and political subdivisions in anticipation of falling interest rates. In 2019, interest rates fell
and the attractiveness of tax-free state and political subdivisions declined. In response, we reduced our holdings of longer maturity tax-free state and political
subdivisions at a gain. We replaced these securities with additional asset-backed and private label commercial CMOs that were either floating rate or had shorter
average lives than the state and political subdivision investments.
Asset-backed securities and CMOs provide monthly cash flows that may be used, in part, to meet anticipated loan demand in 2020, as management
anticipates the loan portfolio will continue to grow.
38
Table of Contents
The following table shows the maturities of investment securities at book value at December 31, 2019, and weighted average yields of such securities. Yields
are shown on a tax equivalent basis, assuming a 21% federal income tax rate.
States and political subdivisions
Book value
Yield
Average maturity (years)
GSE residential CMOs
Book value
Yield
Average maturity (years)
Non-agency CMOs
Book value
Yield
Average maturity (years)
Private label commercial CMOs
Book value
Yield
Average maturity (years)
Asset-backed and other
Book value
Yield
Average maturity (years)
Total
Book value
Yield
Average maturity (years)
Within 1
year
After 1 year
but within 5
years
After 5 years
but within
10 years
After 10
years
Total
$
$
$
$
$
$
230
$
—
$
26,346
$
57,031
$
83,607
2.00 %
0.4
— %
—
3.16 %
8.5
4.11 %
16.7
3.80 %
14.0
—
$
—
$
—
$
67,928
$
67,928
— %
—
— %
—
— %
—
2.82 %
23.8
2.82 %
23.8
—
$
—
$
—
$
17,210
$
17,210
— %
—
— %
—
— %
—
3.22 %
29.9
3.22 %
29.9
—
$
—
$
3,950
$
82,754
$
86,704
— %
—
— %
—
2.51 %
5.5
3.03 %
17.5
3.00 %
16.9
—
$
—
$
9,874
$
225,670
$
235,544
— %
—
— %
—
4.18 %
5.8
2.67 %
22.3
2.73 %
21.6
230
$
—
$
40,170
$
450,593
$
490,993
2.00 %
0.4
— %
—
3.35 %
7.5
2.96 %
21.2
2.99 %
20.1
The average maturity is based on the contractual terms of the debt or mortgage-backed securities, and does not factor in required repayments or anticipated
prepayments. At December 31, 2019, the weighted average estimated life is 3.4 years for mortgage-backed and CMO securities, and 6.9 years for asset-backed
securities, based on current interest rates and anticipated prepayment speeds.
Loan Portfolio
The Company offers a variety of products to meet the credit needs of its borrowers, principally commercial real estate loans, commercial and industrial loans,
and retail loans consisting of loans secured by residential properties, and to a lesser extent, installment loans. No loans are extended to non-domestic borrowers or
governments.
Generally, we are permitted under applicable law to make loans to single borrowers (including certain related persons and entities) in aggregate amounts of
up to 15% of the sum of total capital and the ALL. The Company’s legal lending limit to one borrower was $34.0 million at December 31, 2019. No borrower had
an outstanding exposure exceeding the limit at year-end.
The risks associated with lending activities differ among loan classes and are subject to the impact of changes in interest rates, market conditions of collateral
securing the loans and general economic conditions. Any of these factors may adversely impact a borrower’s ability to repay loans, and also impact the associated
collateral. A further discussion on the classes of loans the Company makes and related risks is included in Note 1, Summary of Significant Accounting Policies,
and Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary
Data."
39
Table of Contents
The following table presents the loan portfolio, excluding residential LHFS, by segments and classes at December 31.
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Total loans (1)
2019
2018
2017
2016
2015
$
170,884 $
129,650 $
116,811 $
112,295 $
361,050
106,893
120,038
15,865
41,538
214,554
47,057
336,372
14,030
165,314
50,735
252,794
78,933
100,367
7,385
42,051
160,964
50,982
235,296
12,208
143,616
33,411
244,491
53,634
77,980
11,730
19,251
115,663
42,065
162,509
11,784
132,192
21,902
206,358
47,681
62,533
4,663
26,085
88,465
53,741
139,851
14,248
120,353
7,118
$
1,644,330 $
1,247,657 $
1,010,012 $
883,391 $
103,578
145,401
35,109
54,175
9,364
41,339
73,625
57,511
126,022
17,337
110,731
7,521
781,713
(1) Includes $395.9 million and $135.0 million of acquired loans as of December 31, 2019 and 2018, respectively.
The loan portfolio at December 31, 2019 increased $396.7 million, or 31.8%, from December 31, 2018, with approximately 75% of the increase attributable
to loans acquired in the Hamilton transaction. The Mercersburg acquisition in 2018 and Hamilton acquisition in 2019 increased the loan portfolio, principally in the
residential mortgage - first lien and commercial real estate - owner and non-owner occupied classes. The Company's organic growth has occurred in both core and
newer markets, such as Lancaster County, Pennsylvania, principally in commercial real estate; and in commercial and industrial loans and installment and other
loans as we focused on increasing diversification in the portfolio. The growth in installment and other loans in 2017 through 2019 was principally attributable to
purchased automobile financing loans at higher returns than comparable cash flows in the investment portfolio.
Competition for new business opportunities remains strong, which may temper loan growth in future quarters.
In addition to monitoring our loan portfolio by loan class as noted above, we also monitor concentrations by segment. The Bank’s lending policy reports
segment concentrations that exceeds 20% of the Bank’s total risk-based capital ("RBC"). The following segments met this criteria at December 31, 2019.
Office space
Strip retail shopping centers
Multi-family commercial real estate
$
Balance
147,945
51,119
111,227
% of Total Loans
9.0%
3.1%
6.8%
% of Total RBC
63.8%
22.1%
48.0%
40
Table of Contents
The following table presents expected maturities of certain loan classes by fixed rate or adjustable rate categories at December 31, 2019.
Acquisition and development:
1-4 family residential construction
Fixed rate
Adjustable and floating rate
Commercial and land development
Fixed rate
Adjustable and floating rate
Commercial and industrial
Fixed rate
Adjustable and floating rate
One Year
or Less
Due In
One
Year Through
Five Years
After Five
Years
Total
$
1,098 $
— $
6,305 $
4,684
5,782
64
1,697
1,761
2,581
57,866
60,447
—
—
8,243
1,930
10,173
66,550
18,125
84,675
3,778
10,083
7,559
22,045
29,604
36,589
32,843
69,432
$
67,990 $
94,848 $
109,119 $
7,403
8,462
15,865
15,866
25,672
41,538
105,720
108,834
214,554
271,957
The final maturity is used in the determination of maturity of acquisition and development loans that convert from construction to permanent status. Variable
rate loans shown above include semi-fixed loans that contractually will adjust with prime or LIBOR after the interest lock period, which may be up to 10 years. At
December 31, 2019, these semi-fixed loans totaled $31.4 million.
Asset Quality
Risk Elements
The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is managed through our underwriting standards, on-going credit
reviews, and monitoring of asset quality measures. Additionally, loan portfolio diversification, which limits exposure to a single industry or borrower, and
collateral requirements also mitigate our risk of credit loss.
41
Table of Contents
The following table presents the Company’s risk elements and relevant asset quality ratios at December 31.
Nonaccrual loans (1)
OREO
Total nonperforming assets
Restructured loans still accruing
Loans past due 90 days or more and still accruing (2)
Total nonperforming and other risk assets
Loans 30-89 days past due
Asset quality ratios:
Total nonperforming loans to total loans
Total nonperforming assets to total assets
Total nonperforming assets to total loans and OREO
Total risk assets to total loans and OREO
Total risk assets to total assets
Allowance for loan losses to total loans
Allowance for loan losses to nonperforming loans
Allowance for loan losses to nonperforming loans and restructured loans
still accruing
2019
2018
2017
2016
$
10,657
$
5,165
$
9,843
$
7,043
$
197
10,854
979
2,232
130
5,295
1,132
57
961
10,804
1,183
—
346
7,389
930
—
2015
16,557
710
17,267
793
24
$
$
14,065
$
6,484
$
11,987
$
8,319
$
18,084
17,527
$
5,186
$
5,277
$
1,218
$
2,532
0.65 %
0.46 %
0.66 %
0.86 %
0.59 %
0.89 %
0.41 %
0.27 %
0.42 %
0.52 %
0.34 %
1.12 %
0.97 %
0.69 %
1.07 %
1.19 %
0.77 %
1.27 %
0.80 %
0.52 %
0.84 %
0.94 %
0.59 %
1.45 %
2.12 %
1.34 %
2.21 %
2.31 %
1.40 %
1.74 %
137.52 %
271.33 %
130.00 %
181.39 %
81.95 %
125.95 %
222.55 %
116.05 %
160.23 %
78.20 %
(1) Includes $5.3 million of purchased credit impaired loans at December 31, 2019.
(2) Includes $2.1 million of purchased credit impaired loans at December 31, 2019.
The following table provides detail of impaired loans at December 31, 2019 and 2018.
Commercial real estate:
Owner occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Nonaccrual
Loans
2019
Restructured
Loans Still
Accruing
Total
Nonaccrual
Loans
2018
Restructured
Loans Still
Accruing
Total
$
5,842 $
30 $
5,872 $
1,841 $
39 $
1,880
345
235
1,763
1,659
13
715
85
—
—
—
931
—
18
—
345
235
1,763
131
309
286
—
—
—
131
309
286
2,590
1,808
1,069
2,877
13
733
85
16
774
—
—
24
—
16
798
—
$
10,657 $
979 $
11,636 $
5,165 $
1,132 $
6,297
Nonperforming assets include nonaccrual loans and foreclosed real estate. Risk assets, which include nonperforming assets and restructured and loans past
due 90 days or more and still accruing, totaled $14.1 million at December 31, 2019, an increase of $7.6 million or 116.9%, from $6.5 million at December 31,
2018. Nonaccrual loans totaled $10.7 million at December 31, 2019, an increase of $5.5 million from December 31, 2018. One commercial loan, downgraded to
nonaccrual status in the fourth quarter of 2019 was the principal driver of the net increase. The change in nonaccrual loan amounts also impacted other asset quality
ratios detailed above. The net reduction of risk assets and nonaccrual loans from December 31, 2015 to December 31, 2016 was due principally to the sale of a loan
with a carrying balance of $5.9 million to a third party. Cash proceeds totaled $5.1 million with the $846 thousand difference recorded as a charge-off to the ALL
in 2016.
The ALL totaled $14.7 million at December 31, 2019, a $641 thousand increase from $14.0 million at December 31, 2018, resulting from net chargeoffs of
$259 thousand and a provision for loan losses of $900 thousand for 2019. The ALL is lower as a percentage of the total loan portfolio at December 31, 2019 than
in prior years, reflecting purchase accounting adjustments for impaired loans acquired from Mercersburg and Hamilton. Management believes its coverage ratios
are
42
Table of Contents
adequate for the risk profile of the loan portfolio given ongoing monitoring of the portfolio and its quantitative and qualitative analysis performed at December 31,
2019. As new information is learned about borrowers or updated appraisals on real estate with lower fair values are obtained, the Company may experience an
increase in impaired loans.
For the years ended December 31, 2019, 2018, and 2017, recoveries of $606 thousand, $882 thousand and $287 thousand, respectively, were credited to the
ALL. These recoveries on previously charged-off relationships are the result of successful loan monitoring and workout solutions. Recoveries are difficult to
predict, and any additional recoveries that the Company receives will be used to replenish the ALL. Recoveries favorably impact historical charge-off factors, and
contribute to changes in the quantitative and qualitative factors used in our allowance adequacy analysis. However, as the loan portfolio continues to grow, future
provisions for loan losses may result.
The Company takes partial charge-offs on collateral-dependent loans when carrying value exceeds estimated fair value, as determined by the most recent
appraisal adjusted for current (within the quarter) conditions, less costs to dispose. Impairment reserves remain in place if updated appraisals are pending, and
represent management’s estimate of potential loss.
The following table presents exposure to relationships with an impaired loan balance, partial charge-offs taken to date and specific reserves established on the
relationships at December 31, 2019 and 2018.
December 31, 2019
Relationships greater than $1 million
Relationships greater than $500 thousand but less than $1 million
Relationships greater than $250 thousand but less than $500 thousand
Relationships less than $250 thousand
December 31, 2018
Relationships greater than $500 thousand but less than $1 million
Relationships greater than $250 thousand but less than $500 thousand
Relationships less than $250 thousand
# of
Relationships
Recorded
Investment
Partial
Charge-offs
to Date
Specific
Reserves
2
2
3
68
75
1
2
64
67
$
5,218 $
— $
1,516
980
3,922
17
—
781
$
11,636 $
798 $
$
810 $
17 $
673
4,814
—
873
$
6,297 $
890 $
—
—
—
36
36
—
—
38
38
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $500 thousand, which includes
confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of $1.0 million. In addition, all relationships greater
than $500 thousand rated Substandard, Doubtful or Loss are reviewed and corresponding risk ratings are reaffirmed by the Bank's Problem Loan Committee, with
subsequent reporting to the Management ERM Committee and the Board of Directors.
In its individual loan impairment analysis, the Company determines the extent of any full or partial charge-offs that may be required, or any reserves that may
be needed. The determination of the Company’s charge-offs or impairment reserve include an evaluation of the outstanding loan balance and the related collateral
securing the credit. Through a combination of collateral securing the loans and partial charge-offs taken to date, the Company believes that it has adequately
provided for the potential losses that it may incur on these relationships at December 31, 2019. However, over time, additional information may result in increased
reserve allocations or, alternatively, it may be deemed that the reserve allocations exceed those that are needed.
The Company’s foreclosed real estate balance consisted of one commercial property totaling $180 thousand and one residential property totaling $17
thousand at December 31, 2019. The Company believes the value of foreclosed real estate represents its fair value, but if the real estate values decline, additional
charges may be needed. During 2019, no expense was recorded for writedown of other real estate owned properties.
43
Table of Contents
Credit Risk Management
Allowance for Loan Losses
The Company maintains the ALL at a level deemed adequate by management for probable incurred credit losses. The ALL is established and maintained
through a provision for loan losses which is charged to earnings. On a quarterly basis, management assesses the adequacy of the ALL utilizing a defined
methodology which considers specific credit evaluation of impaired loans, historical loss experience and qualitative factors. Management addresses the
requirements for loans individually identified as impaired, loans collectively evaluated for impairment, and other bank regulatory guidance in its assessment.
The ALL is evaluated based on review of the collectability of loans in light of historical experience; the nature and volume of the loan portfolio; adverse
situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A description of the methodology
for establishing the allowance and provision for loan losses and related procedures in establishing the appropriate level of reserve is included in Note 4, Loans and
Allowance for Loan Losses, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data."
The following table summarizes the Company’s internal risk ratings at December 31, 2019 and 2018.
Pass
Special
Mention
Non-Impaired
Substandard
Impaired -
Substandard
Doubtful
PCI Loans
Total
December 31, 2019
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
$
151,161 $
4,513 $
3,163 $
5,872 $
— $
6,175 $
342,753
100,361
111,697
15,865
39,939
198,951
42,649
323,040
13,774
164,469
50,497
17,152
4,822
4,534
—
206
1,133
4,408
978
74
74
—
—
682
1,115
—
1,393
8,899
—
—
149
38
—
—
345
235
—
—
1,763
—
2,590
13
733
85
—
—
—
—
—
—
—
—
—
—
—
1,145
683
2,457
—
—
3,808
—
9,764
20
—
153
170,884
361,050
106,893
120,038
15,865
41,538
214,554
47,057
336,372
14,030
165,314
50,735
$
1,555,156 $
37,894 $
15,439 $
11,636 $
— $
24,205 $
1,644,330
44
Table of Contents
December 31, 2018
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Pass
Special
Mention
Non-Impaired
Substandard
Impaired -
Substandard
Doubtful
PCI Loans
Total
$
121,903 $
3,024 $
987 $
1,880 $
— $
1,856 $
242,136
71,482
97,590
7,385
41,251
150,286
50,982
229,971
12,170
142,638
33,229
10,008
5,886
736
—
25
2,278
—
—
—
165
15
—
717
1,197
—
583
2,940
—
—
—
15
1
—
131
309
—
—
286
—
2,877
16
798
—
—
—
—
—
—
—
—
—
—
—
—
650
717
535
—
192
5,174
—
2,448
22
—
166
129,650
252,794
78,933
100,367
7,385
42,051
160,964
50,982
235,296
12,208
143,616
33,411
$
1,201,023 $
22,137 $
6,440 $
6,297 $
— $
11,760 $
1,247,657
Non-Impaired Substandard loans are performing loans which have characteristics that cause management concern over the ability of the borrower to perform
under present loan repayment terms and which may result in the reporting of these loans as nonperforming, or impaired, loans in the future. Generally,
management feels that substandard loans that are currently performing and not considered impaired result in some doubt as to the borrower’s ability to continue to
perform under the terms of the loan, and represent potential problem loans. Non-Impaired Substandard loans totaled $15.4 million at December 31, 2019.
Additionally, the Special Mention classification is intended to be a temporary classification reflective of loans that have potential weaknesses that may, if not
monitored or corrected, weaken the asset or inadequately protect the Company’s position at some future date. Special mention loans represent an elevated risk, but
their weakness does not yet justify a more severe, or classified, rating. These loans require inquiry by lenders on the cause of the potential weakness and, once
analyzed, the loan classification may be downgraded to Substandard or, alternatively, could be upgraded to Pass.
45
Table of Contents
The following tables summarize the average recorded investment in impaired loans and interest income recognized, on a cash basis, and interest income
earned but not recognized for years ended December 31, 2019, 2018, 2017, 2016 and 2015.
December 31, 2019
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
December 31, 2018
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Average
Impaired
Balance
Interest
Income
Recognized
Interest
Earned
But Not
Recognized
$
2,455 $
2
$
$
$
46
152
217
21
683
2,582
13
750
13
—
—
—
—
—
50
—
2
—
6,932 $
54
$
1,495 $
1,842
148
346
181
1
322
3,234
19
657
4
2
$
—
—
—
—
—
—
59
—
2
—
$
8,249 $
63
$
46
387
—
24
21
—
130
91
1
64
2
720
156
236
20
36
—
1
29
130
2
52
5
667
Table of Contents
December 31, 2017
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
December 31, 2016
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
December 31, 2015
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Average
Impaired
Balance
Interest
Income
Recognized
Interest
Earned
But Not
Recognized
$
1,000 $
6 $
$
$
$
$
392
182
418
154
413
4,012
61
488
10
—
—
—
—
—
58
—
2
—
7,130 $
66 $
1,758 $
— $
6,831
216
645
3
575
4,525
98
455
12
—
—
—
—
—
33
—
—
—
15,118 $
33 $
2,613 $
— $
3,470
402
1,020
266
1,208
4,644
130
571
22
—
—
—
137
—
37
—
—
—
$
14,346 $
174 $
47
114
10
19
35
7
25
136
1
26
3
376
124
326
17
35
1
25
175
6
19
3
731
177
256
15
56
2
28
167
3
29
3
736
Table of Contents
The following table summarizes activity in the ALL for years ended December 31, 2019, 2018, 2017, 2016 and 2015.
Commercial
Real Estate
Acquisition
and
Development
Commercial
and
Industrial
Municipal
Total
Residential
Mortgage
Installment
and Other
Total
Unallocated
Total
Commercial
Consumer
December 31, 2019
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2018
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2017
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2016
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2015
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
$
$
$
$
$
$
$
$
$
$
6,876 $
515
(25)
268
7,634 $
6,763 $
(442)
(17)
572
6,876 $
7,530 $
38
(835)
30
6,763 $
7,883 $
107
(872)
412
7,530 $
9,462 $
(1,020)
(711)
152
7,883 $
817 $
139
—
3
959 $
417 $
396
(7)
11
817 $
580 $
(167)
—
4
1,656 $
841
(299)
158
98 $
2
—
—
9,447 $
1,497
(324)
429
3,753 $
(347)
(386)
127
244 $
180
(155)
50
3,997 $
(167)
(541)
177
570 $ 14,014
900
(430)
(865)
—
606
—
2,356 $
100 $ 11,049 $
3,147 $
319 $
3,466 $
140 $ 14,655
1,446 $
209
—
1
1,656 $
1,074 $
333
(85)
124
84 $
14
—
—
8,710 $
177
(24)
584
3,400 $
363
(148)
138
211 $
165
(292)
160
3,611 $
528
(440)
298
475 $ 12,796
800
(464)
882
95
—
—
98 $
9,447 $
3,753 $
244 $
3,997 $
570 $ 14,014
54 $
30
—
—
9,238 $
234
(920)
158
2,979 $
531
(180)
70
144 $
174
(166)
59
3,123 $
705
(346)
129
414 $ 12,775
1,000
(1,266)
287
61
—
—
417 $
1,446 $
84 $
8,710 $
3,400 $
211 $
3,611 $
475 $ 12,796
850 $
(270)
—
—
1,012 $
129
(79)
12
58 $
(4)
—
—
9,803 $
(38)
(951)
424
2,870 $
532
(577)
154
121 $
116
(194)
101
2,991 $
648
(771)
255
774 $ 13,568
250
(360)
(1,722)
—
679
—
580 $
1,074 $
54 $
9,238 $
2,979 $
144 $
3,123 $
414 $ 12,775
697 $
(440)
(22)
615
806 $
249
(115)
72
183 $ 11,148 $
(125)
—
—
(1,336)
(848)
839
2,262 $
1,122
(592)
78
119 $
55
(62)
9
2,381 $
1,177
(654)
87
1,218 $ 14,747
(603)
(444)
(1,502)
—
926
—
850 $
1,012 $
58 $
9,803 $
2,870 $
121 $
2,991 $
774 $ 13,568
The following table summarizes asset quality ratios for years ended December 31, 2019, 2018, 2017, 2016 and 2015.
2019
2018
2017
2016
2015
Ratio of net charge-offs (recoveries) to average loans outstanding
Provision for loan losses to net charge-offs (recoveries)
Ratio of ALL to total loans outstanding at December 31
0.02 %
347.49 %
0.89 %
(0.04)%
(191.39)%
1.12 %
0.10 %
102.15 %
1.27 %
0.13 %
23.97 %
1.45 %
0.08 %
(104.69)%
1.74 %
The Company recorded a provision for loan losses expense of $900 thousand, $800 thousand, $1.0 million, and $250 thousand for 2019, 2018, 2017, and
2016, respectively, and a negative provision of $603 thousand for 2015. The negative provision in 2015 was due to recovery of loans with prior charge-offs. In
addition, in certain cases, loans were successfully worked out with smaller charge-offs than the reserve established on them. The Company has benefited from
organic loan
48
Table of Contents
portfolio growth and favorable historical charge-off data combined with relatively stable economic conditions over the periods presented above. This was a
principal factor in management's determination that a negative or modest provision could be recorded despite net charge-offs recorded in 2015 and 2016. In 2017,
management determined that a provision expense that offset net charge-offs for the year would maintain an adequate ALL, principally due to a charge-off in
connection with one commercial credit downgraded to nonaccrual status during the year. In 2018 and 2019, our continued organic loan portfolio growth was a key
factor in the quantitative and qualitative considerations used by management in the determination of the provision expense required to maintain an adequate
allowance for loan losses. These variations in net charge-offs (recoveries) and provision expense (recovery) resulted in the fluctuations in the ratios presented in the
tables above.
See further discussion in the “Provision for Loan Losses” section of this Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
The following table shows the allocation of the ALL by loan class, as well as the percent of each loan class in relation to the total loan balance at
December 31, 2019, 2018, 2017, 2016 and 2015.
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity - term
Home equity - lines of credit
Installment and other loans
Unallocated
2019
2018
2017
2016
2015
% of
Loan
Type to
Total
Loans
Amount
Amount
% of
Loan
Type to
Total
Loans
% of
Loan
Type to
Total
Loans
% of
Loan
Type to
Total
Loans
Amount
% of
Loan
Type to
Total
Loans
Amount
Amount
$
1,539
3,965
974
1,156
239
720
2,356
100
1,635
59
1,453
319
140
10 % $
22 %
7 %
7 %
1 %
3 %
13 %
3 %
20 %
1 %
10 %
3 %
1,491
3,683
792
910
104
713
1,656
98
2,002
109
1,642
244
570
10 % $
20 %
6 %
8 %
1 %
3 %
13 %
4 %
19 %
1 %
12 %
3 %
1,488
4,059
444
772
169
248
1,446
84
1,855
119
1,426
211
475
12 % $
24 %
5 %
8 %
1 %
2 %
12 %
4 %
16 %
1 %
13 %
2 %
1,591
4,380
604
955
102
478
1,074
54
1,624
151
1,204
144
414
13 % $
23 %
5 %
7 %
1 %
3 %
10 %
6 %
16 %
1 %
14 %
1 %
1,998
4,033
709
1,143
236
614
1,012
58
1,667
184
1,019
121
774
13 %
19 %
5 %
7 %
1 %
5 %
10 %
7 %
16 %
2 %
14 %
1 %
$ 14,655
100 % $ 14,014
100 % $ 12,796
100 % $ 12,775
100 % $ 13,568
100 %
49
Table of Contents
The following table summarizes the ending loan balance individually or collectively evaluated for impairment by loan class and the ALL allocation for each
at December 31, 2019 and 2018.
Commercial
Real Estate
Acquisition
and
Development
Commercial
Commercial
and
Industrial
Municipal
Total
Residential
Mortgage
Installment
and Other
Total
Unallocated
Total
Consumer
December 31, 2019
Loans allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Allowance for loan losses
allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
December 31, 2018
Loans allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Allowance for loan losses
allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
$
6,452 $
— $
1,763 $
— $
8,215 $
3,336 $
85 $
3,421 $
— $
11,636
752,413
57,403
212,791
47,057
1,069,664
512,380
50,650
563,030
—
1,632,694
$
758,865 $
57,403 $
214,554 $
47,057 $ 1,077,879 $
515,716 $
50,735 $ 566,451 $
— $ 1,644,330
$
$
$
— $
— $
— $
— $
— $
36 $
— $
36 $
— $
36
7,634
959
2,356
100
11,049
3,111
319
3,430
140
7,634 $
959 $
2,356 $
100 $
11,049 $
3,147 $
319 $
3,466 $
140 $
14,619
14,655
2,320 $
— $
286 $
— $
2,606 $
3,691 $
— $
3,691 $
— $
6,297
559,424
49,436
160,678
50,982
820,520
387,429
33,411
420,840
—
1,241,360
$
561,744 $
49,436 $
160,964 $
50,982 $
823,126 $
391,120 $
33,411 $ 424,531 $
— $ 1,247,657
$
$
— $
— $
— $
— $
— $
38 $
— $
38 $
— $
38
6,876
817
1,656
98
9,447
3,715
244
3,959
570
6,876 $
817 $
1,656 $
98 $
9,447 $
3,753 $
244 $
3,997 $
570 $
13,976
14,014
In addition to the reserve allocations on impaired loans noted above, 17 loans, with aggregate outstanding principal balances of $3.4 million, have had
cumulative partial charge-offs to the ALL totaling $798 thousand. As updated appraisals were received on collateral-dependent loans, partial charge-offs were
taken to the extent the loans’ principal balance exceeded their fair value.
Management believes the allocation of the ALL between the various loan classes adequately reflects the probable incurred credit losses in each portfolio and
is based on the methodology outlined in Note 4, Loans and Allowance for Loan Losses, to the Consolidated Financial Statements under Part II, Item 8, "Financial
Statements and Supplementary Data." Management re-evaluates and makes certain enhancements to its methodology used to establish a reserve to better reflect the
risks inherent in the different segments of the portfolio, particularly in light of increased charge-offs, with noticeable differences between the different loan classes.
Management believes these enhancements to the ALL methodology improve the accuracy of quantifying probable incurred credit losses inherent in the portfolio.
Management charges actual loan losses to the reserve and bases the provision for loan losses on its overall analysis.
The largest component of the ALL for the years presented has been allocated to the commercial real estate segment, particularly the non-owner occupied loan
classes. The higher allocations in these classes as compared with the other classes is consistent with the inherent risk associated with these loans, as well as
generally higher levels of impaired and criticized loans for the periods presented. There has generally been a decrease in the ALL allocated to the commercial real
estate portfolio, as the level of classified assets has declined, and historical loss rates have improved as a result of improving economic and market conditions.
The unallocated portion of the ALL reflects estimated inherent losses within the portfolio that have not been detected, as well as the risk of error in the
specific and general reserve allocation, other potential exposure in the loan portfolio, variances in management’s assessment of national and local economic
conditions and other factors management believes appropriate at the time. The unallocated portion of the allowance decreased from $570 thousand at December 31,
2018 to $140 thousand at December 31, 2019 and represents 1.0% of the ALL at December 31, 2019, compared with 4.1% at December 31, 2018. Changes in
qualitative factors of certain loan categories were made during 2019 to reflect limited credit losses since loan underwriting improvements were made subsequent to
2012. The Company monitors the unallocated portion of the ALL, and by
50
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policy, has determined it should not exceed 6% of the total reserve. Future negative provisions for loan losses may result if the unallocated portion was to increase,
and management determined the reserves were not required for the anticipated risk in the portfolio.
Management believes the Company’s ALL is adequate based on information currently available. Future adjustments to the ALL and enhancements to the
methodology may be necessary due to changes in economic conditions, regulatory guidance, or management’s assumptions as to future delinquencies or loss rates.
Deposits
Total deposits grew $316.8 million, or 20.3%, from $1.6 billion at December 31, 2018 to $1.9 billion at December 31, 2019. In 2019, we acquired $388.2
million in deposits from Hamilton. At December 31, 2019, those acquired accounts totaled approximately $332.0 million. During 2019, we reduced brokered
deposits by $110.6 million and reduced subscription service CDs by $21.9 million. Organic growth totaled approximately $147.7 million in 2019.
The following table presents average deposits for years ended December 31, 2019, 2018, and 2017.
Demand deposits
Interest-bearing demand deposits
Savings deposits
Time deposits
Total deposits
2019
2018
2017
234,354 $
183,387 $
920,025
138,761
549,937
767,863
102,189
324,118
161,917
648,174
94,815
292,616
1,843,077 $
1,377,557 $
1,197,522
$
$
Average total deposits increased $465.5 million, or 33.8%, from 2018 to 2019. Interest-bearing demand deposit account balances were the principal driver,
increasing $152.2 million, or 19.8%. Average time deposits less than $250 thousand grew from $287.9 million in 2018 to $483.9 million in 2019 and average time
deposits in excess of $250 thousand increased from $36.3 million in 2018 to $66.0 million in 2019.
In addition to deposits from acquisitions, the Company has been able to garner organic growth in both interest-bearing and noninterest-bearing deposit
relationships from enhanced cash management offerings as we continued to develop commercial relationships. We also continued to grow core funding deposits
through marketing campaigns and improvement in our product delivery with investments in technology and increased sales efforts. We have also been able to
increase interest-free funds as we expanded our commercial and industrial loan portfolio.
In 2019, the Company used deposit growth principally to fund loan growth. An additional funding source the Company uses is brokered deposits, which
totaled $16.1 million at December 31, 2019 compared with $126.6 million at December 31, 2018, and averaged $100.8 million for 2019 compared with $112.3
million for 2018. Given interest rate conditions and asset/liability strategies, we borrowed additional funds from FHLB of Pittsburgh to replace called brokered
deposits in the second half of 2019.
Management evaluates its utilization of brokered deposits, taking into consideration the interest rate curve and regulatory views on non-core funding sources,
and balances this funding source with its funding needs based on growth initiatives. The Company anticipates that as loan growth increases, it will be able to
generate core deposit funding by offering competitive rates.
The following table presents maturities of time deposits of $250,000 or more at December 31, 2019.
Three months or less
Over three months through six months
Over six months through one year
Over one year
Total
51
Total
18,738
12,734
19,204
18,402
69,078
$
$
Table of Contents
Borrowings
In addition to deposit products, the Company uses short-term borrowing sources to meet liquidity needs and for temporary funding. Sources of short-term
borrowings include the FHLB of Pittsburgh, federal funds purchased, and to a lesser extent, the FRB discount window. Short-term borrowings also include
securities sold under agreements to repurchase with deposit clients, in which a client sweeps a portion of a deposit balance into a repurchase agreement, which is a
secured borrowing with a pool of securities pledged against the balance.
The Company also utilizes long-term debt, consisting principally of FHLB fixed and amortizing advances to fund its balance sheet with original maturities
greater than one year. The Company evaluates its funding needs, interest rate movements, the cost of options, and the availability of attractive structures when
considering the timing and extent of when it enters into long-term borrowings.
In December 2018, we issued unsecured subordinated notes payable totaling $32.5 million, the proceeds of which were designated for general corporate use,
including funding of cash consideration for mergers and acquisitions.
For additional information about borrowings, refer to Note 13, Short-Term Borrowings, Note 14, Long-Term Debt, and Note 15, Subordinated Notes, to the
Consolidated Financial Statements appearing in Part II, Item 8, "Financial Statements and Supplementary Data."
Shareholders' Equity
In 2019, total shareholders’ equity increased $49.8 million, or 28.7%. The principal factor in the increase was the issuance of 1,765,704 shares of common
stock, valued at $36.6 million, in the Hamilton acquisition. Net income increased equity by $16.9 million. AOCI benefited by $2.5 million from a change in
unrealized gains and losses during the year. Dividends paid to shareholders decreased equity by $6.1 million.
In September, 2015, the Board of Directors authorized a stock repurchase program which is more fully described in Item 5 under Issuer Purchases of Equity
Securities. The maximum number of shares that may yet be purchased under the plan is 333,275 shares at December 31, 2019.
The following table includes additional information for shareholders’ equity for years ended December 31, 2019, 2018, and 2017.
2019
2018
2017
Average shareholders’ equity
Net income
Cash dividends paid
Average equity to average assets ratio
Dividend payout ratio
Return on average equity
Capital Adequacy and Regulatory Matters
$
206,021
$
149,662
$
141,301
16,924
6,150
9.26 %
36.81 %
8.21 %
12,805
4,375
8.75 %
33.33 %
8.56 %
8,090
3,488
9.49 %
42.00 %
5.73 %
Capital management in a regulated financial services industry must properly balance return on equity to its shareholders while maintaining sufficient levels of
capital and related risk-based regulatory capital ratios to satisfy statutory regulatory requirements. The Company’s capital management strategies have been
developed to provide attractive rates of returns to its shareholders, while maintaining a “well capitalized” position of regulatory strength.
Effective with the third quarter of 2018, the FRB raised the consolidated asset limit on small bank holding companies from $1 billion to $3 billion, and a
company with assets under the revised limits is not subject to the FRB consolidated capital rules. A company with consolidated assets under the revised limit may
continue to file reports that include capital amounts and ratios. The Company has elected to continue to file those reports.
Management believes the Company and the Bank met all capital adequacy requirements to which they are subject at December 31, 2019 and December 31,
2018. At December 31, 2019, the Bank was considered well capitalized under applicable banking regulations.
52
Table of Contents
Tables presenting the Company’s and the Bank’s capital amounts and ratios at December 31, 2019 and 2018 are included in Note 16 Shareholders' Equity
and Regulatory Capital, to the Consolidated Financial Statements appearing in Part II, Item 8, "Financial Statements and Supplementary Data."
Tier 1 and total capital increases reflected the Hamilton acquisition and results of operations for 2019. Risk-weighted assets increased from $1.3 billion at
December 31, 2018 to $1.7 billion at December 31, 2019 for the Company and from $1.3 billion at December 31, 2018 to $1.7 billion at December 31, 2019 for the
Bank, reflecting the Hamilton acquisition and growth in the loan and investment portfolios.
The Company routinely evaluates its capital levels in light of its risk profile to assess its capital needs. In addition to the minimum capital ratio requirement
and minimum capital ratio to be well capitalized presented in the tables in Note 16, we must maintain a capital conservation buffer as noted in Item 1 - Business
under the topic Basel III Capital Rules. At December 31, 2019, the Company's and the Bank's capital conservation buffer, based on the most restrictive capital
ratio, was 5.3% and 5.4%, which is above the phase in requirement of 2.50% at December 31, 2019.
Liquidity and Rate Sensitivity
Liquidity. The primary function of asset/liability management is to ensure adequate liquidity and manage the Company’s sensitivity to changing interest rates.
Liquidity management involves the ability to meet the cash flow requirements of clients who may be either depositors wanting to withdraw funds or borrowers
needing assurance that sufficient funds will be available to meet their credit needs. Our primary sources of funds consist of deposit inflows, loan repayments,
maturities and sales of investment securities, the sale of mortgage loans and borrowings from the FHLB of Pittsburgh. While maturities and scheduled amortization
of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-
earning deposits and securities and the objectives of our asset/liability management policy.
At December 31, 2019, outstanding loan commitments totaled $477.2 million, which included $38.8 million in undisbursed loans, $205.5 million in unused
home equity lines of credit, $222.3 million in commercial lines of credit, and $10.6 million in standby letters of credit. Time deposits due within one year after
December 31, 2019 totaled $375.8 million, or 72% of time deposits. The large percentage of time deposits that mature within one year reflects clients’ preference
not to invest funds for long periods in the current interest rate environment. If these maturing deposits do not remain with us, we will be required to seek other
sources of funds, including other time deposits and lines of credit. Depending on market conditions, we may be required to pay higher rates on such deposits or
other borrowings than we currently pay on time deposits outstanding at December 31, 2019. We believe, however, based on past experience that a significant
portion of our time deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates we offer.
Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during
any given period. At December 31, 2019, cash and cash equivalents totaled $56.5 million, compared with $88.8 million at December 31, 2018. Securities classified
as available for sale, net of pledging requirements, provide additional sources of liquidity, and totaled $331.7 million at December 31, 2019. Also at December 31,
2019, we had the ability to borrow up to a total of $836.7 million from the FHLB of Pittsburgh, of which $296.0 million in advances and letters of credit were
outstanding. The Company’s ability to borrow from the FHLB is dependent on having sufficient qualifying collateral, which generally consists of mortgage loans.
In addition, we had $35.0 million in available unsecured lines of credit with other banks at December 31, 2019.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is
responsible for paying any dividends declared to its shareholders and interest on its borrowings. The Company also has repurchased shares of its common
stock. The Company’s primary source of income is dividends received from the Bank. Restrictions on the Bank’s ability to dividend funds to the Company are
included in Note 16, Shareholders' Equity and Regulatory Capital, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and
Supplementary Data."
Interest Rate Sensitivity. Interest rate sensitivity management requires the maintenance of an appropriate balance between interest sensitive assets and
liabilities. Management, through its asset/liability management process, attempts to manage the level of repricing and maturity mismatch so that fluctuations in net
interest income are maintained within policy limits in current and expected market conditions. For further discussion, see Part II, Item 7A, "Quantitative and
Qualitative Disclosures About Market Risk."
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Table of Contents
Contractual Obligations
The Company enters into contractual obligations in the normal course of business to fund loan growth, for asset/liability management purposes, to meet
required capital needs and for other corporate purposes. The following table presents significant fixed and determinable contractual obligations of principal by
payment date at December 31, 2019. Further discussion of the nature of each obligation is included in the referenced Note to the Consolidated Financial Statements
under Part II, Item 8, "Financial Statements and Supplementary Data" referenced in the following table.
Time deposits
Short-term borrowings
Long-term debt
Subordinated notes
Operating lease obligations
Total
Note
Reference
Less than 1
year
2-3 years
4-5 years
More than
5 years
Total
Payments Due
11
13
14
15
6
$
375,795 $
116,580 $
24,375 $
2,818 $
154,869
40,751
—
1,279
—
20,862
—
1,874
—
946
—
1,486
—
508
32,500
10,549
519,568
154,869
63,067
32,500
15,188
$
572,694 $
139,316 $
26,807 $
46,375 $
785,192
The contractual obligations table above does not include off-balance sheet commitments to extend credit that are detailed in the following section. These
commitments generally have fixed expiration dates and many will expire without being drawn upon, therefore the total commitment does not necessarily represent
future cash requirements and is excluded from the contractual obligations table.
Off-Balance Sheet Arrangements
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its clients. These
financial instruments include commitments to extend credit and standby letters of credit.
The following table details significant commitments at December 31, 2019.
Commitments to fund:
Home equity lines of credit
1-4 family residential construction loans
Commercial real estate, construction and land development loans
Commercial, industrial and other loans
Standby letters of credit
Contract or Notional
Amount
$
205,502
19,812
19,018
222,288
10,588
A discussion of the nature, business purpose, and guarantees that result from the Company’s off-balance sheet arrangements is included in Note 18, Financial
Instruments with Off-Balance Sheet Risk, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data."
Recently Adopted and Recently Issued Accounting Standards
Recently adopted and recently issued accounting standards are included in Note 1, Summary of Significant Accounting Policies, to the Consolidated
Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data."
Supplemental Reporting of Non-GAAP Measures
As a result of prior acquisitions, the Company had intangible assets consisting of goodwill and core deposit and other intangible assets totaling $27.1 million
and $16.5 million at December 31, 2019 and 2018, respectively.
Management believes providing certain “non-GAAP” information will assist investors in their understanding of the effect of acquisition activity on reported
results, particularly to overcome comparability issues related to the influence of intangibles (principally goodwill) created in acquisitions.
Tangible book value per share and net interest margin excluding the impact of purchase accounting, as used by the Company in this supplemental reporting,
are not GAAP measures. While we believe this information is a useful supplement to
54
Table of Contents
the GAAP based measures presented in Item 6, Selected Financial Data and Section 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, readers are cautioned that this non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for financial measures
determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results and financial condition as reported
under GAAP, nor are such measures necessarily comparable to non-GAAP performance measures that may be presented by other companies. This supplemental
presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to be determined in accordance with GAAP.
The following table presents the computation of each non-GAAP based measure shown together with its most directly comparable GAAP based measure.
Tangible book value per common share
Shareholders' equity
Less: Goodwill
Other intangible assets
Related tax effect
Tangible common equity (non-GAAP)
Common shares outstanding
Book value per share (most directly comparable GAAP based measure)
Intangible assets per share
Tangible book value per share )non-GAAP)
2019
2018
2017
$
$
$
$
223,249 $
173,433 $
144,765
19,925
7,180
(1,508)
12,592
3,910
(804)
719
356
(21)
197,652 $
157,735 $
143,711
11,200
9,430
8,347
19.93 $
2.28
17.65 $
18.39 $
1.66
16.73 $
17.34
0.12
17.22
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting)
Taxable-equivalent net interest income/margin, as reported
Effect of purchase accounting:
2019
2018
2017
$
70,338
3.43 % $
53,573
3.36 % $
46,256
3.35 %
Loans
Time deposits
Purchase accounting effect on taxable-equivalent income/ margin
Taxable-equivalent net interest income/margin (excluding the effect of
purchase accounting) (non-GAAP)
Income
Expenses
(3,758)
83
(3,840)
(0.30)%
0.02 %
(0.21)%
(335)
(10)
(325)
(0.04)%
— %
(0.01)%
—
—
—
— %
— %
— %
$
66,497
3.22 % $
53,248
3.33 % $
46,256
3.35 %
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk comprises exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market rate or price risks.
In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide
management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of
interest rates. Federal Reserve Board monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant
factors affecting the task of managing interest rate sensitivity positions in recent years.
Interest Rate Risk
Interest rate risk is the exposure to fluctuations in the Company’s future earnings (earnings at risk) and value (value at risk) resulting from changes in interest
rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that reprice within a specified time
period as a result of scheduled maturities, scheduled and unscheduled repayments, the propensity of borrowers and depositors to react to changes in their economic
interests, and loan contractual interest rate changes.
55
Table of Contents
We attempt to manage the level of repricing and maturity mismatch through our asset/liability management process so that fluctuations in net interest income
are maintained within policy limits across a range of market conditions, while satisfying liquidity and capital requirements. Management recognizes that a certain
amount of interest rate risk is inherent, appropriate and necessary to ensure the Company’s profitability. Thus, the goal of interest rate risk management is to
evaluate the amount of reward for taking risk and adjusting both the size and composition of the balance sheet relative to the level of reward available for taking
risk.
Management endeavors to control the exposure to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The
Company primarily uses its securities portfolio, FHLB advances and brokered deposits to manage its interest rate risk position. Additionally, pricing, promotion
and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate
risk objectives. At present, we do not use hedging instruments for risk management, but we do evaluate them and may use them in the future.
We use simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly
monitor both the direction and magnitude of our interest rate risk exposure. These analyses require numerous assumptions including, but not limited to, changes in
balance sheet mix, prepayment rates on loans and securities, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of
the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best
estimates but may not accurately reflect actual results under certain changes in interest rate due to the timing, magnitude and frequency of rate changes and changes
in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and providing a relative gauge of our
interest rate risk position over time.
Our asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of
risk. The committee meets regularly and reviews our interest rate risk position and monitors various liquidity ratios to ensure a satisfactory liquidity position. By
utilizing our analyses, we can determine changes that may need to be made to the asset and liability mixes to mitigate the change in net interest income under
various interest rate scenarios. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to
inform the committee on the selection of investment securities. Regulatory authorities also monitor our interest rate risk position along with other liquidity ratios.
Earnings at Risk
Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves
changing the interest rates used in determining net interest income over the next twelve months. The resulting percentage change in net interest income in various
rate scenarios is an indication of our short-term interest rate risk. The analysis assumes recent trends in new loan and deposit volumes will continue while the
amount of investment securities remains constant. Additional assumptions are applied to modify volumes and pricing under the various rate scenarios.
The simulation analysis results are presented in the Earnings at Risk table below. At December 31, 2019, these results indicate the Company would be better
positioned, over the next 12 months, in a moderately declining rate environment than it would be if interest rates increased. At December 31, 2018, the results
indicated we would be better positioned in a moderately increasing rate environment than if rates decreased moderately or increased more substantially.
Value at Risk
Net present value analysis provides information on the risk inherent in the balance sheet that might not be taken into account in the simulation analysis due to
the short time horizon used in that analysis. The net present value of the balance sheet incorporates the discounted present value of expected asset cash flows minus
the discounted present value of expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in
discounting the cash flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and
options embedded in the balance sheet.
At December 31, 2019, similar to at December 31, 2018, these results indicate the Company would be better positioned in a rising interest rate environment
than it would be if interest rates decreased.
56
Table of Contents
Earnings at Risk
% Change in Net Interest Income
Value at Risk
% Change in Market Value
Change in Market
Interest Rates
December 31, 2019
December 31, 2018
Change in Market
Interest Rates
December 31, 2019
December 31, 2018
(100)
100
200
(0.5) %
(1.3) %
(3.8) %
(2.1) %
(0.6) %
(2.2) %
(100)
100
200
(21.7) %
10.9 %
15.1 %
(14.1) %
6.1 %
7.1 %
Further discussion related to the quantitative and qualitative disclosures about market risk is included under the heading of Liquidity and Rate Sensitivity in
Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.
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Table of Contents
ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SUMMARY OF QUARTERLY FINANCIAL DATA
The following table presents unaudited quarterly results of operations for years ended December 31.
2019
Quarter Ended
2018
Quarter Ended
December
September
June
March
December
September
June
March
Interest income
Interest expense
Net interest income
Provision for loan losses
$
24,028 $
24,836 $
24,472 $
19,658 $
19,152 $
16,276 $
15,843 $
14,396
6,087
6,757
5,957
4,898
4,402
3,536
2,982
2,591
17,941
18,079
18,515
14,760
14,750
12,740
12,861
11,805
—
300
200
400
200
200
200
200
Net interest income after provision for loan
losses
Investment securities gains
Other noninterest income
Merger related and branch consolidation
expenses
17,941
17,779
18,315
14,360
14,550
12,540
12,661
11,605
18
7,012
2,328
6,274
2,064
5,710
339
4,796
115
4,900
29
5,413
46
4,940
816
4,765
988
471
6,860
645
2,724
319
154
—
Other noninterest expenses
18,721
17,669
16,432
15,516
15,559
13,003
13,107
13,069
Income before income tax expense
Income tax expense
Net income
5,262
1,028
8,241
1,340
2,797
110
3,334
232
1,282
130
4,660
644
4,386
374
4,117
492
$
4,234 $
6,901 $
2,687 $
3,102 $
1,152 $
4,016 $
4,012 $
3,625
Per share information:
Basic earnings per share (a)
Diluted earnings per share (a)
Dividends paid per share
$
$
$
0.39 $
0.38 $
0.15 $
0.63 $
0.62 $
0.15 $
0.26 $
0.26 $
0.15 $
0.34 $
0.33 $
0.15 $
0.13 $
0.12 $
0.13 $
0.50 $
0.49 $
0.13 $
0.50 $
0.48 $
0.13 $
0.45
0.44
0.12
(a) Sum of the quarters may not equal the total year due to rounding.
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Index to Financial Statements and Supplementary Data
Management’s Report on Internal Control over Financial Reporting
Report of Crowe LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Page
60
61
63
64
65
66
67
69
59
Table of Contents
Management’s Report on Internal Control Over Financial Reporting
The management of Orrstown Financial Services, Inc., together with its consolidated subsidiaries (the "Company"), has the responsibility for establishing and
maintaining an adequate internal control structure and procedures for financial reporting. Management maintains a comprehensive system of internal control to
provide reasonable assurance of the proper authorization of transactions, the safeguarding of assets and the reliability of the financial records. The system of
internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. The
Company maintains an internal auditing program, under the supervision of the Audit Committee of the Board of Directors, which independently assesses the
effectiveness of the system of internal control and recommends possible improvements.
Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the
Company has evaluated the effectiveness of its internal control over financial reporting at December 31, 2019, using the Internal Control – Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted, management excluded from its evaluation of
effectiveness of internal control over financial reporting the Hamilton Bancorp, Inc. acquisition made on May 1, 2019, which is described in Note 2, Mergers and
Acquisitions, to the Consolidated Financial Statements. Based upon this evaluation, management has concluded that, at December 31, 2019, the Company’s
internal control over financial reporting is effective based on the criteria established in Internal Control-Integrated Framework (2013).
Crowe LLP has audited the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, as stated in their report dated
March 16, 2020.
/s/ Thomas R. Quinn, Jr.
Thomas R. Quinn, Jr.
/s/ Thomas R. Brugger
Thomas R. Brugger
President and Chief Executive Officer
Executive Vice President and Chief Financial Officer
March 16, 2020
Senior Vice President and Principal Accounting Officer
/s/ Gary A. Manley
Gary A. Manley
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors of Orrstown Financial Services, Inc.
Shippensburg, Pennsylvania
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Orrstown Financial Services, Inc. (the "Company") as of December 31, 2019
and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’, and cash flows for each of the years in
the three-year period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). We also have audited
the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated
Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of
December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31,
2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control –
Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for
its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal
Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the
Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company
Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the
U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective
internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements,
whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. As permitted, the Company
has excluded the operations of Hamilton Bancorp, Inc. and its wholly-owned subsidiary, Hamilton Bank acquired during 2019, which is described in
Note 2 of the consolidated financial statements, from the scope of management’s report on internal control over financial reporting. As such, it has
also been excluded from the scope of our audit of internal control
61
Table of Contents
over financial reporting. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe
that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
/s/ Crowe LLP
We have served as the Company's auditor since 2014.
Washington, D.C.
March 16, 2020
62
Table of Contents
Consolidated Balance Sheets
ORRSTOWN FINANCIAL SERVICES, INC.
(Dollars in thousands, except per share amounts)
Assets
Cash and due from banks
Interest-bearing deposits with banks
Federal funds sold
Cash and cash equivalents
Restricted investments in bank stocks
Securities available for sale (amortized cost of $490,993 and $469,607 at December 31, 2019 and 2018, respectively)
Loans held for sale, at fair value
Loans held for sale, at cost
Loans
Less: Allowance for loan losses
Net loans
Premises and equipment, net
Cash surrender value of life insurance
Goodwill
Other intangible assets, net
Accrued interest receivable
Other assets
Total assets
Liabilities
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Short-term borrowings
Long-term debt
Subordinated notes
Other liabilities
Total liabilities
Commitments and contingencies
Shareholders’ Equity
Preferred stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 11,220,604 shares issued and
11,199,874 outstanding at December 31, 2019; 9,439,255 shares issued and 9,430,224 outstanding at December 31, 2018
Additional paid—in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock— 20,730 and 9,031 shares, at cost, at December 31, 2019 and 2018, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
The Notes to Consolidated Financial Statements are an integral part of these statements.
63
December 31,
2019
2018
$
25,969 $
30,493
—
56,462
16,184
490,386
9,364
—
1,644,330
(14,655)
1,629,675
37,524
63,613
19,925
7,180
6,040
46,921
26,156
45,664
16,995
88,815
10,842
465,844
—
3,340
1,247,657
(14,014)
1,233,643
38,201
41,327
12,592
3,910
5,927
29,947
$
$
2,383,274 $
1,934,388
249,450 $
1,626,072
1,875,522
154,869
63,067
31,847
34,720
204,843
1,353,913
1,558,756
64,069
83,450
31,859
22,821
2,160,025
1,760,955
—
584
188,365
35,246
(480)
(466)
223,249
—
491
151,678
24,472
(2,972)
(236)
173,433
$
2,383,274 $
1,934,388
Table of Contents
Consolidated Statements of Income
ORRSTOWN FINANCIAL SERVICES, INC.
(Dollars in thousands, except per share amounts)
Interest income
Loans
Investment securities - taxable
Investment securities - tax-exempt
Short term investments
Total interest income
Interest expense
Deposits
Short-term borrowings
Long-term debt
Subordinated notes
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Service charges on deposit accounts
Interchange income
Other service charges, commissions and fees
Loan swap referral fees
Trust and investment management income
Brokerage income
Mortgage banking activities
Income from life insurance
Other income
Investment securities gains
Total noninterest income
Noninterest expenses
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Automated teller and interchange fees
Advertising and bank promotions
FDIC insurance
Legal fees
Other professional services
Directors' compensation
Taxes other than income
Intangible asset amortization
Merger related and branch consolidation expenses
Insurance claim receivable write off
Other operating expenses
Total noninterest expenses
Income before income tax expense
Income tax expense
Net income
Per share information:
Basic earnings per share
Years Ended Years Ended December 31,
2018
2017
2019
$
75,071 $
50,632 $
14,530
2,054
1,339
92,994
19,310
623
1,779
1,987
23,699
69,295
900
68,395
3,404
3,281
805
1,197
7,255
2,426
3,049
2,044
331
4,749
10,858
3,850
327
65,667
10,229
1,577
1,632
73
13,511
52,156
800
51,356
3,233
2,821
907
—
6,576
2,035
2,663
1,463
320
1,006
40,623
7,478
3,134
218
51,453
6,134
784
726
—
7,644
43,809
1,000
42,809
3,057
2,618
570
—
6,400
1,896
2,919
1,109
190
1,190
28,541
21,024
19,949
39,495
32,524
30,145
4,325
4,723
3,599
1,015
1,967
367
585
2,369
1,003
1,018
1,570
8,964
615
5,687
77,302
19,634
2,710
3,084
4,079
2,674
806
1,592
681
413
1,434
984
1,012
286
3,197
—
5,169
57,935
14,445
1,640
16,924 $
12,805 $
2,806
3,434
2,271
767
1,600
606
802
1,571
996
866
102
—
—
4,364
50,330
12,428
4,338
8,090
1.63 $
1.53 $
1.00
$
$
Diluted earnings per share
Dividends paid per share
1.61
0.60
1.50
0.51
0.98
0.42
The Notes to Consolidated Financial Statements are an integral part of these statements.
64
Table of Contents
Consolidated Statements of Comprehensive Income
ORRSTOWN FINANCIAL SERVICES, INC.
(Dollars in thousands)
Net income
Years Ended December 31,
2019
2018
2017
$
16,924 $
12,805 $
8,090
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) on securities available for sale arising during the period
Reclassification adjustment for gains realized in net income
Net unrealized gains (losses)
Tax effect
Total other comprehensive income (loss), net of tax and reclassification adjustments
7,905
(4,749)
3,156
(664)
2,492
(6,359)
(1,006)
(7,365)
1,548
(5,817)
Total comprehensive income
$
19,416 $
6,988 $
6,557
(1,190)
5,367
(1,586)
3,781
11,871
The Notes to Consolidated Financial Statements are an integral part of these statements.
65
Table of Contents
Consolidated Statements of Changes in Shareholders’ Equity
ORRSTOWN FINANCIAL SERVICES, INC.
(Dollars in thousands, except per share amounts)
Balance, January 1, 2017
Net income
Reclassification of disproportionate tax effects from
accumulated other comprehensive income (loss) to
retained earnings
Total other comprehensive income, net of taxes
Cash dividends ($0.42 per share)
Share-based compensation plans:
4,421 net common shares issued and 56,885 net treasury
shares issued, including compensation expense totaling
$1,386
Balance, December 31, 2017
Net income
Total other comprehensive loss, net of taxes
Cash dividends ($0.51 per share)
Issuance of stock (1,052,635 common shares) to acquire
Mercersburg Financial Corporation
Share-based compensation plans:
38,764 net common shares issued and 8,214 net treasury
shares acquired, including compensation expense
totaling $1,493
Balance, December 31, 2018
Net income
Total other comprehensive income, net of taxes
Cash dividends ($0.60 per share)
Issuance of stock (1,765,704 common shares) to acquire
Hamilton Bancorp, Inc.
Share-based compensation plans:
15,645 net common shares issued and 11,699 net
treasury shares acquired, including compensation
expense totaling $1,586
Years Ended December 31, 2019, 2018, and 2017
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Treasury
Stock
Total
Shareholders’
Equity
$
437 $
124,935 $
11,669 $
(1,165) $
(1,017) $
134,859
—
—
—
—
(2)
435
—
—
—
55
1
491
—
—
—
92
—
8,090
—
—
8,090
—
—
—
523
125,458
—
—
—
(229)
—
(3,488)
—
16,042
12,805
—
(4,375)
24,998
—
1,222
151,678
—
—
—
—
24,472
16,924
—
(6,150)
36,530
—
229
3,781
—
—
2,845
—
(5,817)
—
—
—
(2,972)
—
2,492
—
—
—
—
—
1,002
(15)
—
—
—
—
(221)
(236)
—
—
—
—
—
3,781
(3,488)
1,523
144,765
12,805
(5,817)
(4,375)
25,053
1,002
173,433
16,924
2,492
(6,150)
36,622
1
157
—
—
(230)
(72)
Balance, December 31, 2019
$
584 $
188,365 $
35,246 $
(480) $
(466) $
223,249
The Notes to Consolidated Financial Statements are an integral part of these statements.
66
Table of Contents
Consolidated Statements of Cash Flows
ORRSTOWN FINANCIAL SERVICES, INC.
(Dollars in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Net premium amortization (discount accretion)
Depreciation and amortization expense
Provision for loan losses
Share-based compensation
Gain on sales of loans originated for sale
Mortgage loans originated for sale
Proceeds from sales of loans originated for sale
Gain on sale of portfolio loans
Net gain on disposal of OREO
Writedown of OREO
Net loss (gain) on disposal of premises and equipment
Deferred income taxes
Investment securities gains
Income from life insurance
Increase in accrued interest receivable
Increase in accrued interest payable and other liabilities
Other, net
Net cash provided by operating activities
Cash flows from investing activities
Proceeds from sales of AFS securities
Maturities, repayments and calls of AFS securities
Purchases of AFS securities
Net cash and cash equivalents received from acquisitions
Net purchases of restricted investments in bank stocks
Net increase in loans
Proceeds from sales of portfolio loans
Purchases of bank premises and equipment
Proceeds from disposal of OREO
Purchases of bank owned life insurance
Death benefit proceeds from life insurance contracts
Other
Net cash provided by (used in) investing activities
Cash flows from financing activities
Net (decrease) increase in deposits
Net increase (decrease) in borrowings with original maturities less than 90 days
Proceeds from other short-term borrowings
Payments on other short-term borrowings
Proceeds from long-term debt
Payments on long-term debt
Proceeds from subordinated notes, net of issuance costs
Payment of subordinated notes issuance costs
Dividends paid
Treasury shares repurchased for employee taxes associated with restricted stock vesting
Proceeds from issuance of stock for option exercises and employee stock purchase plan
Net cash (used in) provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Years Ended Years Ended December 31,
2018
2017
2019
$
16,924 $
12,805 $
8,090
(2,547)
5,547
900
1,586
(2,613)
(112,568)
108,885
—
(156)
—
139
1,776
(4,749)
(2,044)
1,248
(5,291)
2,053
9,090
199,928
33,265
(190,530)
29,442
(2,684)
(46,157)
—
(2,911)
1,318
(3,280)
571
—
18,962
(71,561)
115,800
—
(25,000)
20,000
(91,776)
—
(59)
(6,150)
(1,772)
113
(60,405)
(32,353)
88,815
1,406
3,642
800
1,493
(2,144)
(90,305)
94,727
(291)
(108)
24
12
543
(1,006)
(1,463)
(879)
2,696
535
22,487
156,364
18,373
(226,014)
12,407
(592)
(99,828)
3,589
(4,791)
1,413
(900)
576
7
(139,396)
178,798
(14,507)
25,000
(40,000)
—
(365)
31,857
—
(4,375)
(651)
160
175,917
59,008
29,807
$
56,462 $
88,815 $
67
4,034
3,265
1,000
1,386
(2,447)
(104,512)
103,131
(32)
(18)
4
(18)
3,078
(1,190)
(1,109)
(376)
2,012
52
16,350
162,320
28,768
(203,719)
—
(2,027)
(130,791)
2,195
(2,653)
541
(600)
—
74
(145,892)
67,063
(34,288)
70,000
(30,000)
80,000
(20,348)
—
—
(3,488)
—
137
129,076
(466)
30,273
29,807
Table of Contents
(Dollars in thousands)
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest
Income taxes
Supplemental schedule of noncash investing and financing activities:
Other real estate acquired in settlement of loans
Premises and equipment transferred to held for sale
The Notes to Consolidated Financial Statements are an integral part of these statements.
68
Years Ended Years Ended December 31,
2018
2017
2019
$
24,313 $
—
12,930 $
60
161
4,894
539
1,003
7,586
1,638
1,007
—
Table of Contents
Notes to Consolidated Financial Statements
(All dollar amounts presented in the tables, except share and per share amounts, are in thousands)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
See the Glossary of Defined Terms at the beginning of this Report for terms used throughout the consolidated financial statements and related notes of this
Form 10-K.
Nature of Operations – Orrstown Financial Services, Inc. and subsidiaries is a financial holding company that operates Orrstown Bank, a commercial bank
with banking and financial advisory offices in Berks, Cumberland, Dauphin, Franklin, Lancaster, Perry and York Counties, Pennsylvania, and in Anne Arundel,
Baltimore, Howard and Washington Counties, Maryland, as well as Baltimore City, Maryland and Wheatland Advisors, Inc., a registered investment advisor non-
bank subsidiary, headquartered in Lancaster County, Pennsylvania. The Company operates in the community banking segment and engages in lending activities,
including commercial, residential, commercial mortgages, construction, municipal, and various forms of consumer lending, and deposit services, including
checking, savings, time, and money market deposits. The Company also provides fiduciary services, investment advisory, insurance and brokerage services. The
Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by such regulatory authorities.
Basis of Presentation – The accompanying consolidated financial statements include the accounts of Orrstown Financial Services, Inc. and its wholly owned
subsidiaries, the Bank and Wheatland. The accounting and reporting policies of the Company conform to GAAP and, where applicable, to accounting and
reporting guidelines prescribed by bank regulatory authorities. All significant intercompany transactions and accounts have been eliminated. Certain
reclassifications have been made to prior year amounts to conform with current year classifications. In October 2018, the Company acquired Mercersburg
Financial Corporation and its wholly-owned subsidiary, First Community Bank of Mercersburg, based in Mercersburg, Pennsylvania. In May 2019, the Company
acquired Hamilton Bancorp, Inc., and its wholly-owned subsidiary, Hamilton Bank, based in Towson, Maryland. The results of operations and assets acquired and
liabilities assumed from acquired entities are included only from the date of acquisition. The comparability of the Company's results of operations for the years
ended December 31, 2019, to 2018 and 2017 have been impacted by these acquisitions.
The Company's management has evaluated all activity of the Company and concluded that subsequent events are properly reflected in the Company's
consolidated financial statements and notes as required by GAAP.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change
include the determination of the ALL and those used in valuation methodologies in areas with no observable market, such as loans, deposits, borrowings, goodwill,
core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations.
Concentration of Credit Risk – The Company grants commercial, residential, construction, municipal, and various forms of consumer lending to clients
primarily in its market area in south central Pennsylvania and in the greater Baltimore region and Washington County, Maryland.. Therefore, the Company's
exposure to credit risk is significantly affected by changes in the economy in those areas. Although the Company maintains a diversified loan portfolio, a
significant portion of its clients’ ability to honor their contracts is dependent upon economic sectors for commercial real estate, including office space, retail strip
centers, sales finance, sub-dividers and developers, and multi-family, hospitality, and residential building operators. Management evaluates each clients'
creditworthiness on a case-by-case basis. The amount of collateral obtained upon the extension of credit, is based on management’s credit evaluation of the client.
Collateral held varies, but generally includes real estate and equipment.
The types of securities the Company invests in are included in Note 3, Securities Available for Sale, and the types of lending the Company engages in are
included in Note 4, Loans and Allowance for Loan Losses.
Cash and Cash Equivalents – Cash and cash equivalents includes cash, balances due from banks, federal funds sold and interest-bearing deposits due on
demand, all of which have original maturities of 90 days or less. Net cash flows are reported for client loan and deposit transactions, loans held for sale, redemption
(purchases) of restricted investments in bank stocks, and short-term borrowings.
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Table of Contents
Cash and cash equivalents includes amounts that the Company is required to maintain on hand or on deposit at the Federal Reserve Bank to meet certain
regulatory reserve balance requirements. At December 31, 2019 and 2018, the Company had reserve requirements of $9.2 million and $11.0 million, respectively.
Balances with correspondent banks may, at times, exceed federally insured limits. The Company considers this to be a normal business risk and reviews the
financial condition of its correspondent banks on a quarterly basis.
Restricted Investments in Bank Stocks – Restricted investments in bank stocks consist of Federal Reserve Bank of Philadelphia stock, FHLB of Pittsburgh
stock and Atlantic Community Bankers Bank stock. Federal law requires a member institution of the district Federal Reserve Bank and FHLB to hold stock
according to predetermined formulas. Atlantic Community Bankers Bank requires its correspondent banking institutions to hold stock as a condition of
membership. The restricted investment in bank stocks is carried at cost. On a quarterly basis, management evaluates the bank stocks for impairment based on
assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the
ultimate recoverability of cost is influenced by criteria such as operating performance, liquidity, funding and capital positions, stock repurchase history, dividend
history, and impact of legislative and regulatory changes.
Securities – The Company typically classifies debt securities as available for sale on the date of purchase. At December 31, 2019 and 2018, the Company had
no held to maturity or trading securities. AFS securities are reported at fair value. Interest income and dividends on debt securities are recognized in interest
income on an accrual basis. Purchase premiums and discounts on debt securities are amortized to interest income using the interest method over the terms of the
securities and approximate the level yield method.
Changes in unrealized gains and losses, net of related deferred taxes, for AFS securities are recorded in AOCI. Realized gains and losses on securities are
recorded on the trade date using the specific identification method and are included in noninterest income on the consolidated statements of income.
AFS securities include investments that management intends to use as part of its asset/liability management strategy. Securities may be sold in response to
changes in interest rates, changes in prepayment rates and other factors. The Company does not have the intent to sell any of its AFS securities that are in an
unrealized loss position and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost.
Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an
evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-
term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an
unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference
between amortized cost and fair value is recognized as an impairment through earnings. For debt securities that do not meet the aforementioned criteria, the
amount of impairment is split into two components: OTTI related to other factors, which is recognized in OCI, and the remaining OTTI, which is recognized in
earnings. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
The Company’s securities are exposed to various risks, such as interest rate risk, market risk, and credit risk. Due to the level of risk associated with certain
investments and the level of uncertainty related to changes in the value of investments, it is at least reasonably possible that changes in risks in the near term would
materially affect investment assets reported in the consolidated financial statements.
Loans Held for Sale – Effective October 1, 2019, The Company adopted the fair value option on these loans which allows the Company to record the
mortgage loans held for sale portfolio at fair market value as opposed to the lower of cost or market. The Company economically hedges its residential loans held
for sale portfolio with forward sale agreements which are reported at fair value. A lower of cost or market accounting treatment would not allow the Company to
record the excess of the fair market value over book value but would require the Company to record the corresponding reduction in value on the hedges. Both the
loans and related hedges are carried at fair value which reduces earnings volatility as the amounts more closely offset, particularly in environments when interest
rates are declining. For loans held for sale for which the fair value option has been elected, the aggregate fair value exceeded the aggregate principal balance by
$226 thousand. There were no loans held for sale that were nonaccrual or 90 or more days past due as of December 31, 2019. In previous periods, loans originated
and intended for sale in the secondary market were carried at the lower of aggregate cost or fair value. Gains and losses on loan sales (sales proceeds minus
carrying value) are recorded in noninterest income. Interest income on these loans is recognized in interest and fees on loans in the consolidated statements of
operations.
Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding
unpaid principal balances adjusted for charge-offs, the ALL, and any deferred fees or costs on
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originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and
amortized as a yield adjustment over the respective term of the loan. For purchased loans that are not deemed impaired at the acquisition date, premiums and
discounts are amortized or accreted as adjustments to interest income using the effective yield method.
For all classes of loans, the accrual of interest income on loans, including impaired loans, ceases when principal or interest is past due 90 days or more or
immediately if, in the opinion of management, full collection is unlikely. Interest will continue to accrue on loans past due 90 days or more if the collateral is
adequate to cover principal and interest, and the loan is in the process of collection. Interest accrued, but not collected, at the date of placement on nonaccrual
status, is reversed and charged against interest income, unless fully collateralized. Subsequent payments received are either applied to the outstanding principal
balance or recorded as interest income, depending upon management’s assessment of the ultimate collectability of principal. Loans are returned to accrual status,
for all loan classes, when all the principal and interest amounts contractually due are brought current, the loan has performed in accordance with the contractual
terms of the note for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is reasonably
assured. Past due status is based on the contractual terms of the loan.
Loans, the terms of which are modified, are classified as TDRs if a concession was granted in connection with the modification, for legal or economic
reasons, related to the debtor’s financial difficulties. Concessions granted under a TDR typically involve a temporary deferral of scheduled loan payments, an
extension of a loans' stated maturity date, a temporary reduction in interest rates, or granting of an interest rate below market rates given the risk of the transaction.
If a modification occurs while the loan is on accrual status, it will continue to accrue interest under the modified terms. Nonaccrual TDRs may be restored to
accrual status if scheduled principal and interest payments, under the modified terms, are current for six months after modification, and the borrower continues to
demonstrate its ability to meet the modified terms. TDRs are evaluated individually for impairment on a quarterly basis including monitoring of performance
according to their modified terms.
Allowance for Loan Losses – The ALL is evaluated on at least a quarterly basis, as losses are estimated to be probable and incurred, and, if deemed
necessary, is increased or decreased through the provision for loan losses on the consolidated statements of income. Loan losses are charged against the ALL when
management determines that all or a portion of the loan is uncollectible. Recoveries on previously charged-off loans are credited to the ALL when received. The
ALL is allocated to loan portfolio classes on a quarterly basis, but the entire balance is available to cover losses from any of the portfolio classes when those losses
are confirmed.
Management uses internal policies and bank regulatory guidance in periodically evaluating loans for collectability and incorporates historical experience, the
nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and
prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information
becomes available.
See Note 4, Loans and Allowance for Loan Losses, for additional information.
Acquired Loans - Loans acquired in connection with business combinations are recorded at fair value with no carryover of any allowance for loan losses. Fair
value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash
flows at a market rate of interest.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income
over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition
is referred to as the nonaccretable discount. These loans are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit
Quality ("ASC 310-30"). The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases
in expected cash flows will require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvement in expected cash flows will
result in the reversal of a corresponding amount of the nonaccretable discount, which we will then reclassify as accretable discount to be recognized into interest
income over the remaining life of the loan.
Loans acquired through business combinations that do meet the specific criteria of ASC 310-30 are individually evaluated each period to analyze expected
cash flows. To the extent that the expected cash flows of a loan have decreased due to credit deterioration, the Company establishes an allowance.
Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30 are accounted for under ASC 310-20, Receivables -
Nonrefundable Fees and Other Costs. These loans are initially recorded at fair value, and include credit and interest rate marks associated with acquisition
accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans.
There is no allowance for
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loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans
subsequent to acquisition.
Acquired loans that meet the criteria for impairment or nonaccrual of interest prior to the acquisition may be considered performing upon acquisition,
regardless of whether the client is contractually delinquent if the Company expects to fully collect the new carrying value (i.e., fair value) of the loans. As such, the
Company may no longer consider the loan to be nonperforming and may accrue interest on these loans, including the impact of any accretable discount. In
addition, charge-offs on such loans would be first applied to the nonaccretable difference portion of the fair value adjustment.
Loan Commitments and Related Financial Instruments – Financial instruments include off-balance sheet credit commitments issued to meet client financing
needs, such as commitments to make loans and commercial letters of credit. These financial instruments are recorded when they are funded. The face amount
represents the exposure to loss, before considering client collateral or ability to repay. The Company maintains a reserve for probable losses on off-balance sheet
commitments which is included in other liabilities on the consolidated balance sheets.
Loans Serviced – The Bank administers secondary market mortgage programs available through the FHLB and the Federal National Mortgage Association
and offers residential mortgage products and services to clients. The Bank originates single-family residential mortgage loans for immediate sale in the secondary
market and retains the servicing of those loans. At December 31, 2019 and 2018, the balance of loans serviced for others totaled $360.1 million and $360.3 million,
respectively.
Transfers of Financial Assets – Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their maturity.
Cash Surrender Value of Life Insurance – The Company has purchased life insurance policies on certain employees. Life insurance is recorded at the cash
surrender value adjusted for other charges or other amounts due that are probable at settlement.
Premises and Equipment – Buildings, improvements, equipment, furniture and fixtures are carried at cost less accumulated depreciation and amortization.
Land is carried at cost. Depreciation and amortization has been recognized generally on the straight-line method and is computed over the estimated useful lives of
the various assets as follows: buildings and improvements, including leasehold improvements – 10 to 40 years; and furniture and equipment – 3 to 15 years.
Leasehold improvements are amortized over the shorter of the lease term or the indicated life. Repairs and maintenance are charged to operations as incurred, while
additions and improvements are typically capitalized. Gains or losses on the retirement or disposal of individual assets is recorded as income or expense in the
period of retirement or disposal. Premises no longer in use and held for sale are included in other assets on the consolidated balance sheets at the lower of carrying
value or fair value and no depreciation is charged on them. At December 31, 2019 and 2018, premises held for sale totaled $5.2 million and $1.0 million,
respectively.
Leases - The Company evaluates its contracts at inception to determine if an arrangement is,or contains, a lease. Operating leases are included in operating
lease ROU assets in other assets and operating lease liabilities in accrued interest payable and other liabilities in the consolidated balance sheets. The Company had
no finance leases at December 31, 2019.
ROU assets represent the right to use an underlying asset for the lease term, and lease liabilities represent an obligation to make lease payments arising from
the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The
Company's leases do not provide an implicit rate, so it uses our incremental borrowing rate, which approximates its fully collateralized borrowing rate, based on
the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate is reevaluated upon lease
modification. The operating lease ROU asset also includes any initial direct costs and prepaid lease payments made less any lease incentives. The Company's lease
terms may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option.
The Company adopted ASU 2016-02, “Leases (Topic 842),” on January 1, 2019, using the practical expedient transition method whereby the Company did
not revise comparative period information or disclosure. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with
terms longer than 12 months. The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which
among other things, allows the Company to carryforward the historical lease classification. The Company also elected certain optional practical expedients,
including the hindsight practical expedient under which the Company considered the actual outcomes of lease renewals and terminations when measuring the lease
term at adoption, and the Company made an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. The
Company recognizes these lease payments in
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the consolidated statements of income on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components, and
has elected the practical expedient to account for these as a single lease component.
The Company's operating leases relate primarily to bank branches and office space. Upon the adoption on January 1, 2019, operating lease liabilities of $8.0
million and related lease assets of $7.5 million were recognized on the consolidated balance sheets. The difference between the lease assets and lease liabilities
primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets. The standard did not materially impact the
Company's consolidated net income and had no impact on cash flows.
Goodwill and Other Intangible Assets – Goodwill is calculated as the purchase premium, if any, after adjusting for the fair value of net assets acquired in
purchase transactions. Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event
occurs or circumstances change that could potentially reduce the fair value of a reporting unit. Other intangible assets represent purchased assets that can be
distinguished from goodwill because of contractual or other legal rights. The Company’s other intangible assets have finite lives and are amortized on either an
accelerated amortization method or straight line basis over their estimated lives, generally 10 years for deposit premiums and 10 to 15 years for other client
relationship intangibles.
Mortgage Servicing Rights – The estimated fair value of MSRs related to loans sold and serviced by the Company is recorded as an asset upon the sale of
such loans. MSRs are amortized as a reduction to servicing income over the estimated lives of the underlying loans. MSRs are evaluated periodically for
impairment by comparing the carrying amount to estimated fair value. Fair value is determined periodically through a discounted cash flow valuation performed by
a third party. Significant inputs to the valuation include expected servicing income, net of expense, the discount rate and the expected life of the underlying loans.
To the extent the amortized cost of the MSRs exceeds their estimated fair values, a valuation allowance is established for such impairment through a charge against
servicing income on the consolidated statements of income. If the Company determines, based on subsequent valuations, that the impairment no longer exists or is
reduced, the valuation allowance is reduced through a credit to earnings. MSRs totaled $3.1 million and $3.2 million at December 31, 2019 and December 31,
2018, respectively, and are included in other assets on the consolidated balance sheets.
Foreclosed Real Estate – Real estate acquired through foreclosure or other means is initially recorded at the fair value of the related real estate collateral at
the transfer date less estimated selling costs, and subsequently at the lower of its carrying value or fair value less estimated costs to sell. Fair value is determined
based on an independent third party appraisal of the property or, when appropriate, a recent sales offer. Costs to maintain such real estate are expensed as incurred.
Costs that significantly improve the value of the properties are capitalized. Real estate acquired through foreclosure or other means totaled $197 thousand and $130
thousand at December 31, 2019 and 2018, respectively, and is included in other assets on the consolidated balance sheets.
Investments in Real Estate Partnerships – The Company has a 99% limited partner interest in several real estate partnerships in central Pennsylvania. These
investments are affordable housing projects, which entitle the Company to tax deductions and credits that expire through 2025. The Company accounts for its
investments in affordable housing projects under the proportional amortization method when the criteria are met, which is limited to one investment at
December 31, 2019. Other investments are accounted for under the equity method of accounting. The investment in these real estate partnerships, included in other
assets on the consolidated balance sheets, totaled $3.6 million and $3.9 million at December 31, 2019 and 2018, respectively, of which $1.3 million and $1.6
million are accounted for under the proportional amortization method.
Equity method losses totaled $55 thousand, $331 thousand and $277 thousand for the years ended December 31, 2019, 2018 and 2017, respectively, and are
included in other noninterest income on the consolidated income statements. Proportional amortization method losses totaled $214 thousand, $214 thousand and
$217 thousand for the years ended December 31, 2019, 2018 and 2017, respectively, and are included in income tax expense on the consolidated income
statements. During 2019, 2018 and 2017, the Company recognized federal tax credits from these projects totaling $460 thousand, $578 thousand and $1.0 million,
respectively, which are included in income tax expense on the consolidated income statements.
Advertising – The Company expenses advertising as incurred. Advertising expense totaled $577 thousand, $418 thousand and $631 thousand for the years
ended December 31, 2019, 2018 and 2017, respectively.
Repurchase Agreements – The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar
securities which are included in short-term borrowings on the consolidated balance sheets. Under these agreements, the Company may transfer legal control over
the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase
agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The
obligation to repurchase the securities is reflected as a liability on the Company’s consolidated balance sheets, while the securities underlying the repurchase
agreements remaining are reflected in AFS securities. The repurchase obligation and underlying securities are not offset or netted as the Company does not enter
into reverse repurchase agreements.
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The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase
agreement should the Company be in default (e.g., fail to make an interest payment to the counterparty). For the repurchase agreements, the collateral is held by the
Company in a segregated custodial account under a third party agreement. Repurchase agreements are secured by GSE MBSs and mature overnight.
Share Compensation Plans – The Company has share compensation plans that cover employees and non-employee directors. Compensation expense relating
to share-based payment transactions is measured based on the grant date fair value of the share award, including a Black-Scholes model for stock options.
Compensation expense for all share awards is calculated and recognized over the employees’ or non-employee directors' service period, generally defined as the
vesting period.
Income Taxes – Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects
taxes to be paid or refunded for the current period by applying the provisions of enacted tax law to taxable income or excess of deductions over revenues. The
Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the
tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in
which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely
than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of
more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that
meets the more likely than not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent
likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax
position has met the more likely than not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to
management’s judgment. Deferred tax assets are reduced by a valuation allowance when, based on the weight of available evidence, it is more likely than not that
some portion or all of a deferred tax asset will not be realized. The Company recognizes interest and penalties, if any, on income taxes as a component of income
tax expense.
Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Treasury Stock – Common stock shares repurchased are recorded as treasury stock, at cost on the consolidated balance sheets.
Earnings Per Share – Basic earnings per share represents income available to common stockholders divided by the weighted average number of common
shares outstanding during the period. Restricted stock awards are included in weighted average common shares outstanding as they are earned. Diluted earnings per
share includes additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may
be issued by the Company relate solely to outstanding stock options and restricted stock awards and are determined using the treasury stock method.
Treasury shares are not deemed outstanding for earnings per share calculations.
Comprehensive Income – Comprehensive income consists of net income and OCI. Unrealized gains (losses) on securities available for sale, net of tax, was
the sole component of AOCI at December 31, 2019 and 2018.
Fair Value – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in the Fair
Value note to the consolidated financial statements. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in
market conditions could significantly affect the estimates.
Segment Reporting – The Company operates in one segment – Community Banking. The Company’s non-community banking activities, principally related
to Wheatland, are insignificant to the consolidated financial statements.
Recent Accounting Pronouncements - ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments ("ASU 2016-13"). The amendments in this update require an organization to measure all expected credit losses for financial assets held at the reporting
date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will use forward-
looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to
those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation
method is appropriate for their circumstances. Additionally, the amendments in this update amend the accounting for credit losses on available-for-sale debt
securities and purchased financial assets with credit
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deterioration. For certain public companies, this update will be effective for interim and annual periods beginning after December 15, 2019. ASU No. 2019-10,
Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates, extended the implementation
deadline for smaller reporting and other companies until the fiscal year and interim periods beginning after December 15, 2022. The Company meets the
requirements to be considered a smaller reporting company under SEC Regulation S-K and SEC Rule 405, and did not adopt ASU 2016-13 on January 1, 2020.
The Company is evaluating the impact of the delay for adoption of ASU 2016-13.
The Company is working with a third party vendor solution to assist with the application of ASU 2016-13 and finalizing the loss estimation models to be
used. Once management determines which methods will be utilized, a third party will be contracted to perform a model validation prior to adoption. While the
Company anticipates the allowance for loan losses will increase under its current assumptions, it expects the impact of adopting ASU 2016-13 will be influenced
by the composition, characteristics and quality of its loan and securities portfolios, as well as general economic conditions and forecasts at the adoption date.
ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The update simplifies how all entities assess
goodwill for impairment by eliminating Step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing
the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount
exceeds the reporting unit’s fair value. The adoption of this guidance, effective January 1, 2020, will not have a material impact on the Company's consolidated
financial statements.
NOTE 2. MERGERS AND ACQUISITIONS AND BRANCH CONSOLIDATIONS
Mercersburg Financial Corporation
On October 1, 2018, the Company acquired 100% of the outstanding common shares of Mercersburg Financial Corporation and its wholly-owned subsidiary,
First Community Bank of Mercersburg, headquartered in Mercersburg, Pennsylvania. The Company issued 1,052,635 shares of its common stock and paid $4.9
million in cash for all outstanding shares of Mercersburg stock. Based on the Company's $23.80 closing stock price on Friday, September 28, 2018, the
consideration paid to acquire Mercersburg totaled $29.9 million.
The fair value of assets acquired, excluding goodwill, totaled $181.4 million, including loans totaling $141.1 million and investment securities available for
sale totaling $7.4 million. The fair value of liabilities assumed totaled $163.4 million, including deposits totaling $160.4 million. The Company recognized
$11.9 million in initial goodwill, representing consideration transferred in excess of the fair value of the net assets acquired in the Mercersburg acquisition. The
goodwill resulting from the acquisition represents the value expected from the expansion of our market in south central Pennsylvania and the enhancement of our
operations through client synergies and efficiencies, thereby providing enhanced client service.
The Mercersburg acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable
intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and
liabilities assumed were subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair
values became available. No material measurement period adjustments were made in the year ended December 31, 2019. The results of operations for the
Company include Mercersburg's results from and after October 1, 2018.
Hamilton Bancorp, Inc.
On May 1, 2019, the Company acquired 100% of the outstanding common shares of Hamilton Bancorp, Inc., and its wholly-owned subsidiary, Hamilton
Bank, based in Towson, Maryland. The Company acquired Hamilton to introduce our banking and financial services into the greater Baltimore area of Maryland.
Pursuant to the merger agreement, the Company issued 1,765,704 shares of its common stock and paid $14.2 million in cash for all outstanding shares of
Hamilton stock and options vesting upon acquisition. Based on the Company's closing stock price of $20.74 on Tuesday, April 30, 2019, the consideration paid to
acquire Hamilton totaled $50.8 million.
The fair value of assets acquired, excluding goodwill, totaled $492.8 million, including loans totaling $347.4 million. The fair value of liabilities assumed
totaled $449.4 million, including deposits totaling $388.2 million. Goodwill represents consideration transferred in excess of the fair value of the net assets
acquired. At May 1, 2019, the Company recognized $7.3 million in goodwill associated with the Hamilton acquisition. The goodwill resulting from the acquisition
represents the value expected from the expansion of our market in the greater Baltimore area and the enhancement of our operations through client
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synergies and efficiencies, thereby providing enhanced client service. Goodwill acquired in the Hamilton acquisition is not deductible for tax purposes.
The Hamilton acquisition was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible
assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed
are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available.
The Company continues to finalize the fair values of loans, intangible assets, other assets, income taxes and liabilities. As a result, the recorded fair value
adjustments are preliminary and may change as additional information becomes available. Fair value adjustments will be finalized no later than May 2020. No
material measurement period adjustments were made from the date of acquisition through December 31, 2019. The results of operations for the Company include
Hamilton's results from and after May 1, 2019.
The following table summarizes the consideration paid for Hamilton and the estimated fair values of the assets acquired and liabilities assumed at the
acquisition date.
Fair value of consideration transferred:
Cash
Common stock issued
Total consideration transferred
Estimated fair values of assets acquired and liabilities assumed:
Cash and cash equivalents
Securities available for sale
Restricted investments in bank stocks
Loans
Premises and equipment
Core deposit intangible
Goodwill
Cash surrender value of life insurance
Deferred tax asset, net
ROU lease asset
Other assets
Total assets acquired
Deposits
Borrowings
Other liabilities
Total liabilities assumed
$
$
$
$
$
$
14,197
36,622
50,819
43,140
60,882
2,658
347,361
3,749
4,550
7,333
17,948
5,838
2,793
3,925
500,177
(388,246)
(51,393)
(9,719)
(449,358)
The determination of estimated fair values of the acquired loans required the Company to make certain estimates about discount rates, future expected cash
flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status,
and credit risk ratings, the acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30
(purchased credit impaired), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (purchased non-impaired). Expected cash flows,
both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These
assumptions were developed using both Hamilton's historical experience and the portfolio characteristics as of the acquisition date as well as available market
research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected
prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Company considered to be level 3 fair value
measurements. Deposit liabilities assumed in the Hamilton acquisition were segregated into two categories: time-deposits (i.e., deposit accounts with a stated
maturity) and demand deposits, both using level 2 fair value measurements. In determining fair value of time deposits, the Company discounted the contractual
cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration. For demand deposits, the
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acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. Acquisition date fair values for securities available for sale
were determined using Level 1 or Level 2 inputs consistent with the methods discussed further in Note 19 - Fair Value. The remaining acquisition date fair values
represent either Level 2 or Level 3 fair value measurements (premises and equipment and core deposit intangible).
The Company recognized a core deposit intangible of $4.6 million, which is being amortized using an accelerated method over a 10-year amortization period,
consistent with expected future cash flows.
Loans acquired from Hamilton were measured at fair value at the acquisition date with no carryover of any ALL. Loans were segregated into those loans
considered to be performing and those considered PCI. The following table presents performing and PCI loans acquired, by loan class, at May 1, 2019.
Upon completion of the Hamilton acquisition, the Company sold the acquired investment portfolio and paid off acquired borrowings at the indicated fair
value amounts in conjunction with its asset/liability management strategies.
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home-equity - term
Home equity - lines of credit
Installment and other loans
Total loans acquired
Performing
PCI
Total
$
42,148 $
45,401
10,773
7,450
4,528
32,316
152,657
4,478
13,657
14,467
6,324 $
770
—
—
—
1,702
10,494
1
—
195
$
327,875 $
19,486 $
The following table presents the fair value adjustments made to the amortized cost basis of loans acquired at May 1, 2019.
Gross amortized cost basis at acquisition
Market rate adjustment
Credit fair value adjustment on non-credit impaired loans
Credit fair value adjustment on impaired loans
Estimated fair value of acquired loans
$
$
48,472
46,171
10,773
7,450
4,528
34,018
163,151
4,479
13,657
14,662
347,361
362,125
(5,309)
(3,947)
(5,508)
347,361
The market rate adjustment represents the movement in market interest rates, irrespective of credit adjustments, compared to the contractual rates of the
acquired loans. The credit fair value adjustment made on non-credit impaired loans represents the changes in credit quality of the underlying borrowers from loan
inception to the acquisition date. The credit fair value adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan
balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.
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The following table provides information about acquired PCI loans at May 1, 2019.
Contractually required principal and interest at acquisition
Contractual cash flows not expected to be collected (nonaccretable discount)
Expected cash flows at acquisition
Interest component of expected cash flows (accretable discount)
Estimated fair value of acquired PCI loans
$
$
31,599
(8,616)
22,983
(3,497)
19,486
Unaudited pro forma net income for the year ended December 31, 2019 would have totaled $20.9 million, and revenues would have totaled $102.5 million
for the same period had the Hamilton acquisition occurred January 1, 2019. Unaudited pro forma net income for the year ended December 31, 2018, would have
totaled $12.2 million, and revenues would have totaled $95.3 million for the same period had the Mercersburg and Hamilton acquisitions occurred January 1, 2018.
In connection with the Mercersburg and Hamilton acquisitions, the Company incurred merger related expenses. Mercersburg related merger expenses totaled
$280 thousand and $2.9 million during the years ended December 31, 2019 and 2018, respectively, which are included in merger related and branch consolidation
expenses on the consolidated statements of income. For December 31, 2019 and 2018, the expenses consisted primarily of $81 thousand and $1.2 million of
investment banking, legal and consulting fees; $199 thousand and $1.1 million of information systems expense, including canceling of contracts; and zero and
$617 thousand, respectively, of other expenses, including payout of employee termination contracts. Hamilton related merger expenses totaled $7.7 million and
$267 thousand for the years ended December 31, 2019 and 2018, respectively, which are included in merger related and branch consolidation expenses on the
consolidated statements of income. For December 31, 2019 and 2018, these expenses consisted primarily of $1.9 million and $254 thousand of investment
banking, legal and consulting fees; $3.7 million and zero of information systems expense, including canceling of contracts; and $2.2 million and $13 thousand,
respectively, of other expenses, including payout of employee termination contracts.
Branch Consolidation
In October, 2019, the Company announced the consolidation of five branches in Franklin and Perry Counties, Pennsylvania, into other, larger branches of the
Bank, as part of its ongoing evaluation of branch profitability. The Company also announced the sale/leaseback of an operations center facility to eliminate
approximately 50,000 square feet of excess back office space. The branch consolidations were completed in January 2020, and the sale of the operations center
facility is anticipated to be completed in the second quarter of 2020.
In conjunction with the consolidation and operations center facility sale/leaseback, the Company recorded $988 thousand in expenses in the fourth quarter of
2019, consisting of $762 thousand in fixed asset writedowns, $126 thousand in lease termination costs, and $100 thousand in severance and other costs. At
December 31, 2019, fixed assets included in this consolidation, with an estimated fair value of $4.9 million, were held for sale and carried in other assets on the
consolidated balances sheets.
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NOTE 3. SECURITIES AVAILABLE FOR SALE
At December 31, 2019 and 2018, all investment securities were classified as AFS. The following table summarizes amortized cost and fair value of AFS
securities, and the corresponding amounts of gross unrealized gains and losses recognized in AOCI at December 31, 2019 and 2018.
December 31, 2019
States and political subdivisions
GSE residential CMOs
Non-agency CMOs
Private label commercial CMOs
Asset-backed and other
Totals
December 31, 2018
States and political subdivisions
GSE residential CMOs
Private label residential CMOs
Private label commercial CMOs
Asset-backed and other
Totals
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
$
$
$
$
83,607 $
67,928
17,210
86,704
235,544
4,288 $
1,000
—
156
138
490,993 $
5,582 $
32 $
774
123
231
5,029
6,189 $
144,596 $
1,919 $
1,511 $
110,421
144
75,911
138,535
332
—
55
126
2,689
1
921
1,073
469,607 $
2,432 $
6,195 $
87,863
68,154
17,087
86,629
230,653
490,386
145,004
108,064
143
75,045
137,588
465,844
The following table summarizes AFS securities with unrealized losses at December 31, 2019 and 2018, aggregated by major security type and length of
time in a continuous unrealized loss position.
Less Than 12 Months
12 Months or More
# of Securities
Fair
Value
Unrealized
Losses
# of Securities
Fair
Value
Unrealized
Losses
# of Securities
Total
Fair
Value
Unrealized
Losses
December 31, 2019
States and political subdivisions
GSE residential CMOs
Non-agency CMOs
Private label commercial CMOs
Asset-backed and other
Totals
December 31, 2018
States and political subdivisions
GSE residential CMOs
Private label residential CMOs
Private label commercial CMOs
Asset-backed and other
Totals
$
1
5
1
6
9
6,173 $
37,158
17,087
26,079
92,189
22
$ 178,686 $
$
46,585 $
18,037
143
56,499
78,900
27
1
1
11
6
46
32
309
123
67
1,145
1,676
662
122
1
712
859
$ 200,164 $
2,356
—
1
—
8
9
18
6
7
—
2
3
18
$
0 $
11,602
—
39,726
121,399
$
172,727 $
$
23,036 $
46,168
—
6,349
10,808
$
86,361 $
0
465
—
164
3,884
4,513
849
2,567
—
209
214
3,839
1
6
1
14
18
40
33
8
1
13
9
64
$
6,173 $
48,760
17,087
65,805
213,588
$ 351,413 $
$
69,621 $
64,205
143
62,848
89,708
$ 286,525 $
32
774
123
231
5,029
6,189
1,511
2,689
1
921
1,073
6,195
The Company determines whether unrealized losses are temporary in nature in accordance with FASB ASC 325-40, when applicable, and FASB ASC 320-
10, Investments - Overall, (“FASB ASC 320-10”). The evaluation is based upon factors such as the creditworthiness of the underlying borrowers, performance of
the underlying collateral, if applicable, and the level of credit support in the security structure. Management also evaluates other factors and circumstances that
may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value
has been less than cost and near-term prospects of the issuer.
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FASB ASC 320-10 requires the Company to assess if an OTTI exists by considering whether the Company has the intent to sell the security or it is more
likely than not that it will be required to sell the security before recovery. If either of these situations applies, the guidance requires the Company to record an OTTI
charge to earnings on debt securities for the difference between the amortized cost basis of the security and the fair value of the security. If neither of these
situations applies, the Company is required to assess whether it is expected to recover the entire amortized cost basis of the security. If the Company is not
expected to recover the entire amortized cost basis of the security, the guidance requires the Company to bifurcate the identified OTTI into a credit loss component
and a component representing loss related to other factors. A discount rate is applied which equals the effective yield of the security. The difference between the
present value of the expected flows and the amortized book value is considered a credit loss, which would be recorded through earnings as an OTTI charge. When
a market price is not readily available, the market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company
determines from the open market and other sources as appropriate for the security. The difference between the market value and the present value of cash flows
expected to be collected is recognized in accumulated other comprehensive loss on the consolidated statements of financial condition.
As of December 31, 2019, the Company had no cumulative OTTI. There were no OTTI charges recognized in earnings as a result of credit losses on
investments in the years ended December 31, 2019, 2018 and 2017.
State and Political Subdivisions. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates
from the time these securities were purchased. Management considers the investment rating, the state of the issuer of the security and other credit support in
determining whether the security is OTTI. As of December 31, 2019 and 2018, management concluded that an OTTI did not exist on any of the aforementioned
securities based upon its assessment. Management also concluded that it does not intend to sell nor will it be required to sell the securities, before their recovery,
which may be maturity, and management expects to recover the entire amortized cost basis of these securities.
GSE Residential CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates from the
time these securities were purchased. The contractual terms of these securities do not permit the issuer to settle the securities at a price less than its par value basis.
As of December 31, 2019 and 2018, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment.
Management also concluded that it does not intend to sell nor will it be required to sell the securities, before their recovery, which may be maturity, and
management expects to recover the entire amortized cost basis of these securities.
Non-agency CMOs. The unrealized losses presented in the table above have been caused by a widening of spreads and/or a rise in interest rates from the time
the securities were purchased. As of December 31, 2019, management concluded that an OTTI did not exist on any of the aforementioned securities based upon its
assessment. Management also concluded that it does not intend to sell nor will it be required to sell the securities, before their recovery, which may be maturity,
and management expects to recover the entire amortized cost basis of these securities.
Private Label Residential CMOs, Private Label Commercial CMOs and Asset-backed and Other. The unrealized losses presented in the table above have
been caused by a widening of spreads and/or a rise in interest rates from the time the securities were purchased. As of December 31, 2019 and 2018, management
concluded that an OTTI did not exist on any of the aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell
nor will it be required to sell the securities, before their recovery, which may be maturity, and management expects to recover the entire amortized cost basis of
these securities.
The following table summarizes amortized cost and fair value of AFS securities by contractual maturity at December 31, 2019. Expected maturities may
differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a
single maturity date are shown separately.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
CMOs
Asset-backed and other
Available for Sale
Amortized Cost
Fair Value
$
$
230 $
—
26,346
57,031
171,842
235,544
490,993 $
230
—
27,631
60,002
171,870
230,653
490,386
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The following table summarizes proceeds from sales of AFS securities and gross gains and gross losses for the years ended December 31, 2019, 2018 and
2017.
Proceeds from sale of AFS securities
$
199,928 $
156,364 $
162,320
2019
2018
2017
Gross gains
Gross losses
4,974
225
1,681
675
1,477
287
AFS securities with a fair value of $158.7 million and $164.2 million at December 31, 2019 and 2018, respectively, were pledged to secure public funds and
for other purposes as required or permitted by law.
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company’s loan portfolio is grouped into classes to allow management to monitor the performance by the borrower and to monitor the yield on the
portfolio. Consistent with ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Loan Losses, the segments are
further broken down into classes to allow for differing risk characteristics within a segment.
The risks associated with lending activities differ among the various loan classes and are subject to the impact of changes in interest rates, market conditions
of collateral securing the loans, and general economic conditions. All of these factors may adversely impact both the borrower’s ability to repay its loans and
associated collateral.
The Company has various types of commercial real estate loans, which have differing levels of credit risk. Owner occupied commercial real estate loans are
generally dependent upon the successful operation of the borrower’s business, with the cash flows generated from the business being the primary source of
repayment of the loan. If the business suffers a downturn in sales or profitability, the borrower’s ability to repay the loan could be in jeopardy.
Non-owner occupied and multi-family commercial real estate loans and non-owner occupied residential loans present a different credit risk to the Company
than owner occupied commercial real estate loans, as the repayment of the loan is dependent upon the borrower’s ability to generate a sufficient level of occupancy
to produce rental income that exceeds debt service requirements and operating expenses. Lower occupancy or lease rates may result in a reduction in cash flows,
which hinders the ability of the borrower to meet debt service requirements, and may result in lower collateral values. The Company generally recognizes that
greater risk is inherent in these credit relationships as compared to owner occupied loans mentioned above.
Acquisition and development loans consist of 1-4 family residential construction and commercial and land development loans. The risk of loss on these loans
is largely dependent on the Company’s ability to assess the property’s value at the completion of the project, which should exceed the property’s construction
costs. During the construction phase, a number of factors could potentially negatively impact the collateral value, including cost overruns, delays in completing the
project, competition, and real estate market conditions which may change based on the supply of similar properties in the area. In the event the collateral value at
the completion of the project is not sufficient to cover the outstanding loan balance, the Company must rely upon other repayment sources, if any, including the
guarantors of the project or other collateral securing the loan.
Commercial and industrial loans include advances to local and regional businesses for general commercial purposes and include permanent and short-term
working capital, machinery and equipment financing, and may be either in the form of lines of credit or term loans. Although commercial and industrial loans may
be unsecured to our highest-rated borrowers, the majority of these loans are secured by the borrower’s accounts receivable, inventory and machinery and
equipment. In a significant number of these loans, the collateral also includes the business real estate or the business owner’s personal real estate or assets.
Commercial and industrial loans present credit exposure to the Company, as they are more susceptible to risk of loss during a downturn in the economy as
borrowers may have greater difficulty in meeting their debt service requirements and the value of the collateral may decline. The Company attempts to mitigate
this risk through its underwriting standards, including evaluating the creditworthiness of the borrower and, to the extent available, credit ratings of the business.
Additionally, monitoring of the loans through annual renewals and meetings with the borrowers are typical. However, these procedures cannot eliminate the risk of
loss associated with commercial and industrial lending.
Municipal loans consist of extensions of credit to municipalities and school districts within the Company’s market area. These loans generally present a lower
risk than commercial and industrial loans, as they are generally secured by the municipality’s full taxing authority, by revenue obligations, or by its ability to raise
assessments on its clients for a specific utility.
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The Company originates loans to its retail clients, including fixed-rate and adjustable first lien mortgage loans with the underlying 1-4 family owner occupied
residential property securing the loan. The Company’s risk exposure is minimized in these types of loans through the evaluation of the creditworthiness of the
borrower, including credit scores and debt-to-income ratios, and underwriting standards which limit the loan-to-value ratio to generally no more than 80% upon
loan origination, unless the borrower obtains private mortgage insurance.
Home equity loans, including term loans and lines of credit, present a slightly higher risk to the Company than 1-4 family first liens, as these loans can be
first or second liens on 1-4 family owner occupied residential property, but can have loan-to-value ratios of no greater than 90% of the value of the real estate taken
as collateral. The creditworthiness of the borrower is considered including credit scores and debt-to-income ratios.
Installment and other loans’ credit risk are mitigated through prudent underwriting standards, including evaluation of the creditworthiness of the borrower
through credit scores and debt-to-income ratios and, if secured, the collateral value of the assets. These loans can be unsecured or secured by assets the value of
which may depreciate quickly or may fluctuate, and may present a greater risk to the Company than 1-4 family residential loans.
The following table presents the loan portfolio by segment and class, excluding residential LHFS, at December 31, 2019 and 2018.
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Total loans (1)
2019
2018
$
170,884 $
361,050
106,893
120,038
15,865
41,538
214,554
47,057
336,372
14,030
165,314
50,735
129,650
252,794
78,933
100,367
7,385
42,051
160,964
50,982
235,296
12,208
143,616
33,411
$
1,644,330 $
1,247,657
(1) Includes $395.9 million and $135.0 million of acquired loans at December 31, 2019 and 2018, respectively.
In order to monitor ongoing risk associated with its loan portfolio and specific loans within the segments, management uses an internal grading system. The
first several rating categories, representing the lowest risk to the Bank, are combined and given a “Pass” rating. Management generally follows regulatory
definitions in assigning criticized ratings to loans, including "Special Mention," "Substandard," "Doubtful" or "Loss." The Special Mention category includes loans
that have potential weaknesses that may, if not monitored or corrected, weaken the asset or inadequately protect the Bank's position at some future date. These
assets pose elevated risk, but their weakness does not yet justify a more severe, or classified rating. Substandard loans are classified as they have a well-defined
weakness, or weaknesses that jeopardize liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected. Substandard loans include loans that management has determined not to be impaired, as well as loans considered to be impaired. A
Doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as Loss is
deferred. Loss loans are considered uncollectible, as the borrowers are often in bankruptcy, have suspended debt repayments, or have ceased business operations.
Once a loan is classified as Loss, there is little prospect of collecting the loan’s principal or interest and it is charged-off.
The Company has a loan review policy and program which is designed to identify and monitor risk in the lending function. The Management ERM
Committee, comprised of executive officers and loan department personnel, is charged with the oversight of overall credit quality and risk exposure of the
Company's loan portfolio. This includes the monitoring of the lending activities of all Company personnel with respect to underwriting and processing new loans
and the timely follow-up and corrective action for loans showing signs of deterioration in quality. A loan review program provides the Company with an
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independent review of the commercial loan portfolio on an ongoing basis. Generally, consumer and residential mortgage loans are included in the Pass categories
unless a specific action, such as extended delinquencies, bankruptcy, repossession or death of the borrower occurs, which heightens awareness as to a possible
credit event.
Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of $500 thousand, which includes
confirmation of risk rating by an independent credit officer. In addition, all commercial relationships greater than $500 thousand rated Substandard, Doubtful or
Loss are reviewed quarterly and corresponding risk ratings are reaffirmed by the Company's Problem Loan Committee, with subsequent reporting to the
Management ERM Committee and the Board of Directors.
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The following summarizes the Company’s loan portfolio ratings based on its internal risk rating system at December 31, 2019 and 2018:
Pass
Special
Mention
Non-Impaired
Substandard
Impaired -
Substandard
Doubtful
PCI Loans
Total
December 31, 2019
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
December 31, 2018
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
$
151,161 $
4,513 $
3,163 $
5,872 $
— $
6,175 $
170,884
342,753
100,361
111,697
15,865
39,939
198,951
42,649
323,040
13,774
164,469
50,497
17,152
4,822
4,534
—
206
1,133
4,408
978
74
74
—
—
682
1,115
—
1,393
8,899
—
—
149
38
—
—
345
235
—
—
1,763
—
2,590
13
733
85
—
—
—
—
—
—
—
—
—
—
—
1,145
683
2,457
—
—
3,808
—
9,764
20
—
153
361,050
106,893
120,038
15,865
41,538
214,554
47,057
336,372
14,030
165,314
50,735
$
1,555,156 $
37,894 $
15,439 $
11,636 $
— $
24,205 $
1,644,330
$
121,903 $
3,024 $
987 $
1,880 $
— $
1,856 $
129,650
242,136
71,482
97,590
7,385
41,251
150,286
50,982
229,971
12,170
142,638
33,229
10,008
5,886
736
—
25
2,278
—
—
—
165
15
—
717
1,197
—
583
2,940
—
—
—
15
1
—
131
309
—
—
286
—
2,877
16
798
—
—
—
—
—
—
—
—
—
—
—
—
650
717
535
—
192
5,174
—
2,448
22
—
166
252,794
78,933
100,367
7,385
42,051
160,964
50,982
235,296
12,208
143,616
33,411
$
1,201,023 $
22,137 $
6,440 $
6,297 $
— $
11,760 $
1,247,657
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For commercial real estate, acquisition and development, and commercial and industrial loans, a loan is considered impaired when, based on current
information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally
are not classified as impaired. Generally, loans that are more than 90 days past due are deemed impaired. Management determines the significance of payment
delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed to
determine if the loan should be placed on nonaccrual status. Nonaccrual loans in the commercial and commercial real estate portfolios and any TDRs are, by
definition, deemed to be impaired. Impairment is measured on a loan-by-loan basis for commercial, construction and restructured loans by either the present value
of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is
collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For loans that are
deemed to be impaired for extended periods of time, periodic updates on fair values are obtained, which may include updated appraisals. Updated fair values are
incorporated into the impairment analysis in the next reporting period.
Loan charge-offs, which may include partial charge-offs, are taken on an impaired loan that is collateral dependent if the loan’s carrying balance exceeds its
collateral’s appraised value, the loan has been identified as uncollectible, and it is deemed to be a confirmed loss. Typically, impaired loans with a charge-off or
partial charge-off will continue to be considered impaired, unless the note is split into two and management expects the performing note to continue to perform and
the loan is adequately secured. The second, or non-performing note, would be charged-off. Generally, an impaired loan with a partial charge-off may continue to
have an impairment reserve on it after the partial charge-off, if factors warrant.
At December 31, 2019 and 2018, nearly all of the Company’s loan impairments were measured based on the estimated fair value of the collateral securing the
loan, except for TDRs. By definition, TDRs are considered impaired. All TDR impairment analyses are initially based on discounted cash flows for those loans.
For real estate loans, collateral generally consists of commercial real estate, but in the case of commercial and industrial loans, it could also consist of accounts
receivable, inventory, equipment or other business assets. Commercial and industrial loans may also have real estate collateral.
Updated appraisals are generally required every 18 months for classified commercial loans in excess of $250 thousand. The “as is" value provided in the
appraisal is often used as the fair value of the collateral in determining impairment, unless circumstances, such as subsequent improvements or approvals, dictate
that another value provided by the appraiser is more appropriate.
Generally, impaired commercial loans secured by real estate, other than new and performing TDRs, are measured at fair value using certified real estate
appraisals that had been completed within the last 18 months. Appraised values are discounted for estimated costs to sell the property and other selling
considerations to arrive at the property’s fair value. In those situations in which it is determined an updated appraisal is not required for loans individually
evaluated for impairment, fair values are based on either an existing appraisal or a discounted cash flow analysis as determined by management. The approaches
are discussed below:
•
•
Existing appraisal – if the existing appraisal provides a strong loan-to-value ratio (generally 70% or lower) and, after consideration of market conditions
and knowledge of the property and area, it is determined by the Credit Administration staff that there has not been a significant deterioration in the
collateral value, the existing certified appraised value may be used. Discounts to the appraised value, as deemed appropriate for selling costs, are
factored into the fair value.
Discounted cash flows – in limited cases, discounted cash flows may be used on projects in which the collateral is liquidated to reduce the borrowings
outstanding, and is used to validate collateral values derived from other approaches.
Collateral on certain impaired loans is not limited to real estate, and may consist of accounts receivable, inventory, equipment or other business assets.
Estimated fair values may be determined based on borrowers’ financial statements, inventory ledgers, accounts receivable agings or appraisals from individuals
with knowledge in the business. Stated balances are generally discounted for the age of the financial information or the quality of the assets. In determining fair
value, liquidation discounts are applied to this collateral based on existing loan valuation policies.
The Company distinguishes substandard loans on both an impaired and non-impaired basis, as it places less emphasis on a loan’s classification, and increased
reliance on whether the loan was performing in accordance with the contractual terms. A substandard classification does not automatically meet the definition of
impaired. Loss potential, while existing in the aggregate
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amount of substandard loans, does not have to exist in individual extensions of credit classified as substandard. As a result, the Company’s methodology includes
an evaluation of certain accruing commercial real estate, acquisition and development, and commercial and industrial loans rated substandard to be collectively
evaluated for impairment. Although the Company believes these loans meet the definition of substandard, they are generally performing and management has
concluded that it is likely the Company will be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the
loan agreement.
Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Generally, the Company does not separately identify
individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of
the borrower.
The following table, which excludes PCI loans, summarizes impaired loans by segment and class, segregated by those for which a specific allowance was
required and those for which a specific allowance was not required at December 31, 2019 and 2018. The recorded investment in loans excludes accrued interest
receivable due to insignificance. Related allowances established generally pertain to those loans in which loan forbearance agreements were in the process of being
negotiated or updated appraisals were pending and any partial charge-off will be recorded when final information is received.
December 31, 2019
Commercial real estate:
Owner-occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity—term
Home equity—lines of credit
Installment and other loans
December 31, 2018
Commercial real estate:
Owner-occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity—term
Home equity—lines of credit
Impaired Loans with a Specific Allowance
Impaired Loans with No Specific Allowance
Recorded
Investment
(Book Balance)
Unpaid
Principal Balance
(Legal Balance)
Related
Allowance
Recorded
Investment
(Book Balance)
Unpaid
Principal Balance
(Legal Balance)
$
—
$
—
—
—
425
—
—
—
—
—
—
—
425
—
—
—
$
— $
5,872
$
—
—
—
36
—
—
—
345
235
1,763
2,165
13
733
85
$
$
425
$
425
$
36 $
11,211
$
—
$
—
—
—
743
—
—
—
—
—
—
743
—
—
$
— $
1,880
$
—
—
—
38
—
—
131
309
286
2,134
16
798
$
743
$
743
$
38 $
5,554
$
8,086
569
422
3,361
3,164
15
1,077
97
16,791
2,576
336
632
457
2,727
23
1,081
7,832
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The following table, which excludes PCI loans, summarizes the average recorded investment in impaired loans and related recognized interest income for the
years ended December 31, 2019, 2018 and 2017.
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
2019
2018
2017
Average
Impaired
Balance
Interest
Income
Recognized
Average
Impaired
Balance
Interest
Income
Recognized
Average
Impaired
Balance
Interest
Income
Recognized
$
2,455 $
2
$
1,495 $
2
$
1,000 $
46
152
217
—
21
683
2,582
13
750
13
—
—
—
—
—
—
50
—
2
—
1,842
148
346
181
1
322
3,234
19
657
4
—
—
—
—
—
—
59
—
2
—
392
182
418
154
—
413
4,012
61
488
10
$
6,932 $
54
$
8,249 $
63
$
7,130 $
6
—
—
—
—
—
—
58
—
2
—
66
The following table presents impaired loans that are TDRs, with the recorded investment at December 31, 2019 and 2018.
Accruing:
Commercial real estate:
Owner-occupied
Residential mortgage:
First lien
Home equity - lines of credit
Nonaccruing:
Commercial real estate:
Owner-occupied
Residential mortgage:
First lien
2019
2018
Number of
Contracts
Recorded
Investment
Number of
Contracts
Recorded
Investment
1
$
9
1
11
4
5
9
20
$
30
931
18
979
1,909
359
2,268
3,247
1
$
39
11
1
13
1
8
9
22
$
1,069
24
1,132
37
658
695
1,827
There were three new commercial real estate owner occupied TDRs totaling $1.9 million for the year ended December 31, 2019, no restructured loans for the
year ended December 31, 2018, and two commercial real estate owner occupied TDRs totaling $119 thousand for the year ended December 31, 2017 that were
modified as TDRs within the previous 12 months which were in payment default. No additional commitments have been made to borrowers whose loans are
considered TDRs.
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The following table presents the number of loans modified, and their pre-modification and post-modification investment balances for the years ended
December 31, 2019, and 2017. There were no loans modified during 2018.
December 31, 2019
Commercial real estate:
Owner-occupied
December 31, 2017
Commercial real estate:
Owner-occupied
Number of
Contracts
Pre-
Modification
Investment
Balance
Post-
Modification
Investment
Balance
3
$
1,866 $
1,881
2
$
119 $
119
The loans presented in the table above were considered TDRs as a result of the Company agreeing to below market interest rates given the risk of the
transaction; allowing the loan to remain on interest only status; or a reduction in interest rates, in order to give the borrowers an opportunity to improve their cash
flows. For new and accruing TDRs, impairment is generally assessed using a discounted cash flow analysis. For TDRs in default of their modified terms,
impairment is generally determined on a collateral dependent approach. Certain loans modified during a period may no longer be outstanding at the end of the
period if the loan was paid off.
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Management further monitors the performance and credit quality of the loan portfolio by analyzing the length of time a portfolio is past due, by aggregating
loans based on their delinquencies. The following table presents the classes of the loan portfolio summarized by aging categories of performing loans and
nonaccrual loans at December 31, 2019 and 2018.
December 31, 2019
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
Current
30-59
60-89
90+
(still accruing)
Total
Past Due
Non-
Accrual
Total
Loans
Days Past Due
$
158,723 $
144 $
— $
— $
144 $
5,842 $
164,709
359,425
105,865
116,370
15,587
40,403
208,668
47,057
314,473
13,993
163,907
50,224
480
—
841
278
1,135
315
—
—
—
66
—
—
—
—
—
—
69
—
—
—
—
480
—
976
278
1,135
315
—
—
345
235
—
—
1,763
—
9,092
1,234
150
10,476
1,659
—
417
236
4
275
37
—
—
—
4
692
273
13
715
85
359,905
106,210
117,581
15,865
41,538
210,746
47,057
326,608
14,010
165,314
50,582
Subtotal
1,594,695
12,938
1,616
219
14,773
10,657
1,620,125
Loans acquired with credit deterioration:
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Installment and other loans
6,015
564
683
1,710
3,792
6,308
16
131
—
—
—
105
—
1,857
4
22
Subtotal
19,219
1,988
129
—
—
111
—
745
—
—
985
31
581
—
531
16
854
—
—
160
581
—
747
16
3,456
4
22
2,013
4,986
—
—
—
—
—
—
—
—
—
6,175
1,145
683
2,457
3,808
9,764
20
153
24,205
$ 1,613,914 $
14,926 $
2,601 $
2,232 $
19,759 $
10,657 $
1,644,330
89
Current
30-59
60-89
90+
(still accruing)
Total
Past Due
Non-
Accrual
Total
Loans
Days Past Due
$
125,887 $
66 $
— $
—
$
66 $
1,841 $
127,794
Table of Contents
December 31, 2018
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
1-4 family residential construction
Commercial and land development
Commercial and industrial
Municipal
Residential mortgage:
First lien
Home equity – term
Home equity – lines of credit
Installment and other loans
252,144
78,085
99,268
7,385
41,822
154,988
50,982
228,714
11,487
142,394
33,135
—
—
226
—
37
411
—
1,592
678
420
66
Subtotal
1,226,291
3,496
Loans acquired with credit deterioration:
Commercial real estate:
Owner-occupied
Non-owner occupied
Multi-family
Non-owner occupied residential
Acquisition and development:
Commercial and land development
Commercial and industrial
Residential mortgage:
First lien
Home equity – term
Installment and other loans
Subtotal
1,784
650
717
535
192
4,943
1,971
17
149
10,958
—
—
—
—
—
231
382
5
13
631
—
—
29
—
—
105
—
734
5
28
44
945
72
—
—
—
—
—
42
—
—
114
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
53
—
4
57
—
—
255
—
37
516
—
—
131
309
—
—
286
—
2,326
1,808
683
448
110
16
774
—
252,144
78,216
99,832
7,385
41,859
155,790
50,982
232,848
12,186
143,616
33,245
4,441
5,165
1,235,897
72
—
—
—
—
231
477
5
17
802
—
—
—
—
—
—
—
—
—
—
1,856
650
717
535
192
5,174
2,448
22
166
11,760
$ 1,237,249 $
4,127 $
1,059 $
57
$
5,243 $
5,165 $ 1,247,657
The Company maintains its ALL at a level management believes adequate for probable incurred credit losses. The ALL is established and maintained
through a provision for loan losses charged to earnings. On a quarterly basis, management assesses the adequacy of the ALL utilizing a defined methodology
which considers specific credit evaluation of impaired loans as discussed above, historical loan loss experience, and qualitative factors. Management believes its
approach properly addresses relevant accounting guidance for loans individually identified as impaired and for loans collectively evaluated for impairment, and
other bank regulatory guidance.
In connection with its quarterly evaluation of the adequacy of the ALL, management reviews its methodology to determine if it properly addresses the current
risk in the loan portfolio. For each loan class, general allowances based on
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Table of Contents
quantitative factors, principally historical loss trends, are provided for loans that are collectively evaluated for impairment. An adjustment to historical loss factors
may be incorporated for delinquency and other potential risk not elsewhere defined within the ALL methodology.
In addition to this quantitative analysis, adjustments to the ALL requirements are allocated on loans collectively evaluated for impairment based on additional
qualitative factors, including:
Nature and Volume of Loans – including loan growth in the current and subsequent quarters based on the Company’s targeted growth and strategic plan,
coupled with the types of loans booked based on risk management and credit culture; the number of exceptions to loan policy; and supervisory loan to value
exceptions.
Concentrations of Credit and Changes within Credit Concentrations – including the composition of the Company’s overall portfolio makeup and
management's evaluation related to concentration risk management and the inherent risk associated with the concentrations identified.
Underwriting Standards and Recovery Practices – including changes to underwriting standards and perceived impact on anticipated losses; trends in the
number of exceptions to loan policy; supervisory loan to value exceptions; and effectiveness of administration of loan recovery practices.
Delinquency Trends – including delinquency percentages noted in the portfolio relative to economic conditions; severity of the delinquencies; and whether
the ratios are trending upwards or downwards.
Classified Loans Trends – including internal loan ratings of the portfolio; severity of the ratings; whether the loan segment’s ratings show a more favorable or
less favorable trend; and underlying market conditions and impact on the collateral values securing the loans.
Experience, Ability and Depth of Management/Lending staff – including the years of experience of senior and middle management and the lending staff;
turnover of the staff; and instances of repeated criticisms of ratings.
Quality of Loan Review – including the years of experience of the loan review staff; in-house versus outsourced provider of review; turnover of staff; and the
perceived quality of their work in relation to other external information.
National and Local Economic Conditions – including trends in the consumer price index, unemployment rates, the housing price index, housing statistics
compared to the prior year, bankruptcy rates, regulatory and legal environment risks and competition.
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Table of Contents
The following table presents activity in the ALL for the years ended December 31, 2019, 2018 and 2017.
Commercial
Real Estate
Acquisition
and
Development
Commercial
Commercial
and
Industrial
Municipal
Total
Residential
Mortgage
Installment
and Other
Total
Unallocated
Total
Consumer
December 31, 2019
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2018
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
Balance, end of year
December 31, 2017
Balance, beginning of year
Provision for loan losses
Charge-offs
Recoveries
$
$
$
$
$
6,876 $
515
(25)
268
7,634 $
6,763 $
(442)
(17)
572
6,876 $
7,530 $
38
(835)
30
817 $
139
—
3
1,656 $
841
(299)
158
98 $
2
—
—
9,447 $
1,497
(324)
429
3,753 $
(347)
(386)
127
244 $
180
(155)
50
3,997 $
(167)
(541)
177
570 $
(430)
—
—
14,014
900
(865)
606
959 $
2,356 $
100 $
11,049 $
3,147 $
319 $
3,466 $
140 $
14,655
417 $
396
(7)
11
1,446 $
209
—
1
817 $
1,656 $
580 $
(167)
—
4
1,074 $
333
(85)
124
8,710 $
177
(24)
584
3,400 $
363
(148)
138
211 $
165
(292)
160
3,611 $
528
(440)
298
475 $
95
—
—
12,796
800
(464)
882
9,447 $
3,753 $
244 $
3,997 $
570 $
14,014
9,238 $
234
(920)
158
2,979 $
531
(180)
70
144 $
174
(166)
59
3,123 $
705
(346)
129
414 $
61
—
—
12,775
1,000
(1,266)
287
8,710 $
3,400 $
211 $
3,611 $
475 $
12,796
84 $
14
—
—
98 $
54 $
30
—
—
84 $
92
Balance, end of year
$
6,763 $
417 $
1,446 $
Table of Contents
The following table summarizes the ending loan balances individually evaluated for impairment based upon loan segment, as well as the related ALL loss
allocation for each at December 31, 2019 and 2018. PCI loans are excluded from loans individually evaluated for impairment.
Commercial
Real Estate
Acquisition
and
Development
Commercial
Commercial
and
Industrial
Municipal
Total
Residential
Mortgage
Installment
and Other
Total
Unallocated
Total
Consumer
December 31, 2019
Loans allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Allowance for loan losses
allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
December 31, 2018
Loans allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Allowance for loan losses
allocated by:
Individually evaluated for
impairment
Collectively evaluated for
impairment
$
6,452 $
— $
1,763 $
— $
8,215 $
3,336 $
85 $
3,421 $
— $
11,636
752,413
57,403
212,791
47,057
1,069,664
512,380
50,650
563,030
—
1,632,694
$
758,865 $
57,403 $
214,554 $
47,057 $ 1,077,879 $
515,716 $
50,735 $ 566,451 $
— $ 1,644,330
$
$
— $
— $
— $
— $
— $
36 $
— $
36 $
— $
36
7,634
959
2,356
100
11,049
3,111
319
3,430
140
14,619
7,634 $
959 $
2,356 $
100 $
11,049 $
3,147 $
319 $
3,466 $
140 $
14,655
$
2,320 $
— $
286 $
— $
2,606 $
3,691 $
— $
3,691 $
— $
6,297
559,424
49,436
160,678
50,982
820,520
387,429
33,411
420,840
—
1,241,360
$
561,744 $
49,436 $
160,964 $
50,982 $
823,126 $
391,120 $
33,411 $ 424,531 $
— $ 1,247,657
$
$
— $
— $
— $
— $
— $
38 $
— $
38 $
— $
38
6,876
817
1,656
98
9,447
3,715
244
3,959
570
13,976
6,876 $
817 $
1,656 $
98 $
9,447 $
3,753 $
244 $
3,997 $
570 $
14,014
The following table provides activity for the accretable yield of purchased impaired loans for the years ended December 31, 2019 and 2018.
Accretable yield, beginning of period
New loans purchased
Accretion of income
Reclassifications from nonaccretable difference due to improvement in expected cash flows
Other changes, net
Accretable yield, end of period
2019
2018
$
$
2,065 $
3,497
(2,336)
2,444
1,280
6,950 $
—
2,243
(178)
—
—
2,065
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Table of Contents
NOTE 5. PREMISES AND EQUIPMENT
The following table summarizes premises and equipment at December 31, 2019 and 2018.
Land
Buildings and improvements
Leasehold improvements
Furniture and equipment
Construction in progress
Less accumulated depreciation
2019
2018
$
8,786 $
27,520
6,216
22,293
593
65,408
27,884
$
37,524 $
7,825
31,987
3,926
22,998
1,946
68,682
30,481
38,201
Depreciation expense totaled $2.7 million, $2.6 million, and $2.7 million for the years ended December 31, 2019, 2018 and 2017, respectively.
NOTE 6. LEASES
A lease provides the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The Company has primarily
entered into operating leases for branches and office space. Most of the Company's leases contain renewal options, which the Company is reasonably certain to
exercise. Including renewal options, the Company's leases range from three to 50 years. Operating lease right-of-use assets and lease liabilities are included in
other assets and accrued interest and other liabilities on the Company's consolidated balance sheets.
The Company uses its incremental borrowing rate to determine the present value of the lease payments, as the rate implicit in the Company's leases is not
readily determinable. Lease agreements that contain non-lease components are generally accounted for as a single lease component, while variable costs, such as
common area maintenance expenses and property taxes, are expensed as incurred.
The following table summarizes the Company's right-of-use assets and related lease liabilities for the year ended December 31, 2019.
Cash paid for operating lease liabilities
Operating lease right-of-use assets (1)
Weighted-average remaining lease term (in years)
Weighted-average discount rate
$
$
1,122
10,485
17.6
4.5 %
(1) Includes $8.0 million for operating leases existing on January 1, 2019, $144 thousand for operating leases that commenced in the first quarter of 2019,
$2.8 million for operating leases that were acquired in the second quarter of 2019, and the removal of $423 thousand of operating leases due to branch
consolidations recorded in the fourth quarter of 2019.
The following table presents maturities of the Company's lease liabilities by year.
2020
2021
2022
2023
2024
Thereafter
Less: imputed interest
Total lease liabilities
$
$
1,279
1,147
727
748
738
10,549
15,188
5,500
9,688
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Table of Contents
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents changes in goodwill for the years ended December 31, 2019 and 2018.
Balance, beginning of year
Acquired goodwill
Adjustments to acquired goodwill
Balance, end of year
2019
2018
$
$
12,592 $
7,029
304
19,925 $
The following table presents changes in other intangible assets for the years ended December 31, 2019 and 2018.
Balance, beginning of year
Acquired CDI
Non-compete agreement
Amortization expense
Balance, end of year
2019
2018
$
$
3,910 $
4,550
290
(1,570)
7,180 $
719
11,873
—
12,592
356
3,840
—
(286)
3,910
The following table presents the components of other identifiable intangible assets at December 31, 2019 and 2018.
2019
2018
Gross Carrying Amount
Accumulated
Amortization
Gross Carrying Amount
Accumulated Amortization
Amortized intangible assets:
Core deposit intangibles
Other client relationship intangibles
Non-compete agreement
Total
$
$
8,390 $
1,493 $
3,840 $
524
290
338
193
931
—
9,204 $
2,024 $
4,771 $
During 2019, other client relationship intangibles with a gross carrying amount of $406 thousand were fully amortized.
The following table presents future estimated aggregate amortization expense at December 31, 2019.
2020
2021
2022
2023
2024
Thereafter
$
$
190
671
—
861
1,591
1,313
1,137
960
784
1,395
7,180
The Company incurred amortization expense of $1.6 million, $286 thousand and $102 thousand, respectively, in the years ending December 31, 2019, 2018
and 2017.
NOTE 8. INCOME TAXES
The Company files income tax returns in the U.S. federal jurisdiction, the Commonwealth of Pennsylvania and the State of Maryland. The Company is no
longer subject to tax examination by tax authorities for years before 2016.
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The following table summarizes income tax expense for the years ended December 31, 2019, 2018 and 2017.
Current expense
Deferred expense
Expense due to enactment of federal tax reform legislation
Income tax expense
2019
2018
2017
$
$
934 $
1,097 $
1,776
—
543
—
2,710 $
1,640 $
1,260
443
2,635
4,338
The following table reconciles the Company's effective income tax rate to its statutory federal rate for the years ended December 31, 2019, 2018 and 2017.
Statutory federal tax rate
Increase (decrease) resulting from:
Tax exempt interest income
Income from life insurance
Disallowed interest expense
Low-income housing credits and related expense
Merger related
Expense due to enactment of federal tax reform legislation
Other
Effective income tax rate
2019
2018
2017
21.0 %
21.0 %
34.0 %
(4.2)%
(1.7)%
0.3 %
(1.3)%
0.7 %
— %
(1.0)%
13.8 %
(7.7)%
(1.7)%
0.8 %
(2.5)%
0.6 %
— %
0.9 %
11.4 %
(13.0)%
(2.4)%
1.0 %
(4.6)%
— %
21.2 %
(1.3)%
34.9 %
Income tax expense includes $997 thousand, $211 thousand and $405 thousand related to net security gains for the years ended December 31, 2019, 2018,
and 2017.
On December 22, 2017, federal tax reform legislation, commonly referred to as the Tax Cuts and Jobs Act of 2017 (the "Tax Act"), was enacted. Among
other things, the Tax Act reduced the Company's statutory federal tax rate from 34% to 21% effective January 1, 2018. As a result, the Company was required to
remeasure, through income tax expense, certain deferred tax assets and liabilities using the enacted rate at which the Company expects them to be recovered or
settled. The remeasurement of the Company's net deferred tax asset resulted in additional federal deferred tax expense of $2.6 million, which is included in income
tax expense for 2017. Also, on December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118"), which provided guidance on accounting
for the tax effects of the Tax Act. SAB 118 provided for a measurement period that should not extend beyond one year from the Tax Act's enactment date for
companies to complete the accounting under ASC 740, Income Taxes. In remeasuring the Company's net deferred tax asset, the Company estimated the income in
2017 for its limited partnership investments in affordable housing real estate partnerships and interest income on nonperforming loans. Adjustment between the
Company's estimates and the actual amounts determined during the measurement period did not have a material impact to the Company's consolidated financial
statements.
The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the results of
operations. There were no penalties or interest related to income taxes recorded in the consolidated income statements for the years ended December 31, 2019,
2018 and 2017 and no amounts accrued for penalties at December 31, 2019 and 2018.
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The following table summarizes the Company's deferred tax assets and liabilities at December 31, 2019, 2018 and 2017.
2019
2018
Deferred tax assets:
Allowance for loan losses
Deferred compensation
Retirement and salary continuation plans
Share-based compensation
Off-balance sheet reserves
Nonaccrual loan interest
Net unrealized losses on securities available for sale
Purchase accounting adjustments
Bonus accrual
Low-income housing credit carryforward
Net operating loss carryforward
Other
Total deferred tax assets
Deferred tax liabilities:
Depreciation
Mortgage servicing rights
Purchase accounting adjustments
Other
Total deferred tax liabilities
$
3,418 $
415
2,357
631
234
697
127
4,081
493
—
1,872
672
14,997
452
694
1,599
275
3,020
Net deferred tax asset, included in other assets
$
11,977 $
3,143
723
1,416
742
219
537
791
1,795
470
641
—
321
10,798
458
590
1,021
150
2,219
8,579
At December 31, 2019, the Company had acquired federal and state net operating loss carryforwards of $11.1 million and $6.7 million, respectively, subject
to annual loss limitation limits, that expire through 2037. A deferred tax asset is recognized for these carryforwards because the benefit is more likely than not to be
realized.
FASB ASC 740, Income Taxes, (“ASC 740”) clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position
must meet before a financial statement benefit is recognized. The minimum threshold is defined in ASC 740 as a tax position that is more likely than not to be
sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of
the position. The tax benefit to be recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement. ASC 740 was applied to all existing tax positions upon initial adoption. There was no liability for uncertain tax positions and no known unrecognized
tax benefits at December 31, 2019 or 2018.
NOTE 9. RETIREMENT PLANS
The Company maintains a 401(k) profit-sharing plan for all qualified employees. Employees are eligible to participate in the 401(k) profit-sharing plan
following completion of one month of service and attaining age 18. Pursuant to the 401(k) profit-sharing plan, employees can contribute up to the lesser of $53
thousand or 100% of their compensation. Substantially all of the Company’s employees are covered by the plan, which contains limited match or safe harbor
provisions. The Company will match 50% of the first 6% of the base contribution that an employee contributes. The Company’s match is immediately vested and
paid at the end of the year. Employer contributions to the plan are based on the performance of the Company and are at the discretion of the Board of Directors.
Employer contribution expense totaled $590 thousand, $479 thousand and $432 thousand for the years ended December 31, 2019, 2018, and 2017, respectively.
The Company has deferred compensation agreements with certain present and former directors, whereby a director or his beneficiaries will receive a monthly
retirement benefit beginning at age 65. The arrangement is funded by an amount of life insurance on the participating director, which is calculated to meet the
Company’s obligations under the compensation agreement. The cash value of the life insurance policies is an unrestricted asset of the Company. The estimated
present value of future benefits to be paid totaled $68 thousand and $82 thousand at December 31, 2019 and 2018, respectively. Expense for this plan totaled $8
thousand, $9 thousand and $11 thousand for the years ended December 31, 2019, 2018, and 2017, respectively.
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The Company also has supplemental discretionary deferred compensation plans for directors and executive officers. The plans are funded annually with
director fees and salary reductions which are either placed in a trust account invested by the Bank’s OFA division or recognized as a liability. The trust account
balance totaled $1.8 million and $1.7 million at December 31, 2019 and 2018, respectively, and is directly offset in other liabilities. Expense for these plans totaled
$61 thousand, $61 thousand and $10 thousand, for the years ended December 31, 2019, 2018, and 2017, respectively.
In addition, the Company has two 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 Company. The estimated present
value of future benefits to be paid on these plans totaled $10.6 million and $8.5 million at December 31, 2019 and 2018, respectively. Expense for these plans
totaled $1.0 million, $872 thousand and $739 thousand, for the years ended December 31, 2019, 2018, and 2017, respectively.
The Company has promised a continuation of life insurance coverage to certain persons post-retirement. The estimated present value of future benefits to be
paid totaled $1.5 million and $1.5 million at December 31, 2019 and 2018, respectively. Expense for this plan totaled $22 thousand, $126 thousand and $77
thousand for the years ended December 31, 2019, 2018, and 2017, respectively.
Trust account balances, and estimated present values of future benefits and deferred compensation liabilities, noted above are included in other assets and
other liabilities, respectively, on the consolidated balance sheets.
NOTE 10. SHARE-BASED COMPENSATION PLANS
The Company maintains share-based compensation plans under the shareholder-approved 2011 Plan. The purpose of the share-based compensation plans is
to provide officers, employees, and non-employee members of the Board of Directors of the Company with additional incentive to further the success of the
Company. At December 31, 2019, 881,920 shares of the common stock of the Company were reserved to be issued and 455,028 shares were available to be issued.
The 2011 Plan incentive awards may consist of grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock,
deferred stock units and performance shares. All employees and members of the Board of Directors of the Company and its subsidiaries, are eligible to participate
in the 2011 Plan. The 2011 Plan allows for the Compensation Committee of the Board of Directors to determine the type of incentive to be awarded, its term,
manner of exercise, vesting and restrictions on shares. Generally, awards are nonqualified under the IRC, unless the awards are deemed to be incentive awards to
employees at the Compensation Committee’s discretion.
The following table presents a summary of nonvested restricted shares activity for 2019.
Nonvested shares, beginning of year
Granted
Forfeited
Vested
Nonvested shares, end of year
Shares
Weighted Average
Grant Date
Fair Value
275,412 $
114,893
(36,069)
(125,478)
228,758 $
20.33
20.24
19.42
17.65
21.90
The following table presents restricted shares compensation expense, with tax benefit information, and fair value of shares vested at December 31, 2019,
2018 and 2017.
Restricted share award expense
Restricted share award tax benefit
Fair value of shares vested
2019
2018
2017
$
1,578 $
451
2,744
1,479 $
374
1,074
1,369
465
303
At December 31, 2019 and 2018, unrecognized compensation expense related to the share awards totaled $2.2 million and $2.1 million, respectively. The
unrecognized compensation expense at December 31, 2019 is expected to be recognized over a weighted-average period of 1.9 years.
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The following table presents a summary of outstanding stock options activity for 2019.
Outstanding, beginning of year
Expired
Options outstanding and exercisable, end of year
Shares
Weighted Average
Exercise Price
40,984 $
(10,425)
30,559 $
24.34
32.47
21.56
The exercise price of each option equals the market price of the Company’s stock on the grant date. An option’s maximum term is ten years. All options are
fully vested upon issuance. The following table presents information pertaining to options outstanding and exercisable at December 31, 2019.
Range of
Exercise Prices
$21.14 - $25.76
Number
Outstanding and Exercisable
Weighted Average
Remaining Contractual
Life (Years)
Weighted
Average
Exercise Price
30,559
0.53 $
21.56
Outstanding and exercisable options had an intrinsic value of $41 thousand at December 31, 2019 and $0 at December 31, 2018.
The Company maintains an employee stock purchase plan to provide employees of the Company an opportunity to purchase Company common stock.
Eligible employees may purchase shares in an amount that does not exceed 10% of their annual salary at the lower of 95% of the fair market value of the shares on
the semi-annual offering date, or related purchase date. The Company reserved 350,000 shares of its common stock to be issued under the employee stock purchase
plan. At December 31, 2019, 168,066 shares were available to be issued.
The following table presents information for the employee stock purchase plan for years ended December 31, 2019, 2018 and 2017.
2019
2018
2017
Shares purchased
Weighted average price of shares purchased
$
Compensation expense recognized
Tax benefits
5,399
20.69 $
8
2
5,907
23.04 $
14
3
6,632
20.57
17
6
The Company issues new shares or treasury shares, depending on market conditions, in its share-based compensation plans.
NOTE 11. DEPOSITS
The following table summarizes deposits by type at December 31, 2019 and 2018.
Noninterest-bearing
NOW and money market
Savings
Time ($250,000 or less)
Time (over $250,000)
Total
2019
2018
$
249,450 $
963,672
142,832
450,490
69,078
204,843
856,520
113,515
343,551
40,327
$
1,875,522 $
1,558,756
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The following table summarizes scheduled future maturities as of December 31, 2019.
2020
2021
2022
2023
2024
Thereafter
$
375,795
85,047
31,533
19,131
5,244
2,818
$
519,568
Brokered time deposits totaled $16.1 million and $126.6 million at December 31, 2019 and 2018, respectively. Management evaluates brokered deposits as a
funding option, taking into consideration regulatory views on such deposits as non-core funding sources. Time deposits that meet or exceed the FDIC limit of
$250,000 at December 31, 2019 and 2018 totaled $69.1 million and $40.3 million, respectively.
NOTE 12. RELATED PARTY TRANSACTIONS
Directors and executive officers of the Company, including their immediate families and companies in which they have a direct or indirect material interest,
are considered to be related parties. In the ordinary course of business, the Company engages in various related party transactions, including extending credit and
bank service transactions. The Company relies on the directors and executive officers for the identification of their associates.
Federal banking regulations require that any extensions of credit to insiders and their related interests not be offered on terms more favorable than would be
offered to non-related borrowers of similar creditworthiness. The following table presents the aggregate activity in loans to related parties during 2019.
Balance, beginning of year
New loans
Repayments
Balance, end of year
$
$
1,041
1,929
(1,652)
1,318
None of these loans are past due, on nonaccrual status or have been restructured to provide a reduction or deferral of interest or principal because of
deterioration in the financial position of the borrower. There were no loans to a related party that were considered classified loans at December 31, 2019 or 2018.
The Company accepts deposits from related parties, which totaled $5.2 million and $3.5 million at December 31, 2019 and 2018, respectively, on the same
terms, including interest rates, as those prevailing at the time for comparable transactions with non-related parties.
NOTE 13. SHORT-TERM BORROWINGS
The Company has short-term borrowing capability from the FHLB, federal funds purchased and the FRB discount window. The following table summarizes
these short-term borrowings at and for the years ended December 31, 2019, 2018 and 2017.
Balance at year-end
Weighted average interest rate at year-end
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
2019
146,600
2018
2017
$
55,000
$
50,000
1.87 %
2.76 %
1.21 %
23,171
$
71,457
$
54,610
2.20 %
2.09 %
1.08 %
146,600
$
103,000
$
72,000
$
$
$
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The Company also enters into borrowing arrangements with certain of its deposit clients by agreements to repurchase ("repurchase agreements") under which
the Company pledges investment securities owned and under its control as collateral against the borrowing arrangement, which generally matures within one day
from the transaction date. The Company is required to hold U.S. Treasury, U.S. Agency or U.S. GSE securities as underlying securities for repurchase agreements.
The following table provides additional details for repurchase agreements at and for the years ended December 31, 2019, 2018 and 2017.
Balance at year-end
Weighted average interest rate at year-end
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Fair value of securities underlying the agreements at year-end
$
$
$
2019
2018
2017
8,269
$
9,069
$
43,576
1.31 %
1.22 %
0.56 %
8,830
$
9,715
$
43,205
1.28 %
0.82 %
12,774
$
14,591
$
13,062
17,942
0.45 %
55,270
53,485
NOTE 14. LONG-TERM DEBT
The following table presents components of the Company’s long-term debt at December 31, 2019, and 2018.
Amount
Weighted Average rate
2019
2018
2019
2018
FHLB fixed rate advances maturing:
2020
2022
FHLB amortizing advance requiring monthly principal and interest
payments, maturing:
2025
Total FHLB Advances
$
40,350 $
40,350
20,000
60,350
2,717
$
63,067 $
—
40,350
3,100
43,450
1.76 %
3.06 %
2.19 %
4.74 %
2.30 %
Except for amortizing advances, interest only is paid on a quarterly basis.
The following table summarizes the future annual principal payments required on these borrowings at December 31, 2019.
2020
2021
2022
2023
2024
Thereafter
1.76 %
— %
1.76 %
4.74 %
1.92 %
40,751
421
20,441
462
484
508
$
$
63,067
The Bank is a member of the FHLB of Pittsburgh and has access to the FHLB program of overnight and term advances. Under terms of a blanket collateral
agreement for advances, lines and letters of credit from the FHLB, collateral for all outstanding advances, lines and letters of credit consisted of 1-4 family
mortgage loans and other real estate secured loans totaling $836.7 million at December 31, 2019. The Bank had additional availability of $540.7 million at the
FHLB on December 31, 2019 based on its qualifying collateral, net of short-term borrowings and long-term debt detailed above, deposit letters of credit totaling
$85.0 million and non-deposit letters of credit totaling $1.4 million at December 31, 2019.
The Bank has available unsecured lines of credit, with interest based on the daily Federal Funds rate, with two correspondent banks totaling $30.0 million, at
December 31, 2019. The Company also has a $5.0 million unsecured line of
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credit, with a bank, at the prime rate of interest, at December 31, 2019. There were no borrowings under these lines of credit at December 31, 2019 and 2018.
NOTE 15. SUBORDINATED NOTES
The Company has unsecured subordinated notes payable, which mature on December 30, 2028. At December 31, 2019 and 2018, subordinated notes payable
outstanding totaled $31.8 million and $31.9 million, respectively, which qualified for Tier 2 capital. The notes are recorded on the consolidated balance sheets net
of remaining debt issuance costs totaling $653 thousand and $641 thousand at December 31, 2019 and 2018, respectively, which are amortized over a 10 year
period on an effective yield basis. The subordinated notes have a fixed interest rate of 6.0% through December 30, 2023, which then converts to a variable rate of
three-month LIBOR for the applicable interest period plus 3.16% through maturity. The Company may, at its option, redeem the notes, in whole or in part, on any
interest payment date on or after December 30, 2023, and at any time upon the occurrence of certain events. There are no debt covenants on the subordinated notes
payable.
NOTE 16. SHAREHOLDERS’ EQUITY AND REGULATORY CAPITAL
The Company maintains a stockholder dividend reinvestment and stock purchase plan. Under the plan, shareholders may purchase additional shares of the
Company’s common stock at the prevailing market prices with reinvestment dividends and voluntary cash payments. The Company reserved 1,045,000 shares of
its common stock to be issued under the dividend reinvestment and stock purchase plan. At December 31, 2019, approximately 665,000 shares were available to be
issued under the plan.
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and,
additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements
can initiate regulatory action. Under the Basel Committee on Banking Supervision's capital guidelines for U.S. Banks ("Basel III rules"), an entity must hold a
capital conservation buffer above the adequately capitalized risk-based capital ratios. The required capital conservation buffer was 1.25% for 2017, 1.875% for
2018 and 2.50% for 2019 under phase-in rules. The Company and the Bank have elected not to include net unrealized gain or loss on available for sale securities in
computing regulatory capital.
Effective with the third quarter of 2018, the FRB raised the consolidated asset limit to be considered a small bank holding company from $1.0 billion to $3.0
billion, and a company with assets under the revised limits is not subject to the FRB consolidated capital rules. A company with consolidated assets under the
revised limit may continue to file reports that include capital amounts and ratios. The Company has elected to continue to file those reports.
Management believes, at December 31, 2019 and 2018, that the Company and the Bank met all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to
accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At
December 31, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.
There are no conditions or events since that notification that management believes have changed the Bank's classification.
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The following table presents capital amounts and ratios at December 31, 2019 and 2018.
Actual
For Capital Adequacy Purposes
(includes applicable capital
conservation buffer)
To Be Well
Capitalized Under
Prompt Corrective
Action Regulations
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2019
Total risk-based capital:
Orrstown Financial Services, Inc.
$
244,003
14.1 % $
182,028
10.500 %
n/a
Orrstown Bank
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.
Orrstown Bank
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.
Orrstown Bank
Tier 1 leverage capital:
Orrstown Financial Services, Inc.
Orrstown Bank
December 31, 2018
Total risk-based capital:
231,805
13.4 %
181,948
10.500 % $
173,284
196,451
216,100
196,451
216,100
196,451
216,100
11.3 %
12.5 %
11.3 %
12.5 %
8.6 %
9.4 %
147,356
147,291
121,352
121,299
91,782
91,798
8.500 %
8.500 %
n/a
138,627
7.000 %
7.000 %
n/a
112,635
4.0 %
4.0 %
n/a
114,747
Orrstown Financial Services, Inc.
$
206,988
15.6 % $
131,393
9.875 %
n/a
Orrstown Bank
Tier 1 risk-based capital:
Orrstown Financial Services, Inc.
Orrstown Bank
Tier 1 common equity risk-based capital:
Orrstown Financial Services, Inc.
Orrstown Bank
Tier 1 leverage capital:
Orrstown Financial Services, Inc.
Orrstown Bank
177,892
13.4 %
131,286
9.875 % $
132,948
160,117
162,880
160,117
162,880
160,117
162,880
12.0 %
12.3 %
12.0 %
12.3 %
8.4 %
8.6 %
104,782
104,696
7.875 %
7.875 %
n/a
106,358
84,823
84,754
76,089
76,113
6.375 %
6.375 %
4.0 %
4.0 %
n/a
86,416
n/a
95,142
n/a
10.0 %
n/a
8.0 %
n/a
6.5 %
n/a
5.0 %
n/a
10.0 %
n/a
8.0 %
n/a
6.5 %
n/a
5.0 %
In September 2015, the Board of Directors of the Company authorized a share repurchase program under which the Company may repurchase up to 5% of
the Company's outstanding shares of common stock, or approximately 416,000 shares, in accordance with all applicable securities laws and regulations, including
Rule 10b-18 of the Securities Exchange Act of 1934, as amended. When and if appropriate, repurchases may be made in open market or privately negotiated
transactions, depending on market conditions, regulatory requirements and other corporate considerations, as determined by management. Share repurchases may
not occur and may be discontinued at any time. At December 31, 2019, 82,725 shares had been repurchased under the program at a total cost of $1.4 million, or
$17.38 per share.
On January 21, 2020, the Board declared a cash dividend of $0.17 per common share, which was paid on February 10, 2020.
Banking regulations limit the ability of the Bank to pay dividends or make loans or advances to the Parent Company. Dividends that may be paid in any
calendar year are limited to the current year's net profits, combined with the retained net profits of the preceding two years. At December 31, 2019, dividends from
the Bank available to be paid to the Parent Company, without prior approval of the Bank's regulatory agency, totaled $30.7 million, subject to the Bank meeting or
exceeding regulatory capital requirements. The Parent Company's principal source of funds for dividend payments to shareholders is dividends received from the
Bank.
At December 31, 2019, there were no loans from the Bank to any nonbank affiliate, including the Parent Company. The Bank's loans to a single affiliate may
not exceed 10%, and loans to all affiliates may not exceed 20%, of the Bank’s capital stock, surplus, and undivided profits, plus the ALL (as defined by
regulation). Loans from the Bank to nonbank affiliates,
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including the Parent Company, are also required to be collateralized according to regulatory guidelines. At December 31, 2019, the maximum amount the Bank
had available to loan nonbank affiliates totaled $196 thousand.
NOTE 17. EARNINGS PER SHARE
The following table presents earnings per share for the years ended December 31, 2019, 2018 and 2017.
Net income
Weighted average shares outstanding - basic
Dilutive effect of share-based compensation
Weighted average shares outstanding - diluted
Per share information:
Basic earnings per share
Diluted earnings per share
2019
2018
2017
$
$
16,924 $
12,805 $
10,362
152
10,514
8,360
177
8,537
1.63 $
1.61
1.53 $
1.50
8,090
8,070
156
8,226
1.00
0.98
Average outstanding stock options of approximately 22,000, 21,000 and 42,000, respectively, for the years ended December 31, 2019, 2018 and 2017 were
not included in the computation of earnings per share because the effect was antidilutive, as the exercise price exceeded the average market price. The dilutive
effect of share-based compensation in each year above relates principally to restricted stock awards.
NOTE 18. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its clients. 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 consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement
the Company has in particular classes of financial instruments.
The Company’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 Company uses the same credit policies
in making commitments and conditional obligations as it does for on-balance sheet instruments. The following table presents these contractual, or notional,
amounts at December 31, 2019, and 2018.
Commitments to fund:
Home equity lines of credit
1-4 family residential construction loans
Commercial real estate, construction and land development loans
Commercial, industrial and other loans
Standby letters of credit
2019
2018
$
205,502 $
19,812
19,018
222,288
10,588
160,971
13,002
31,133
147,518
13,909
Commitments to extend credit are agreements to lend to a client 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 Company evaluates each client’s credit-
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s
credit evaluation of the client. Collateral varies but may include accounts receivable, inventory, equipment, residential real estate, and income-producing
commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a client 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 clients. The Company holds collateral supporting those commitments when deemed necessary by
management. The
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liability, at December 31, 2019 and 2018, for guarantees under standby letters of credit issued was not considered to be material.
The Company maintains a reserve, based on historical loss experience of the related loan class, for off-balance sheet credit exposures that currently are not
funded, in other liabilities on the consolidated balance sheets. This reserve totaled $1.0 million and $998 thousand at December 31, 2019 and 2018, respectively.
The following table presents the net amount expensed for this off-balance sheet credit exposures reserve for years ended December 31, 2019, 2018 and 2017.
2019
2018
2017
Off-balance sheet credit exposures expense
$
39 $
182 $
32
The Company sells loans to the FHLB of Chicago as part of its MPF Program. Under the terms of the MPF Program, there is limited recourse back to the
Company for loans that do not perform in accordance with the terms of the loan agreement. Each loan that is sold under the program is “credit enhanced” such that
the individual loan’s rating is raised to a minimum “BBB,” as determined by the FHLB of Chicago. Outstanding loans sold under the MPF Program totaled $26.0
million and $30.1 million at December 31, 2019 and 2018, respectively, with limited recourse back to the Company on these loans of $777 thousand and $1.2
million, respectively. Many of the loans sold under the MPF Program have primary mortgage insurance, which reduces the Company’s overall exposure. The net
amount expensed or recovered for the Company's estimate of losses under its recourse exposure for loans foreclosed, or in the process of foreclosure, is recorded in
other operating expenses on the consolidated statements of income. The following table presents the net amounts expensed (recovered) for years ended
December 31, 2019, 2018 and 2017.
2019
2018
2017
MPF program recourse (recovery) loss
$
(20) $
(135) $
25
NOTE 19. FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for
the asset or liability in an orderly transaction between market participants on the measurement date. Certain financial instruments and all non-financial instruments
are excluded from fair value disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the
Company.
The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources
(observable inputs) and (2) an entity's own assumptions about market participant assumptions based on the best information available in the circumstances
(unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are:
Level 1 – quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.
Level 2 – significant other observable inputs other than Level 1 prices such as prices for similar assets and liabilities in active markets; quoted prices for
identical or similar instruments in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – at least one significant unobservable input that reflects a company's own assumptions about the assumptions that market participants would use in
pricing an asset or liability.
In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to
the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the asset or liability.
The Company used the following methods and significant assumptions to estimate fair value for instruments measured on a recurring basis:
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Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly
liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 and
fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. Level 2 securities include U.S.
agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain
cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. All of the
Company’s securities are classified as available for sale.
The Company had no fair value liabilities measured on a recurring basis at December 31, 2019 or 2018.
The following table summarizes assets measured at fair value on a recurring basis at December 31, 2019 or 2018.
December 31, 2019
AFS Securities:
States and political subdivisions
GSE residential CMOs
Non-agency CMOs
Private label commercial CMOs
Asset-backed and other
Loans held for sale
Interest rate lock commitments on residential mortgages
Totals
December 31, 2018
AFS Securities:
States and political subdivisions
GSE residential CMOs
Private label residential CMOs
Private label commercial CMOs
Asset-backed and other
Totals
Level 1
Level 2
Level 3
Total Fair
Value
Measurements
$
— $
87,863 $
—
—
—
—
—
—
68,154
—
79,437
230,653
9,364
—
— $
—
17,087
7,192
—
—
103
87,863
68,154
17,087
86,629
230,653
9,364
103
$
$
$
— $
475,471 $
24,382 $
499,853
— $
145,004 $
— $
—
—
—
—
108,064
143
67,836
137,588
—
—
7,209
—
— $
458,635 $
7,209 $
145,004
108,064
143
75,045
137,588
465,844
The Company has CMOs measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at December 31, 2019 and 2018. The
Level 3 valuation is based on a non-executable broker quote, which is considered a significant unobservable input. Such quotes are updated as available and may
remain constant for a period of time for certain broker-quoted securities that do not move with the market or that are not interest rate sensitive as a result of their
structure or overall attributes.
Effective October 1, 2019, the Company’s residential mortgage loans held-for-sale were recorded at fair value utilizing Level 2 measurements. This fair
value measurement is determined based upon third party quotes obtained on similar loans. The adoption of this accounting election resulted in an increase of $226
thousand in gain on sale of loans in the consolidated statements of income for the year ended December 31, 2019. For loans held-for-sale for which the fair value
option has been elected, the aggregate fair value exceeded the aggregate principal balance by $226 thousand as of December 31, 2019.
As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The
Company enters into a corresponding commitment to an investor to sell that loan at a specific price shortly after origination. In accordance with FASB ASC 820,
adjustments are recorded through earnings to account for the net change in fair value of these transactions for the held-for-sale pipeline. The determination of the
fair value of interest rate lock commitments on residential mortgages is based on agreed upon pricing with the respective investor on each loan and includes a pull
through percentage. The pull through percentage represents an estimate of loans in the pipeline to be delivered to an investor versus the total loans committed for
delivery. Significant changes in this input could result in a significantly higher or lower fair value measurement. As the pull through percentage is a significant
unobservable input, this is deemed a Level 3 valuation input. The pull through percentage, which is based upon historical experience, was 95% as of December 31,
2019. The fair value of interest rate lock commitments was $103 thousand at December 31, 2019 and is included in other assets on the consolidated balance sheets.
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The following provides details of the Level 3 fair value measurement activity for the years ended December 31, 2019 or 2018.
CMOs:
Balance, beginning of year
Unrealized (loss) gain included in OCI
Purchases
Net discount accretion (premium amortization)
Principal payments
Balance, end of year
Interest rate lock commitments on residential mortgages:
Balance, beginning of year
Total gains (losses), realized/unrealized:
Included in earnings
Balance, end of year
2019
2018
$
$
7,209 $
(17)
17,619
7
(539)
24,279 $
2019
$
$
—
37
7,213
(41)
—
7,209
—
103
103
Certain financial assets are measured at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually results from the application of
lower-of-cost-or-market accounting or write-downs of individual assets. The Company used the following methods and significant assumptions to estimate fair
value for these financial assets.
Impaired Loans
Loans are designated as impaired when, in the judgment of management and based on current information and events, it is probable that all amounts due,
according to the contractual terms of the loan agreement, will not be collected. The measurement of loss associated with impaired loans for all loan classes can be
based on either the observable market price of the loan, the fair value of the collateral, or discounted cash flows using a market rate of interest for performing
TDRs. For collateral-dependent loans, fair value is measured based on the value of the collateral securing the loan, less estimated costs to sell. Collateral may be in
the form of real estate or business assets including equipment, inventory, and accounts receivable. The value of the real estate collateral is determined utilizing an
income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data
(Level 2). However, if the collateral is a house or building in the process of construction, or if management adjusts the appraisal value, then the fair value is
considered Level 3. The value of business equipment is based upon an outside appraisal, if deemed significant, or the net book value on the applicable business’
financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on
financial statement balances or aging reports (Level 3). Impaired loans with an allocation to the ALL are measured at fair value on a nonrecurring basis. Any fair
value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income. Changes in the fair value of impaired
loans for those still held at December 31 considered in the determination of the provision for loan losses totaled $77 thousand, $146 thousand and $867 thousand
for the years ended December 31, 2019, 2018, and 2017, respectively.
Foreclosed Real Estate
OREO property acquired through foreclosure is initially recorded at the fair value of the property at the transfer date less estimated selling cost.
Subsequently, OREO is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based upon an
independent third-party appraisal of the property or occasionally upon a recent sales offer. There were no specific charges to value OREO at the lower of cost or
fair value on properties held at December 31, 2019 and 2018. Changes in the fair value of foreclosed real estate for those still held at December 31 charged to
OREO totaled $0 for the years ended December 31, 2019, 2018, and 2017.
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Mortgage Servicing Rights
The fair value of mortgage servicing rights is estimated to be equal to its carrying value, unless the quarterly valuation model calculates the present value of
the estimated net servicing income is less than its carrying value, in which case a lower of cost or fair value charge is taken. At December 31, 2019, a $70 thousand
lower of cost or fair value reserve existed on the mortgage servicing right portfolio. In 2019, net impairment charges of $70 thousand were recorded in mortgage
banking activities on the consolidated statements of income. No reserve existed at December 31, 2018, and no impairment charges were recorded in 2018.
The following table summarizes assets measured at fair value on a nonrecurring basis at December 31, 2019 and 2018.
December 31, 2019
Impaired loans
Commercial real estate:
Owner-occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity - lines of credit
Installment and other loans
Total impaired loans
Mortgage servicing rights
December 31, 2018
Impaired loans
Commercial real estate:
Owner-occupied
Multi-family
Non-owner occupied residential
Commercial and industrial
Residential mortgage:
First lien
Home equity - lines of credit
Total impaired loans
Level 1
Level 2
Level 3
Total
Fair Value
Measurements
$
— $
— $
938 $
—
—
—
—
—
—
—
—
—
—
—
—
96
103
11
641
400
7
938
96
103
11
641
400
7
— $
— $
2,196 $
2,196
— $
3,119 $
— $
3,119
— $
— $
1,087 $
1,087
—
—
—
—
—
—
—
—
—
—
131
278
25
1,121
409
— $
— $
3,051 $
131
278
25
1,121
409
3,051
$
$
$
$
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The following table presents additional qualitative information about assets measured on a nonrecurring basis and for which the Company has utilized Level
3 inputs to determine fair value.
Fair Value
Estimate
Valuation Techniques
Unobservable Input
Range
December 31, 2019
Impaired loans
$
2,196 Appraisal of collateral
Management adjustments on appraisals for
property type and recent activity
- Management adjustments for liquidation
expenses
Mortgage servicing rights
3,119 Discounted cash flows
Weighted average CPR
Discount rate
0% - 20% discount
6% - 33% discount
11.63%
9.54%
December 31, 2018
Impaired loans
$
3,051 Appraisal of collateral
Management adjustments on appraisals for
property type and recent activity
- Management adjustments for liquidation
expenses
5% - 75% discount
6% - 20% discount
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Table of Contents
Fair values of financial instruments
GAAP requires disclosure of the fair value of financial assets and liabilities, including those that are not measured and reported at fair value on a recurring or
nonrecurring basis. The following table presents the carrying amounts and estimated fair values of financial assets and liabilities at December 31, 2019, and 2018.
Carrying
Amount
Fair Value
Level 1
Level 2
Level 3
Loans, net of allowance for loan losses
1,629,675
1,652,788
December 31, 2019
Financial Assets
Cash and due from banks
Interest-bearing deposits with banks
Restricted investments in bank stock
AFS securities
Loans held for sale
Interest rate lock commitments on residential mortgages
Accrued interest receivable
Financial Liabilities
Deposits
Short-term borrowings
Long-term debt
Subordinated notes
Accrued interest payable
December 31, 2018
Financial Assets
Cash and due from banks
Interest-bearing deposits with banks
Federal funds sold
Restricted investments in bank stock
AFS securities
Loans held for sale
Loans, net of allowance for loan losses
Accrued interest receivable
Financial Liabilities
Deposits
Short-term borrowings
Long-term debt
Subordinated notes
Accrued interest payable
$
25,969 $
25,969 $
25,969 $
— $
30,493
16,184
490,386
9,364
30,493
n/a
490,386
9,364
103
6,040
103
6,040
1,875,522
1,876,555
154,869
154,869
63,067
31,847
879
63,405
33,953
879
30,493
n/a
—
—
—
—
—
—
—
—
—
—
—
n/a
466,107
9,364
—
—
1,863
1,876,555
154,869
63,405
33,953
879
$
26,156 $
26,156 $
26,156 $
— $
45,664
16,995
10,842
465,844
3,340
45,664
16,995
n/a
465,844
3,413
1,233,643
1,229,645
5,927
5,927
1,558,756
1,555,912
64,069
83,450
31,859
1,301
64,069
82,951
31,256
1,301
45,664
16,995
n/a
—
—
—
—
—
—
—
—
—
—
—
n/a
458,635
3,413
—
2,853
1,555,912
64,069
82,951
31,256
1,301
—
—
n/a
24,279
—
1,652,788
103
4,177
—
—
—
—
—
—
—
—
n/a
7,209
—
1,229,645
3,074
—
—
—
—
—
The methods used to estimate the fair value of financial instruments at December 31, 2019 did not necessarily represent an exit price. In accordance with the
Company's adoption of ASU 2016-01, the methods utilized to measure the fair value of financial instruments at December 31, 2019 represents an approximation of
exit price; however, an actual exit price may differ.
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NOTE 20. REVENUE FROM CONTRACTS WITH CLIENTS
On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent amendments (collectively
“ASC 606”). The update implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASC 606 is that an
entity should recognize revenue to depict the transfer of promised goods or services to clients in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services. The majority of the Company's revenue comes from interest income, including loans and securities,
that are outside the scope of ASC 606. The Company's services that fall within the scope of ASC 606 are presented within noninterest income on the consolidated
statements of income and are recognized as revenue as the Company satisfies its obligation to the client. Services within the scope of ASC 606 include service
charges on deposit accounts, income from fiduciary investment management and brokerage activities and interchange fees from service charges on ATM and debit
card transactions. ASC 606 did not result in a change to the accounting for any in-scope revenue streams; as such, no cumulative effect adjustment was recorded.
Descriptions of revenue generating activities that are within the scope of ASC 606 are as follows:
Service Charges on Deposit Accounts - The Company earns fees from its deposit clients for transaction-based, account maintenance, and overdraft services.
Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the
transaction is executed as that is the point in time the Company fulfills the client's request. Account maintenance fees, which relate primarily to monthly
maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are
recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the client's account balance.
Interchange Income - The Company earns interchange fees from debit/credit cardholder transactions conducted through the MasterCard payment network.
Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction
processing services provided to the cardholder. Interchange income is presented net of cardholder rewards.
Loan swap referral fees - The Company earns fees from a third-party service provider for loan hedging referrals provided to lending clients. The Company
acts as an agent in arranging the relationship between our client and the third-party service provider. The company is paid and recognizes income upon completion
of the loan hedge between our client and the third-party service provider.
Trust and Investment Management Income - The Company earns wealth management and investment brokerage fees from its contracts with trust and wealth
management clients to manage assets for investment, and/or to transact on their accounts. These fees are primarily earned over time as the Company provides the
contracted services and are generally assessed based on a tiered scale of the market value of assets under management. Fees that are transaction based, including
trade execution services, are recognized at the point in time that the transaction is executed, i.e., the trade date. Other related services provided included financial
planning services and the associated fees the Company earns, which are based on a fixed fee schedule, are recognized when the services are rendered. Services are
generally billed in arrears and a receivable is recorded until fees are paid.
Brokerage Income - The Company earns fees from investment management and brokerage services provided to its clients through a third-party service
provider. The Company receives commissions from the third-party service provider and recognizes income on a weekly basis based upon client activity. As the
Company acts as an agent in arranging the relationship between the client and the third-party service provider and does not control the services rendered to the
clients, brokerage income is presented net of related costs.
Gains/Losses on Sales of OREO - The Company records a gain or loss on the sale of OREO when control of the property transfers to the buyer, which
generally occurs at the time of an executed deed. If the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to
perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is
derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the
Company adjusts the transaction price and related gain or loss on sale if a significant financing component is present.
At December 31, 2019 and December 31, 2018, the Company had receivables from trust and wealth management clients totaling $719 thousand and $640
thousand, respectively.
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Table of Contents
The following table presents the Company's noninterest income disaggregated by revenue source for the years ended December 31, 2019, 2018 and 2017.
Noninterest income
Service charges on deposit accounts
Loan swap referral fees
Trust and investment management income
Brokerage income
Interchange income
Revenue from contracts with clients
Other service charges
Mortgage banking activities
Income from life insurance
Other income
Investment securities gains
2019
2018
2017
$
3,793 $
3,578 $
1,197
7,255
2,426
3,281
17,952
416
3,049
2,044
331
4,749
—
6,576
2,035
2,821
15,010
562
2,663
1,463
320
1,006
Total noninterest income
$
28,541 $
21,024 $
NOTE 21. ORRSTOWN FINANCIAL SERVICES, INC. (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION
Condensed Balance Sheets
3,392
—
6,400
1,896
2,618
14,306
235
2,919
1,109
190
1,190
19,949
Assets
Cash in Orrstown Bank
Investment in Orrstown Bank
Other assets
Total assets
Liabilities
Subordinated notes
Accrued interest and other liabilities
Total liabilities
Shareholders’ Equity
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock
Total shareholders’ equity
Total liabilities and shareholders’ equity
112
December 31,
2019
2018
$
$
$
11,568 $
242,041
1,724
255,333 $
31,847 $
237
32,084
584
188,365
35,246
(480)
(466)
223,249
$
255,333 $
28,596
175,299
2,057
205,952
31,859
660
32,519
491
151,678
24,472
(2,972)
(236)
173,433
205,952
Table of Contents
Condensed Statements of Income
Income
Dividends from bank subsidiary
Interest income from bank subsidiary
Other income
Total income
Expenses
Interest on short-term borrowings
Interest on subordinated notes
Total interest expense
Share-based compensation
Management fee to bank subsidiary
Merger related expenses
Other expenses
Total expenses
(Loss) income before income tax benefit and equity in undistributed income of subsidiaries
Income tax benefit
(Loss) income before equity in undistributed income of subsidiaries
Equity in undistributed income of subsidiaries
Net income
113
For the Years Ended December 31,
2019
2018
2017
$
2,000 $
4,450 $
257
55
2,312
—
1,987
1,987
236
1,350
1,574
802
5,949
(3,637)
(1,182)
(2,455)
19,379
7
102
4,559
57
73
130
205
1,042
1,545
656
3,578
981
(735)
1,716
11,089
$
16,924 $
12,805 $
—
15
61
76
—
—
—
247
501
—
1,116
1,864
(1,788)
(596)
(1,192)
9,282
8,090
Table of Contents
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Amortization
Deferred income taxes
Equity in undistributed income of subsidiaries
Share-based compensation
Net change in other liabilities
Net change in other assets
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Capital contributed to subsidiaries
Net cash paid for acquisitions
Net cash used in investing activities
Cash flows from financing activities:
Dividends paid
Proceeds from issuance of subordinated notes, net of costs
Proceeds from issuance of common stock
Payments to repurchase common stock
Other, net
Net cash (used in) provided by financing activities
Net (decrease) increase in cash
Cash, beginning
Cash, ending
NOTE 22. CONTINGENCIES
For the Years Ended December 31,
2019
2018
2017
$
16,924 $
12,805 $
8,090
47
16
3
22
(19,379)
(11,089)
236
(423)
311
(2,268)
(100)
(8,142)
(8,242)
(6,150)
—
1,463
(1,772)
(59)
(6,518)
(17,028)
28,596
205
12
2,039
3,997
—
(4,597)
(4,597)
(4,375)
31,857
1,448
(651)
—
28,279
27,679
917
$
11,568 $
28,596 $
—
16
(9,282)
247
(35)
(377)
(1,341)
(6,100)
—
(6,100)
(3,488)
—
1,276
—
—
(2,212)
(9,653)
10,570
917
The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. Except as
described below, in the opinion of management, there are no legal proceedings that might have a material effect on the results of operations, liquidity, or the
financial position of the Company at this time.
On May 25, 2012, SEPTA filed a putative class action complaint in the U.S. District Court for the Middle District of Pennsylvania against the Company, the
Bank and certain current and former directors and executive officers (collectively, the “Orrstown Defendants”). The complaint alleges, among other things, that (i)
in connection with the Company’s Registration Statement on Form S-3 dated February 23, 2010 and its Prospectus Supplement dated March 23, 2010, and (ii)
during the purported class period of March 24, 2010 through October 27, 2011, the Company issued materially false and misleading statements regarding the
Company’s lending practices and financial results, including misleading statements concerning the stringent nature of the Bank’s credit practices and underwriting
standards, the quality of its loan portfolio, and the intended use of the proceeds from the Company’s March 2010 public offering of common stock. The complaint
asserts claims under Sections 11, 12(a) and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder, and seeks class certification, unspecified money damages, interest, costs, fees and equitable or injunctive relief. Under the Private
Securities Litigation Reform Act of 1995 (“PSLRA”), motions for appointment of Lead Plaintiff in this case were due by July 24, 2012. SEPTA was the sole
movant and the Court appointed SEPTA Lead Plaintiff on August 20, 2012.
Pursuant to the PSLRA and the Court’s September 27, 2012 Order, SEPTA was given until October 26, 2012 to file an amended complaint and the Orrstown
Defendants until December 7, 2012 to file a motion to dismiss the amended complaint. SEPTA’s opposition to the Orrstown Defendants’ motion to dismiss was
originally due January 11, 2013. Under the PSLRA,
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discovery and all other proceedings in the case were stayed pending the Court’s ruling on the motion to dismiss. The September 27, 2012 Order specified that if the
motion to dismiss were denied, the Court would schedule a conference to address discovery and the filing of a motion for class certification. On October 26, 2012,
SEPTA filed an unopposed motion for enlargement of time to file its amended complaint in order to permit the parties and new defendants to be named in the
amended complaint time to discuss plaintiff’s claims and defendants’ defenses. On October 26, 2012, the Court granted SEPTA’s motion, mooting its September
27, 2012 scheduling Order, and requiring SEPTA to file its amended complaint on or before January 16, 2013 or otherwise advise the Court of circumstances that
require a further enlargement of time. On January 14, 2013, the Court granted SEPTA’s second unopposed motion for enlargement of time to file an amended
complaint on or before March 22, 2013.
On March 4, 2013, SEPTA filed an amended complaint. The amended complaint expanded the list of defendants in the action to include the Company’s
former independent registered public accounting firm, Smith Elliott Kearns & Company, LLC (“SEK”), and the underwriters of the Company’s March 2010 public
offering of common stock. In addition, among other things, the amended complaint extends the purported 1934 Exchange Act class period from March 15, 2010
through April 5, 2012. Pursuant to the Court’s March 28, 2013 Second Scheduling Order, on May 28, 2013, all defendants filed their motions to dismiss the
amended complaint, and on July 22, 2013, SEPTA filed its “omnibus” opposition to all of the defendants’ motions to dismiss. On August 23, 2013, all defendants
filed reply briefs in further support of their motions to dismiss. On December 5, 2013, the Court ordered oral argument on the Orrstown Defendants’ motion to
dismiss the amended complaint to be heard on February 7, 2014. Oral argument on the pending motions to dismiss SEPTA’s amended complaint was held on April
29, 2014.
The Second Scheduling Order stayed all discovery in the case pending the outcome of the motions to dismiss, and informed the parties that, if required, a
telephonic conference to address discovery and the filing of SEPTA’s motion for class certification would be scheduled after the Court’s ruling on the motions to
dismiss.
On April 10, 2015, pursuant to Court order, all parties filed supplemental briefs addressing the impact of the U.S. Supreme Court’s March 24, 2015 decision
in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund on defendants’ motions to dismiss the amended complaint.
On June 22, 2015, in a 96-page Memorandum, the Court dismissed without prejudice SEPTA’s amended complaint against all defendants, finding that
SEPTA failed to state a claim under either the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. The Court ordered that,
within 30 days, SEPTA either seek leave to amend its amended complaint, accompanied by the proposed amendment, or file a notice of its intention to stand on the
amended complaint.
On July 22, 2015, SEPTA filed a motion for leave to amend under Local Rule 15.1, and attached a copy of its proposed second amended complaint to its
motion. Many of the allegations of the proposed second amended complaint are essentially the same or similar to the allegations of the dismissed amended
complaint. The proposed second amended complaint also alleges that the Orrstown Defendants did not publicly disclose certain alleged failures of internal controls
over loan underwriting, risk management, and financial reporting during the period 2009 to 2012, in violation of the federal securities laws. On February 8, 2016,
the Court granted SEPTA’s motion for leave to amend and SEPTA filed its second amended complaint that same day.
On February 25, 2016, the Court issued a scheduling Order directing: all defendants to file any motions to dismiss by March 18, 2016; SEPTA to file an
omnibus opposition to defendants’ motions to dismiss by April 8, 2016; and all defendants to file reply briefs in support of their motions to dismiss by April 22,
2016. Defendants timely filed their motions to dismiss the second amended complaint and the parties filed their briefs in accordance with the Court-ordered
schedule, above. The February 25, 2016 Order stays all discovery and other deadlines in the case (including the filing of SEPTA’s motion for class certification)
pending the outcome of the motions to dismiss.
The allegations of SEPTA’s second amended complaint disclosed the existence of a confidential, non-public, fact-finding inquiry regarding the Company
being conducted by the SEC. As disclosed in the Company’s Form 8-K filed on September 27, 2016, on that date the Company entered into a settlement agreement
with the SEC resolving the investigation of accounting and related matters at the Company for the periods ended June 30, 2010, to December 31, 2011. As part of
the settlement of the SEC’s administrative proceedings and pursuant to the cease-and-desist order, without admitting or denying the SEC’s findings, the Company,
its Chief Executive Officer, its former Chief Financial Officer, its former Executive Vice President and Chief Credit Officer, and its Chief Accounting Officer,
agreed to pay civil money penalties to the SEC. The Company agreed to pay a civil money penalty of $1.0 million. The Company had previously established a
reserve for that amount which was expensed in the second fiscal quarter of 2016. In the settlement agreement with the SEC, the Company also agreed to cease and
desist from committing or causing any violations and any future violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)
(2)(A) and 13(b)(2)(B), and Rules 12b-20, 13a-1 and 13a-13 promulgated thereunder.
On September 27, 2016, the Orrstown Defendants filed with the Court a Notice of Subsequent Event in Further Support of their Motion to Dismiss the
Second Amended Complaint, regarding the settlement with the SEC. The Notice attached a copy of the SEC’s cease-and-desist order and briefly described what
the Company believed were the most salient terms of the neither-
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admit-nor-deny settlement. On September 29, 2016, SEPTA filed a Response to the Notice, in which SEPTA argued that the settlement with the SEC did not
support dismissal of the second amended complaint.
On December 7, 2016, the Court issued an Order and Memorandum granting in part and denying in part defendants’ motions to dismiss SEPTA’s second
amended complaint. The Court granted the motions to dismiss the Securities Act claims against all defendants, and granted the motions to dismiss the Exchange
Act Section 10(b) and Rule 10b-5 claims against all defendants except Orrstown Financial Services, Inc., Orrstown Bank, Thomas R. Quinn, Jr., Bradley S. Everly,
and Jeffrey W. Embly. The Court also denied the motions to dismiss the Exchange Act Section 20(a) claims against Quinn, Everly, and Embly.
On January 31, 2017, the Court entered a Case Management Order establishing the schedule for the litigation and, on August 15, 2017, it entered a revised
Order that, among other things, set the following deadlines: all fact discovery closes on March 1, 2018, and SEPTA’s motion for class certification is due the same
day; expert merits discovery closes May 30, 2018; summary judgment motions are due by June 26, 2018; the mandatory pretrial and settlement conference is set
for December 11, 2018; and trial is scheduled to begin on January 7, 2019.
On December 15, 2017, the Orrstown Defendants and SEPTA exchanged expert reports in opposition to and in support of class certification, respectively. On
January 15, 2018, the parties exchanged expert rebuttal reports. SEPTA’s motion for class certification was due March 1, 2018, with the Orrstown Defendants’
opposition due April 2, 2018, and SEPTA’s reply due April 23, 2018.
On February 9, 2018, SEPTA filed a Status Report and Request for a Telephonic Status Conference asking the Court to convene a conference to discuss the
status of discovery in the case and possible revisions to the case schedule. On February 12, 2018, the Orrstown Defendants filed their status report to provide the
Court with a summary of document discovery in the case to date. On February 27, 2018, SEPTA filed an unopposed motion for a continuance of the existing case
deadlines pending a status conference with the Court or the issuance of a revised case schedule. On February 28, 2018, the Court issued an Order continuing all
case management deadlines until further order of the Court.
On March 27, 2018, the Court held a telephonic status conference with the parties to discuss outstanding discovery issues and case deadlines. On May 2,
2018, the parties filed a joint status report. On May 10, 2018, the Court held a follow-up telephonic status conference at which the parties reported on the progress
of discovery to date. Party and non-party document discovery in the case has continued. To date, SEPTA has taken a few non-party depositions.
On August 9, 2018, SEPTA filed a motion to compel the production of Confidential Supervisory Information (CSI) of non-parties the Board of Governors of
the Federal Reserve System (FRB) and the Pennsylvania Department of Banking and Securities, in the possession of Orrstown and third parties. On August 23,
2018, the Orrstown Defendants filed a response to the motion to compel. On August 30, 2018, the FRB filed an unopposed motion to intervene in the Action for
the purpose of opposing SEPTA’s motion to compel, and on September 27, 2018, the FRB filed its brief in opposition to SEPTA’s motion. On October 11, 2018,
SEPTA filed its reply brief in support of its motion to compel. On February 12, 2019, the Court denied SEPTA’s motion to compel the production of CSI on the
ground that SEPTA had failed to exhaust its administrative remedies.
On April 11, 2019, SEPTA filed a motion for leave to file a third amended complaint. The proposed third amended complaint seeks to reassert the Securities
Act claims that the Court dismissed as to all defendants on December 7, 2016, when the Court granted in part and denied in part defendants’ motions to dismiss
SEPTA’s second amended complaint. The proposed third amended complaint also seeks to reassert the Exchange Act claims against those defendants that the
Court dismissed from the case on December 7, 2016. Defendants’ briefs in opposition to SEPTA’s motion for leave to file a third amended complaint were filed on
April 25, 2019. SEPTA filed a reply brief in further support of its motion for leave to file a third amended complaint on May 9, 2019.
On June 13, 2019, Orrstown filed a motion for protective order to stay discovery pending resolution of SEPTA’s motion for leave to file a third amended
complaint. On June 19, 2019, former defendants SEK and the underwriters of the Company’s March 2010 public offering joined in Orrstown’s motion for
protective order. On June 25, 2019, SEPTA filed its opposition to Orrstown’s motion. On July 9, 2019, Orrstown filed a reply brief in further support of its motion.
On July 17, 2019, the Court entered an Order partially granting Orrstown’s motion for protective order, ruling that all deposition discovery in the case is stayed
pending a decision on SEPTA’s motion for leave to file a third amended complaint.
On February 14, 2020, the Court issued an Order and Memorandum granting SEPTA’s motion for leave to file a third amended complaint. The third
amended complaint is now the operative complaint. It reinstates the Orrstown Defendants, as well as SEK and the underwriter defendants, previously dismissed
from the case on December 7, 2016. The third amended complaint also revives the previously-dismissed 1933 Securities Act claim against the Orrstown
Defendants and the underwriter defendants. Under the Court-ordered briefing schedule, all defendants’ motions to dismiss the third amended complaint are due
March 27, 2020, SEPTA’s oppositions are due May 1, 2020, and defendants’ reply briefs are due May 22, 2020.
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On February 24, 2020, the Orrstown Defendants, and the underwriter defendants and SEK, separately filed motions under 28 U.S.C. § 1292(b) asking the
Court to certify its February 14, 2020 Order for interlocutory appeal to the Third Circuit Court of Appeals. That motion is pending.
The Company believes that the allegations of SEPTA’s third amended complaint are without merit and intends to defend itself vigorously against those
claims. It is not possible at this time to estimate reasonably possible losses, or even a range of reasonably possible losses, in connection with the litigation.
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ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A – CONTROLS AND PROCEDURES
Based on the evaluation required by Securities Exchange Act Rules 13a-15(b) and 15d-15(b), the Company's management, including the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Securities Exchange Act
Rules 13a-15(e) and 15d-15(e), at December 31, 2019. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective at December 31, 2019. There have been no changes in internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the fourth quarter of 2019.
Management's Report on Internal Controls Over Financial Reporting is included in Part II, Item 8, "Financial Statements and Supplementary Data." The
effectiveness of the Company's internal control over financial reporting at December 31, 2019 has been audited by Crowe LLP, an independent registered public
accounting firm, as stated in the Report of Independent Registered Public Accounting Firm appearing in Part II, Item 8, "Financial Statements and Supplementary
Data."
ITEM 9B – OTHER INFORMATION
None.
PART III
ITEM 10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The Company has adopted a code of ethics that applies to all senior financial officers (including its chief executive officer, chief financial officer, chief
accounting officer, and any person performing similar functions). You can find a copy of the Code of Ethics for Senior Financial Officers by visiting our website at
www.orrstown.com and following the links to “Investor Relations” and “Governance Documents.” A copy of the Code of Ethics for Senior Financial Officers may
also be obtained, free of charge, by written request to Orrstown Financial Services, Inc., 77 East King Street, PO Box 250, Shippensburg, Pennsylvania 17257,
Attention: Secretary. The Company intends to disclose any amendments to or waivers from a provision of the Company’s Code of Ethics for Senior Financial
Officers in a timely manner.
All other information required by Item 10 is incorporated by reference from the Company’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders filed pursuant to Regulation 14A, under Section 16(a) Beneficial Ownership Reporting Compliance and Proposal 1 – Election of Directors –
Biographical Summaries of Nominees and Directors; Information About Executive Officers; Involvement in Certain Legal Proceedings; and Proposal 1 – Election
of Directors – Nomination of Directors, and Board Structure, Committees and Meeting Attendance.
ITEM 11 – EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the Company’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders filed pursuant to Regulation 14A, under Proposal 1 – Election of Directors – Compensation of Directors, Compensation Discussion and Analysis,
Compensation Committee Report, Executive Compensation Tables, Potential Payments Upon Termination or Change in Control and Compensation Committee
Interlocks and Insider Participation.
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ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table presents equity compensation plan information at December 31, 2019.
Plan Category
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
Weighted
average exercise
price of outstanding
options, warrants and
rights
(b)
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)
Equity compensation plan approved by security holders
Equity compensation plan not approved by security holders (1)
27,767
$
2,792
21.14
25.76
455,028
—
Total
(1) Awards from the Non-Employee Director Stock Option Plan of 2000. Certain options granted remain outstanding from this plan, however no additional options will be
granted under this plan.
30,559
$
21.56
455,028
All other information required by Item 12 is incorporated, by reference, from the Company’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders filed pursuant to Regulation 14A, under Share Ownership of Certain Beneficial Owners and Management.
ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated by reference from the Company’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders filed pursuant to Regulation 14A, under Proposal 1 – Election of Directors – Director Independence, and Transactions with Related Persons,
Promoters and Certain Control Persons.
ITEM 14 – PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 is incorporated by reference from the Company’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders filed pursuant to Regulation 14A, under Proposal 3 – Ratification of the Audit Committee’s Selection of Crowe LLP as the Company’s Independent
Registered Public Accounting Firm for the Fiscal Year Ending December 31, 2019 – Relationship with Independent Registered Public Accounting Firm.
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PART IV
ITEM 15 – EXHIBITS, FINANCIAL STATEMENT SCHEDULES
a. The following documents are filed as part of this report:
(1) – Financial Statements
Consolidated financial statements of the Company and subsidiaries required in response to this Item are incorporated by reference from Item 8 of this report.
(2) – Financial Statement Schedules
All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore have been omitted.
(3) – Exhibits
2.1(a)
2.1(b)
3.1
3.2
4.1
4.2
4.3
4.4
10.1(a)
10.1(b)
10.1(c)
10.1(d)
10.1(e)
10.1(f)
10.1(g)
10.1(h)
10.1(i)
Agreement and Plan of Merger, dated May 31, 2018, by and between Orrstown Financial Services, Inc. and Mercersburg Financial Corporation,
incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed June 1, 2018.
Agreement and Plan of Merger, dated October 23, 2018, by and between Orrstown Financial Services, Inc. and Hamilton Bancorp, Inc.,
incorporated by reference to Exhibit 2.1 of the Registrant's Form 8-K filed October 24, 2018.
Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on January 29, 2010.
By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed January 30, 2018.
Specimen Common Stock Certificate, incorporated by reference to the Registrant’s Registration Statement on Form S-3 filed February 8, 2010
(File No. 333-164780).
Subordinated Indenture, dated December 19, 2018, by and between Orrstown Financial Services, Inc., and U.S. Bank, National Association,
incorporated by reference to Exhibit 4.1 of the Registrant's Form 8-K filed on December 20, 2018.
Form of Global Note for subordinated notes, incorporated by reference to Exhibit 4.2 of the Registrant's Form 8-K filed December 20, 2018.
Form of Registration Rights Agreement for subordinated notes, incorporated by reference to Exhibit 10.2 of the Registrant's Form 8-K filed
December 20, 2018.
Form of Change in Control Agreement for selected officers – incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K filed May
14, 2008.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Quinn, Jr. incorporated by reference to
Exhibit 10.2 of the Registrant’s Form 8-K filed June 8, 2015.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Quinn, Jr. incorporated by reference to
Exhibit 10.2 to the Registrant's Form 8-K filed September 27, 2019.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Philip E. Fague, incorporated by reference to
Exhibit 10.4 to the Registrant's Form 8-K filed June 2, 2015.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Robert G. Coradi, incorporated by reference to
Exhibit 10.8 to the Registrant's Form 8-K filed June 2, 2015.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Barbara E. Brobst, incorporated by reference to
Exhibit 10.10 to the Registrant's Form 8-K filed June 2, 2015.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Adam L. Metz, incorporated by reference to
Exhibit 10.2 to the Registrant's Form 8-K filed March 14, 2017.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Robert J. Fignar, incorporated by reference to
Exhibit 10.3 to the Registrant's Form 8-K filed June 1, 2018.
Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Brugger, incorporated by reference to
Exhibit 10.2 to the Registrant's Form 8-K filed June 25, 2019.
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Table of Contents
10.2(a)
10.2(b)
10.2(c)
10.2(d)
10.3
10.4(a)
10.4(b)
10.4(c)
10.4(d)
10.4(e)
10.4(f)
10.5
10.6
10.7
10.8
10.9(a)
10.9(b)
10.9(c)
10.9(d)
10.9(e)
10.9(f)
10.9(g)
10.10
10.11(a)
10.11(b)
Amended and Restated Salary Continuation Agreement between Orrstown Bank and Phillip E. Fague, incorporated by reference to Exhibit 10.2
(b) of the Registrant’s Form 10-K filed March 15, 2010.
Salary Continuation Agreement between Orrstown Bank and Thomas R. Quinn, Jr. – incorporated by reference to Exhibit 10.1 to the Registrant’s
Form 8-K filed January 8, 2010.
Salary Continuation Agreement between Orrstown Bank and Thomas R. Quinn, Jr. – incorporated by reference to Exhibit 10.1 to the Registrant’s
Form 8-K filed September 27, 2019.
Salary Continuation Agreement between Orrstown Bank and David P. Boyle – incorporated by reference to Exhibit 10.1 to the Registrant’s Form
8-K filed July 17, 2015.
Officer group term replacement plan for selected officers – incorporated by reference to Exhibit 10.2 to Registrant’s Form 10-K for the year ended
December 31, 1999 filed March 28, 2000.
Director Retirement Agreement, as amended, between Orrstown Bank and Anthony F. Ceddia, incorporated by reference to Exhibit 10.4(a) to the
Registrant’s Form 10-K filed March 15, 2010.
Director Retirement Agreement, as amended, between Orrstown Bank and Jeffrey W. Coy, incorporated by reference to Exhibit 10.4(b) to the
Registrant’s Form 10-K filed March 15, 2010.
Director Retirement Agreement, as amended, between Orrstown Bank and Andrea Pugh, incorporated by reference to Exhibit 10.4(c) to the
Registrant’s Form 10-K filed March 15, 2010.
Director Retirement Agreement, as amended, between Orrstown Bank and Gregory A. Rosenberry, incorporated by reference to Exhibit 10.4(d) to
the Registrant’s Form 10-K filed March 15, 2010.
Director Retirement Agreement, as amended, between Orrstown Bank and Glenn W. Snoke, incorporated by reference to Exhibit 10.4(f) to the
Registrant’s Form 10-K filed March 15, 2010.
Director Retirement Agreement, as amended, between Orrstown Bank and Joel R. Zullinger, incorporated by reference to Exhibit 10.4(h) to the
Registrant’s Form 10-K filed March 15, 2010.
Revenue neutral retirement plan – incorporated by reference to Exhibit 10.4 to the Registrant’s Form 10-K filed March 28, 2000.
Non-employee director stock option plan of 2000 – incorporated by reference to the Registrant’s registration statement on Form S-8 filed March
31, 2000.
Employee stock option plan of 2000 – incorporated by reference to the Registrant’s registration statement on Form S-8 filed March 31, 2000.
2011 Orrstown Financial Services, Inc. Stock Incentive Plan – incorporated by reference to Exhibit 10.1 of the Registrant’s registration statement
on Form S-8 filed May 24, 2018..
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Quinn, Jr. incorporated by reference to
Exhibit 10.1 to Registrant’s Form 8-K filed June 8, 2015.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. Brugger, incorporated by reference to Exhibit
10.1 to Registrant’s Form 8-K filed June 25, 2019.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Philip E. Fague, incorporated by reference to Exhibit
10.3 to the Registrant's Form 8-K filed June 2, 2015.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Robert G. Coradi, incorporated by reference to Exhibit
10.7 to the Registrant's Form 8-K filed June 2, 2015.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Barbara E. Brobst, incorporated by reference to Exhibit
10.9 to the Registrant's Form 8-K filed June 2, 2015.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Adam L. Metz, incorporated by reference to Exhibit 10.1
to the Registrant's Form 8-K filed March 14, 2017.
Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Robert J. Fignar, incorporated by reference to Exhibit
10.2 to the Registrant's Form 8-K filed June 1, 2018.
Brick Plan – Deferred Income Agreement between Orrstown Bank and Joel R. Zullinger, incorporated by reference to Exhibit 10.11 to the
Registrant’s Form 10-K filed March 15, 2010.
Director/Executive Officer Deferred Compensation Plan, incorporated by reference to Exhibit 10.13(a) to the Registrant’s Form 10-K filed March
15, 2010.
Trust Agreement for Director/Executive Officer Deferred Compensation Plan, incorporated by reference to Exhibit 10.13(b) to the Registrant’s
Form 10-K filed March 15, 2010.
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Table of Contents
10.12
10.13
14
21
23.1
31.1
31.2
32.1
32.2
101.LAB
101.PRE
101.INS
101.SCH
101.CAL
101.DEF
Deferred Compensation Agreement between Orrstown Bank and Thomas R. Quinn, Jr., incorporated by reference to Exhibit 10.1 to the
Registrant's Form 8-K filed September 27, 2019.
Form of Subordinated Note Purchase Agreement, incorporated by reference to Exhibit 10.1 of the Registrant's Report of Form 8-K filed on
December 20, 2018.
Code of Ethics Policy for Senior Financial Officers posted on Registrant’s website.
Subsidiaries of the registrant
Consent of Crowe LLP, Independent Registered Public Accounting Firm
Rule 13a – 14(a)/15d-14(a) Certification (Chief Executive Officer)
Rule 13a – 14(a)/15d-14(a) Certifications (Chief Financial Officer)
Section 1350 Certifications (Chief Executive Officer)
Section 1350 Certifications (Chief Financial Officer)
XBRL Taxonomy Extension Label Linkbase
XBRL Taxonomy Extension Presentation Linkbase
XBRL Instance Document
XBRL Taxonomy Extension Schema
XBRL Taxonomy Extension Calculation Linkbase
XBRL Taxonomy Extension Definition Linkbase
All other exhibits for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
b. Exhibits – The exhibits to this Form 10-K begin after the signature page.
c. Financial statement schedules – None required.
ITEM 16 – FORM 10-K SUMMARY
Not applicable.
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Table of Contents
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.
SIGNATURES
ORRSTOWN FINANCIAL SERVICES, INC.
(Registrant)
Dated: March 16, 2020
By:
/s/ Thomas R. Quinn, Jr.
Thomas R. Quinn, Jr., President and Chief Executive Officer
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Thomas R. Quinn, Jr.
Thomas R. Quinn, Jr.
/s/ Thomas R. Brugger
Thomas R. Brugger
/s/ Gary A. Manley
Gary A. Manley
/s/ Joel R. Zullinger
Joel R. Zullinger
/s/ Robert A. DeAlmeida
Robert A. DeAlmeida
/s/ Cindy J. Joiner
Cindy J. Joiner
/s/ Mark K. Keller
Mark K. Keller
/s/ Thomas D. Longenecker
Thomas D. Longenecker
/s/ Andrea Pugh
Andrea Pugh
/s/ Michael J. Rice
Michael J. Rice
/s/ Eric A. Segal
Eric A. Segal
/s/ Glenn W. Snoke
Glenn W. Snoke
/s/ Floyd E. Stoner
Floyd E. Stoner
President and Chief Executive Officer (Principal Executive Officer) and Director
March 16, 2020
Executive Vice President and Chief Financial Officer (Principal Financial Officer)
March 16, 2020
Senior Vice President and Principal Accounting Officer
March 16, 2020
Chairman of the Board and Director
March 16, 2020
Director
Director
Director
Director
Director
Director
Director
Director
Director
123
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
SUBSIDIARIES OF THE REGISTRANT
Exhibit 21
1. Orrstown Bank, Shippensburg, Pennsylvania; a state-chartered bank organized under the Pennsylvania Banking Code of 1965.
2. Wheatland Advisors, Inc, Lancaster, Pennsylvania; a Registered Investment Advisor.
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 23.1
We consent to the incorporation by reference in Registration Statement Nos. 333-225169, 333-196239, 333-33714 and 333-33712 on Form S-8 and Registration
Statement Nos. 333-234321, 333-208614 and 333-53405 on Form S-3 of Orrstown Financial Services, Inc. of our report dated March 16, 2020 relating to the
consolidated financial statements and effectiveness of internal control over financial reporting appearing in this Annual Report on Form 10-K.
/s/ Crowe LLP
Washington, D.C.
March 16, 2020
Exhibit 31.1
I, Thomas R. Quinn, Jr., certify that:
CERTIFICATION
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Orrstown Financial Services, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant’s internal control over financial reporting;
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a.
b.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal
control over financial reporting.
Date: March 16, 2020
By:
/s/ Thomas R. Quinn, Jr.
Thomas R. Quinn, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
I, Thomas R. Brugger, certify that:
CERTIFICATION
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Orrstown Financial Services, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this
report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and have:
a.
b.
c.
d.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant’s internal control over financial reporting;
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a.
b.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal
control over financial reporting.
Date: March 16, 2020
By:
/s/ Thomas R. Brugger
Thomas R. Brugger
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the Annual Report of Orrstown Financial Services, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2019 as
filed with the Securities and Exchange Commission on the date therein specified (the “Report”), I, Thomas R. Quinn, Jr., President and Chief Executive Officer of
the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of
and for the period covered by the Report.
Date: March 16, 2020
By:
/s/ Thomas R. Quinn, Jr.
Thomas R. Quinn, Jr.
President and Chief Executive Officer
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report of Orrstown Financial Services, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2019 as
filed with the Securities and Exchange Commission on the date therein specified (the “Report”), I, Thomas R. Brugger, Executive Vice President and Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of
and for the period covered by the Report.
Date: March 16, 2020
By:
/s/ Thomas R. Brugger
Thomas R. Brugger
Executive Vice President and Chief Financial Officer