Table of ~~financial holding companies and banks.~~Contents

The Dodd-Frank Act materially changed the regulation of financial institutions and the financial services industry and created a framework for regulatory reform. The Dodd-Frank Act and the regulations thereunder, some of which are still being drafted and implemented,include provisions affecting large and small financial institutions alike, including several provisions that affect the regulation of community banks and bank holding companies.

The Dodd-Frank Act, among other things, imposed new capital requirements on bank holding companies; changed the base for FDIC insurance assessments to a bank’s average consolidated total assets minus average tangible equity, rather than upon its deposit base; permanently raised the current standard deposit insurance limit to $250,000; and expanded the FDIC’s authority to raise insurance premiums. The legislation also called for the FDIC to raise its ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to “offset the effect” of increased assessments on insured depository institutions with assets of less than $10 billion.

The Dodd-Frank Act also included provisions that affect corporate governance and executive compensation at all publicly-traded companies and allows financial institutions to pay interest on business checking accounts. The legislation also restricts proprietary trading by banking organizations, places restrictions on the owning or sponsoring of hedge and private equity funds, and regulates the derivatives activities of banks and their affiliates. The Dodd-Frank Act established the Financial Stability Oversight Council to identify threats to the financial stability of the U.S., promote market discipline, and respond to emerging threats to the stability of the U.S. financial system.

The Dodd-Frank Act also established the Consumer Financial Protection Bureau (the "CFPB") as an independent entity funded by the FRB. The CFPB has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB’s rules contain provisions on mortgage-related matters such as steering incentives, and determinations as to a borrower’s ability to repay, loan servicing, and prepayment penalties. The CFPB has primary examination and enforcement authority over banks with over $10 billion in assets as to consumer financial products.

One of the announced goals of the CFPB is to bring greater consumer protection to the mortgage servicing market. The CFPB has defined a “qualified mortgage” for purposes of the Dodd-Frank Act, and set standards for mortgage lenders to determine whether a consumer has the ability to repay the mortgage. It has also issued regulations affording safe harbor legal protections for lenders making qualified loans that are not “higher priced.” The CFPB's regulations contain new mortgage servicing rules applicable to the Bank, which took effect in 2014. Changes affect notices to be given to consumers as to delinquency, foreclosure alternatives, modification applications, interest rate adjustments and options for avoiding “force-placed” insurance. Servicers are prohibited from processing foreclosures when a loan modification is pending, and must wait until a loan is more than 120 days delinquent before initiating a foreclosure action.

The servicer must provide direct and ongoing access to its personnel, and provide prompt review of any loss mitigation application. Servicers must maintain accurate and accessible mortgage records for the life of a loan and until one year after the loan is paid off or transferred.

The Bank presently services 5,000 or fewer mortgage loans which it owns or originated, so it is considered a “Small Servicer” and is exempt from certain parts of the mortgage servicing rules. The mortgage servicing requirements applicable to the Bank’s servicing operations under the new mortgage servicing rules are: adjustable rate mortgage interest rate adjustment notices; prompt payment crediting and payoff statements; limits on force-placed insurance; responses to written information requests and complaints of errors; and loss mitigation with regard to the first notice or filing for a foreclosure and no foreclosure proceedings if a borrower is performing pursuant to the terms of a loss mitigation agreement.

Federal Deposit Insurance

The ~~Bank’s~~FDIC's Deposit Insurance Fund provides insurance coverage for certain deposits, ~~are insured~~up to ~~applicable limits by the FDIC. The~~a standard maximum deposit insurance amount of $250,000 per depositor and is ~~$250,000 under~~funded through assessments on insured depository institutions, based on the ~~Dodd-Frank Act.~~

risk each institution poses to the Deposit Insurance Fund. The ~~FDIC is required~~Bank accepts client deposits that are insured by the Dodd-Frank Act to return its insurance reserve ratio to 1.35% no later than September 30, 2020. Once the fund reaches 1.15%, banks larger than $10 billion in assets will be required to assume the burden of bringing the fund to 1.35%.

~~On June 30, 2016, the Federal~~ Deposit Insurance Fund ~~reached the 1.15% ratio. As required by the Dodd-Frank Act, the FDIC changed its calculation of FDIC~~and, therefore, must pay insurance premiums. ~~Institutions are now assigned a base rate using their examination ratings, which is then adjusted~~The FDIC may increase the Bank’s insurance premiums based on their leverage ratio, net income before taxes to total assets ratio, nonperforming loans and leases to gross assets ratio, other real estate owned to gross assets ratio, loan mix index, and one-year asset growth rate. The result is then further adjusted to reflectvarious factors, including the FDIC’s assessment of its ~~level of unsecured debt issued, the level of unsecured depository institution debt it owns, and the level of brokered deposits (excluding reciprocal deposits) it has issued above regulatory minimums.~~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

~~Under the Dodd-Frank Act and applicable FRB policy, a bank holding company~~

Orrstown is ~~expected~~required to ~~act~~serve as a source of financial and managerial strength to ~~each of its subsidiary banks~~the Bank and, under appropriate conditions, to commit resources to ~~their support.~~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 ~~holding company~~and may ~~not have~~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 ~~it. Similarly, under~~financial assistance to the ~~cross-guarantee provisions~~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 ~~Federal Deposit Insurance Act (the “FDIA”),~~Bank. In the ~~FDIC can hold~~event of Orrstown's bankruptcy, any ~~FDIC-insured depository institution liable for any loss suffered or anticipated~~commitment by Orrstown to a federal bank regulatory agency to maintain the capital of the Bank would be assumed by the ~~FDIC in connection with the “default” of a commonly controlled FDIC-insured depository institution; or any assistance provided by the FDIC~~bankruptcy trustee and entitled to a ~~commonly controlled FDIC-insured depository institution “in danger~~priority of ~~default.”~~payment.

Pennsylvania Banking Law

The Pennsylvania Banking Code ~~(“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 ~~PDB~~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;~~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’s funding for cash~~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, ~~to its shareholders is derived from a variety of sources,~~ including ~~cash~~paying dividends and ~~temporary investments. One of the principal sources of those funds has historically been dividends received from the Bank. Various federal and state laws limit the amount~~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, ~~without~~including those related to regulatory ~~approval. In addition, federal bank~~capital requirements, general regulatory ~~agencies have authority~~oversight to ~~prohibit the Bank from engaging in an~~prevent unsafe or unsound ~~practice in conducting its business. The~~practices, and federal banking law requirements concerning the payment of dividends ~~depending upon~~out of net profits, surplus, and available earnings. Certain contractual restrictions also may limit the ~~financial condition of the bank in question, could be deemed to constitute an unsafe or unsound practice. 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 ~~future~~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%.

Table of Contents

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 ~~influenced~~deemed to control for these purposes. Transactions covered by ~~bank~~these provisions must be on arm’s-length terms and cannot exceed certain amounts which are determined with reference to the bank’s regulatory ~~policies~~capital. Moreover, if the transaction is a loan or other extension of credit, it must be secured by collateral in an amount and ~~capital guidelines.~~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 ~~by the Company and the Bank~~ with respect to capital requirements is incorporated by reference from Note ~~13,~~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~~

~~Effective January 1, 2015,~~capital rules adopted by the ~~Company~~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 ~~Bank became~~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, which substantially revised risk-based~~ capital ~~requirements. The Basel III Capital Rules revised~~rules, Orrstown's and the ~~definitions~~Bank’s assets, exposures, and ~~components of regulatory capital, addressed other issues affecting~~certain off-balance sheet items are subject to risk weights used to determine the ~~numerator in banking~~ institutions’ ~~regulatory~~risk-weighted assets. These risk-weighted assets are used to calculate the following minimum capital ratios ~~asset risk weights~~for Orrstown and ~~other matters affecting~~ the ~~denominator in banking institutions’ regulatory capital ratios and replaced~~Bank:

• CET1 Risk-Based Capital Ratio, equal to the ~~existing general risk-weighting approach.~~

~~The Basel III Capital Rules introduced a new capital measure called Common Equity Tier 1 and a related regulatory capital~~ ratio of CET1 capital to risk-weighted ~~assets; increased the minimum requirements for~~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 as well as~~Ratio, equal to the minimum levels to be considered well capitalized under prompt corrective action; and introduced the “capital conservation buffer,” designed to absorb losses during periods of economic stress. Institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer are subject to constraints on dividends, equity repurchases and discretionary bonuses to executive officers based on the amount of the shortfall. When fully phased-in on January 1, 2019, the capital standards applicable to the Parent Company and the Bank will include an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios inclusive of the capital conservation buffer of (i) CET1 to risk-weighted assets of at least 7%, (ii) 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 ~~at least 8.5%,~~goodwill, certain other intangible assets, and ~~(iii) Total~~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

Table of Contents

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 ~~at least 10.5%.~~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.

~~The Basel III Capital Rules~~Orrstown has the ability to provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized from net operating loss carrybacks and significant investments in unconsolidated financial entities be deducted from CET1additional capital to the ~~extent~~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 ~~any one such category exceeds 10% of CET1 or all such categories,~~results in the ~~aggregate, exceed 15%~~BHC owning or controlling 5% or more of ~~CET1.~~any class of voting securities of a bank or another BHC.

~~Under the Basel III Capital Rules, the effects~~

Acquisitions of Ownership of Orrstown

Acquisitions of Orrstown's voting stock above certain accumulated other comprehensive income items are not excluded from regulatory capital, including unrealized gains or losses on certain securities available for sale; however, certain banking organizations were able to make a one-time permanent election with the first filing of reports under the Basel III Capital Rules to continue to exclude these items. The Parent Company and Bank made this one-time permanent election, with the result that most AOCI items will be excluded from regulatory capital.

~~Implementation of the deductions and other adjustments to CET1 were phased in and will be fully implemented beginning January 1, 2018.~~

The Basel III Capital Rules prescribe a standardized approach for risk weightings that expands the risk-weighting categories to a larger and more risk-sensitive number of categories than previously used, depending on the nature of the assets. These categories generally range from 0%, for U.S. government and agency securities, to 600%, for certain equity exposures, and result in higher risk weights for a variety of asset categories.

~~Other Federal Laws and Regulations~~

~~The Company’s operations~~thresholds are subject to ~~additional~~prior regulatory notice or approval under federal banking laws, including the BHC Act and ~~regulations applicable to financial institutions, including, without limitation:~~

~~Privacy provisions~~the Change in Bank Control Act of 1978. Under the ~~Gramm-Leach-Bliley~~Change in Bank Control Act, (the "GLB Act") and related regulations, which require us to maintain privacy policies intended to safeguard customer financial information, to disclose the policies to our customers and to allow customers to “opt out” of having their financial service providers disclose their confidential financial information to non-affiliated third parties, subject to certain exceptions;

~~Right to Financial Privacy Act, which imposes~~ a ~~duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;~~

~~Consumer protection rules for the sale of insurance products by depository institutions, adopted pursuant~~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 ~~of the~~when acquiring shares in our stock.

Data Privacy

Federal and state law contains extensive consumer privacy protection provisions. The GLB ~~Act; and~~

~~the USA PATRIOT~~ Act ~~which~~ requires financial institutions to ~~take~~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 ~~actions~~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.

Table of Contents

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 ~~prevent,~~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 ~~prosecute international~~prevent the use of the U.S. financial system for money laundering and terrorist financing activities. The Bank Secrecy Act, as amended by the ~~financing~~PATRIOT Act, requires depository institutions and their holding companies to undertake activities including maintaining an anti-money laundering program, verifying the identity of ~~terrorism.~~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.

Table of Contents

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, ~~and~~ the Bank, and Wheatland do business, can affect the operating environment of ~~the Company and the Bank~~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~~

Nasdaq Capital Market

The Company’s common stock is listed on ~~The NASDAQ~~the Nasdaq Capital Market under the trading symbol “ORRF” and is subject to ~~NASDAQ’s~~Nasdaq’s rules for listed companies.

~~Competition~~Available Information

The Bank’s principal market area consists of Berks County, Cumberland County, Dauphin County, Franklin County, Lancaster County, and Perry County, Pennsylvania, and Washington County, Maryland. The Bank serves a substantial number of depositors in this market area and contiguous counties, with the greatest concentration in Chambersburg, Shippensburg, and Carlisle, Pennsylvania and the surrounding areas.

We are subject to ~~robust competition~~the informational requirements of the Exchange Act and, in our market areas. Like other depository institutions, we compete with less heavily regulated entities such as credit unions, brokerage firms, money market funds, consumer finance and credit card companies, and with other commercial banks, many of which are larger than the Bank. The principal methods of competing effectively in the

~~financial services industry include improving customer service through the quality and range of services provided, improving efficiencies and pricing services competitively. The Bank is competitive~~accordance with the ~~financial institutions in its service areas~~Exchange Act, we file annual, quarterly, and current reports, proxy statements, and other information with ~~respect to interest rates paid on time~~the SEC. The SEC maintains an Internet web site that contains reports, proxy statements, and ~~savings deposits, service charges on deposit accounts~~other information about issuers, like us, who file electronically with the SEC. The address of the site is www.sec.gov. The reports and ~~interest rates charged on loans.~~

~~We continue to implement strategic initiatives focused on expanding our core businesses and to explore, on an ongoing basis, acquisition, divestiture, and joint venture opportunities~~other information, including any related amendments, filed by us with, or furnished by us to, the ~~extent permitted~~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 ~~our regulators. We analyze each~~reference into this Annual Report on Form 10-K, information on those web sites is not part of our products and businesses in the context of shareholder return, customer 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.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.

Table of Contents

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. In 2017, we recorded a provision for loan losses of $1,000,000 compared with a provision expense totaling $250,000 in 2016. The Company recorded net charge-offs of $979,000 in 2017 compared with net charge-offs of $1,043,000 in 2016. Risk elements, including nonperforming loans, troubled debt restructurings still accruing, loans greater than 90 days past due still accruing, and other real estate owned totaled $11,987,000 at December 31, 2017 compared with $8,319,000 at December 31, 2016. 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, ~~trends in~~ 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 ~~the~~our financial condition ~~of the Company,~~and results of ~~operations and cash flows.~~operations.

The ALL was 1.27% of total loans and 116% of nonaccrual and restructured loans still accruing at December 31, 2017, compared with 1.45% of total loans and 160% of nonaccrual and restructured loans still accruing at December 31, 2016. In addition, at December 31, 2017, the top 25 lending relationships individually had commitments of $86,506,000, and an aggregate total outstanding loan balance of $182,950,000, or 18% of the loan portfolio.

The deterioration of one or more of ~~these loan~~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 ~~involves~~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.

~~Commercial and industrial loans comprise 11% of our loan portfolio.~~

The credit risk related to ~~these types of~~commercial and industrial loans is greater than the risk related to residential loans.

~~Our commercial and industrial loan portfolio grew by $27,198,000, or 31%, during the year ended December 31, 2017 to $115,663,000.~~

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

Table of Contents

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 ~~primarily in south central Pennsylvania and in Washington County, Maryland.~~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;~~competition, general economic ~~conditions;~~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.

Table of Contents

Risks Related to Competition and to Our Business Strategy

Difficult economic and market conditions ~~have~~can adversely ~~affected~~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 ~~customers'~~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 in 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 ~~customers’~~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 ~~loans,~~ 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~~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).~~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 ~~aggressive~~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.

Table of Contents

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.

Loans grew $126,621,000, or 14% from $883,391,000 at December 31, 2016, to $1,010,012,000 at December 31, 2017, due to organic growth through increases in consumer, commercial and commercial real estate loans. 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, ~~our asset quality metrics have improved sufficiently that~~ 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 ~~customers~~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 ~~customer~~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 ~~customers~~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.

~~The Company’s success depends, in large part, on our ability to attract and retain skilled people. We have, at times, experienced turnover among our senior officers.~~

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.

~~An interruption~~

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 ~~breach~~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 ~~security with respect to our information systems, or our outsourced service providers,~~the future, could ~~adversely impact the Company’s reputation and~~ have an adverse ~~impact~~effect on our business, financial condition, or ~~results~~operating results.

We face security risks, including denial of ~~operations.~~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.

~~Information~~Our computer systems and network infrastructure and those of third parties, on which we are ~~critical~~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 ~~business. We use various technological~~computer and data management systems ~~to manage our customer relationships, general ledger, securities investments, deposits and loans. We rely on software, communication, and information exchange on a variety of computing platforms~~ and networks, and ~~over~~in the ~~internet.~~ 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 ~~established policies~~been subject to, and ~~procedures~~are likely to ~~prevent~~continue to be the target of, cyber attacks. These cyber attacks include computer viruses, malicious or ~~limit~~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 ~~effect~~systems of ~~system failures, business interruptions and~~third parties or other security breaches ~~but~~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,

Table of Contents

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 ~~cannot~~may be ~~certain that all~~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 ~~entirely free from vulnerability~~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 ~~technological difficulties~~information or ~~failures. In addition, any compromise~~security breach that significantly degrades, deletes, or compromises the systems or data of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from security breaches.

~~We rely on the services of a variety of vendors to meet our data processing and communication needs. If these third-party providers encounter difficulties,~~one or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and we could be exposed to claims from customers. Any of these resultsmore financial entities could have a material ~~adverse~~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 ~~financial condition,~~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 ~~liquidity.~~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.

Table of Contents

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.

~~A failure~~

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 ~~internal~~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 ~~have a~~result in significant ~~negative impact not only~~harm to us. This could include client remediation costs, regulatory fines or penalties, litigation or enforcement actions, or limitations on our ~~earnings, but~~business activities. We could also ~~on the perception that customers, regulators~~suffer damage to our reputation, impacting our ability to attract and ~~investors may have of us.~~ retain clients and employees.

We continue to devote a significant amount of effort and resources to ~~continually~~constantly strengthening our controls and ensuring compliance with complex accounting standards and ~~banking~~ 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 ~~customers~~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 ~~customers,~~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.

Table of Contents

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.

Table of Contents

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.

~~The Dodd-Frank Act may affect the Company’s financial condition, results of operations, liquidity~~ A failure to comply, or to have adequate policies and ~~stock price.~~

The Dodd-Frank Act includes provisions affecting large and small financial institutions, including several provisions that affect how community banks and bank holding companies will be regulated in the future. Among other things, these provisions relax rules regarding interstate branching; allow financial institutions to pay interest on business checking accounts; change the scope of federal deposit insurance coverage; and impose new capital requirements on bank holding companies. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and will be subject to implementation regulations developed over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is not certain.

The Dodd-Frank Act created the CFPB which has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets are examined by their applicable bank regulators.

~~The Company may be required to invest significant management attention and resources to evaluate and make any changes necessary~~procedures designed to comply, with ~~new statutory~~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 ~~under the Dodd-Frank Act. Failure to comply~~for engaging in new activities, and could also injure our reputation with ~~the new requirements may negatively impact our results of operations~~clients and financial condition. While the Company cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.others with whom we do business.

Increases in FDIC insurance premiums may have a material adverse effect on our results of operations.

Market developments significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. As the fund continues to recover, the Company may be required to pay significantly higher premiums or additional special assessments or taxes that could adversely affect earnings.

We are generally unable to control the amount of premiums that are required to be paid for FDIC insurance. If there are ~~additional~~ bank or financial institution failures, the Company may be required to pay ~~even~~significantly higher ~~FDIC~~ premiums than the levels currently ~~imposed.~~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.

Table of Contents

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.

Any U.S. federal tax reform that lowers corporate tax rates could have a significant non-cash adverse effect on results of operations as the Company's net deferred tax asset would be impacted, resulting in an increase in tax expense. In December 2017, U.S. federal tax reform was enacted that, among other things, lowered our statutory tax rate to 21% effective January 1, 2018. As described more fully in Note 7, Income Taxes, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," the Company was required to remeasure its net deferred tax asset at the date the tax reform was enacted and incurred a $2,635,000 expense, which is included in total tax expense for 2017. We are unable to predict if, or when, any additional changes or proposals could be enacted.

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, ~~accounting for income taxes and the ability to recognize deferred tax assets, and~~ the fair value of certain financial instruments, particularly ~~securities.~~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 ~~impact~~materially affect how we report our financial results and condition.

From time to time, the ~~Company's financial condition and results of operations.~~

~~The Financial Accounting Standards Board (the "FASB"), the~~FASB, SEC and other regulatory bodies ~~periodically~~ change the financial accounting and reporting standards that govern the preparation of ~~the Company’s~~our consolidated financial statements. These changes ~~including the use of an expected loss impairment methodology in the determination of the ALL which will be effective for the Company beginning January 1, 2020,~~ can be ~~hard~~operationally complex to ~~predict~~implement and can materially impact how ~~the Company records~~we record and ~~reports its~~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 ~~some cases,~~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 ~~could be required~~will depend on whether we elect to ~~apply new or revised guidance retrospectively, which may result~~phase in the ~~revision~~impact of ~~prior financial statements by material amounts.~~ASU 2016-13 over a three year period. The ~~implementation~~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 ~~new or revised guidance could result in material adverse effects to our reported regulatory capital.~~ASU 2016-13.

The short-term and long-term impact of ~~the~~ changing regulatory capital requirements and new capital rules is ~~uncertain.~~uncertain.

The Basel III Capital Rules ~~which became effective for~~have targeted higher levels of base capital, certain capital buffers, and a migration toward common equity as the Company and Bank on January 1, 2015, established a new comprehensive capital framework for U.S. banking organizations, including community banks. The Basel III Capital Rules substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions. The Basel III Capital Rules define the componentskey source of ~~capital and address other issues affecting the numerator in banking institutions’~~ regulatory capital, ~~ratios,~~ as ~~well as address risk weights~~domestic and ~~other issues affecting the denominator in banking institutions’~~international bank regulatory ~~capital ratios.~~

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.~~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, ~~restructuring~~restructure our business models, and/or ~~increasing~~increase our holdings of liquid assets. ~~Implementation~~

Table of ~~changes~~Contents

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 ~~asset risk weightings~~detect and prevent the use of the U.S. financial system for ~~risk-based capital calculations, items included~~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 ~~deducted~~the policies, procedures, and systems of the financial institutions that we have already acquired or may acquire in ~~calculating~~the future are deficient, we would be subject to liability, including fines and regulatory ~~capital and/or additional capital conservation buffers could result in management modifying its business strategy and could limit~~actions such as restrictions on our ability to ~~make distributions,~~pay dividends and the necessity to obtain regulatory approvals to proceed with certain planned business activities, including ~~paying out dividends or buying back shares.~~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 ~~19,~~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 allegations of Southeastern Pennsylvania Transportation Authority's ("SEPTA") proposed second amended complaint disclosed the existence of a confidential, non-public, fact-finding inquiry regarding the Company being conducted by the SEC. On September 27, 2016, 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 agreement, the Company agreed to pay a civil money penalty of $1 million. On January 31, 2017, the Court entered a Case Management Order establishing the schedule for the litigation. The Case Management Order, among other things, sets the deadlines for the completion of discovery, the filing of motions and various pre-trial conferences. The trial is scheduled to begin on January 7, 2019.

~~The~~ Company believes that the allegations of ~~SEPTA's second~~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, ~~if any,~~or even a range of reasonably possible losses, in connection with the litigation. ~~However, there~~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 ~~block~~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.~~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 ~~need~~are required to maintain to support such growth.

Table of Contents

Risks Related to Owning our Stock

If the Company wants, ~~to,~~ or is compelled, to raise additional capital in the future, that capital may not be available when it is needed ~~and~~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, ~~2017,~~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,” ~~banking companies~~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 implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

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 and, thus, could dilute the per share book value and earnings per share~~ 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 ~~has been~~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 ~~14, Restrictions on Dividends, Loans~~16, Shareholders' Equity and ~~Advances,~~Regulatory Capital, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data."

ITEM 1B – UNRESOLVED STAFF COMMENTS

None.

Table of Contents

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 ~~Perry~~York Counties, Pennsylvania and Anne Arundel, Baltimore, Howard, and Washington ~~County,~~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 ~~customers~~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 ~~19,~~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.

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, ~~2018,~~2020, there were ~~approximately 2,700~~2,984 shareholders of record.

The ~~following table sets forth for each quarter of 2017 and 2016 the high and low sales prices per share of our common stock and the~~Board declared cash dividends ~~declared. Trading prices are based on published financial sources.~~

2017 2016
Market Price
Quarterly
Dividend
Market Price
Quarterly
Dividend
High Low High Low

First quarter $ 23.40
$ 20.00
$ 0.10
$ 18.11
$ 16.60
$ 0.08
Second quarter 23.00
19.05
0.10
19.95
17.05
0.09
Third quarter 26.55
22.15
0.10
23.73
17.59
0.09
Fourth quarter 26.95
24.15
0.12
23.75
18.05
0.09
$ 0.42
$ 0.35

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 ~~14, Restrictions on Dividends, Loans~~16, Shareholders' Equity and ~~Advances,~~Regulatory Capital, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data." On January ~~24, 2018,~~21, 2020, the Board declared a cash dividend of ~~$0.12~~$0.17 per common share, which was paid on February ~~9, 2018.~~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, ~~2017~~2019 to December 31, ~~2017. At~~2019. As of December 31, ~~2017,~~2019, 82,725 shares had been repurchased under the program at a total cost of ~~$1,438,000,~~$1.4 million, or $17.38 per ~~share. The~~share and the maximum number of shares that may yet be purchased under the plan is 333,275 ~~shares at December 31, 2017.~~shares.

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$1.0 billion and $5$5.0 billion, the S&P 500 Index, and the NASDAQ Composite index. The graph assumes an investment of $100 on December 31, ~~2012~~2014 and reinvestment of dividends on the date of payment without commissions. Shareholder returns on our common stock are based ~~upon~~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.

Period Ending
Index 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 12/31/17
Orrstown Financial Services, Inc. 100.00
169.61
176.35
187.42
239.80
275.16
SNL Bank $1B-$5B Index 100.00
145.41
152.04
170.20
244.85
261.04
S&P 500 Index 100.00
132.39
150.51
152.59
170.84
208.14
NASDAQ Composite Index 100.00
140.12
160.78
171.97
187.22
242.71


	Period Ending
Index	12/31/14	12/31/15	12/31/16	12/31/17	12/31/18	12/31/19
Orrstown Financial Services, Inc.	100.00	106.28	135.98	156.03	114.89	146.90
SNL Bank $1B-$5B Index	100.00	111.94	161.04	171.69	150.42	182.85
S&P 500 Index	100.00	101.38	113.51	138.29	132.23	173.86
NASDAQ Composite Index	100.00	106.96	116.45	150.96	146.67	200.49

Source : S&P Global Market Intelligence © ~~2017~~2020

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.

Table of Contents

ITEM 6 – SELECTED FINANCIAL DATA


	At or For The Year Ended December 31,
	2019			2018			2017			2016			2015
Summary of Operations
Interest income	$	92,994		$	65,667		$	51,453		$	42,276		$	39,013
Interest expense	23,699			13,511			7,644			5,417			4,301
Net interest income	69,295			52,156			43,809			36,859			34,712
Provision for loan losses	900			800			1,000			250			(603)
Net interest income after provision for loan losses	68,395			51,356			42,809			36,609			35,315
Investment securities gains	4,749			1,006			1,190			1,420			1,924
Noninterest income	23,792			20,018			18,759			18,005			16,876

Noninterest expenses	77,302			57,935			50,330			48,140			44,607
Income before income tax expense	19,634			14,445			12,428			7,894			9,508
Income tax expense	2,710			1,640			4,338			1,266			1,634
Net income	$	16,924		$	12,805		$	8,090		$	6,628		$	7,874
Per Share Information
Basic earning per share	$	1.63		$	1.53		$	1.00		$	0.82		$	0.97
Diluted earnings per share	1.61			1.50			0.98			0.81			0.97

Dividends paid per share	0.60			0.51			0.42			0.35			0.22
Book value per share	19.93			18.39			17.34			16.28			16.08

Weighted average shares outstanding – basic	10,362			8,360			8,070			8,059			8,106
Weighted average shares outstanding – diluted	10,514			8,537			8,226			8,145			8,142
Stock Price Statistics
Close	$	22.62		$	18.21		$	25.25		$	22.40		$	17.84
High	23.48			27.05			26.95			23.75			18.45
Low	17.30			18.10			19.05			16.60			15.10
Price earnings ratio at close	13.9			11.9			25.3			27.3			18.4
Diluted price earnings ratio at close	14.0			12.1			25.8			27.7			18.4
Price to book at close	1.1			1.0			1.5			1.4			1.1

Year-End Information
Total assets	$	2,383,274		$	1,934,388		$	1,558,849		$	1,414,504		$	1,292,816
Loans	1,644,330			1,247,657			1,010,012			883,391			781,713
Total investment securities	506,570			476,686			425,305			408,124			402,844
Deposits – noninterest-bearing	249,450			204,843			162,343			150,747			131,390
Deposits – interest-bearing	1,626,072			1,353,913			1,057,172			1,001,705			900,777
Total deposits	1,875,522			1,558,756			1,219,515			1,152,452			1,032,167
Repurchase agreements	8,269			9,069			43,576			35,864			29,156
Borrowed money	241,514			170,309			133,815			76,163			84,495
Total shareholders’ equity	223,249			173,433			144,765			134,859			133,061
Assets under management – market value	1,613,223			1,330,595			1,370,950			1,174,143			966,362
Financial Ratios
Average equity / average assets	9.26		%	8.75		%	9.49		%	10.41		%	10.66		%
Return on average equity	8.21		%	8.56		%	5.73		%	4.80		%	5.99		%

Return on average assets	0.76		%	0.75		%	0.54		%	0.50		%	0.64		%

At or For The Year Ended December 31,
(Dollars in thousands except per share information) 2017 2016 2015 2014 2013
Summary of Operations
Interest and dividend income $ 51,015
$ 41,962
$ 38,635
$ 38,183
$ 37,098
Interest expense 7,644
5,417
4,301
4,159
5,011
Net interest income 43,371
36,545
34,334
34,024
32,087
Provision for loan losses 1,000
250
(603 ) (3,900 ) (3,150 )
Net interest income after provision for loan losses 42,371
36,295
34,937
37,924
35,237
Investment securities gains 1,190
1,420
1,924
1,935
332
Noninterest income 19,197
18,319
17,254
16,919
17,476
Noninterest expenses 50,330
48,140
44,607
43,768
43,247
Income before income tax expense (benefit) 12,428
7,894
9,508
13,010
9,798
Income tax expense (benefit) 4,338
1,266
1,634
(16,132 ) (206 )
Net income $ 8,090
$ 6,628
$ 7,874
$ 29,142
$ 10,004
Per Share Information
Basic earning per share $ 1.00
$ 0.82
$ 0.97
$ 3.59
$ 1.24
Diluted earnings per share 0.98
0.81
0.97
3.59
1.24
Dividends per share 0.42
0.35
0.22
0.00
0.00
Book value at December 31 17.34
16.28
16.08
15.40
11.28
Weighted average shares outstanding – basic 8,070,472
8,059,412
8,106,438
8,110,344
8,093,306
Weighted average shares outstanding – diluted 8,226,261
8,145,456
8,141,600
8,116,054
8,093,306
Stock Price Statistics
Close $ 25.25
$ 22.40
$ 17.84
$ 17.00
$ 16.35
High 26.95
23.75
18.45
17.50
18.00
Low 19.05
16.60
15.10
15.33
9.49
Price earnings ratio at close 25.3
27.3
18.4
4.7
13.2
Diluted price earnings ratio at close 25.8
27.7
18.4
4.7
13.2
Price to book at close 1.5
1.4
1.1
1.1
1.4
Year-End Information
Total assets $ 1,558,849
$ 1,414,504
$ 1,292,816
$ 1,190,443
$ 1,177,812
Loans 1,010,012
883,391
781,713
704,946
671,037
Total investment securities 425,305
408,124
402,844
384,549
416,864
Deposits – noninterest-bearing 162,343
150,747
131,390
116,302
116,371
Deposits – interest-bearing 1,057,172
1,001,705
900,777
833,402
884,019
Total deposits 1,219,515
1,152,452
1,032,167
949,704
1,000,390
Repurchase agreements 43,576
35,864
29,156
21,742
9,032
Borrowed money 133,815
76,163
84,495
79,812
66,077
Total shareholders’ equity 144,765
134,859
133,061
127,265
91,439
Assets under management – market value 1,370,950
1,174,143
966,362
1,017,013
1,085,216
Financial Ratios
Average equity / average assets 9.49 % 10.41 % 10.66 % 8.63 % 7.45 %
Return on average equity 5.73 % 4.80 % 5.99 % 28.78 % 11.30 %
Return on average assets 0.54 % 0.50 % 0.64 % 2.48 % 0.84 %

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. ~~The Company's~~Our profitability for the years ended December 31, ~~2017, 2016~~2019, 2018 and ~~2015~~2017 was influenced by ~~its~~our continued organic growth and ongoing expansion into targeted markets, ~~while it maintained improvement in~~the acquisitions of Mercersburg and Hamilton, and a continued focus on maintaining strong asset ~~quality from prior years.~~quality. These and other matters are discussed more fully below.

Critical Accounting ~~Policies~~Estimates

The Company's consolidated financial statements are prepared in accordance with GAAP, and follow general practices within the financial services industry. Application of these principles involves complex judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are based on historical experiences and other factors, which we believe are reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations.

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." ~~These~~In applying those accounting policies, ~~along with~~ the ~~disclosures presented~~Company's management is required to exercise judgment in determining many of the other consolidated financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods,methodologies, assumptions and estimates ~~underlying those amounts, the Company has identified the adequacy~~to be utilized. Certain of the ~~ALL and accounting for income taxes as~~ critical accounting ~~policies.~~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.

~~The ALL represents management’s estimate of probable incurred~~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. ~~Determining~~A provision for credit losses is recorded to adjust the ~~amount~~level of the ALL ~~is considered a complex accounting estimate because it requires significant~~as deemed necessary by management. In estimating losses inherent in the loan portfolio, assumptions and judgment ~~and the use of estimates related~~are applied to ~~the amount~~measure amounts and timing of expected future cash flows, ~~on impaired loans, estimated losses on pools of homogeneous loans based on historical~~collateral values and other factors used to determine the borrowers’ abilities to repay obligations. Historical loss ~~experience, and consideration of current~~trends are also considered, as are economic conditions, industry trends, portfolio trends and ~~conditions, all~~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 ~~which may be susceptible~~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 ~~significant change. The loan portfolio~~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 ~~represents~~in adjustment of the ~~largest asset on~~ALL, or, in the ~~consolidated balance sheets.~~case of loans acquired at a discount, increases in interest income in future periods.

~~The Company recognizes deferred tax~~

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 ~~future effects of temporary differences and tax credits. Enacted tax rates~~particular items being valued. Quoted market prices are applied to cumulative temporary differences based on expected taxable income in the periods in which the deferred tax asset or liability is anticipated to be realized. Future tax rate changes could occur that would require the recognition of income or expense in the statement of income in the period in which they are enacted. The Company records deferred tax assets to the extent the Company believes these assets will more likely than not be realized, utilizing a valuation allowance if all or a portion of the deferred tax assets is not so considered to be realized. In making this determination, the Company considers all available evidence, including future reversals of existing deferred tax liabilities, projected future taxable income, feasible and prudent tax planning strategies and recent financial operating results. In the event the Company was to determine that it would be able to realize deferred tax assets in the future in excess of their net recorded amount, an adjustment to the valuation allowance would be made that would impact income tax expense. Management may need to modify its judgment in this regard, from one period to another, should a material change occur in the business environment, tax legislation, or in any other business factor that could impair the Company’s ability to benefit from the asset in the future.

~~On December 22, 2017, federal tax reform legislation, commonly~~ referred to when estimating fair values for certain assets, such as ~~the Tax Cuts~~most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and ~~Jobs Act~~assumptions to value such items. Examples of ~~2017 (the "Tax Act"), was enacted. Among~~these items include loans, deposits, borrowings, goodwill, core deposit and other things, the Tax Act reduced the Company's statutory federal tax rate from 34% to 21% effective January 1, 2018. As a result, we were required to remeasure, through income tax expense, certain deferred taxintangible assets, other assets and liabilities ~~using~~obtained or assumed in business combinations, and capitalized servicing assets. These valuations require the ~~enacted rate at~~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 ~~expect them to~~must assess whether there are any declines in value below the carrying value of assets that should be ~~recovered~~considered other than temporary or ~~settled. The remeasurement~~otherwise require an adjustment in carrying value and recognition of our net deferred tax asset resulted in additional federal deferred tax expense of $2,635,000, which is included in total tax expense for 2017. The Company's deferred tax assets related to low-income housing credit and alternative minimum tax credit carryforwards were not impacted by the change in statutory tax rate, as they are treated as payments on future federal income taxes due and are not subject to remeasurement. However, the Tax Act did change alternative minimum tax credit carryforwards to be refundable credits. To reflect this change, the Company reclassed its alternative minimum tax credit carryforwards, totaling $5,343,000 at December 31, 2017, from deferred tax assets to other assetsa loss in the consolidated ~~balance sheets.~~statements of income. Examples include investment securities, loan servicing rights, goodwill and core deposit and other intangible assets, among others.

Readers of ~~the~~our consolidated financial statements should be aware that the estimates and assumptions used in ~~the Company’s~~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.

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 ~~has~~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, ~~increased above~~around the ~~modest two percent average~~globe. The fast spread of the ~~recent expansion. The passage of tax cuts, a federal budget with significantly increased government spending,~~virus and the ~~possibility~~fear that has occurred has created a high level of ~~an infrastructure bill all contribute~~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 ~~a more positive consensus~~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 ~~for 2018. This expansion is now within 14 months of becoming the longest expansion since World War II. There are signs that~~remains uncertain at this ~~expansion is reaching maturity: credit spreads are near their historical lows, the unemployment rate has approached four percent, and the yield curve is flatter.~~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 ~~over the last several years have been~~remain modest ~~however, with the current unemployment rate~~ and ~~fiscal stimulus on the way, concerns that~~there is great uncertainty about when, or if, inflation ~~may~~will increase ~~faster than the last several years are starting to make their way into economic forecasts~~ and ~~may~~ 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. During the first two of the three years presented in this financial statement review, interest rates were near all-time lows. The FRB began raising short term interest rates in December 2015 and raised the Fed Funds rate 25 basis points four more times between December of 2016 and December of 2017. The yield curve shifted upward with the increase in the Fed Funds rate with short term rates increasing further than long term rates resulting in a flatter yield curve. The Company has been able to grow its net interest income by ~~$9,037,000~~$17.1 million from ~~2015~~2018 to ~~2017,~~2019, through ~~the~~a combination of organic growth ~~of loans~~ and ~~higher yielding securities in combination with slower increases in its funding costs.~~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 ~~$8,090,000, $6,628,000~~$16.9 million, $12.8 million and ~~$7,874,000~~$8.1 million for 2019, 2018 and 2017, ~~2016 and 2015.~~respectively. Diluted earnings per share totaled $1.61, $1.50 and $0.98 ~~$0.81~~for 2019, 2018 and ~~$0.97 for 2017, 2016 and 2015.~~2017.

Net interest income totaled ~~$43,371,000, $36,545,000~~$69.3 million, $52.2 million and ~~$34,334,000~~$43.8 million for 2019, 2018 and 2017, ~~2016 and 2015,~~respectively, principally reflecting our expanded geographic footprint, as well as organic growth in loans from an expanded sales force ~~and efforts~~as we continued to ~~expand our geographic footprint while taking~~take advantage of market opportunities. ~~A higher~~As previously noted, interest ~~rate environment each year contributed~~rates increased throughout 2017 and 2018 and decreased throughout 2019, contributing to ~~increased~~fluctuations in yields on loans and investments, and, to a lesser extent, costs of interest-bearing liabilities.

~~Favorable historical charge-off data~~Asset quality trends continue to exhibit low levels of charge-offs and ~~management's emphasis on loan quality have impacted our results, as the allowance for loan losses has remained stable as loans have increased.~~non-performing loans. The provision for loan losses totaled ~~$1,000,000~~$900 thousand, $800 thousand and ~~$250,000~~$1.0 million in 2019, 2018 and 2017, ~~and 2016. In 2015, a negative provision or recovery of amounts previously provided for or charged-off totaling $(603,000) was recognized.~~respectively.

Noninterest expenses totaled ~~$50,330,000, $48,140,000~~$77.3 million, $57.9 million and ~~$44,607,000~~$50.3 million for 2019, 2018 and 2017, ~~2016 and 2015.~~respectively. The changes in certain components of noninterest expenses between years reflect the ~~years are reflective of the Company's~~Mercersburg and Hamilton acquisitions, and our continued focus on investing in additional talent and locations to better serve the needs of our ~~customers~~clients, particularly in Lancaster and ~~efforts to develop new relationships by taking advantage of market opportunities created by consolidation of other banks.~~Dauphin Counties, Pennsylvania, and in Maryland. Salaries and employee benefits expense increased ~~$2,314,000~~$2.4 million from ~~2015~~2017 to ~~2016~~2018 and ~~$3,775,000~~$7.0 million from ~~2016~~2018 to ~~2017.~~2019. Occupancy and furniture and fixture costs increased ~~$544,000~~$923 thousand from ~~2015~~2017 to ~~2016~~2018 and ~~$414,000~~$1.9 million from ~~2016~~2018 to ~~2017.~~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 ~~$4,338,000, $1,266,000~~$2.7 million, $1.6 million and ~~$1,634,000~~$4.3 million for ~~2017, 2016~~2019, 2018 and ~~2015,~~2017, or an effective tax rate of ~~34.9%~~13.8%, ~~16.0%~~11.4% and ~~17.2%~~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 ~~$2,635,000,~~$2.6 million, which is included in ~~total~~income tax expense for the year ended December 31, 2017.

Table of Contents

Net Interest Income

Net interest income is the primary component of ~~the Company's~~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. ~~The net~~Net interest spread represents the difference between the yields earned on interest-earning assets and the rates paid for interest-bearing liabilities. ~~The net~~Net interest margin is ~~defined as~~ 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. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, remained at 3.25% during most of 2015. In December 2015, the prime rate increased 25 basis points to 3.50% and remained at that level through most of 2016. In December 2016, the prime rate increased 25 basis points to end the year at 3.75%. During 2017, the prime rate increased ~~75 basis points (25~~25 basis points in each of March, June and ~~December)~~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 ~~customers~~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 ~~$43,371,000, $36,545,000~~$69.3 million, $52.2 million and ~~$34,334,000~~$43.8 million in 2019, 2018 and 2017, ~~2016 and 2015.~~respectively. The following table presents net interest income, net interest spread and net interest margin on a taxable-equivalent basis for ~~2017, 2016~~2019, 2018 and ~~2015.~~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 ~~34%~~21% federal corporate tax rate for ~~2017~~2019 and ~~2016~~2018 and ~~35%~~34% for ~~2015,~~2017, reflecting our statutory tax rates for those years.

~~Effective January 1, 2018, the Tax Act changed our statutory tax rate to 21%. As a result~~

Table of ~~this lower tax rate, taxable-equivalent adjustments in future years will be less than if the 2017 tax rate had remained in effect.~~

Contents


																										2019										2018								2017
	2017								2016								2015									Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate		Average Balance		Taxable- Equivalent Interest		Taxable- Equivalent Rate
(Dollars in thousands)	Average Balance			Taxable- Equivalent Interest			Taxable- Equivalent Rate		Average Balance			Taxable- Equivalent Interest			Taxable- Equivalent Rate		Average Balance			Taxable- Equivalent Interest			Taxable- Equivalent Rate
Assets																									Assets
Federal funds sold and interest-bearing bank balances	$	15,487		$	218		1.41	%	$	31,452		$	208		0.66	%	$	18,901		$	81		0.43	%	Federal funds sold and interest-bearing bank balances	$	58,100	$	1,339	2.30	%	$	16,442	$	327	1.99	%	$	15,487	$	218	1.41	%
Taxable securities	326,900			7,478			2.29		303,124			6,012			1.98		348,613			6,697			1.92		Taxable securities	435,839		14,530		3.33		359,852		10,858		3.02		326,900		7,478		2.29
Tax-exempt securities	93,683			4,748			5.07		57,231			2,767			4.83		33,055			1,629			4.93
Tax-exempt securities ⁽¹⁾																									Tax-exempt securities ⁽¹⁾	63,443		2,600		4.10		119,665		4,873		4.07		93,683		4,748		5.07
Total securities	420,583			12,226			2.91		360,355			8,779			2.44		381,668			8,326			2.18		Total securities	499,282		17,130		3.43		479,517		15,731		3.28		420,583		12,226		2.91
Taxable loans	893,555			38,568			4.32		774,984			32,036			4.13		687,079			28,787			4.19	%
Tax-exempt loans	50,797			2,450			4.82		58,281			2,848			4.89		59,600			3,094			5.19
Taxable loans ⁽²⁾⁽³⁾																									Taxable loans ⁽²⁾⁽³⁾	1,432,951		73,201		5.11		1,053,308		49,151		4.67		893,555		39,006		4.37
Tax-exempt loans ^(1)(2)(3)																									Tax-exempt loans ^(1)(2)(3)	59,864		2,367		3.95		47,318		1,875		3.96		50,797		2,450		4.82
Total loans	944,352			41,018			4.34		833,265			34,884			4.19		746,679			31,881			4.27		Total loans	1,492,815		75,568		5.06		1,100,626		51,026		4.64		944,352		41,456		4.39
Total interest-earning assets	1,380,422			53,462			3.87		1,225,072			43,871			3.58		1,147,248			40,288			3.51		Total interest-earning assets	2,050,197		94,037		4.59		1,596,585		67,084		4.20		1,380,422		53,900		3.90
Cash and due from banks	20,391								20,803								19,155								Cash and due from banks	25,046						18,951						20,391
Bank premises and equipment	35,055								31,413								24,386								Bank premises and equipment	40,982						35,399						35,055
Other assets	65,293								61,391								56,894								Other assets	123,362						72,960						65,293
Allowance for loan losses	(12,738		)						(13,529		)						(14,134		)						Allowance for loan losses	(14,466)						(13,298)						(12,738)
Total	$	1,488,423							$	1,325,150							$	1,233,549							Total	$	2,225,121					$	1,710,597					$	1,488,423
Liabilities and Shareholders’ Equity																									Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	648,174		2,148			0.33		$	565,524		1,195			0.21		$	500,474		908			0.18		Interest-bearing demand deposits	$	920,025	8,253		0.90		$	767,863	4,968		0.65		$	648,174	2,148		0.33
Savings deposits	94,815			150			0.16		90,272			144			0.16		85,068			136			0.16		Savings deposits	138,761		261		0.19		102,189		159		0.16		94,815		150		0.16
Time deposits	292,616			3,836			1.31		289,574			3,472			1.20		263,414			2,562			0.97
Time deposits ⁽⁴⁾																									Time deposits ⁽⁴⁾	549,937		10,796		1.96		324,118		5,102		1.57		292,616		3,836		1.31
Short-term borrowings	97,814			784			0.80		56,387			187			0.33		85,262			295			0.35		Short-term borrowings	32,001		623		1.95		81,172		1,577		1.94		97,814		784		0.80
Long-term debt	36,336			726			2.00		24,335			419			1.72		22,522			400			1.78		Long-term debt	80,636		1,779		2.21		83,640		1,632		1.95		36,336		726		2.00
Subordinated notes																									Subordinated notes	31,842		1,987		6.24		1,139		73		6.41		—		—		—
Total interest-bearing liabilities	1,169,755			7,644			0.65		1,026,092			5,417			0.53		956,740			4,301			0.45		Total interest-bearing liabilities	1,753,202		23,699		1.35		1,360,121		13,511		0.99		1,169,755		7,644		0.65
Noninterest-bearing demand deposits	161,917								147,473								134,040								Noninterest-bearing demand deposits	234,354						183,387						161,917
Other	15,450								13,612								11,316								Other	31,544						17,427						15,450
Total Liabilities	1,347,122								1,187,177								1,102,096								Total Liabilities	2,019,100						1,560,935						1,347,122
Shareholders’ Equity	141,301								137,973								131,453								Shareholders’ Equity	206,021						149,662						141,301
Total	$	1,488,423							$	1,325,150							$	1,233,549							Total	$	2,225,121					$	1,710,597					$	1,488,423
Taxable-equivalent net interest income / net interest spread				45,818			3.22	%				38,454			3.05	%				35,987			3.06	%	Taxable-equivalent net interest income / net interest spread			70,338		3.24	%			53,573		3.21	%			46,256		3.25	%
Taxable-equivalent net interest margin							3.32	%							3.14	%							3.14	%	Taxable-equivalent net interest margin					3.43	%					3.36	%					3.35	%
Taxable-equivalent adjustment				(2,447		)						(1,909		)						(1,653		)			Taxable-equivalent adjustment			(1,043)						(1,417)						(2,447)
Net interest income				$	43,371							$	36,545							$	34,334				Net interest income			$	69,295					$	52,156					$	43,809
Ratio of average interest-earning assets to average interest-bearing liabilities																									Ratio of average interest-earning assets to average interest-bearing liabilities					117	%					117	%					118	%



~~Note:~~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 ~~34%~~21% tax rate in ~~2017~~2019 and ~~2016,~~2018, and ~~35%~~34% in ~~2015.~~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.

Table of Contents

The following table presents changes in net interest income on a taxable-equivalent basis for ~~2017, 2016~~2019, 2018 and ~~2015~~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	$	828	$	184	$	1,012	$	13	$	96	$	109
Taxable securities	2,292		1,380		3,672		754		2,626		3,380
Tax-exempt securities	(2,289)		16		(2,273)		1,317		(1,192)		125
Taxable loans	17,715		6,335		24,050		6,974		3,171		10,145
Tax-exempt loans	497		(5)		492		(168)		(407)		(575)
Total interest income	19,043		7,910		26,953		8,890		4,294		13,184
Interest Expense
Interest-bearing demand deposits	984		2,301		3,285		397		2,423		2,820
Savings deposits	57		45		102		12		(3)		9
Time deposits	3,555		2,139		5,694		413		853		1,266
Short-term borrowings	(955)		1		(954)		(133)		926		793
Long-term debt	(59)		206		147		945		(39)		906
Subordinated notes	1,968		(54)		1,914		73		—		73
Total interest expense	5,550		4,638		10,188		1,707		4,160		5,867
Taxable-Equivalent Net Interest Income	$	13,493	$	3,272	$	16,765	$	7,183	$	134	$	7,317

2017 Versus 2016 Increase (Decrease)
Due to Change in 2016 Versus 2015 Increase (Decrease)
Due to Change in
(Dollars in thousands)
Average
Volume

Average
Rate
Total
Average
Volume

Average
Rate
Total
Interest Income
Federal funds sold and interest-bearing bank balances $ (106 ) $ 116
$ 10
$ 54
$ 73
$ 127
Taxable securities 472
994
1,466
(874 ) 189
(685 )
Tax-exempt securities 1,762
219
1,981
1,191
(53 ) 1,138
Taxable loans 4,901
1,631
6,532
3,683
(434 ) 3,249
Tax-exempt loans (366 ) (32 ) (398 ) (68 ) (178 ) (246 )
Total interest income 6,663
2,928
9,591
3,986
(403 ) 3,583
Interest Expense
Interest-bearing demand deposits 175
778
953
118
169
287
Savings deposits 7
(1 ) 6
8
0
8
Time deposits 36
328
364
254
656
910
Short-term borrowings 137
460
597
(100 ) (8 ) (108 )
Long-term debt 207
100
307
32
(13 ) 19
Total interest expense 562
1,665
2,227
312
804
1,116
Net Interest Income $ 6,101
$ 1,263
$ 7,364
$ 3,674
$ (1,207 ) $ 2,467



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.

~~2017~~2019 versus ~~2016~~2018

In ~~2017,~~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 ~~$7,364,000,~~$16.8 million, or ~~19.2%~~31.3%, compared with ~~2016.~~2018. The Company’s net interest spread increased 17three basis ~~point~~points to ~~3.22%~~3.24% for ~~2017~~2019 compared with ~~2016.~~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 ~~$6,134,000,~~$24.5 million, or ~~17.6%~~48.1%, from ~~2016~~2018 to ~~2017.~~2019. The increase resulted from an increase in both average loan volume and yield, with average loans increasing ~~$111,087,000,~~$392.2 million, or ~~13.3%~~35.6%, and yield increasing 1542 basis points from ~~4.19%~~4.64% in ~~2016~~2018 to ~~4.34%~~5.06% in ~~2017.~~2019. The Company's geographic expansion and sales efforts with additional loan officers continued to drive loan growth in ~~2017~~2019 across most loan classes. Increases in prime lending rates ~~during the year~~in 2018 contributed to ~~the~~an increased yield in the first half of 2019, but ~~a flattening~~were partially offset by rate decreases in the second half. In addition, the middle of the yield curve ~~partially offset the benefit~~inverted for much of 2019, which lowered the rate ~~increases.~~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 ~~$3,447,000,~~$1.4 million, or ~~39.3%~~8.9%, from ~~2016~~2018 to ~~2017,~~2019, with both average volume and yield increasing. Average securities increased ~~$60,228,000,~~$19.8 million, or ~~16.7%~~4.1%, and the taxable-equivalent yield increased from ~~2.44%~~3.28% in ~~2016~~2018 to ~~2.91%~~3.43% in ~~2017.~~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 ~~environment in 2017, a higher composition of tax free~~ securities, ~~with accompanying higher taxable-equivalent yields and strategic moves within the portfolio~~which fell as the ~~interest rate environment changed.~~Federal Reserve reduced short-term rates by 75 basis points in the second half of 2019.

Table of Contents

Interest expense on deposits and borrowings increased ~~$2,227,000~~$10.2 million from ~~2016~~2018 to ~~2017,~~2019, as the average balance of interest-bearing liabilities increased ~~$143,663,000,~~$393.1 million, or ~~14.00%~~28.9%. ~~Generally,~~Interest expense on interest-bearing deposits declined less than the ~~cost of interest-bearing liabilities has increased at a slower pace than yields earned on interest-earning assets~~decline in ~~2017, as~~market rates due to competitive factors in the ~~market for interest-bearing liabilities was initially slower to respond to interest rate changes.~~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 ~~$82,650,000,~~$152.2 million, or ~~14.6%,~~19.8% in ~~2017.~~2019, of which approximately $51.0 million was acquired in the Hamilton acquisition. Interest expense for these deposits increased ~~$953,000,~~$3.3 million, with the cost of funds increasing from ~~0.21%~~0.65% in ~~2016~~2018 to ~~0.33%~~0.90% in ~~2017.~~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 ~~increased~~decreased our average short-term ~~and long-term~~ borrowings in ~~2017 to partially fund loan~~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 ~~investment portfolio growth.~~acquisition activity and for general corporate purposes. Borrowings generally have higher interest rates associated with ~~them.~~them than interest-bearing deposits. Interest expense on all borrowings increased ~~$904,000~~$1.1 million in ~~2017,~~2019, with average balances ~~increasing $41,427,000~~decreasing $49.2 million for short-term borrowings ~~and $12,001,000 for~~while long-term

~~borrowings.~~ borrowings also decreased $3.0 million. The average rate paid on short-term borrowings increased from ~~0.33%~~1.94% in ~~2016~~2018 to ~~0.80%~~1.95% in ~~2017~~2019 and the average rate paid on long-term borrowings increased from ~~1.72%~~1.95% in ~~2016~~2018 to ~~2.00%~~2.21% in ~~2017.~~2019.

~~2016~~2018 versus ~~2015~~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 ~~$2,467,000,~~$7.0 million, or ~~6.9%~~15.2%, ~~from 2015 to 2016.~~compared with 2017. The Company’s net interest spread decreased 1six basis point to ~~3.05%~~3.16% for ~~2016~~2018 compared with 2015. Despite higher average balances in loans during 2016 compared with 2015 and a 25 basis point increase in the prime lending rate between the years, a flattening yield curve as the market reacted to slowing economic growth negatively impacted the2017. Taxable-equivalent yields on loans and caused funding costs to increase. Payments on and maturities of existing loans were reinvested at lower rates due to competitive market conditions. An increase in securities yields helped increase the average yield earned on interest-earning assets ~~for 2016 compared with 2015~~ and ~~helped maintain~~costs of interest-bearing liabilities both increased from 2017 to 2018, reflecting the ~~net interest margin at the same 3.14% as in 2015. The average~~increased interest rate ~~increased as~~environment between years. Other factors impacting the ~~Company was able~~comparison of taxable-equivalent yields between 2017 and 2018 included the effect of purchase accounting related to ~~invest a large portion of~~ the ~~additional funds at~~Mercersburg acquisition; the Company's gradual increase in rates ~~above~~paid on interest-bearing deposits in response to market demand; and the ~~FRB's target for the Fed Funds~~change in our statutory tax rate.

Interest income on a taxable-equivalent basis on loans increased ~~$3,003,000,~~$9.2 million, or ~~9.4%~~22.4%, from ~~2015~~2017 to ~~2016.~~2018. The increase ~~in interest income on loans was primarily a result of~~resulted from an increase in both average loan volume ~~offset partially by a decrease in~~and yield, ~~which decreased eight~~with average loans increasing $156.3 million, or 16.5%, and yield increasing 22 basis points from ~~4.27% for 2015~~4.34% in 2017 to ~~4.19% for 2016. Average loans increased $86,586,000 from 2015~~4.56% in 2018. The Company's geographic expansion and sales efforts with additional loan officers continued to ~~2016 and reflected successful sales efforts~~drive loan growth in 2018 across most loan classes. ~~Favorable market conditions and~~Increases in prime lending rates during the ~~addition of several seasoned loan officers~~year contributed to ~~loan growth. However, new loans added were generally at lower rates than~~ the ~~existing portfolio.~~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 ~~$453,000,~~$3.5 million, or ~~5.4%~~28.7%, from ~~2015~~2017 to ~~2016. The~~2018, with both average ~~balance of~~volume and yield increasing. Average securities ~~decreased $21,313~~increased $58.9 million, or 14.0%, and yield increased from ~~2015~~2.91% in 2017 to ~~2016, with funds obtained from maturing and prepaying securities used to fund a portion of the Company's loan growth.~~3.28% in 2018. Contributing to the increase in interest income on securities was ~~a higher composition of tax free securities, and~~ the higher ~~tax-equivalent yields associated with them. The Company sold its~~rate environment in 2018 and strategic moves within the portfolio ~~of GSE CMOs in February 2016 and it took longer to deploy~~as the ~~funds into new loans than originally anticipated.~~interest rate environment changed.

Interest expense on deposits and borrowings increased ~~$1,116,000~~$5.8 million from ~~2015~~2017 to ~~2016,~~2018, as the average balance of interest-bearing liabilities increased ~~$69,352,000,~~$190.4 million, or ~~7.25%~~16.3%. Our cost of funds on interest-bearing liabilities also increased, from 0.45% for 2015 to 0.53% for 2016. The $910,000 increase, or 23 basis points, in interest expense on time deposits from 2015 to 2016 was the primary contributor to the overall increase.

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. The Company has been able to gather both noninterest-bearing and interest-bearing deposit relationships from enhanced cash management offerings as it increases its commercial relationships. Thedeposits 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 ~~liabilities is influenced by changes~~deposits in ~~short-term interest rates.~~ 2018 in response to market conditions, but at a slower pace than yields earned on interest-earning assets.

We also ~~paid a higher rate on certain intermediate-term brokered deposits~~increased our short-term and long-term borrowings in 2018 to ~~help protect earnings from a rising rate environment~~partially fund loan and ~~incurred $108,000~~investment portfolio growth. In late 2018, we issued $32.5 million in aggregate principal amount of ~~accelerated interest expense on~~subordinated notes, the ~~call~~proceeds of ~~brokered certificates~~which were designated for the cash portion of ~~deposits in 2016.~~

~~The increase in deposits enabled us to decrease our use of short-term borrowings, which~~merger and acquisition activity and for general corporate purposes. Borrowings generally have higher interest rates associated with ~~them. The~~them than interest-bearing deposits. Interest expense on all borrowings increased $1.8 million in 2018, with average ~~balance of~~balances decreasing $16.6 million for short-term borrowings ~~decreased $28,875,000 from 2015~~while long-term borrowings increased $47.3 million as the Company responded to ~~2016.~~the changing interest rate environment. The average rate paid on short-term borrowings ~~decreased 2 basis points~~increased from ~~2015~~0.80% in 2017 to ~~2016. We added to our~~1.94% in 2018 and the average rate paid on long-term borrowings ~~during 2016, with an average balance increase~~decreased from 2.00% in 2017 to 1.95% in 2018.

Table of ~~$1,813,000 from 2015 to 2016, with an associated increase in expense of $19,000.~~Contents

Provision for Loan Losses

The Company recorded a provision for loan losses of ~~$1,000,000~~$900 thousand, $800 thousand and ~~$250,000~~$1.0 million in 2019, 2018, and 2017, ~~and 2016, and a negative provision for loan losses, or a reversal of amounts previously provided, of $(603,000) in 2015.~~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 ~~2017~~2019, 2018 and 2016. The provision expense in 2017 principally reflected a charge-off on one commercial loan that was downgraded to nonaccrual status in the fourth quarter. The negative provision in 2015 was the result of a recovery on a loan with prior charge-offs totaling this amount, as well as significant improvement in asset quality metrics from prior years. Favorable charge-off data, combined with relatively stable economic and market conditions, resulted in the determination that a negative provision could be recorded in 2015 despite net charge-offs for the periods, as ALL coverage metrics remained strong.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 ~~2017, 2016~~2019, 2018 and ~~2015.~~2017.


																		2019		2018		2017		$ Change						% Change
(Dollars in thousands)	2017		2016		2015		$ Change						% Change
							2017-2016			2016-2015			2017-2016		2016-2015
																		2019		2018		2017										2019-2018	2018-2017	2019-2018	2018-2017

Service charges on deposit accounts	$	5,675	$	5,445	$	5,226	$	230		$	219		4.2	%	4.2	%	Service charges on deposit accounts	$	3,404	$	3,233	$	3,057	$	171	$	176	5.3	%	5.8	%
Interchange income																	Interchange income	3,281		2,821		2,618		460		203		16.3	%	7.8	%
Other service charges, commissions and fees	1,008		994		1,223		14			(229		)	1.4	%	(18.7	)%	Other service charges, commissions and fees	805		907		570		(102)		337		(11.2)	%	59.1	%
Loan swap referral fees																	Loan swap referral fees	1,197		—		—		1,197		—		—	%	—	%
Trust and investment management income	6,400		5,091		4,598		1,309			493			25.7	%	10.7	%	Trust and investment management income	7,255		6,576		6,400		679		176		10.3	%	2.8	%
Brokerage income	1,896		1,933		2,025		(37		)	(92		)	(1.9	)%	(4.5	)%	Brokerage income	2,426		2,035		1,896		391		139		19.2	%	7.3	%
Mortgage banking activities	2,919		3,412		2,747		(493		)	665			(14.4	)%	24.2	%	Mortgage banking activities	3,049		2,663		2,919		386		(256)		14.5	%	(8.8)	%
Earnings on life insurance	1,109		1,099		1,025		10			74			0.9	%	7.2	%
Income from life insurance																	Income from life insurance	2,044		1,463		1,109		581		354		39.7	%	31.9	%

Other income	190		345		410		(155		)	(65		)	(44.9	)%	(15.9	)%	Other income	331		320		190		11		130		3.4	%	68.4	%
Subtotal before securities gains	19,197		18,319		17,254		878			1,065			4.8	%	6.2	%	Subtotal before securities gains	23,792		20,018		18,759		3,774		1,259		18.9	%	6.7	%
Investment securities gains	1,190		1,420		1,924		(230		)	(504		)	(16.2	)%	(26.2	)%	Investment securities gains	4,749		1,006		1,190		3,743		(184)		372.1	%	(15.5)	%
Total noninterest income	$	20,387	$	19,739	$	19,178	$	648		$	561		3.3	%	2.9	%	Total noninterest income	$	28,541	$	21,024	$	19,949	$	7,517	$	1,075	35.8	%	5.4	%

~~2017~~2019 versus ~~2016~~2018

Noninterest income increased ~~$648,000~~$7.5 million from ~~2016~~2018 to ~~2017. The~~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 ~~contributed to~~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.

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 ~~2017~~2018 as a result of new product offerings and increased activity associated with deposit growth.

~~Increased trust~~•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 ~~was realized throughout~~increased more modestly in 2018 than in 2017, ~~from favorable market conditions and~~reflecting a reduction in fee income in the ~~addition~~latter part of ~~an office in Berks County, Pennsylvania. Wheatland, which was acquired in December 2016, contributed approximately 39% of this increased revenue category in 2017.~~2018 as financial markets declined.

•The decrease in mortgage banking activities reflects a combination of overall decreased refinance activity as interest rates ~~have~~ increased ~~some slight compression in sales profit margins that~~and a shortage of available housing inventory during the ~~Company has experienced and the portion of mortgage production retained for the Company's loan portfolio.~~year.

~~Other income decreased in 2017~~•Income from life insurance increased principally due to ~~lower gains on sales of other real estate owned.~~death benefit proceeds.

•In both ~~2017~~2018 and ~~2016,~~2017, asset/liability management strategies resulted in net gains on sales of securities, as market ~~and interest rate~~ conditions presented opportunities ~~to accelerate earnings on securities, while meeting funding requirements of the Company. In 2017, the Company repositioned a part of its investment portfolio at a gain~~ to improve responsiveness of the portfolio to ~~increases in short-term interest rates.~~

~~2016 versus 2015~~

~~Noninterest income increased $561,000 from 2015 to 2016. The following factors contributed to that net increase.~~

Service charges on deposit accounts increased due principally to revenues generated from new cash management product offerings and higher interchange fees associated with increased usage by our customers

Other service charges, commissions and fees decreased in comparing 2016 with 2015. In 2015, these revenues were favorably impacted by gains on sale of Small Business Administration and U.S. Department of Agriculture loans.

Trust, investment management and brokerage income increased $401,000 for 2016 compared with 2015. Trust and brokerage income in 2016 included increased estate fees partially offset by lower brokerage income. The addition of Wheatland as an investment manager had a modest impact on 2016 revenues as that acquisition occurred in December 2016.

~~Favorable~~ interest rate conditions, ~~supported increased new home purchases and refinancing activity resulting in the increase in mortgage banking revenue.~~

~~Other income reflected, in part, decreased gains on sales of other real estate owned as well as changes due to customary business activities.~~

For both years, asset/liability management strategies and interest rate conditions resulted in gains on sales of securities, as market conditions presented opportunities to accelerate earnings on securities through gains, while also ~~meeting the~~considering funding requirements of ~~current and~~ anticipated lending activity.

Noninterest Expenses

The following table compares noninterest expenses for ~~2017, 2016~~2019, 2018 and ~~2015.~~2017.


							$ Change						% Change
	2019		2018		2017		2019-2018		2018-2017		2019-2018		2018-2017

Salaries and employee benefits	$	39,495	$	32,524	$	30,145	$	6,971	$	2,379	21.4	%	7.9	%
Occupancy	4,325		3,084		2,806		1,241		278		40.2	%	9.9	%
Furniture and equipment	4,723		4,079		3,434		644		645		15.8	%	18.8	%
Data processing	3,599		2,674		2,271		925		403		34.6	%	17.7	%

Automated teller machine and interchange fees	1,015		806		767		209		39		25.9	%	5.1	%
Advertising and bank promotions	1,967		1,592		1,600		375		(8)		23.6	%	(0.5)	%
FDIC insurance	367		681		606		(314)		75		(46.1)	%	12.4	%
Legal fees	585		413		802		172		(389)		41.6	%	(48.5)	%
Other professional services	2,369		1,434		1,571		935		(137)		65.2	%	(8.7)	%
Directors' compensation	1,003		984		996		19		(12)		1.9	%	(1.2)	%


Taxes other than income	1,018		1,012		866		6		146		0.6	%	16.9	%
Intangible asset amortization	1,570		286		102		1,284		184		449.0	%	180.4	%

Merger related and branch consolidation expenses	8,964		3,197		—		5,767		3,197		180.4	%	—	%
Insurance claim receivable write off	615		—		—		615		—		—	%	—	%
Other operating expenses	5,687		5,169		4,364		518		805		10.0	%	18.4	%
Total noninterest expenses	$	77,302	$	57,935	$	50,330	$	19,367	$	7,605	33.4	%	15.1	%

Table of Contents

$ Change % Change
(Dollars in thousands) 2017 2016 2015 2017-2016 2016-2015 2017-2016 2016-2015

Salaries and employee benefits $ 30,145
$ 26,370
$ 24,056
$ 3,775
$ 2,314
14.3 % 9.6 %
Occupancy 2,806
2,491
2,221
315
270
12.6 % 12.2 %
Furniture and equipment 3,434
3,335
3,061
99
274
3.0 % 9.0 %
Data processing 2,271
2,378
2,026
(107 ) 352
(4.5 )% 17.4 %
Telephone and communication 647
740
692
(93 ) 48
(12.6 )% 6.9 %
Automated teller machine and interchange fees 767
748
798
19
(50 ) 2.5 % (6.3 )%
Advertising and bank promotions 1,600
1,717
1,564
(117 ) 153
(6.8 )% 9.8 %
FDIC insurance 606
775
859
(169 ) (84 ) (21.8 )% (9.8 )%
Legal 802
850
1,440
(48 ) (590 ) (5.6 )% (41.0 )%
Other professional services 1,571
1,332
1,262
239
70
17.9 % 5.5 %
Directors' compensation 996
969
737
27
232
2.8 % 31.5 %
Collection and problem loan 186
238
447
(52 ) (209 ) (21.8 )% (46.8 )%
Real estate owned 69
239
162
(170 ) 77
(71.1 )% 47.5 %
Taxes other than income 866
767
916
99
(149 ) 12.9 % (16.3 )%
Regulatory settlement 0
1,000
0
(1,000 ) 1,000
(100.0 )% 100.0 %
Other operating expenses 3,564
4,191
4,366
(627 ) (175 ) (15.0 )% (4.0 )%
Total noninterest expenses $ 50,330
$ 48,140
$ 44,607
$ 2,190
$ 3,533
4.5 % 7.9 %
2019 versus 2018

~~2017 versus 2016~~

Noninterest expenses increased ~~$2,190,000~~$19.4 million from ~~2016~~2018 to ~~2017. The~~2019. In addition to the impact of the Mercersburg and Hamilton acquisitions, the following were significant factors ~~contributed to~~in that net increase.

•The salaries and employee benefits increase includes the impact in ~~2017~~2019 of additional employees, including new ~~customer-facing~~client-facing employees in new branches in targeted expansion markets and others that were hired throughout ~~2016~~2018 and ~~2017.~~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 ~~2017, increased medical benefit costs for the expanded workforce~~2018 and ~~increased claim activity,~~ incentive compensation increases, ~~and~~ 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 ~~acquired~~opened in ~~2016 in Berks, Cumberland, Dauphin~~2017 and ~~Lancaster counties, Pennsylvania, as well as increases attributable to new facilities acquired in 2017~~2018, principally in Lancaster County, Pennsylvania.

~~Advertising and bank promotion expense in 2016 included higher expenses related to expansion activities.~~

•The ~~FDIC reached its 1.15% of insured funds target in June 2016, resulting in lower assessments. FDIC insurance expense in 2017 benefited from that lower assessment applied to our increased deposit base.~~

~~Resolution of the SEC administrative proceedings in 2016 generally resulted in lower legal fees incurred in 2017. However, the~~ Company incurred certain indemnification costs totaling ~~$645,000,~~$645 thousand, which isare included in legal fees, ~~with~~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.

~~In 2016, the Company agreed to pay a $1,000,000 civil money penalty~~•Intangible asset amortization increased due to the ~~Securities and Exchange Commission to settle administrative proceedings.~~

Principal contributors to lower other operating expenses in 2017 were decreases in provision expense for off-balance sheet reserves on loans that have been committed to borrowers, but not funded, resulting from changes in qualitative factors similar to those usedcore deposit intangible recorded in the ~~determination~~Mercersburg acquisition.

•Merger related costs were principally for investment banking and legal and consulting fees for the Mercersburg acquisition.

Table of ~~the provision for loan losses, and reduced consumer fraud expenses.~~Contents

•Other line items within noninterest expenses ~~reflect~~ are generally attributable to normal fluctuations in the conduct of business.

~~2016 versus 2015~~

~~Noninterest expenses increased $3,533,000 from 2015 to 2016. The following factors contributed to that net increase.~~

The increase in salaries and employee benefits reflects the impact of adding new customer-facing employees in markets targeted for expansion as well as merit increases. Other drivers were additional medical expense incurred for new employees and increased claim activity, increased expense associated with supplemental executive compensation and compensation related to share-based awards granted in 2016.

~~Consistent with our growth strategy in which new facilities were acquired in Berks, Cumberland, Dauphin and Lancaster counties, we experienced increases in occupancy, furniture and equipment expenses.~~

~~Increases in data processing and telephone and communication expenses reflect our volume and physical growth and costs associated with more sophisticated product and service offerings.~~

Advertising and bank promotion increased principally due to $100,000 of incremental Educational Improvement Tax Credit contributions (a component of Pennsylvania tax credits) made in 2016 and increased expenditures related to brand marketing and expansion in new markets.

~~The Company benefited from a lower assessment rate as the FDIC reached its 1.15% of insured funds target on June 20, 2016.~~

Legal fees decreased as the Company had higher than normal legal expenses in 2015 as it attended to legal matters, including outstanding litigation against the Company and an investigation with the SEC which began in the second quarter of 2015 and concluded in the third quarter of 2016. Although certain legal matters were ongoing, the legal expenses associated with them in 2016 were less than the levels in 2015.

The increase in directors' compensation includes fees associated with two new directors added to the Board of Directors in 2016 and increased expense in 2016 for share-based compensation. In 2015, share-based compensation was only in effect for seven months of the year.

Collection and problem loan expense decreased as a result of a lower level of classified loans that were being worked out by the Company. Partially offsetting this expense benefit was an increase in real estate owned expense of $77,000 from 2015 to 2016.

A significant portion of the decrease in taxes, other than income, relates to incremental Educational Improvement Tax Credit contribution credits for qualifying contributions made in 2016 versus 2015, and which largely offset the related increase in advertising and bank promotions noted above.

~~The Company incurred and paid a civil money penalty of $1,000,000 to the SEC in 2016 to settle administrative proceedings against the Company.~~

~~Other line items within noninterest expenses reflect modest changes from 2015 to 2016 and are generally attributable to normal fluctuations in the conduct of business.~~

Income Taxes

Income tax expense totaled ~~$4,338,000, $1,266,000~~$2.7 million, $1.6 million and ~~$1,634,000~~$4.3 million for 2019, 2018 and 2017, ~~2016~~respectively. The effective tax rate for 2019 was 13.8% compared with 11.4% for 2018 and ~~2015. As described more fully~~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 7,8, Income Taxes, to the Consolidated Financial Statements under Part II, Item 8, "Financial Statements and Supplementary Data," ~~due to tax reform enacted in 2017 the Company was required to remeasure its net deferred tax asset and incurred a tax expense of $2,635,000, which is included in total tax expense for 2017.~~

~~Note 7 also~~ 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. The effective tax rate for 2017 was 34.9% compared with 16.0% for 2016 and 17.2% for 2015. Generally, our effective tax rate is lower than the federal statutory tax rate principally due to nontaxable interest earned on tax-free loans and securities and earnings on the cash surrender value of life insurance policies, offset partially by nondeductible expenses. In 2017, our higher effective tax rate was principally impacted by the tax expense incurred due to enacted tax reform. Effective January 1, 2016, the Company changed its statutory federal tax rate from 35% to 34% to reflect its assessment that it will not be in the higher tax bracket. As a result, income tax expense for 2016 increased $185,000 due to the application of the new rate to existing deferred balances.

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.

~~The Company has~~We have established investment policies and an asset management policy to assist in administering ~~its~~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~~repurchase agreements and other factors while trying to maximize return on the investments. ~~The Company~~We may segregate ~~its~~our investment portfolio into three categories: “securities held to maturity,” “trading securities” and “securities available for sale.” ~~Management~~At December 31, 2019, management has classified the entire securities portfolio as available for sale, which ~~are~~is accounted for at current market value with unrealized gains and losses excluded from earnings and reported in ~~other comprehensive income,~~OCI, net of income taxes.

~~The Company’s~~Our securities available for sale portfolio includes debt ~~and equity~~ 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 ~~extent~~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 ~~the Company~~we will have to sell the security prior to recovery, or if ~~it is~~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 ~~other-than-temporary~~OTTI impairment in earnings and the remaining portion in ~~other comprehensive income.~~OCI. Given the strong asset quality of ~~the~~our debt security portfolio, ~~the Company~~we did not record any ~~other-than-temporary impairment~~OTTI expense in ~~2017, 2016~~2019, 2018 or ~~2015.~~2017.

~~For equity securities, when the Company has decided to sell an impaired available for sale security and does not expect the fair value~~

Table of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other-than-temporary even if a decision to sell has not been made. The Company recorded no other-than-temporary impairment expense on equity securities for the years ended December 31, 2017, 2016 and 2015.Contents

The following table summarizes the fair value of securities available for sale at December ~~31.~~31, 2019, 2018 and 2017.


	2019		2018		2017



States and political subdivisions	$	87,863	$	145,004	$	159,458
GSE residential mortgage-backed securities	—		—		49,530

GSE residential CMOs	68,154		108,064		111,119
Non-agency CMOs	17,087		—		—

Private label residential CMOs	—		143		1,003
Private label commercial CMOs	86,629		75,045		7,653
Asset-backed and other	230,653		137,588		86,545
Total debt securities	$	490,386	$	465,844	$	415,308

(Dollars in thousands) 2017 2016 2015

U.S. Government Agencies $ 0
$ 39,592
$ 47,227
States and political subdivisions 159,458
164,282
125,961
GSE residential mortgage-backed securities 49,530
116,944
132,349
GSE residential CMOs 111,119
69,383
15,843
GSE commercial CMOs 0
4,856
63,770
Private label residential CMOs 1,003
5,006
8,901
Private label commercial CMOs 7,653
0
0
Asset-backed 86,431
0
0
Total debt securities 415,194
400,063
394,051
Equity securities 114
91
73
Totals $ 415,308
$ 400,154
$ 394,124

~~The Company~~We modestly increased ~~its~~our investment portfolio in ~~2017 to generate additional interest income,~~2019, with the average balance of securities increasing from ~~$360,355,000~~$479.5 million for the year ended December 31, ~~2016~~2018 to ~~$420,583,000~~$499.3 million for the year ended December 31, ~~2017.~~2019.

In ~~early 2017, the Company liquidated its U.S. Government Agencies investments~~late 2018, we increased our holdings of longer maturity state and political subdivisions in anticipation of ~~a flattening yield curve, with funds reinvested in fixed rate CMOs. The Company also took advantage of historically wide spreads and higher~~falling interest rates. In 2019, interest rates ~~to add modestly to its holdings~~fell and the attractiveness of longer-term fixed rate securities issued by states and political subdivisions. In the second half of 2017, the Company reduced its holdings of seasoned GSE residential mortgage-backed securities and intermediate maturity taxable securities issued by statestax-free state and political subdivisions declined. In response, we reduced our holdings of longer maturity tax-free state and ~~reinvested the proceeds in~~political subdivisions at a gain. We replaced these securities with additional asset-backed and private label commercial CMOs that were either floating rate ~~asset-backed~~or had shorter average lives than the state and political subdivision investments.

Asset-backed securities ~~in anticipation of further increases in short-term interest rates.~~

In 2016, as a result of interest rate market conditions, the Company liquidated its GSE commercial CMOs portfolio during the first quarter of 2016 at a net gain of $1,420,000. The proceeds from the sale were used to fund loan growth, reduce short-term borrowings and maintain liquidity for the first half of 2016. In the third quarter of 2016, the Company elected to reduce liquidity and enhance interest income through the purchase of securities, primarily GSE residential CMOs.

~~Management anticipates the loan portfolio will continue to grow in 2018. Asset backed securities, MBSs~~ and CMOs provide monthly cash flows that may be used, in part, to meet ~~this~~ anticipated loan ~~demand.~~demand in 2020, as management anticipates the loan portfolio will continue to grow.

Table of Contents

The following table shows the maturities of investment securities at book value at December 31, ~~2017,~~2019, and weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a ~~34%~~21% federal income tax rate.


																	Within 1 year			After 1 year but within 5 years			After 5 years but within 10 years			After 10 years			Total
(Dollars in thousands)	Within 1 year			After 1 year but within 5 years			After 5 years but within 10 years			After 10 years			Total

States and political subdivisions																States and political subdivisions
Book value	$	0		$	8,712		$	49,958		$	95,133		$	153,803		Book value	$	230		$	—		$	26,346		$	57,031		$	83,607
Yield	0.00		%	3.29		%	3.82		%	4.56		%	4.25		%	Yield	2.00		%	—		%	3.16		%	4.11		%	3.80		%
Average maturity (years)	0.0			3.9			8.0			16.4			12.9			Average maturity (years)	0.4			—			8.5			16.7			14.0
GSE residential mortgage-backed securities
Book value	0			0			0			48,600			48,600
Yield	0.00		%	0.00		%	0.00		%	2.57		%	2.57		%
Average maturity (years)	0.0			0.0			0.0			46.0			46.0

GSE residential CMOs																GSE residential CMOs
Book value	0			0			0			113,658			113,658			Book value	$	—		$	—		$	—		$	67,928		$	67,928
Yield	0.00		%	0.00		%	0.00		%	2.07		%	2.07		%	Yield	—		%	—		%	—		%	2.82		%	2.82		%
Average maturity (years)	0.0			0.0			0.0			28.6			28.6			Average maturity (years)	—			—			—			23.8			23.8
Private label residential CMOs
Non-agency CMOs																Non-agency CMOs
Book value	0			0			0			999			999			Book value	$	—		$	—		$	—		$	17,210		$	17,210
Yield	0.00		%	0.00		%	0.00		%	2.34		%	2.34		%	Yield	—		%	—		%	—		%	3.22		%	3.22		%
Average maturity (years)	0.0			0.0			0.0			18.1			18.1			Average maturity (years)	—			—			—			29.9			29.9

Private label commercial CMOs																Private label commercial CMOs
Book value	0			0			0			7,809			7,809			Book value	$	—		$	—		$	3,950		$	82,754		$	86,704
Yield	0.00		%	0.00		%	0.00		%	2.75		%	2.75		%	Yield	—		%	—		%	2.51		%	3.03		%	3.00		%
Average maturity (years)	0.0			0.0			0.0			17.4			17.4			Average maturity (years)	—			—			5.5			17.5			16.9
Asset-backed
Asset-backed and other																Asset-backed and other
Book value	0			0			3,808			82,979			86,787			Book value	$	—		$	—		$	9,874		$	225,670		$	235,544
Yield	0.00		%	0.00		%	2.30		%	2.31		%	2.31		%	Yield	—		%	—		%	4.18		%	2.67		%	2.73		%
Average maturity (years)	0.0			0.0			8.4			23.1			16.9			Average maturity (years)	—			—			5.8			22.3			21.6
Total																Total
Book value	$	0		$	8,712		$	53,766		$	349,178		$	411,656		Book value	$	230		$	—		$	40,170		$	450,593		$	490,993
Yield	0.00		%	3.29		%	3.72		%	2.89		%	3.01		%	Yield	2.00		%	—		%	3.35		%	2.96		%	2.99		%
Average maturity (years)	0.0			3.9			8.0			26.1			23.3			Average maturity (years)	0.4			—			7.5			21.2			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, ~~2017,~~2019, the weighted average estimated life is ~~5.1~~3.4 years for mortgage-backed and CMO securities, and ~~8.3~~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 ~~our~~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 ~~$22,100,000~~$34.0 million at December 31, ~~2017.~~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."

Table of Contents

The following table presents the loan portfolio, excluding residential LHFS, by segments and classes at December 31.


	2019		2018		2017		2016		2015
Commercial real estate:
Owner-occupied	$	170,884	$	129,650	$	116,811	$	112,295	$	103,578
Non-owner occupied	361,050		252,794		244,491		206,358		145,401
Multi-family	106,893		78,933		53,634		47,681		35,109
Non-owner occupied residential	120,038		100,367		77,980		62,533		54,175
Acquisition and development:
1-4 family residential construction	15,865		7,385		11,730		4,663		9,364
Commercial and land development	41,538		42,051		19,251		26,085		41,339
Commercial and industrial	214,554		160,964		115,663		88,465		73,625
Municipal	47,057		50,982		42,065		53,741		57,511
Residential mortgage:
First lien	336,372		235,296		162,509		139,851		126,022
Home equity – term	14,030		12,208		11,784		14,248		17,337
Home equity – lines of credit	165,314		143,616		132,192		120,353		110,731
Installment and other loans	50,735		33,411		21,902		7,118		7,521
Total loans ⁽¹⁾	$	1,644,330	$	1,247,657	$	1,010,012	$	883,391	$	781,713

(Dollars in thousands) December 31, 2017 December 31, 2016 December 31, 2015 December 31, 2014 December 31, 2013
Commercial real estate:
Owner-occupied $ 116,811
$ 112,295
$ 103,578
$ 100,859
$ 111,290
Non-owner occupied 244,491
206,358
145,401
144,301
135,953
Multi-family 53,634
47,681
35,109
27,531
22,882
Non-owner occupied residential 77,980
62,533
54,175
49,315
55,272
Acquisition and development:
1-4 family residential construction 11,730
4,663
9,364
5,924
3,338
Commercial and land development 19,251
26,085
41,339
24,237
19,440
Commercial and industrial 115,663
88,465
73,625
48,995
33,446
Municipal 42,065
53,741
57,511
61,191
60,996
Residential mortgage:
First lien 162,509
139,851
126,022
126,491
124,728
Home equity – term 11,784
14,248
17,337
20,845
20,131
Home equity – lines of credit 132,192
120,353
110,731
89,366
77,377
Installment and other loans 21,902
7,118
7,521
5,891
�� 6,184
$ 1,010,012
$ 883,391
$ 781,713
$ 704,946
$ 671,037

⁽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, ~~2017~~2019 increased ~~$126,621,000,~~$396.7 million, or ~~14.3%~~31.8%, from December 31, ~~2016. Loan~~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 ~~was experienced in most loan classes. We have hired and anticipate hiring additional lenders as we continue to grow~~has occurred in both core ~~markets~~ and ~~in new~~newer markets, such as Lancaster County, Pennsylvania, principally in commercial real estate; and Dauphin counties, Pennsylvania, through expansion of our sales force and by capitalizing on continued disruption caused by the acquisition of some of our competitors by larger institutions. Commercial real estate experienced the largest dollar increase and grew by $64,049,000, or 14.9%. The residential mortgage loan segment grew $32,033,000, or 11.7%. Commercialin commercial and industrial loans ~~grew $27,198,000, or 30.7%,~~ and ~~reflected management's additional emphasis~~installment and other loans as we focused on increasing diversification in ~~2017 on growing this segment to increase portfolio diversification. In 2017, we also purchased approximately $15,000,000 of automobile financing loans, which are included~~the portfolio. The growth in installment and other loans in 2017 through 2019 was principally attributable to purchased automobile financing loans at higher returns ~~higher~~ 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 ~~industry.~~segment. The Bank’s lending policy ~~defines an industry concentration as one~~reports segment concentrations that exceeds ~~25%~~20% of the Bank’s total risk-based capital ("RBC"). The following ~~industries~~segments met this criteria at December 31, ~~2017:~~2019.


	Balance		% of Total Loans	% of Total RBC
Office space	$	147,945	9.0%	63.8%
Strip retail shopping centers	51,119		3.1%	22.1%
Multi-family commercial real estate	111,227		6.8%	48.0%

(Dollars in thousands) Balance % of Total Loans % of Total RBC

Office space $88,159 8.7% 59.2%
Strip retail shopping centers 41,929 4.2% 28.1%

Table of Contents

The following table presents expected maturities of certain loan classes by fixed rate or adjustable rate categories at December 31, ~~2017.~~2019.


										Due In
	Due In									One Year or Less		One Year Through Five Years		After Five Years		Total
(Dollars in thousands)	One Year or Less		One Year Through Five Years		After Five Years		Total
Acquisition and development:									Acquisition and development:
1-4 family residential construction									1-4 family residential construction
Fixed rate	$	0	$	0	$	6,138	$	6,138	Fixed rate	$	1,098	$	—	$	6,305	$	7,403
Adjustable and floating rate	4,734		0		858		5,592		Adjustable and floating rate	4,684		—		3,778		8,462
	4,734		0		6,996		11,730			5,782		—		10,083		15,865
Commercial and land development									Commercial and land development
Fixed rate	574		713		3,360		4,647		Fixed rate	64		8,243		7,559		15,866
Adjustable and floating rate	1,639		374		12,591		14,604		Adjustable and floating rate	1,697		1,930		22,045		25,672
	2,213		1,087		15,951		19,251			1,761		10,173		29,604		41,538
Commercial and industrial									Commercial and industrial
Fixed rate	757		36,428		16,064		53,249		Fixed rate	2,581		66,550		36,589		105,720
Adjustable and floating rate	40,053		8,174		14,187		62,414		Adjustable and floating rate	57,866		18,125		32,843		108,834
	40,810		44,602		30,251		115,663			60,447		84,675		69,432		214,554
	$	47,757	$	45,689	$	53,198	$	146,644		$	67,990	$	94,848	$	109,119	$	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, ~~2017,~~2019, these semi-fixed loans totaled ~~$17,479,000.~~$31.4 million.

Asset Quality

Risk Elements

The Company’s loan portfolio is subject to varying degrees of credit risk. Credit risk is ~~mitigated~~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.

Table of Contents

The following table presents the Company’s risk elements and relevant asset quality ratios at December 31.


	2019			2018			2017			2016			2015
Nonaccrual loans ⁽¹⁾	$	10,657		$	5,165		$	9,843		$	7,043		$	16,557
OREO	197			130			961			346			710
Total nonperforming assets	10,854			5,295			10,804			7,389			17,267
Restructured loans still accruing	979			1,132			1,183			930			793
Loans past due 90 days or more and still accruing ⁽²⁾	2,232			57			—			—			24
Total nonperforming and other risk assets	$	14,065		$	6,484		$	11,987		$	8,319		$	18,084

Loans 30-89 days past due	$	17,527		$	5,186		$	5,277		$	1,218		$	2,532
Asset quality ratios:
Total nonperforming loans to total loans	0.65		%	0.41		%	0.97		%	0.80		%	2.12		%
Total nonperforming assets to total assets	0.46		%	0.27		%	0.69		%	0.52		%	1.34		%
Total nonperforming assets to total loans and OREO	0.66		%	0.42		%	1.07		%	0.84		%	2.21		%
Total risk assets to total loans and OREO	0.86		%	0.52		%	1.19		%	0.94		%	2.31		%
Total risk assets to total assets	0.59		%	0.34		%	0.77		%	0.59		%	1.40		%
Allowance for loan losses to total loans	0.89		%	1.12		%	1.27		%	1.45		%	1.74		%
Allowance for loan losses to nonperforming loans	137.52		%	271.33		%	130.00		%	181.39		%	81.95		%
Allowance for loan losses to nonperforming loans and restructured loans still accruing	125.95		%	222.55		%	116.05		%	160.23		%	78.20		%

(Dollars in thousands) 2017 2016 2015 2014 2013

Nonaccrual loans (cash basis) $ 9,843
$ 7,043
$ 16,557
$ 14,432
$ 19,347
Other real estate owned (OREO) 961
346
710
932
987
Total nonperforming assets 10,804
7,389
17,267
15,364
20,334
Restructured loans still accruing 1,183
930
793
1,100
5,988
Loans past due 90 days or more and still accruing 0
0
24
0
0
Total nonperforming and other risk assets $ 11,987
$ 8,319
$ 18,084
$ 16,464
$ 26,322

Loans 30-89 days past due $ 5,277
$ 1,218
$ 2,532
$ 1,612
$ 3,963
Ratio of:
Total nonperforming loans to loans 0.97 % 0.80 % 2.12 % 2.05 % 2.88 %
Total nonperforming assets to assets 0.69 % 0.52 % 1.34 % 1.29 % 1.73 %
Total nonperforming assets to total loans and OREO 1.07 % 0.84 % 2.21 % 2.18 % 3.03 %
Total risk assets to total loans and OREO 1.19 % 0.94 % 2.31 % 2.33 % 3.92 %
Total risk assets to total assets 0.77 % 0.59 % 1.40 % 1.38 % 2.23 %
Allowance for loan losses to total loans 1.27 % 1.45 % 1.74 % 2.09 % 3.12 %
Allowance for loan losses to nonperforming loans 130.00 % 181.39 % 81.95 % 102.18 % 108.36 %
Allowance for loan losses to nonperforming loans and restructured loans still accruing 116.05 % 160.23 % 78.20 % 94.95 % 82.75 %
⁽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, ~~2017~~2019 and ~~2016.~~2018.


														2019										2018
	2017						2016							Nonaccrual Loans		Restructured Loans Still Accruing		Total		Nonaccrual Loans		Restructured Loans Still Accruing		Total
(Dollars in thousands)	Nonaccrual Loans		Restructured Loans Still Accruing		Total		Nonaccrual Loans		Restructured Loans Still Accruing		Total
Commercial real estate:													Commercial real estate:
Owner occupied	$	1,185	$	52	$	1,237	$	1,070	$	0	$	1,070	Owner occupied	$	5,842	$	30	$	5,872	$	1,841	$	39	$	1,880
Non-owner occupied	4,065		0		4,065		736		0		736

Multi-family	165		0		165		199		0		199		Multi-family	345		—		345		131		—		131
Non-owner occupied residential	381		0		381		452		0		452		Non-owner occupied residential	235		—		235		309		—		309
Acquisition and development
1-4 family residential construction	492		0		492		0		0		0
Commercial and land development	0		0		0		1		0		1

Commercial and industrial	350		0		350		595		0		595		Commercial and industrial	1,763		—		1,763		286		—		286
Residential mortgage:													Residential mortgage:
First lien	2,734		1,102		3,836		3,396		896		4,292		First lien	1,659		931		2,590		1,808		1,069		2,877
Home equity – term	22		0		22		93		34		127		Home equity – term	13		—		13		16		—		16
Home equity – lines of credit	438		29		467		495		0		495		Home equity – lines of credit	715		18		733		774		24		798
Installment and other loans	11		0		11		6		0		6		Installment and other loans	85		—		85		—		—		—
	$	9,843	$	1,183	$	11,026	$	7,043	$	930	$	7,973		$	10,657	$	979	$	11,636	$	5,165	$	1,132	$	6,297

Nonperforming assets include nonaccrual loans and foreclosed real estate. Risk assets, which ~~incorporate~~include nonperforming assets and restructured and loans past due 90 days or more and still accruing, totaled ~~$11,987,000~~$14.1 million at December 31, ~~2017,~~2019, an increase of ~~$3,668,000,~~$7.6 million or ~~44.1%~~116.9%, from ~~$8,319,000~~$6.5 million at December 31, ~~2016.~~2018. Nonaccrual loans totaled ~~$9,843,000~~$10.7 million at December 31, ~~2017,~~2019, an increase of ~~$2,800,000~~$5.5 million from December 31, ~~2016. Both measures principally reflect the addition of one~~2018. One commercial loan, downgraded to nonaccrual status in the fourth quarter of ~~2017.~~2019 was the principal driver of the net increase. The ~~overall~~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 ~~$5,946,000~~$5.9 million to a third party. Cash proceeds totaled ~~$5,100,000~~$5.1 million with the ~~$846,000~~$846 thousand difference recorded as a charge-off to the ALL in 2016.

The ALL totaled ~~$12,796,000~~$14.7 million at December 31, ~~2017,~~2019, a ~~$21,000~~$641 thousand increase from ~~$12,775,000~~$14.0 million at December 31, ~~2016,~~2018, resulting from net ~~charge-offs~~chargeoffs of ~~$979,000~~$259 thousand and a provision for loan losses of ~~$1,000,000~~$900 thousand for ~~2017. While the~~2019. The ALL is lower as a percentage of the total loan portfolio at December 31, ~~2017~~2019 than in prior years, ~~management~~reflecting purchase accounting adjustments for impaired loans acquired from Mercersburg and Hamilton. Management believes its coverage ratios are

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, ~~2017.~~2019. As new information is learned about borrowers or updated appraisals on real estate with lower fair values are obtained, the Company may ~~continue to~~ experience ~~additional~~an increase in impaired loans.

For the years ended December 31, ~~2017, 2016,~~2019, 2018, and ~~2015~~2017, recoveries of ~~$287,000, $679,000~~$606 thousand, $882 thousand and ~~$926,000~~$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 ~~as well as~~and qualitative factors used in our allowance adequacy analysis. ~~In 2015, a negative provision for loan losses was recorded.~~ 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, ~~2017~~2019 and ~~2016. Of the relationships deemed to be impaired at December 31, 2017, one had a recorded balance in excess of $1,000,000 and 62, or 91.2%, had recorded balances less than $250,000.~~2018.

(Dollars in thousands)
# of
Relationships

Recorded
Investment

Partial
Charge-offs
to Date

Specific
Reserves
December 31, 2017
Relationships greater than $1,000,000 1
$ 4,065
$ 791
$ 0
Relationships greater than $500,000 but less than $1,000,000 1
518
145
0
Relationships greater than $250,000 but less than $500,000 4
1,501
120
0
Relationships less than $250,000 62
4,942
1,160
51
68
$ 11,026
$ 2,216
$ 51
December 31, 2016
Relationships greater than $1,000,000 0
$ 0
$ 0
$ 0
Relationships greater than $500,000 but less than $1,000,000 2
1,327
620
0
Relationships greater than $250,000 but less than $500,000 2
640
120
0
Relationships less than $250,000 75
6,006
1,184
43
79
$ 7,973
$ 1,924
$ 43


	# of Relationships	Recorded Investment		Partial Charge-offs to Date		Specific Reserves
December 31, 2019
Relationships greater than $1 million	2	$	5,218	$	—	$	—
Relationships greater than $500 thousand but less than $1 million	2	1,516		17		—
Relationships greater than $250 thousand but less than $500 thousand	3	980		—		—
Relationships less than $250 thousand	68	3,922		781		36
	75	$	11,636	$	798	$	36
December 31, 2018

Relationships greater than $500 thousand but less than $1 million	1	$	810	$	17	$	—
Relationships greater than $250 thousand but less than $500 thousand	2	673		—		—
Relationships less than $250 thousand	64	4,814		873		38
	67	$	6,297	$	890	$	38

Internal loan reviews are completed annually on all commercial relationships with a committed loan balance in excess of ~~$500,000,~~$500 thousand, which includes confirmation of risk rating by an independent credit officer. Credit Administration also reviews loans in excess of ~~$1,000,000.~~$1.0 million. In addition, all relationships greater than ~~$250,000~~$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.~~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, ~~2017.~~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 ~~two~~one commercial ~~properties~~property totaling ~~$961,000~~$180 thousand and one residential property totaling $17 thousand at December 31, ~~2017.~~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 ~~2017,~~2019, no expense was recorded for writedown of other real estate owned properties.

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. ~~Quarterly,~~On a quarterly basis, management assesses the adequacy of the ALL utilizing a defined methodology which considers specific credit evaluation of impaired loans, ~~past loan~~historical loss ~~historical~~ 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.~~31, 2019 and 2018.


	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
December 31, 2019
Commercial real estate:
Owner-occupied	$	151,161	$	4,513	$	3,163	$	5,872	$	—	$	6,175	$	170,884
Non-owner occupied	342,753		17,152		—		—		—		1,145		361,050
Multi-family	100,361		4,822		682		345		—		683		106,893
Non-owner occupied residential	111,697		4,534		1,115		235		—		2,457		120,038
Acquisition and development:
1-4 family residential construction	15,865		—		—		—		—		—		15,865
Commercial and land development	39,939		206		1,393		—		—		—		41,538
Commercial and industrial	198,951		1,133		8,899		1,763		—		3,808		214,554
Municipal	42,649		4,408		—		—		—		—		47,057
Residential mortgage:
First lien	323,040		978		—		2,590		—		9,764		336,372
Home equity – term	13,774		74		149		13		—		20		14,030
Home equity – lines of credit	164,469		74		38		733		—		—		165,314
Installment and other loans	50,497		—		—		85		—		153		50,735
	$	1,555,156	$	37,894	$	15,439	$	11,636	$	—	$	24,205	$	1,644,330

Table of Contents


														Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		PCI Loans		Total
(Dollars in thousands)	Pass		Special Mention		Non-Impaired Substandard		Impaired - Substandard		Doubtful		Total
December 31, 2017
December 31, 2018													December 31, 2018
Commercial real estate:													Commercial real estate:
Owner-occupied	$	113,240	$	413	$	1,921	$	1,237	$	0	$	116,811	Owner-occupied	$	121,903	$	3,024	$	987	$	1,880	$	—	$	1,856	$	129,650
Non-owner occupied	235,919		0		4,507		4,065		0		244,491		Non-owner occupied	242,136		10,008		—		—		—		650		252,794
Multi-family	48,603		4,113		753		165		0		53,634		Multi-family	71,482		5,886		717		131		—		717		78,933
Non-owner occupied residential	76,373		142		1,084		381		0		77,980		Non-owner occupied residential	97,590		736		1,197		309		—		535		100,367
Acquisition and development:													Acquisition and development:
1-4 family residential construction	11,238		0		0		492		0		11,730		1-4 family residential construction	7,385		—		—		—		—		—		7,385
Commercial and land development	18,635		5		611		0		0		19,251		Commercial and land development	41,251		25		583		—		—		192		42,051
Commercial and industrial	113,162		2,151		0		350		0		115,663		Commercial and industrial	150,286		2,278		2,940		286		—		5,174		160,964
Municipal	42,065		0		0		0		0		42,065		Municipal	50,982		—		—		—		—		—		50,982
Residential mortgage:													Residential mortgage:
First lien	158,673		0		0		3,836		0		162,509		First lien	229,971		—		—		2,877		—		2,448		235,296
Home equity – term	11,762		0		0		22		0		11,784		Home equity – term	12,170		—		—		16		—		22		12,208
Home equity – lines of credit	131,585		80		60		467		0		132,192		Home equity – lines of credit	142,638		165		15		798		—		—		143,616
Installment and other loans	21,891		0		0		11		0		21,902		Installment and other loans	33,229		15		1		—		—		166		33,411
	$	983,146	$	6,904	$	8,936	$	11,026	$	0	$	1,010,012		$	1,201,023	$	22,137	$	6,440	$	6,297	$	—	$	11,760	$	1,247,657
December 31, 2016
Commercial real estate:
Owner-occupied	$	103,652	$	5,422	$	2,151	$	1,070	$	0	$	112,295
Non-owner occupied	190,726		4,791		10,105		736		0		206,358
Multi-family	42,473		4,222		787		199		0		47,681
Non-owner occupied residential	59,982		949		1,150		452		0		62,533
Acquisition and development:
1-4 family residential construction	4,560		103		0		0		0		4,663
Commercial and land development	25,435		10		639		1		0		26,085
Commercial and industrial	87,588		251		32		594		0		88,465
Municipal	53,741		0		0		0		0		53,741
Residential mortgage:
First lien	135,558		0		0		4,293		0		139,851
Home equity – term	14,155		0		0		93		0		14,248
Home equity – lines of credit	119,681		82		61		529		0		120,353
Installment and other loans	7,112		0		0		6		0		7,118
	$	844,663	$	15,830	$	14,925	$	7,973	$	0	$	883,391

(Dollars in thousands) Total

Three months or less $ 8,066
Over three months through six months 3,255
Over six months through one year 5,260
Over one year 5,307
Total $ 21,888

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 ~~customers,~~clients, in which a ~~customer~~client sweeps a portion of a deposit balance into a ~~Repurchase Agreement,~~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 ~~continues to evaluate~~evaluates its funding needs, interest rate movements, the cost of options, and the availability of attractive structures ~~in its evaluation as to~~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 ~~11,~~13, Short-Term Borrowings, Note 14, Long-Term Debt, and Note ~~12, Long-Term Debt~~15, Subordinated Notes, to the Consolidated Financial Statements appearing in Part II, Item 8, "Financial Statements and Supplementary Data."

Shareholders' Equity

~~Total~~In 2019, total shareholders’ equity increased ~~$9,906,000,~~$49.8 million, or ~~7.3%, during 2017. Increases~~28.7%. The principal factor in ~~equity included net income of $8,090,000, $1,523,000 from~~the increase was the issuance of 1,765,704 shares of common stock, ~~related to share-based compensation and an increase~~valued at $36.6 million, in the ~~fair value of available for sale securities, net of taxes, of $3,781,000.~~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$3,488,000.~~by $6.1 million.

In February 2018, the FASB issued changes related to the accounting for the effects of the Tax Act on items in AOCI. The impact of tax rate changes is recorded in income and items accounted for in AOCI could be left with a 'stranded' tax effect that could have those items appear to not reflect the appropriate tax rate. The FASB's changes allow a reclassification from AOCI to retained earnings for stranded tax effects from the Tax Act to improve the usefulness of information reported to financial statement users. The changes are effective for years beginning after December 31, 2018, with early adoption permitted. We elected to adopt the changes in December 2017. The amount transferred from AOCI to retained earnings totaled $229,000 and represented the impact of the Tax Law rate change to 21% at the date of enactment for unrealized gains and losses accounted for in AOCI.

On January 19, 2016, the Company filed a shelf registration statement on Form S-3 with the SEC, covering up to an aggregate of $100,000,000 of securities, through the sale of common stock, preferred stock, warrants, debt securities, and units. To date, the Company has not issued any securities under this shelf registration statement.

On September, ~~14,~~ 2015, the Board of Directors ~~of the Company~~ 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, ~~2017.~~2019.

The following table includes additional information for shareholders’ equity for ~~the~~ years ended December ~~31.~~31, 2019, 2018, and 2017.


											2019			2018			2017
(Dollars in thousands)	2017			2016			2015

Average shareholders’ equity	$	141,301		$	137,973		$	131,453		Average shareholders’ equity	$	206,021		$	149,662		$	141,301
Net income	8,090			6,628			7,874			Net income	16,924			12,805			8,090
Cash dividends paid	3,488			2,898			1,822			Cash dividends paid	6,150			4,375			3,488
Equity to asset ratio	9.29		%	9.53		%	10.29		%
Average equity to average assets ratio										Average equity to average assets ratio	9.26		%	8.75		%	9.49		%
Dividend payout ratio	42.00		%	42.68		%	22.68		%	Dividend payout ratio	36.81		%	33.33		%	42.00		%
Return on average equity	5.73		%	4.80		%	5.99		%	Return on average equity	8.21		%	8.56		%	5.73		%

Capital Adequacy and Regulatory Matters

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.

~~Under requirements~~Effective with the third quarter of 2018, the ~~Dodd-Frank Act~~FRB raised the consolidated asset limit on small bank holding companies from $1 billion to $3 billion, and ~~Basel III Capital Rules as described in Item 1 - Business,~~a company with assets under the ~~Company and the Bank have been~~revised limits is not subject to ~~increasingly stringent regulatory~~the FRB consolidated capital ~~requirements. Significant provisions of~~rules. A company with consolidated assets under the ~~Basel III Capital Rules~~revised limit may continue to file reports that ~~have impacted the Company's~~include capital amounts and ~~the Bank's capital calculations include:~~

~~Restricting the amount of deferred tax assets that can be included in CET1 capital with assets relating~~ratios. The Company has elected to net operating loss and credit carry forwards being excluded, and a 10% - 15% limitation on deferred tax assets arising from temporary differences that cannot be realized through net operating loss carry backs. At December 31, 2017 and 2016, $2,151,000 and $7,976,000 of the Company's deferred tax asset relatedcontinue to ~~operating loss and tax credit carryforwards was deducted from our calculation of CET1;~~

~~Applying a 150% risk weight for certain high volatility commercial real estate acquisition, development and construction loans;~~

~~Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due or in nonaccrual status;~~

~~Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and~~

The allowance for credit losses, including the ALL and reserve for off-balance sheet credit commitments, is included as Tier 2 capital to the extent it does not exceed 1.25% of risk weighted assets. The amount that exceeds 1.25% of risk weighted assets, is disallowed as Tier 2 capital, but also reduces the Company’s risk weighted assets. At December 31, 2017 and 2016, $0 and $1,559,000 of the allowance for credit losses was excluded from our calculation of Tier 2 capital. The lower disallowed amount in 2017 was the result of the higher balance of risk-weighted assets.file those reports.

Management believes the Company and the Bank met all capital adequacy requirements to which they are subject at December 31, ~~2017~~2019 and December 31, ~~2016.~~2018. At December 31, ~~2017,~~2019, the Bank was considered well capitalized under applicable banking regulations. ~~Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific guidelines that involve quantitative measures~~

Table of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Although applicable to the Bank, prompt corrective action provisions are not applicable to bank holding companies, including financial holding companies.Contents

Tables presenting the Company’s and the Bank’s capital amounts and ratios at December 31, ~~2017~~2019 and ~~2016~~2018 are included in Note ~~13,~~16 Shareholders' Equity and Regulatory Capital, to the Consolidated Financial Statements appearing in Part II, Item 8, "Financial Statements and Supplementary Data."

~~The Company~~Tier 1 and ~~Bank's~~total capital ~~ratios~~increases reflected the Hamilton acquisition and results of operations for 2019. Risk-weighted assets increased from $1.3 billion at December 31, ~~2017 have declined since December 31, 2016, despite an increase in consolidated capital, due primarily~~2018 to ~~consolidated risk-weighted assets increasing from $955,253,000~~$1.7 billion at December 31, ~~2016 to $1,146,378,000 at December 31, 2017~~2019 for the Company and from ~~$954,533,000~~$1.3 billion at December 31, ~~2016~~2018 to ~~$1,143,207,000~~$1.7 billion at December 31, ~~2017~~2019 for the ~~Bank. The increase in risk-weighted assets is principally due to~~Bank, reflecting the Hamilton acquisition and growth ~~experienced~~ in the loan ~~portfolio.~~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 ~~13, the Company and the Bank~~16, we must maintain a capital conservation buffer as noted in Item 1 - Business under the topic Basel III Capital Rules. At December 31, ~~2017,~~2019, the Company's and the Bank's capital conservation buffer, based on the most restrictive capital ratio, was 5.3% and ~~5.0%~~5.4%, which is above the phase in requirement of ~~1.25%~~2.50% at December 31, ~~2017.~~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 ~~customers~~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, ~~2017, we had $352,960,000 in~~2019, outstanding loan commitments ~~outstanding,~~totaled $477.2 million, which included ~~$56,012,000~~$38.8 million in undisbursed loans, ~~$139,281,000~~$205.5 million in unused home equity lines of credit, ~~$145,394,000~~$222.3 million in commercial lines of credit, and ~~$12,273,000~~$10.6 million in standby letters of credit. Time deposits due within one year ofafter December 31, ~~2017~~2019 totaled ~~$107,765,000,~~$375.8 million, or ~~39%~~72% of time deposits. The large percentage of time deposits that mature within one year reflects ~~customers’~~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, ~~2017.~~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, ~~2017,~~2019, cash and cash equivalents totaled ~~$29,807,000, which approximated the total of $30,273,000~~$56.5 million, compared with $88.8 million at December 31, ~~2016.~~2018. Securities classified as available for sale, net of pledging requirements, ~~which~~ provide additional sources of liquidity, and totaled ~~$95,401,000~~$331.7 million at December 31, ~~2017. In addition,~~2019. Also at December 31, ~~2017,~~2019, we had the ability to borrow up to a total of ~~approximately $517,257,000~~$836.7 million from the FHLB of Pittsburgh, of which ~~we had $135,365,000~~$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 ~~consisting~~consists of mortgage loans. In addition, ~~the Company has up to $35,000,000~~we had $35.0 million in available unsecured lines of credit with other ~~banks.~~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.~~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 ~~14, Restrictions on Dividends, Loans~~16, Shareholders' Equity and ~~Advances,~~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."

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, ~~2017.~~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.


														Payments Due
		Payments Due											Note Reference	Less than 1 year		2-3 years		4-5 years		More than 5 years		Total
(Dollars in thousands)	Note Reference	Less than 1 year		2-3 years		4-5 years		More than 5 years		Total

Time deposits	10	$	107,765	$	159,177	$	6,269	$	877	$	274,088	Time deposits	11	$	375,795	$	116,580	$	24,375	$	2,818	$	519,568
Short-term borrowings	11	93,576		0		0		0		93,576		Short-term borrowings	13	154,869		—		—		—		154,869
Long-term debt	12	365		81,133		862		1,455		83,815		Long-term debt	14	40,751		20,862		946		508		63,067
Subordinated notes												Subordinated notes	15	—		—		—		32,500		32,500
Operating lease obligations	6	574		1,024		564		474		2,636		Operating lease obligations	6	1,279		1,874		1,486		10,549		15,188
Total		$	202,280	$	241,334	$	7,695	$	2,806	$	454,115	Total		$	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 ~~customers.~~clients. These financial instruments include commitments to extend credit and standby letters of credit.

The following table details significant commitments at December 31, ~~2017.~~2019.

(Dollars in thousands)
Contract or Notional
Amount
Commitments to fund:
Revolving, open-ended home equity loans $ 139,281
1-4 family residential construction loans 11,420
Commercial real estate, construction and land development loans 44,592
Commercial, industrial and other loans 145,394
Standby letters of credit 12,273


	Contract or Notional Amount
Commitments to fund:
Home equity lines of credit	$	205,502
1-4 family residential construction loans	19,812
Commercial real estate, construction and land development loans	19,018
Commercial, industrial and other loans	222,288
Standby letters of credit	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 ~~16,~~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."

~~Caution About Forward-Looking Statements~~Supplemental Reporting of Non-GAAP Measures

~~This report contains statements that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act~~As a result of ~~1995. In addition,~~prior acquisitions, the Company ~~may make other written~~had intangible assets consisting of goodwill and oral communications, from time to time, that contain such statements. Forward-looking statements, including statements that include projections, predictions, expectations or beliefs as to industry trends, future expectationscore deposit and other ~~matters that do not relate strictly~~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 historical facts, are based on certain assumptions by management, and are often identified by words or phrases such as "may," "anticipate," "believe," "expect," "estimate," "intend," "seek," "plan," "objective," "trend," "goal." and other similar terms. Forward-looking statements are subject to various assumptions, risks, and uncertainties, which change over time, and speak only at the date they are made.

In addition to factors mentioned elsewhere in this Annual Report on Form 10-K or previously disclosed in our SEC reports (accessible on the SEC’s website at www.sec.gov or on our website at www.orrstown.com), the following factors, among others, could cause actual results to differ materially from forward-looking statements and future results could differ materially from historical performance:

~~If our ALL is not sufficient to cover actual losses, our earnings would decrease.~~

~~Commercial real estate lending may expose us to a greater risk of loss and impact our earnings and profitability.~~

~~Commercial and industrial loans comprise 10% of our loan portfolio. The credit risk~~overcome comparability issues related to ~~these types~~the influence of ~~loans is greater than the risk related to residential loans.~~intangibles (principally goodwill) created in acquisitions.

~~Changes in~~Tangible book value per share and net interest ~~rates could adversely impact the Company’s financial condition and results of operations.~~

~~Difficult economic and market conditions have adversely affected the financial services industry and may continue to materially and adversely affect the Company.~~

Because our business is concentrated in south central Pennsylvania and Washington County, Maryland, our financial performance could be materially adversely affected by economic conditions and real estate values in these market areas.

~~Competition from other banks and financial institutions in originating loans, attracting deposits and providing other financial services may adversely affect our profitability and liquidity.~~

~~The Company may be adversely affected by technological advances.~~

~~The Company may not be able to attract and retain skilled people.~~

An interruption or breach in security with respect to our information systems, or our outsourced service providers, could adversely impact the Company’s reputation and have an adverse impact on our financial condition or results of operations.

~~We could be adversely affected by failure in our internal controls.~~

~~Negative public opinion could damage our reputation and adversely affect our earnings.~~

~~Governmental regulation and regulatory actions against us may impair our operations or restrict our growth.~~

~~The Dodd-Frank Act may affect the Company’s financial condition, results of operations, liquidity and stock price.~~

~~Increases in FDIC insurance premiums may have a material adverse effect on our results of operations.~~

~~Legislative, regulatory and legal developments involving income and other taxes could materially adversely affect the Company’s results of operations and cash flows.~~

~~Changes in accounting standards could impact the Company's financial condition and results of operations.~~

~~The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is uncertain.~~

~~Pending litigation and legal proceedings and~~margin excluding the impact of ~~any finding of liability or damages could adversely impact~~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

Table of Contents

the GAAP based measures presented in Item 6, Selected Financial Data and ~~its~~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 ~~and~~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 ~~of operations.~~

~~Indemnification costs associated~~will be unaffected by similar adjustments to be determined in accordance with ~~litigation and legal proceedings could adversely impact the Company and its financial condition and results of operations.~~GAAP.

The ~~Parent Company is a holding company dependent for liquidity on payments from~~following table presents the computation of each non-GAAP based measure shown together with its ~~bank subsidiary, which is subject to restrictions.~~most directly comparable GAAP based measure.

~~The soundness of other financial institutions could adversely affect the Company.~~


	2019		2018		2017
Tangible book value per common share
Shareholders' equity	$	223,249	$	173,433	$	144,765
Less: Goodwill	19,925		12,592		719
Other intangible assets	7,180		3,910		356
Related tax effect	(1,508)		(804)		(21)
Tangible common equity (non-GAAP)	$	197,652	$	157,735	$	143,711

Common shares outstanding	11,200		9,430		8,347

Book value per share (most directly comparable GAAP based measure)	$	19.93	$	18.39	$	17.34
Intangible assets per share	2.28		1.66		0.12
Tangible book value per share )non-GAAP)	$	17.65	$	16.73	$	17.22

~~If the Company wants to, or is compelled to, raise additional capital in the future, that capital may not be available when it is needed and on terms favorable to current shareholders.~~

~~The market price of our common stock has been subject to volatility.~~


		2019						2018						2017
Taxable-Equivalent Net Interest Margin (excluding the effect of purchase accounting)
Taxable-equivalent net interest income/margin, as reported		$	70,338	3.43	%	$	53,573	3.36	%	$	46,256	3.35	%
Effect of purchase accounting:
Loans	Income	(3,758)		(0.30)	%	(335)		(0.04)	%	—		—	%
Time deposits	Expenses	83		0.02	%	(10)		—	%	—		—	%

Purchase accounting effect on taxable-equivalent income/ margin		(3,840)		(0.21)	%	(325)		(0.01)	%	—		—	%
Taxable-equivalent net interest income/margin (excluding the effect of purchase accounting) (non-GAAP)		$	66,497	3.22	%	$	53,248	3.33	%	$	46,256	3.35	%

~~The Parent Company's primary source of income is dividends received from its bank subsidiary.~~

~~Other risks and uncertainties.~~

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. ~~For domestic banks, including~~In the ~~Company, the majority~~banking industry, a major risk exposure is changing interest rates. The primary objective of ~~market~~monitoring our interest rate sensitivity, or risk, is ~~related~~ 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 ~~risk. Interest rate~~ sensitivity ~~management requires the maintenance of an appropriate balance between reward,~~positions in ~~the form of net interest margin, and risk as measured by the amount of earnings and value at risk.~~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 ~~security and~~loan contractual interest rate changes.

~~Management attempts~~

Table of Contents

We attempt to manage the level of repricing and maturity mismatch through ~~its~~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.

~~The asset/liability committee operates under management policies, approved by the Board of Directors, which define guidelines and limits on the level of risk.~~

~~The Company uses~~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 ~~the Company’s~~our interest rate risk exposure. These ~~modeling techniques involve~~analyses require numerous assumptions including, but not limited to, changes in balance sheet mix, prepayment rates on loans and ~~estimates that inherently cannot be measured with complete precision. Key assumptions in the analyses include maturity~~securities, cash flows and repricing ~~characteristics~~ of ~~assets~~all financial instruments, changes in volumes and ~~liabilities, prepayments on amortizing assets, non-maturity deposit sensitivity, and loan~~pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit ~~pricing. These assumptions~~sensitivity. Assumptions are ~~inherently uncertain~~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 ~~the Company’s~~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 ~~the Company’s~~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. ~~These include prepayment assumptions on mortgage assets, sensitivity of non-maturity deposit rates, and other factors deemed significant.~~

The simulation analysis results are presented in the Earnings at Risk table below. At December 31, ~~2017,~~2019, these results indicate the Company would ~~expect net interest income to decrease~~be better positioned, over the next ~~twelve~~12 months, ~~by 6.5%, assuming~~in a ~~downward shock in market~~moderately declining rate environment than it would be if interest rates ~~of 1.00%, and to decrease by 4.9% assuming an upward shock of 2.00%. A decrease in interest rates of 1.00% would create an environment in which deposit rates could not practically decline further.~~

~~The simulation analysis results at~~increased. At December 31, ~~2016 exhibited slightly greater sensitivity to both rising interest~~2018, the results indicated we would be better positioned in a moderately increasing rate environment than if rates ~~and a declining rate environment.~~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 ~~is defined as~~incorporates the discounted present value of expected asset cash flows minus the discounted present value of ~~the~~ 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.

~~The net present value analysis results are presented in the Value at Risk table below.~~ At December 31, ~~2017,~~2019, similar to at December 31, 2018, these results indicate ~~that~~ the ~~net present value~~Company would ~~decrease 7.2% assuming~~be better positioned in a ~~downward shock in market~~rising interest rate environment than it would be if interest rates ~~of 1.00% and decrease 5.4% assuming an upward shock of 2.00%.~~

decreased.

Table of Contents


Earnings at Risk	Earnings at Risk					Value at Risk						Earnings at Risk								Value at Risk
		% Change in Net Interest Income						% Change in Market Value					% Change in Net Interest Income							% Change in Market Value
Change in Market Interest Rates	Change in Market Interest Rates	December 31, 2017		December 31, 2016		Change in Market Interest Rates		December 31, 2017		December 31, 2016		Change in Market Interest Rates	December 31, 2019		December 31, 2018		Change in Market Interest Rates	December 31, 2019		December 31, 2018

(100	)	(6.5	%)	(3.3	%)	(100	)	(7.2	%)	(1.0	%)
(100)												(100)	(0.5)	%	(2.1)	%	(100)	(21.7)	%	(14.1)	%
100		(1.3	%)	(1.5	%)	100		(1.8	%)	(1.5	%)	100	(1.3)	%	(0.6)	%	100	10.9	%	6.1	%
200		(4.9	%)	(2.5	%)	200		(5.4	%)	(2.9	%)	200	(3.8)	%	(2.2)	%	200	15.1	%	7.1	%

Table of ~~these statements.~~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 ~~Perry~~York Counties, of Pennsylvania, and in Anne Arundel, Baltimore, Howard and Washington ~~County,~~Counties, Maryland, as well as Baltimore City, Maryland and Wheatland Advisors, Inc., a registered investment advisor non-bank subsidiary, headquartered in Lancaster ~~Pennsylvania,~~County, Pennsylvania. The Company operates in the community banking segment and ~~which was acquired in December 2016. The Bank~~ engages in lending activities, including commercial, residential, commercial mortgages, construction, municipal, and various forms of consumer ~~lending. Deposit~~lending, and deposit services, ~~include~~including checking, savings, time, and money market deposits. The ~~Bank~~Company also provides fiduciary services, investment advisory, insurance and brokerage ~~services through its OFA division.~~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 ~~December 2016,~~October 2018, the Company acquired ~~Wheatland.~~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 orand assets acquired and liabilities assumed from acquired entities are included only from the date of acquisition. ~~Pro forma financial information~~The comparability of the Company's results of operations for the ~~acquisition has not~~years ended December 31, 2019, to 2018 and 2017 have been ~~included because the acquisition was not material.~~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 ~~income taxes.~~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 ~~customers~~clients primarily in its market area ~~of Berks, Cumberland, Dauphin, Franklin, Lancaster, and Perry Counties of~~in south central Pennsylvania and in the greater Baltimore region and Washington County, ~~Maryland.~~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 ~~customers’~~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 ~~customer’s~~clients' creditworthiness on a case-by-case basis. The amount of collateral obtained ~~if collateral is deemed necessary by the Company~~ upon the extension of credit, is based on management’s credit evaluation of the ~~customer.~~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 ~~type~~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 ~~include~~includes cash, balances due from banks, federal funds sold and ~~interest bearing~~interest-bearing deposits due on demand, all of which have original maturities of 90 days or less. Net cash flows are reported for ~~customer~~client loan and deposit transactions, loans held for sale, redemption (purchases) of restricted investments in bank stocks, and short-term borrowings.

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. ~~Quarterly,~~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 ~~and marketable equity~~ securities as available for sale on the date of purchase. At December 31, ~~2017~~2019 and ~~2016~~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. ~~For equity securities, the entire amount of impairment is recognized through earnings.~~

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 – ~~Loans~~ 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 ~~are~~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 – The Company grants commercial loans; residential, commercial and construction mortgage loans; and various forms of consumer loans to its customers located principally in south central Pennsylvania and northern Maryland. The ability of the Company’s debtors to honor their contracts is dependent largely upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off ~~generally~~ are reported at their outstanding unpaid principal balances adjusted for charge-offs, the ALL, and any deferred fees or costs on

Table of Contents

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 ~~current~~ 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 ~~loan’s~~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 ~~accruing~~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 athe provision for loan losses ~~charged to earnings.~~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

Table of Contents

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 ~~customer~~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 ~~customer~~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.~~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 ~~customers.~~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, ~~2017~~2019 and ~~2016,~~2018, the balance of loans serviced for others totaled ~~$334,802,000~~$360.1 million and ~~$328,701,000.~~$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 ~~provided~~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 ~~major~~ additions and improvements are typically capitalized. ~~Gain~~Gains or ~~loss~~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

Table of Contents

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 ~~would more likely than not~~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 ~~the sum of the years digits~~an accelerated amortization method or straight line ~~bases~~basis over their estimated lives, generally 10 years for deposit premiums and 10 to 15 years for ~~customer lists.~~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 ~~flows~~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 ~~$2,897,000~~$3.1 million and ~~$2,835,000~~$3.2 million at December 31, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively, and are included in ~~Other Assets.~~other assets on the consolidated balance sheets.

Foreclosed Real Estate – Real estate ~~property~~ 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 ~~usually~~ determined based on an independent third party appraisal of the property or, ~~occasionally on~~when appropriate, a recent sales offer. Costs to maintain ~~foreclosed~~such real estate are expensed as incurred. Costs that significantly improve the value of the properties are capitalized. ~~Foreclosed real~~Real estate acquired through foreclosure or other means totaled ~~$961,000~~$197 thousand and ~~$346,000~~$130 thousand at December 31, ~~2017~~2019 and ~~2016~~2018, respectively, and is included in ~~Other Assets.~~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~~1 investment ~~entered into in 2015.~~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,~~other assets on the consolidated balance sheets, totaled ~~$4,416,000~~$3.6 million and ~~$4,909,000~~$3.9 million at December 31, ~~2017~~2019 and ~~2016,~~2018, respectively, of which ~~$1,776,000~~$1.3 million and ~~$1,993,000~~$1.6 million are accounted for under the proportional amortization method.

Equity method losses totaled ~~$277,000, $350,000~~$55 thousand, $331 thousand and ~~$384,000~~$277 thousand for the years ended December 31, 2019, 2018 and 2017, ~~2016 and 2015~~respectively, and are included in other noninterest ~~income.~~income on the consolidated income statements. Proportional amortization method losses totaled ~~of $217,000, $191,000~~$214 thousand, $214 thousand and ~~$22,000~~$217 thousand for the years ended December 31, 2019, 2018 and 2017, ~~2016 and 2015~~respectively, and are included in income tax ~~expense.~~expense on the consolidated income statements. During ~~2017, 2016~~2019, 2018 and ~~2015,~~2017, the Company recognized federal tax credits from these projects totaling ~~$1,010,000, $736,000~~$460 thousand, $578 thousand and ~~$475,000,~~$1.0 million, respectively, which are included in income tax ~~expense.~~expense on the consolidated income statements.

Advertising – The Company expenses advertising as incurred. Advertising expense totaled ~~$631,000, $763,000~~$577 thousand, $418 thousand and ~~$723,000~~$631 thousand for the years ended December 31, 2019, 2018 and 2017, ~~2016 and 2015.~~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.~~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~~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 inon the Company’s consolidated balance sheets, while the securities underlying the ~~Repurchase Agreements~~repurchase agreements remaining are reflected in AFS securities. The repurchase obligation and underlying securities are not offset or ~~netted. The~~netted as the Company does not enter into reverse ~~Repurchase Agreements, so there is no offsetting to be performed with Repurchase Agreements.~~repurchase agreements.

Table of Contents

The right of setoff for a ~~Repurchase Agreement~~repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the ~~Repurchase Agreement~~repurchase agreement should the Company be in default (e.g., fail to make an interest payment to the counterparty). For the ~~Repurchase Agreements,~~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.~~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. ~~OCI is limited to unrealized gains (losses) on securities available for sale for all years presented.~~ Unrealized gains (losses) on securities available for sale, net of tax, was the sole component of AOCI at December 31, ~~2017~~2019 and ~~2016 and totaled $2,845,000 and $(1,165,000).~~2018.

Fair Value – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in ~~Note 17,~~the Fair ~~Value.~~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 significant~~1 segment – Community Banking. The Company’s ~~non-banking~~non-community banking activities, principally related to Wheatland, are insignificant to the consolidated financial statements.

Recent Accounting Pronouncements - ~~ASU 2014-09, Revenue from Contracts with Customers (Topic 606).~~ ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. A substantial portion of the Company's revenue is generated from interest income related to loans and investment securities, which are not within the scope of ASU 2014-09. The Company's evaluation of the impact of changes for in-scope items within noninterest income, including service charges on deposit accounts and trust and investment management income, has not identified any significant impact on our consolidated financial statements. ASU 2014-09 was effective for the Company on January 1, 2018 and did not have a significant impact on our consolidated financial statements.

~~ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.~~ ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. ASU 2016-01 was effective for the Company on January 1, 2018 and did not have a significant impact on our consolidated financial statements.

~~ASU 2016-02, Leases (Topic 842).~~ ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 will be effective for the Company on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Notwithstanding the foregoing, in January 2018, the FASB issued a proposal to provide an additional transition

method that would allow entities to not apply the guidance in ASU 2016-02 in the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company anticipates that the impact on its consolidated balance sheet will result in an increase in assets and liabilities for its right of use assets and related lease liabilities for those leases that are outstanding at the date of adoption, however, it does not anticipate it will have a material impact on its results of operations. Management is evaluating other effects of this standard on the Company's consolidated financial position and regulatory capital.

~~ASU 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting (Topic 718).~~ ASU 2016-09 requires recognition of the income tax effects of share-based awards in the income statement when the awards vest or are settled, eliminating additional paid-in capital pools. The adoption of these changes by the Company on January 1, 2017 did not have a material impact on our financial position or results of operations.

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial ~~Instruments.~~ Instruments ("ASU ~~2016-13 requires the measurement of~~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~~forecasts. Financial institutions and ~~requires enhanced disclosures related~~other organizations will use forward-looking information to better inform their credit loss estimates. Many of the ~~significant estimates and judgments used~~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 ~~estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends~~this update amend the accounting for credit losses on ~~available for sale~~available-for-sale debt securities and purchased financial assets with credit

Table of Contents

deterioration. ~~ASU 2016-13~~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 ~~currently~~ evaluating the ~~potential~~ impact of the delay for adoption of ASU ~~2016-13 on our consolidated financial statements. In that regard, the~~2016-13.

The Company ~~has formed~~is working with a cross-functional working group, under the direction of the Chief Financial Officer and the Chief Risk Officer. The working group is comprised of individuals from various functional areas including credit, risk management, finance and information technology. We are currently developing an implementation plan to include, but not limited to, an assessment of processes, portfolio segmentation, model development, system requirements and the identification of data and resource needs. We have selected a third-partythird party vendor solution to assist ~~us in~~with the application of ASU ~~2016-13.~~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 ~~is currently unable to reasonably estimate~~anticipates the allowance for loan losses will increase under its current assumptions, it expects the impact of adopting ASU 2016-13 ~~we expect that the impact of adoption~~ will be ~~significantly~~ influenced by the composition, characteristics and quality of ~~the Company's~~its loan and securities portfolios, as well as ~~the prevailing~~general economic conditions and forecasts at the adoption date.

~~ASU 2016-15, Statement of Cash Flows (Topic 230) - Restricted Cash~~. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 was effective for the Company on January 1, 2018 and did have a significant impact on our consolidated financial statements.

ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill ~~Impairment. ASU 2017-04~~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. ~~ASU 2017-04 will be~~The adoption of this guidance, effective ~~for the Company on~~ January 1, 2020, ~~with earlier adoption permitted, and is~~will not ~~expected to~~ have a material impact on the Company's consolidated financial statements.

~~ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20).~~ ~~ASU 2017-08 shortens~~

NOTE 2. MERGERS AND ACQUISITIONS AND BRANCH CONSOLIDATIONS

Mercersburg Financial Corporation

On October 1, 2018, the amortization period of certain callable debt securities held at a premium to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual lifeCompany acquired 100% of the ~~security. ASU 2017-08 does not change~~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 ~~callable debt securities held at a discount. ASU 2017-08 will be effective~~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 ~~on January~~include Mercersburg's results from and after October 1, 2018.

Hamilton Bancorp, Inc.

On May 1, 2019, ~~with early adoption permitted. Management does not anticipate ASU 2017-08 will have a material impact~~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 ~~consolidated financial statements.~~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

~~ASU 2017-09, Compensation - Stock Compensation (Topic 718).~~ ~~ASU 2017-09 clarifies when changes to~~

Table of Contents

synergies and efficiencies, thereby providing enhanced client service. Goodwill acquired in the ~~terms or conditions of a share-based payment award must be~~Hamilton acquisition is not deductible for tax purposes.

The Hamilton acquisition was accounted for ~~as modifications. Under ASU 2017-09, an entity will not apply modification~~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 ~~a share-based payment award if all~~refinement for up to one year after the closing date of the ~~following are~~acquisition as additional information relative to closing date fair values become available. The Company continues to finalize the ~~same immediately before~~fair values of loans, intangible assets, other assets, income taxes and ~~after~~liabilities. As a result, the ~~change: (i) the award's~~recorded fair value ~~(ii)~~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 ~~award's vesting conditions and (iii) the award's classification as an equity or liability instrument. ASU 2017-09 was effective~~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	$	14,197
Common stock issued	36,622
Total consideration transferred	$	50,819

Estimated fair values of assets acquired and liabilities assumed:
Cash and cash equivalents	$	43,140
Securities available for sale	60,882
Restricted investments in bank stocks	2,658
Loans	347,361
Premises and equipment	3,749
Core deposit intangible	4,550
Goodwill	7,333
Cash surrender value of life insurance	17,948
Deferred tax asset, net	5,838
ROU lease asset	2,793
Other assets	3,925
Total assets acquired	$	500,177

Deposits	$	(388,246)
Borrowings	(51,393)
Other liabilities	(9,719)
Total liabilities assumed	$	(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

Table of Contents

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.


	Performing		PCI		Total
Commercial real estate:
Owner-occupied	$	42,148	$	6,324	$	48,472
Non-owner occupied	45,401		770		46,171
Multi-family	10,773		—		10,773

Acquisition and development:
1-4 family residential construction	7,450		—		7,450
Commercial and land development	4,528		—		4,528
Commercial and industrial	32,316		1,702		34,018

Residential mortgage:
First lien	152,657		10,494		163,151
Home-equity - term	4,478		1		4,479
Home equity - lines of credit	13,657		—		13,657
Installment and other loans	14,467		195		14,662
Total loans acquired	$	327,875	$	19,486	$	347,361

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	$	362,125
Market rate adjustment	(5,309)
Credit fair value adjustment on non-credit impaired loans	(3,947)
Credit fair value adjustment on impaired loans	(5,508)
Estimated fair value of acquired loans	$	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.

Table of Contents

The following table provides information about acquired PCI loans at May 1, 2019.



Contractually required principal and interest at acquisition	$	31,599
Contractual cash flows not expected to be collected (nonaccretable discount)	(8,616)
Expected cash flows at acquisition	22,983
Interest component of expected cash flows (accretable discount)	(3,497)
Estimated fair value of acquired PCI loans	$	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, ~~2018 and did not have a significant impact on our consolidated financial statements.~~

~~ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 allows entities to reclassify from AOCI to retained earnings~~2019. Unaudited pro forma net income for the 'stranded' tax effects of accounting for income tax rate changes on items accounted for in AOCI which were impacted by tax reform enacted in December 2017. The impact of tax rate changes is recorded in income and items accounted for in AOCI could

be left with such a stranded tax effect that could have those items appear to not reflect the appropriate tax rate. The FASB's changes are intended to improve the usefulness of information reported to financial statement users. The changes are effective for years beginning afteryear 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 ~~early adoption permitted. We elected to adopt~~ the ~~changes~~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 ~~2017. The amount transferred from AOCI to retained earnings~~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 0 and $617 thousand, respectively, of other expenses, including payout of employee termination contracts. Hamilton related merger expenses totaled ~~$229,000~~$7.7 million and ~~represented~~$267 thousand for the ~~impact~~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 0 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 5 branches in Franklin and Perry Counties, Pennsylvania, into other, larger branches of the ~~Tax Law rate change~~Bank, as part of its ongoing evaluation of branch profitability. The Company also announced the sale/leaseback of an operations center facility to ~~21% at~~eliminate approximately 50,000 square feet of excess back office space. The branch consolidations were completed in January 2020, and the ~~date~~sale of ~~enactment for~~ the ~~unrealized gains and losses on securities accounted for~~operations center facility is anticipated to be completed in ~~AOCI.~~the second quarter of 2020.

~~NOTE 2. RESTRICTIONS ON CASH AND DUE FROM BANKS~~

~~Cash on hand or on deposit~~In conjunction with the ~~Federal Reserve Bank or~~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 ~~correspondent banks, totaling $1,395,000 and $4,371,000 at~~costs. At December 31, ~~2017~~2019, fixed assets included in this consolidation, with an estimated fair value of $4.9 million, were held for sale and ~~2016, was required to meet regulatory reserve and clearing requirements.~~carried in other assets on the consolidated balances sheets.

Balances with correspondent banks may, at times, exceed federally insured limits; however the Company considers this to be a normal business risk. The Company reviews correspondent banks' financial condition on a quarterly basis.

Table of Contents

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, ~~at December 31, 2017 and 2016~~ and the corresponding amounts of gross unrealized gains and losses recognized in ~~AOCI. At~~AOCI at December 31, ~~2017~~2019 and ~~2016 all investment securities were classified as AFS.~~2018.

(Dollars in thousands)
Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses
Fair Value
December 31, 2017
States and political subdivisions $ 153,803
$ 6,133
$ 478
$ 159,458
GSE residential MBSs 48,600
930
0
49,530
GSE residential CMOs 113,658
296
2,835
111,119
Private label residential CMOs 999
4
0
1,003
Private label commercial CMOs 7,809
0
156
7,653
Asset-backed 86,787
69
425
86,431
Total debt securities 411,656
7,432
3,894
415,194
Equity securities 50
64
0
114
Totals $ 411,706
$ 7,496
$ 3,894
$ 415,308
December 31, 2016
U.S. Government Agencies $ 39,569
$ 147
$ 124
$ 39,592
States and political subdivisions 163,677
1,782
1,177
164,282
GSE residential MBSs 116,022
928
6
116,944
GSE residential CMOs 72,411
240
3,268
69,383
GSE commercial CMOs 5,148
0
292
4,856
Private label residential CMOs 5,042
0
36
5,006
Total debt securities 401,869
3,097
4,903
400,063
Equity securities 50
41
0
91
Totals $ 401,919
$ 3,138
$ 4,903
$ 400,154


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
December 31, 2019


States and political subdivisions	$	83,607	$	4,288	$	32	$	87,863

GSE residential CMOs	67,928		1,000		774		68,154
Non-agency CMOs	17,210		—		123		17,087


Private label commercial CMOs	86,704		156		231		86,629
Asset-backed and other	235,544		138		5,029		230,653
Totals	$	490,993	$	5,582	$	6,189	$	490,386
December 31, 2018


States and political subdivisions	$	144,596	$	1,919	$	1,511	$	145,004


GSE residential CMOs	110,421		332		2,689		108,064


Private label residential CMOs	144		—		1		143
Private label commercial CMOs	75,911		55		921		75,045
Asset-backed and other	138,535		126		1,073		137,588
Totals	$	469,607	$	2,432	$	6,195	$	465,844

The following table summarizes AFS securities with unrealized losses at December 31, ~~2017~~2019 and ~~2016,~~2018, aggregated by major security type and length of time in a continuous unrealized loss position.


	Less Than 12 Months								12 Months or More							Total
	# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses		# of Securities	Fair Value		Unrealized Losses
December 31, 2019


States and political subdivisions	1	$	6,173	$	32	—	$	0	$	0	1	$	6,173	$	32

GSE residential CMOs	5	37,158		309		1	11,602		465		6	48,760		774
Non-agency CMOs	1	17,087		123		—	—		—		1	17,087		123


Private label commercial CMOs	6	26,079		67		8	39,726		164		14	65,805		231
Asset-backed and other	9	92,189		1,145		9	121,399		3,884		18	213,588		5,029
Totals	22	$	178,686	$	1,676	18	$	172,727	$	4,513	40	$	351,413	$	6,189
December 31, 2018


States and political subdivisions	27	$	46,585	$	662	6	$	23,036	$	849	33	$	69,621	$	1,511

GSE residential CMOs	1	18,037		122		7	46,168		2,567		8	64,205		2,689


Private label residential CMOs	1	143		1		—	—		—		1	143		1
Private label commercial CMOs	11	56,499		712		2	6,349		209		13	62,848		921
Asset-backed and other	6	78,900		859		3	10,808		214		9	89,708		1,073
Totals	46	$	200,164	$	2,356	18	$	86,361	$	3,839	64	$	286,525	$	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.

Table of Contents

Less Than 12 Months 12 Months or More Total
(Dollars in thousands) # of Securities
Fair
Value

Unrealized
Losses
# of Securities
Fair
Value

Unrealized
Losses
# of Securities
Fair
Value

Unrealized
Losses
December 31, 2017
States and political subdivisions 7
$ 24,577
$ 473
1
$ 5,585
$ 5
8
$ 30,162
$ 478
GSE residential CMOs 4
25,155
914
5
37,459
1,921
9
62,614
2,835
Private label commercial CMOs 2
7,653
156
0
0
0
2
7,653
156
Asset-backed 6
60,006
425
0
0
0
6
60,006
425
Totals 19
$ 117,391
$ 1,968
6
$ 43,044
$ 1,926
25
$ 160,435
$ 3,894
December 31, 2016
U.S. Government Agencies 6
$ 10,710
$ 23
2
$ 13,531
$ 101
8
$ 24,241
$ 124
States and political subdivisions 25
58,924
610
1
5,075
567
26
63,999
1,177
GSE residential MBSs 1
5,034
6
0
0
0
1
5,034
6
GSE residential CMOs 6
59,534
3,264
1
634
4
7
60,168
3,268
GSE commercial CMOs 1
4,856
292
0
0
0
1
4,856
292
Private label residential CMOs 0
0
0
3
5,005
36
3
5,005
36
Totals 39
$ 139,058
$ 4,195
7
$ 24,245
$ 708
46
$ 163,303
$ 4,903
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.

~~U.S. Government Agencies~~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 ~~Securities.~~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. ~~Because~~As of December 31, 2019 and 2018, management concluded that an OTTI did not exist on any of the ~~Company~~aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell ~~these securities and~~nor will it ~~is not more likely than not that the Company will~~ be required to sell ~~them~~the securities, before ~~recovery of~~ their ~~amortized cost basis,~~recovery, which may be maturity, and management expects to recover the ~~Company does not consider these securities to be OTTI at December 31, 2017 or at December 31, 2016.~~

~~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. Because the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of theirentire amortized cost basis ~~which may be maturity, the Company does not consider~~of these ~~securities to be OTTI at December 31, 2017 or at December 31, 2016.~~securities.

~~Private Label Residential CMOs.~~ 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. ~~Because~~As of December 31, 2019, management concluded that an OTTI did not exist on any of the ~~Company~~aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell ~~these securities and~~nor will it ~~is not more likely than not that the Company will~~ be required to sell ~~them~~the securities, before ~~recovery of~~ their ~~amortized cost basis,~~recovery, which may be maturity, and management expects to recover the ~~Company does not consider~~entire amortized cost basis of these ~~securities to be OTTI at December 31, 2017 or at December 31, 2016.~~securities.

Private Label Residential CMOs, Private Label Commercial CMOs and ~~Asset-backed.~~ Asset-backed and Other. The unrealized losses presented in the table above have been caused by ~~the bid ask spread,~~a widening of spreads and/or a rise in interest rates from the time the securities were purchased. ~~Because~~As of December 31, 2019 and 2018, management concluded that an OTTI did not exist on any of the ~~Company~~aforementioned securities based upon its assessment. Management also concluded that it does not intend to sell ~~these securities and~~nor will it ~~is not more likely than not that the Company will~~ be required to sell ~~them~~the securities, before ~~recovery of~~ their ~~amortized cost basis,~~recovery, which may be maturity, and management expects to recover the ~~Company does not consider~~entire amortized cost basis of these ~~securities to be OTTI at December 31, 2017 or at December 31, 2016.~~

securities.

The following table summarizes amortized cost and fair value of AFS securities by contractual maturity at December 31, ~~2017 by contractual maturity.~~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.


	Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	230	$	230
Due after one year through five years	—		—
Due after five years through ten years	26,346		27,631
Due after ten years	57,031		60,002
CMOs	171,842		171,870
Asset-backed and other	235,544		230,653
	$	490,993	$	490,386

Available for Sale
(Dollars in thousands) Amortized Cost Fair Value

Due in one year or less $ 0
$ 0
Due after one year through five years 8,712
8,929
Due after five years through ten years 49,958
51,188
Due after ten years 95,133
99,341
MBSs and CMOs 171,066
169,305
Asset-backed 86,787
86,431
Total debt securities 411,656
415,194
Equity securities 50
114
Totals $ 411,706
$ 415,308

Table of Contents

The following table summarizes proceeds from sales of AFS securities and gross gains and gross losses for the years ended December 31, ~~2017, 2016,~~2019, 2018 and ~~2015.~~2017.


	Years Ended December 31,
(Dollars in thousands)	2017		2016		2015
								2019		2018		2017
Proceeds from sale of AFS securities	$	162,320	$	64,742	$	65,611	Proceeds from sale of AFS securities	$	199,928	$	156,364	$	162,320
Gross gains	1,477		1,468		1,948		Gross gains	4,974		1,681		1,477
Gross losses	287		48		24		Gross losses	225		675		287

Table of ~~borrowing arrangements.~~Contents

~~Long-Term Debt~~

Fair value of the Company’s fixed rate long-term borrowings is estimated using a discounted cash flow analysis based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amounts of variable rate long-term borrowings approximates fair value at the reporting date.

~~Accrued Interest~~

~~The carrying amounts of accrued interest receivable and payable approximate their fair value.~~

~~Off-Balance Sheet Instruments~~

~~The Company generally does not charge commitment fees. Fees for standby letters of credit and other off-balance sheet instruments are not significant.~~

The following table presents ~~estimated fair values of~~ the ~~Company’s financial instruments at~~Company's noninterest income disaggregated by revenue source for the years ended December ~~31.~~31, 2019, 2018 and 2017.


	2019		2018		2017
Noninterest income
Service charges on deposit accounts	$	3,793	$	3,578	$	3,392
Loan swap referral fees	1,197		—		—
Trust and investment management income	7,255		6,576		6,400
Brokerage income	2,426		2,035		1,896
Interchange income	3,281		2,821		2,618
Revenue from contracts with clients	17,952		15,010		14,306

Other service charges	416		562		235
Mortgage banking activities	3,049		2,663		2,919
Income from life insurance	2,044		1,463		1,109
Other income	331		320		190
Investment securities gains	4,749		1,006		1,190
Total noninterest income	$	28,541	$	21,024	$	19,949

(Dollars in thousands)
Carrying
Amount
Fair Value Level 1 Level 2 Level 3
December 31, 2017
Financial Assets
Cash and due from banks $ 21,734
$ 21,734
$ 21,734
$ 0
$ 0
Interest-bearing deposits with banks 8,073
8,073
8,073
0
0
Restricted investments in bank stock 9,997
n/a
n/a
n/a
n/a
Securities available for sale 415,308
415,308
0
415,308
0
Loans held for sale 6,089
6,272
0
6,272
0
Loans, net of allowance for loan losses 997,216
994,617
0
0
994,617
Accrued interest receivable 5,048
5,048
0
2,580
2,468
Financial Liabilities
Deposits 1,219,515
1,213,288
0
1,213,288
0
Short-term borrowings 93,576
93,576
0
93,576
0
Long-term debt 83,815
83,949
0
83,949
0
Accrued interest payable 495
495
0
495
0
Off-balance sheet instruments 0
0
0
0
0
December 31, 2016
Financial Assets
Cash and due from banks $ 16,072
$ 16,072
$ 16,072
$ 0
$ 0
Interest-bearing deposits with banks 14,201
14,201
14,201
0
0
Restricted investments in bank stock 7,970
n/a
n/a
n/a
n/a
Securities available for sale 400,154
400,154
0
400,154
0
Loans held for sale 2,768
2,843
0
2,843
0
Loans, net of allowance for loan losses 870,616
870,470
0
0
870,470
Accrued interest receivable 4,672
4,672
0
2,643
2,029
Financial Liabilities
Deposits 1,152,452
1,149,727
0
1,149,727
0
Short-term borrowings 87,864
87,864
0
87,864
0
Long-term debt 24,163
24,966
0
24,966
0
Accrued interest payable 437
437
0
437
0
Off-balance sheet instruments 0
0
0
0
0

NOTE ~~18.~~21. ORRSTOWN FINANCIAL SERVICES, INC. (PARENT COMPANY ONLY) CONDENSED FINANCIAL INFORMATION

Condensed Balance Sheets


	December 31,
	2019		2018
Assets
Cash in Orrstown Bank	$	11,568	$	28,596



Investment in Orrstown Bank	242,041		175,299

Other assets	1,724		2,057
Total assets	$	255,333	$	205,952
Liabilities
Subordinated notes	$	31,847	$	31,859
Accrued interest and other liabilities	237		660
Total liabilities	32,084		32,519
Shareholders’ Equity
Common stock	584		491
Additional paid-in capital	188,365		151,678
Retained earnings	35,246		24,472
Accumulated other comprehensive loss	(480)		(2,972)
Treasury stock	(466)		(236)
Total shareholders’ equity	223,249		173,433
Total liabilities and shareholders’ equity	$	255,333	$	205,952

112

December 31,
(Dollars in thousands) 2017 2016
Assets
Cash in Orrstown Bank $ 703
$ 10,263
Deposits with other banks 214
307
Total cash 917
10,570
Securities available for sale 114
91
Investment in Orrstown Bank 140,429
121,362
Other assets 3,953
3,519
Total assets $ 145,413
$ 135,542

Liabilities $ 648
$ 683
Shareholders’ Equity
Common stock 435
437
Additional paid-in capital 125,458
124,935
Retained earnings 16,042
11,669
Accumulated other comprehensive income (loss) 2,845
(1,165 )
Treasury stock (15 ) (1,017 )
Total shareholders’ equity 144,765
134,859
Total liabilities and shareholders’ equity $ 145,413
$ 135,542

Table of Contents

Condensed Statements of Income


	For the Years Ended December 31,
	2019		2018		2017
Income
Dividends from bank subsidiary	$	2,000	$	4,450	$	—
Interest income from bank subsidiary	257		7		15
Other income	55		102		61

Total income	2,312		4,559		76
Expenses
Interest on short-term borrowings	—		57		—
Interest on subordinated notes	1,987		73		—
Total interest expense	1,987		130		—
Share-based compensation	236		205		247
Management fee to bank subsidiary	1,350		1,042		501
Merger related expenses	1,574		1,545		—
Other expenses	802		656		1,116
Total expenses	5,949		3,578		1,864
(Loss) income before income tax benefit and equity in undistributed income of subsidiaries	(3,637)		981		(1,788)
Income tax benefit	(1,182)		(735)		(596)
(Loss) income before equity in undistributed income of subsidiaries	(2,455)		1,716		(1,192)
Equity in undistributed income of subsidiaries	19,379		11,089		9,282
Net income	$	16,924	$	12,805	$	8,090

113

For the Years Ended December 31,
(Dollars in thousands) 2017 2016 2015
Income
Dividends from subsidiaries $ 0
$ 2,200
$ 17,900
Other interest and dividend income 15
38
3
Other income 61
62
35
Total income 76
2,300
17,938
Expenses
Share-based compensation 247
216
135
Management fee to Bank 501
504
500
Other expenses 1,116
2,152
1,720
Total expenses 1,864
2,872
2,355
Income (loss) before income tax benefit and equity in undistributed income (distributions in excess of income) of subsidiaries (1,788 ) (572 ) 15,583
Income tax benefit (596 ) (606 ) (831 )
Income (loss) before equity in undistributed income (distributions in excess of income) of subsidiaries (1,192 ) 34
16,414
Equity in undistributed income (distributions in excess of income) of subsidiaries 9,282
6,594
(8,540 )
Net income $ 8,090
$ 6,628
$ 7,874

Table of Contents

Condensed Statements of Cash Flows


	For the Years Ended December 31,
	2019		2018		2017
Cash flows from operating activities:
Net income	$	16,924	$	12,805	$	8,090
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Amortization	47		3		—
Deferred income taxes	16		22		16


Equity in undistributed income of subsidiaries	(19,379)		(11,089)		(9,282)
Share-based compensation	236		205		247
Net change in other liabilities	(423)		12		(35)
Net change in other assets	311		2,039		(377)

Net cash (used in) provided by operating activities	(2,268)		3,997		(1,341)
Cash flows from investing activities:



Capital contributed to subsidiaries	(100)		—		(6,100)
Net cash paid for acquisitions	(8,142)		(4,597)		—

Net cash used in investing activities	(8,242)		(4,597)		(6,100)
Cash flows from financing activities:
Dividends paid	(6,150)		(4,375)		(3,488)
Proceeds from issuance of subordinated notes, net of costs	—		31,857		—

Proceeds from issuance of common stock	1,463		1,448		1,276
Payments to repurchase common stock	(1,772)		(651)		—
Other, net	(59)		—		—

Net cash (used in) provided by financing activities	(6,518)		28,279		(2,212)
Net (decrease) increase in cash	(17,028)		27,679		(9,653)
Cash, beginning	28,596		917		10,570
Cash, ending	$	11,568	$	28,596	$	917

For the Years Ended December 31,
(Dollars in thousands) 2017 2016 2015
Cash flows from operating activities:
Net income $ 8,090
$ 6,628
$ 7,874
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Deferred income taxes 16
4
(53 )
Equity in (undistributed income) distributions in excess of income of subsidiaries (9,282 ) (6,594 ) 8,540
Share-based compensation 247
216
135
Net change in other liabilities (35 ) (6 ) 17
Other, net (377 ) (849 ) (712 )
Net cash provided by (used in) operating activities (1,341 ) (601 ) 15,801
Cash flows from investing activities:
Capital contributed to subsidiaries (6,100 ) 0
0
Other, net 0
(500 ) 0
Net cash used in investing activities (6,100 ) (500 ) 0
Cash flows from financing activities:
Dividends paid (3,488 ) (2,898 ) (1,822 )
Proceeds from issuance of common stock 1,276
847
794
Payments to repurchase common stock 0
(631 ) (809 )
Net cash used in financing activities (2,212 ) (2,682 ) (1,837 )
Net increase (decrease) in cash (9,653 ) (3,783 ) 13,964
Cash, beginning 10,570
14,353
389
Cash, ending $ 917
$ 10,570
$ 14,353

NOTE ~~19.~~22. CONTINGENCIES

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 no0 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 ~~“Defendants”~~“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 ~~Defendant’s~~Orrstown Defendants’ motion to dismiss was originally due January 11, 2013. Under the PSLRA,

114

Table of Contents

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 ~~expands~~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 ~~proposed~~ second amended complaint disclosed the existence of a confidential, non-public, fact-finding inquiry regarding the Company being conducted by the ~~Commission.~~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 ~~Commission~~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 ~~Commission’s~~SEC’s administrative proceedings and pursuant to the cease-and-desist order, without admitting or denying the ~~Commission’s~~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 ~~Commission.~~SEC. The Company agreed to pay a civil money penalty of ~~$1,000,000.~~$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 ~~Commission,~~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-admit-nor-deny~~neither-

115

Table of Contents

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~~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~~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.

~~Document discovery has begun in the case and is ongoing. To date, one deposition, of a non-party, has been concluded.~~

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.

116

Table of Contents

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 ~~second~~third amended complaint are without merit and intends to ~~vigorously~~ 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. The Company incurred indemnification costs totaling $645,000 for the year ended December 31, 2017, with several professional service providers in connection with the SEPTA litigation. These costs are included in legal fees in the consolidated statements

117

Table of ~~income.~~Contents

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, ~~2017.~~2019. Based on that evaluation, ~~the~~our Chief Executive Officer and Chief Financial Officer concluded that ~~the~~our disclosure controls and procedures were effective at December 31, ~~2017.~~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 ~~2017.~~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, ~~2017~~2019 has been audited by Crowe ~~Horwath~~ 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 ~~2018~~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 ~~2018~~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.

118

Table of Contents

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, ~~2017.~~2019.


Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)	(b)		(c)

Equity compensation plan approved by security holders	27,767	$	21.14	455,028
Equity compensation plan not approved by security holders ⁽¹⁾	2,792	25.76		—
Total	30,559	$	21.56	455,028
⁽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.

Plan Category
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights

Weighted
average exercise
price of outstanding
options, warrants and
rights

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(a) (b) (c)

Equity compensation plan approved by security holders 49,595
$ 25.70
82,277
Equity compensation plan not approved by security holders (1) 9,988
26.81
0
Total 59,583
$ 25.89
82,277


~~(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.~~

All other information required by Item 12 is incorporated, by reference, from the Company’s definitive proxy statement for the ~~2018~~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 ~~2018~~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 ~~2018~~2020 Annual Meeting of Shareholders filed pursuant to Regulation 14A, under Proposal 3 – Ratification of the Audit Committee’s Selection of Crowe ~~Horwath~~ LLP as the Company’s Independent Registered Public Accounting Firm for the Fiscal Year Ending December 31, ~~2018~~2019 – Relationship with Independent Registered Public Accounting Firm.

119

Table of Contents

PART IV

ITEM 15 – EXHIBITS, FINANCIAL STATEMENT SCHEDULES


~~(a)~~	~~The following documents are filed as part of this report:~~

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)		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.

~~3.1~~2.1(b)		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.

3.1		Articles of Incorporation as amended, incorporated by reference to Exhibit 3.1 of the Registrant’s ~~Report on~~ Form 8-K filed on January 29, 2010.

3.2		By-laws as amended, incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K filed January 30, 2018.

4.1		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).

~~10.1(a)~~4.2		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.

4.3		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.

4.4		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.

10.1(a)		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.

10.1(b)		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.

10.1(c)		Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and ~~David Boyle,~~Thomas R. Quinn, Jr. incorporated by reference to Exhibit 10.2 to the Registrant's Form 8-K filed ~~June 2, 2015.~~September 27, 2019.

10.1(d)		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.

10.1(e)		~~Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Benjamin W. Wallace, incorporated by reference to Exhibit 10.6 to the Registrant's Form 8-K filed June 2, 2015.~~

~~10.1(f)~~	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.

~~10.1(g)~~10.1(f)		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.

~~10.1(h)~~10.1(g)		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.

~~10.2(a)~~10.1(h)		~~Amended and Restated Salary Continuation~~Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and ~~Kenneth~~Robert J. Fignar, incorporated by reference to Exhibit 10.3 to the Registrant's Form 8-K filed June 1, 2018.

10.1(i)		Change in Control Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Thomas R. ~~Shoemaker,~~Brugger, incorporated by reference to Exhibit 10.2 ~~(a) of~~to the ~~Registrant’s~~Registrant's Form ~~10-K~~8-K filed ~~March 15, 2010.~~June 25, 2019.

120

Table of Contents


~~10.2(b)~~10.2(a)						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.

~~10.2(c)~~10.2(b)						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.

~~10.2(d)~~10.2(c)						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.

10.2(d)						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.

10.3						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.

10.4(a)						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.

10.4(b)						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.



10.4(c)		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.

10.4(d)		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.

10.4(e)		~~Director Retirement Agreement, as amended, between Orrstown Bank and Kenneth R. Shoemaker, incorporated by reference to Exhibit 10.4(e) to the Registrant’s Form 10-K filed March 15, 2010.~~

~~10.4(f)~~	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.

~~10.4(g)~~10.4(f)		~~Director Retirement Agreement, as amended, between Orrstown Bank and John S. Ward, incorporated by reference to Exhibit 10.4(g) to the Registrant’s Form 10-K filed March 15, 2010.~~

~~10.4(h)~~	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.

10.5		Revenue neutral retirement plan – incorporated by reference to Exhibit 10.4 to the Registrant’s Form 10-K ~~for the year ended December 31, 1999~~ filed March 28, 2000.

10.6		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.

10.7		Employee stock option plan of 2000 – incorporated by reference to the Registrant’s registration statement on Form S-8 filed March 31, 2000.

10.8		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 ~~June 3, 2011.~~May 24, 2018..

10.9(a)		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.

10.9(b)		Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and ~~David Boyle,~~Thomas R. Brugger, incorporated by reference to Exhibit 10.1 to ~~the Registrant's~~Registrant’s Form 8-K filed June ~~2, 2015.~~25, 2019.

10.9(c)		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.

10.9(d)		~~Employment Agreement between Orrstown Financial Services, Inc., Orrstown Bank and Benjamin W. Wallace, incorporated by reference to Exhibit 10.5 to the Registrant's Form 8-K filed June 2, 2015.~~

~~10.9(e)~~	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.

~~10.9(f)~~10.9(e)		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.

~~10.9(g)~~10.9(f)		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.

~~10.10~~10.9(g)		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.

10.10		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.

~~10.11~~10.11(a)		~~Form of Executive Employment Agreement for selected officers – incorporated by reference to Exhibit 10.1 to Registrant’s Form 8-K filed January 22, 2010.~~

~~10.12(a)~~	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.

~~10.12(b)~~10.11(b)		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.

121

Table of Contents


~~10.14~~10.12						~~Form of Restricted Share Grant~~Deferred Compensation Agreement ~~issued to certain employees on August 15, 2014,~~between Orrst own Bank and Thomas R. Quinn, Jr., incorporated by reference to Exhibit 10.1 to the Registrant's Form ~~10-Q~~8-K filed ~~November 7, 2014.~~September 27, 2019.

1410.13						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.

14						Code of Ethics Policy for Senior Financial Officers posted on Registrant’s website.

21						Subsidiaries of the registrant

23.1						Consent of Crowe ~~Horwath~~ LLP, Independent Registered Public Accounting Firm

31.1						Rule 13a – 14(a)/15d-14(a) Certification (Chief Executive Officer)

31.2						Rule 13a – 14(a)/15d-14(a) Certifications (Chief Financial Officer)



32.1						Section 1350 Certifications (Chief Executive Officer)

32.2						Section 1350 Certifications (Chief Financial Officer)


101.LAB		XBRL Taxonomy Extension Label Linkbase

~~101.LAB~~101.PRE		~~XBRL Taxonomy Extension Label Linkbase~~

~~101.PRE~~	XBRL Taxonomy Extension Presentation Linkbase

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		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.~~

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.

122

Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ORRSTOWN FINANCIAL SERVICES, INC.

(Registrant)

~~ORRSTOWN FINANCIAL SERVICES, INC.~~

~~(Registrant)~~

Dated: March ~~9, 2018~~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

~~Signature~~

~~Title~~

~~Date~~

/s/ Thomas R. Quinn, Jr.

President and Chief Executive Officer (Principal Executive Officer) and Director

March ~~9, 2018~~16, 2020

Thomas R. Quinn, Jr.

/s/ ~~David P. Boyle~~Thomas R. Brugger

Executive Vice President and Chief Financial Officer (Principal Financial ~~and Accounting~~ Officer)

March ~~9, 2018~~16, 2020

~~David P. Boyle~~Thomas R. Brugger

/s/ Gary A. Manley

Senior Vice President and Principal Accounting Officer

March 16, 2020

Gary A. Manley

/s/ Joel R. Zullinger

Chairman of the Board and Director

March ~~9, 2018~~16, 2020

Joel R. Zullinger

/s/ ~~Jeffrey W. Coy~~Robert A. DeAlmeida

~~Vice Chairman of the Board and~~ Director

March ~~9, 2018~~16, 2020

~~Jeffrey W. Coy~~Robert A. DeAlmeida

~~/s/ Dr. Anthony F. Ceddia~~

~~Secretary of the Board and Director~~

~~March 9, 2018~~

~~Dr. Anthony F. Ceddia~~

/s/ Cindy J. Joiner

Director

March ~~9, 2018~~16, 2020

Cindy J. Joiner

/s/ Mark K. Keller

Director

March ~~9, 2018~~16, 2020

Mark K. Keller

/s/ Thomas D. Longenecker

Director

March ~~9, 2018~~16, 2020

Thomas D. Longenecker

/s/ Andrea Pugh

Director

March ~~9, 2018~~16, 2020

Andrea Pugh

/s/ ~~Gregory A. Rosenberry~~Michael J. Rice

Director

March ~~9, 2018~~16, 2020

~~Gregory A. Rosenberry~~Michael J. Rice

/s/ Eric A. Segal

Director

March ~~9, 2018~~16, 2020

Eric A. Segal

/s/ Glenn W. Snoke

Director

March ~~9, 2018~~16, 2020

Glenn W. Snoke

/s/ Floyd E. Stoner

Director

March ~~9, 2018~~16, 2020

Floyd E. Stoner

~~107~~

123



Pennsylvania (State or Other Jurisdiction of Incorporation or Organization)			23-2530374 (I.R.S. Employer Identification No.)

77 East King Street, P. O. Box 250, Shippensburg, Pennsylvania (Address of Principal Executive Offices)			17257 (Zip Code)


				Page
Part I

			~~Page~~
~~Part I~~

Item 1.	Business		34
Item 1A.		Risk Factors		912
Item 1B.		Unresolved Staff Comments		1623
Item 2.		Properties		1624
Item 3.		Legal Proceedings		1624
Item 4.		Mine Safety Disclosures		1624

Part II

Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		1725
Item 6.		Selected Financial Data		1927
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		2028
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		4855
Item 8.		Financial Statements and Supplementary Data		5158
Item 9.		Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		~~101~~118
Item 9A.		Controls and Procedures		~~101~~118
Item 9B.		Other Information		~~101~~118

Part III

Item 10.		Directors, Executive Officers and Corporate Governance		~~101~~118
Item 11.		Executive Compensation		~~101~~118
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		~~102~~119
Item 13.		Certain Relationships and Related Transactions, and Director Independence		~~102~~119
Item 14.		Principal Accounting Fees and Services		~~102~~119

Part IV

Item 15.		Exhibits, Financial Statement Schedules		~~103~~120

Item 16.		Form 10-K Summary		~~105~~122

Signatures					~~106~~123



	Commercial															Consumer
(Dollars in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Municipal			Total			Residential Mortgage			Installment and Other			Total			Unallocated			Total
December 31, 2017
Balance, beginning of year	$	7,530		$	580		$	1,074		$	54		$	9,238		$	2,979		$	144		$	3,123		$	414		$	12,775
Provision for loan losses	38			(167		)	333			30			234			531			174			705			61			1,000
Charge-offs	(835		)	0			(85		)	0			(920		)	(180		)	(166		)	(346		)	0			(1,266		)
Recoveries	30			4			124			0			158			70			59			129			0			287
Balance, end of year	$	6,763		$	417		$	1,446		$	84		$	8,710		$	3,400		$	211		$	3,611		$	475		$	12,796
December 31, 2016
Balance, beginning of year	$	7,883		$	850		$	1,012		$	58		$	9,803		$	2,870		$	121		$	2,991		$	774		$	13,568
Provision for loan losses	107			(270		)	129			(4		)	(38		)	532			116			648			(360		)	250
Charge-offs	(872		)	0			(79		)	0			(951		)	(577		)	(194		)	(771		)	0			(1,722		)
Recoveries	412			0			12			0			424			154			101			255			0			679
Balance, end of year	$	7,530		$	580		$	1,074		$	54		$	9,238		$	2,979		$	144		$	3,123		$	414		$	12,775
December 31, 2015
Balance, beginning of year	$	9,462		$	697		$	806		$	183		$	11,148		$	2,262		$	119		$	2,381		$	1,218		$	14,747
Provision for loan losses	(1,020		)	(440		)	249			(125		)	(1,336		)	1,122			55			1,177			(444		)	(603		)
Charge-offs	(711		)	(22		)	(115		)	0			(848		)	(592		)	(62		)	(654		)	0			(1,502		)
Recoveries	152			615			72			0			839			78			9			87			0			926
Balance, end of year	$	7,883		$	850		$	1,012		$	58		$	9,803		$	2,870		$	121		$	2,991		$	774		$	13,568
December 31, 2014
Balance, beginning of year	$	13,215		$	670		$	864		$	244		$	14,993		$	3,780		$	124		$	3,904		$	2,068		$	20,965
Provision for loan losses	(1,674		)	92			(554		)	(61		)	(2,197		)	(960		)	107			(853		)	(850		)	(3,900		)
Charge-offs	(2,637		)	(70		)	(270		)	0			(2,977		)	(587		)	(177		)	(764		)	0			(3,741		)
Recoveries	558			5			766			0			1,329			29			65			94			0			1,423
Balance, end of year	$	9,462		$	697		$	806		$	183		$	11,148		$	2,262		$	119		$	2,381		$	1,218		$	14,747
December 31, 2013
Balance, beginning of year	$	13,719		$	3,502		$	1,635		$	223		$	19,079		$	2,275		$	85		$	2,360		$	1,727		$	23,166
Provision for loan losses	4,109			(6,087		)	(3,478		)	21			(5,435		)	1,845			99			1,944			341			(3,150		)
Charge-offs	(4,767		)	(193		)	(132		)	0			(5,092		)	(491		)	(144		)	(635		)	0			(5,727		)
Recoveries	154			3,448			2,839			0			6,441			151			84			235			0			6,676
Balance, end of year	$	13,215		$	670		$	864		$	244		$	14,993		$	3,780		$	124		$	3,904		$	2,068		$	20,965


																						Commercial																		Consumer
	Commercial										Consumer											Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
(Dollars in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Municipal		Total		Residential Mortgage		Installment and Other		Total		Unallocated		Total
December 31, 2017
December 31, 2019																					December 31, 2019
Loans allocated by:																					Loans allocated by:
Individually evaluated for impairment	$	5,848	$	492	$	350	$	0	$	6,690	$	4,325	$	11	$	4,336	$	0	$	11,026	Individually evaluated for impairment	$	6,452	$	—	$	1,763	$	—	$	8,215	$	3,336	$	85	$	3,421	$	—	$	11,636
Collectively evaluated for impairment	487,068		30,489		115,313		42,065		674,935		302,160		21,891		324,051		0		998,986		Collectively evaluated for impairment	752,413		57,403		212,791		47,057		1,069,664		512,380		50,650		563,030		—		1,632,694
	$	492,916	$	30,981	$	115,663	$	42,065	$	681,625	$	306,485	$	21,902	$	328,387	$	0	$	1,010,012		$	758,865	$	57,403	$	214,554	$	47,057	$	1,077,879	$	515,716	$	50,735	$	566,451	$	—	$	1,644,330
Allowance for loan losses allocated by:																					Allowance for loan losses allocated by:
Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	42	$	9	$	51	$	0	$	51	Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	36	$	—	$	36	$	—	$	36
Collectively evaluated for impairment	6,763		417		1,446		84		8,710		3,358		202		3,560		475		12,745		Collectively evaluated for impairment	7,634		959		2,356		100		11,049		3,111		319		3,430		140		14,619
	$	6,763	$	417	$	1,446	$	84	$	8,710	$	3,400	$	211	$	3,611	$	475	$	12,796		$	7,634	$	959	$	2,356	$	100	$	11,049	$	3,147	$	319	$	3,466	$	140	$	14,655
December 31, 2016
December 31, 2018																					December 31, 2018
Loans allocated by:																					Loans allocated by:
Individually evaluated for impairment	$	2,457	$	1	$	594	$	0	$	3,052	$	4,915	$	6	$	4,921	$	0	$	7,973	Individually evaluated for impairment	$	2,320	$	—	$	286	$	—	$	2,606	$	3,691	$	—	$	3,691	$	—	$	6,297
Collectively evaluated for impairment	426,410		30,747		87,871		53,741		598,769		269,537		7,112		276,649		0		875,418		Collectively evaluated for impairment	559,424		49,436		160,678		50,982		820,520		387,429		33,411		420,840		—		1,241,360
	$	428,867	$	30,748	$	88,465	$	53,741	$	601,821	$	274,452	$	7,118	$	281,570	$	0	$	883,391		$	561,744	$	49,436	$	160,964	$	50,982	$	823,126	$	391,120	$	33,411	$	424,531	$	—	$	1,247,657
Allowance for loan losses allocated by:																					Allowance for loan losses allocated by:
Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	43	$	0	$	43	$	0	$	43	Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	38	$	—	$	38	$	—	$	38
Collectively evaluated for impairment	7,530		580		1,074		54		9,238		2,936		144		3,080		414		12,732		Collectively evaluated for impairment	6,876		817		1,656		98		9,447		3,715		244		3,959		570		13,976
	$	7,530	$	580	$	1,074	$	54	$	9,238	$	2,979	$	144	$	3,123	$	414	$	12,775		$	6,876	$	817	$	1,656	$	98	$	9,447	$	3,753	$	244	$	3,997	$	570	$	14,014



☒			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 transition period from _____ to _____


Term		Definition

~~Term~~ALL		~~Definition~~

~~ALL~~	Allowance for loan losses
AFS		Available for sale
AOCI		Accumulated other comprehensive income (loss)
ASC		Accounting Standards Codification
ASU		Accounting Standards Update
Bank		Orrstown Bank, the commercial banking subsidiary of Orrstown Financial Services, Inc.
~~CET1~~BHC Act		Bank Holding Company Act of 1965
CDI		Core deposit intangible
CET1		Common Equity Tier 1
CMO		Collateralized mortgage obligation
Company		Orrstown Financial Services, Inc. and subsidiaries (interchangeable with "Orrstown” below)
~~EPS~~
CFPB		Consumer Financial Protection Bureau
CRA		Community Reinvestment Act
Dodd-Frank Act		Dodd-Frank Wall Street Reform and Consumer Protection Act
EPS		Earnings per common share
ERM		Enterprise risk management
Exchange Act		Securities Exchange Act of 1934, as amended
FASB		Financial Accounting Standards Board
~~FDIC~~FDIA		Federal Deposit Insurance Act
FDIC		Federal Deposit Insurance Corporation
~~FHLB~~FHC		Financial holding company
FHLB		Federal Home Loan Bank
FRB		Board of Governors of the Federal Reserve System
GAAP		Accounting principles generally accepted in the United States of America
~~GSE~~GLB Act		Gramm-Leach-Bliley Act
GSE		United States government-sponsored enterprise
~~IRC~~Hamilton		Hamilton Bancorp, Inc., and its wholly-owned banking subsidiary, Hamilton Bank (acquired May 1, 2019)
IRC		Internal Revenue Code of 1986, as amended
LHFS		Loans held for sale
MBS		Mortgage-backed securities
Mercersburg		Mercersburg Financial Corporation and its wholly-owned banking subsidiary, First Community Bank of Mercersburg (acquired October 1, 2018)
MPF Program		Mortgage Partnership Finance Program
MSR		Mortgage servicing right
NIM		Net interest margin
OCI		Other comprehensive income (loss)
OFA		Orrstown Financial Advisors, a division of the Bank that provides investment and brokerage services
OREO		Other real estate owned (foreclosed real estate)
Orrstown		Orrstown Financial Services, Inc. and subsidiaries
OTTI		Other-than-temporary impairment
Parent Company		Orrstown Financial Services, Inc., the parent company of Orrstown Bank and Wheatland Advisors, Inc.
2011 Plan		2011 Orrstown Financial Services, Inc. Stock Incentive ~~Stock~~ Plan

PCI loans		Purchased credit impaired loans
Repurchase Agreements		Securities sold under agreements to repurchase
SEC		Securities and Exchange Commission
Securities Act		Securities Act of 1933, as amended
TDR		Troubled debt restructuring
U.S.		United States of America
Wheatland		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.



	2017						2016
	Market Price				Quarterly Dividend		Market Price				Quarterly Dividend
	High		Low		Quarterly Dividend		High		Low		Quarterly Dividend

First quarter	$	23.40	$	20.00	$	0.10	$	18.11	$	16.60	$	0.08
Second quarter	23.00		19.05		0.10		19.95		17.05		0.09
Third quarter	26.55		22.15		0.10		23.73		17.59		0.09
Fourth quarter	26.95		24.15		0.12		23.75		18.05		0.09
					$	0.42					$	0.35



	Period Ending
Index	12/31/12	12/31/13	12/31/14	12/31/15	12/31/16	12/31/17
Orrstown Financial Services, Inc.	100.00	169.61	176.35	187.42	239.80	275.16
SNL Bank $1B-$5B Index	100.00	145.41	152.04	170.20	244.85	261.04
S&P 500 Index	100.00	132.39	150.51	152.59	170.84	208.14
NASDAQ Composite Index	100.00	140.12	160.78	171.97	187.22	242.71



	At or For The Year Ended December 31,
(Dollars in thousands except per share information)	2017			2016			2015			2014			2013
Summary of Operations
Interest and dividend income	$	51,015		$	41,962		$	38,635		$	38,183		$	37,098
Interest expense	7,644			5,417			4,301			4,159			5,011
Net interest income	43,371			36,545			34,334			34,024			32,087
Provision for loan losses	1,000			250			(603		)	(3,900		)	(3,150		)
Net interest income after provision for loan losses	42,371			36,295			34,937			37,924			35,237
Investment securities gains	1,190			1,420			1,924			1,935			332
Noninterest income	19,197			18,319			17,254			16,919			17,476
Noninterest expenses	50,330			48,140			44,607			43,768			43,247
Income before income tax expense (benefit)	12,428			7,894			9,508			13,010			9,798
Income tax expense (benefit)	4,338			1,266			1,634			(16,132		)	(206		)
Net income	$	8,090		$	6,628		$	7,874		$	29,142		$	10,004
Per Share Information
Basic earning per share	$	1.00		$	0.82		$	0.97		$	3.59		$	1.24
Diluted earnings per share	0.98			0.81			0.97			3.59			1.24
Dividends per share	0.42			0.35			0.22			0.00			0.00
Book value at December 31	17.34			16.28			16.08			15.40			11.28
Weighted average shares outstanding – basic	8,070,472			8,059,412			8,106,438			8,110,344			8,093,306
Weighted average shares outstanding – diluted	8,226,261			8,145,456			8,141,600			8,116,054			8,093,306
Stock Price Statistics
Close	$	25.25		$	22.40		$	17.84		$	17.00		$	16.35
High	26.95			23.75			18.45			17.50			18.00
Low	19.05			16.60			15.10			15.33			9.49
Price earnings ratio at close	25.3			27.3			18.4			4.7			13.2
Diluted price earnings ratio at close	25.8			27.7			18.4			4.7			13.2
Price to book at close	1.5			1.4			1.1			1.1			1.4
Year-End Information
Total assets	$	1,558,849		$	1,414,504		$	1,292,816		$	1,190,443		$	1,177,812
Loans	1,010,012			883,391			781,713			704,946			671,037
Total investment securities	425,305			408,124			402,844			384,549			416,864
Deposits – noninterest-bearing	162,343			150,747			131,390			116,302			116,371
Deposits – interest-bearing	1,057,172			1,001,705			900,777			833,402			884,019
Total deposits	1,219,515			1,152,452			1,032,167			949,704			1,000,390
Repurchase agreements	43,576			35,864			29,156			21,742			9,032
Borrowed money	133,815			76,163			84,495			79,812			66,077
Total shareholders’ equity	144,765			134,859			133,061			127,265			91,439
Assets under management – market value	1,370,950			1,174,143			966,362			1,017,013			1,085,216
Financial Ratios
Average equity / average assets	9.49		%	10.41		%	10.66		%	8.63		%	7.45		%
Return on average equity	5.73		%	4.80		%	5.99		%	28.78		%	11.30		%
Return on average assets	0.54		%	0.50		%	0.64		%	2.48		%	0.84		%



	2017 Versus 2016 Increase (Decrease) Due to Change in									2016 Versus 2015 Increase (Decrease) Due to Change in
(Dollars in thousands)	Average Volume			Average Rate			Total			Average Volume			Average Rate			Total
Interest Income
Federal funds sold and interest-bearing bank balances	$	(106	)	$	116		$	10		$	54		$	73		$	127
Taxable securities	472			994			1,466			(874		)	189			(685		)
Tax-exempt securities	1,762			219			1,981			1,191			(53		)	1,138
Taxable loans	4,901			1,631			6,532			3,683			(434		)	3,249
Tax-exempt loans	(366		)	(32		)	(398		)	(68		)	(178		)	(246		)
Total interest income	6,663			2,928			9,591			3,986			(403		)	3,583
Interest Expense
Interest-bearing demand deposits	175			778			953			118			169			287
Savings deposits	7			(1		)	6			8			0			8
Time deposits	36			328			364			254			656			910
Short-term borrowings	137			460			597			(100		)	(8		)	(108		)
Long-term debt	207			100			307			32			(13		)	19
Total interest expense	562			1,665			2,227			312			804			1,116
Net Interest Income	$	6,101		$	1,263		$	7,364		$	3,674		$	(1,207	)	$	2,467


	Average Impaired Balance		Interest Income Recognized		Interest Earned But Not Recognized
December 31, 2019
Commercial real estate:
Owner-occupied	$	2,455	$	2	$	387
Non-owner occupied	46		—		—
Multi-family	152		—		24
Non-owner occupied residential	217		—		21
Acquisition and development:

Commercial and land development	21		—		—
Commercial and industrial	683		—		130
Residential mortgage:
First lien	2,582		50		91
Home equity – term	13		—		1
Home equity – lines of credit	750		2		64
Installment and other loans	13		—		2
	$	6,932	$	54	$	720
December 31, 2018
Commercial real estate:
Owner-occupied	$	1,495	$	2	$	156
Non-owner occupied	1,842		—		236
Multi-family	148		—		20
Non-owner occupied residential	346		—		36
Acquisition and development:
1-4 family residential construction	181		—		—
Commercial and land development	1		—		1
Commercial and industrial	322		—		29
Residential mortgage:
First lien	3,234		59		130
Home equity – term	19		—		2
Home equity – lines of credit	657		2		52
Installment and other loans	4		—		5
	$	8,249	$	63	$	667


	Total

Three months or less	$	18,738
Over three months through six months	12,734
Over six months through one year	19,204
Over one year	18,402
Total	$	69,078


	2019 Quarter Ended														2018 Quarter Ended
	December		September		June		March		December		September		June		March

Interest income	$	24,028	$	24,836	$	24,472	$	19,658	$	19,152	$	16,276	$	15,843	$	14,396
Interest expense	6,087		6,757		5,957		4,898		4,402		3,536		2,982		2,591
Net interest income	17,941		18,079		18,515		14,760		14,750		12,740		12,861		11,805
Provision for loan losses	—		300		200		400		200		200		200		200
Net interest income after provision for loan losses	17,941		17,779		18,315		14,360		14,550		12,540		12,661		11,605
Investment securities gains	18		2,328		2,064		339		115		29		46		816
Other noninterest income	7,012		6,274		5,710		4,796		4,900		5,413		4,940		4,765
Merger related and branch consolidation expenses	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	5,262		8,241		2,797		3,334		1,282		4,660		4,386		4,117
Income tax expense	1,028		1,340		110		232		130		644		374		492
Net income	$	4,234	$	6,901	$	2,687	$	3,102	$	1,152	$	4,016	$	4,012	$	3,625

Per share information:
Basic earnings per share (a)	$	0.39	$	0.63	$	0.26	$	0.34	$	0.13	$	0.50	$	0.50	$	0.45
Diluted earnings per share (a)	$	0.38	$	0.62	$	0.26	$	0.33	$	0.12	$	0.49	$	0.48	$	0.44
Dividends paid per share	$	0.15	$	0.15	$	0.15	$	0.15	$	0.13	$	0.13	$	0.13	$	0.12
(a) Sum of the quarters may not equal the total year due to rounding.



	2017 Quarter Ended								2016 Quarter Ended
(Dollars in thousands, except per share information)	December		September		June		March		December		September		June		March

Interest and dividend income	$	13,619	$	13,098	$	12,468	$	11,830	$	11,075	$	10,654	$	10,272	$	9,961
Interest expense	2,284		2,017		1,750		1,593		1,365		1,420		1,321		1,311
Net interest income	11,335		11,081		10,718		10,237		9,710		9,234		8,951		8,650
Provision for loan losses	800		100		100		0		0		250		0		0
Net interest income after provision for loan losses	10,535		10,981		10,618		10,237		9,710		8,984		8,951		8,650
Investment securities gains	0		533		654		3		0		0		0		1,420
Noninterest income	5,173		4,723		4,969		4,332		4,969		4,568		4,537		4,245
Noninterest expenses	12,680		13,087		12,417		12,146		12,476		11,985		12,558		11,121
Income before income tax expense	3,028		3,150		3,824		2,426		2,203		1,567		930		3,194
Income tax expense	3,022		376		516		424		275		125		252		614
Net income	$	6	$	2,774	$	3,308	$	2,002	$	1,928	$	1,442	$	678	$	2,580

Per share information:
Basic earnings per share	$	0.00	$	0.34	$	0.41	$	0.25	$	0.24	$	0.18	$	0.08	$	0.32
Diluted earnings per share (a)	0.00		0.34		0.40		0.24		0.24		0.18		0.08		0.32
Dividends per share	0.12		0.10		0.10		0.10		0.09		0.09		0.09		0.08
(a) Sum of the quarters may not equal the total year due to rounding.



			Page
Management’s Report on Internal Control over Financial Reporting			5360
Report of Crowe ~~Horwath~~ LLP, Independent Registered Public Accounting Firm			5461
Consolidated Balance Sheets			5663
Consolidated Statements of Income			5764
Consolidated Statements of Comprehensive Income			5865
Consolidated Statements of Changes in Shareholders’ Equity			5966
Consolidated Statements of Cash Flows			6067
Notes to Consolidated Financial Statements			6169


/s/ Thomas R. Quinn, Jr.	/s/ Thomas R. Brugger
Thomas R. Quinn, Jr.	Thomas R. Brugger
President and Chief Executive Officer	Executive Vice President and Chief Financial Officer


	/s/ ~~Thomas R. Quinn, Jr.~~	~~/s/ David P. Boyle~~Gary A. Manley
~~Thomas R. Quinn, Jr.~~	~~David P. Boyle~~Gary A. Manley
~~President and Chief Executive Officer~~March 16, 2020	~~Executive~~Senior Vice President and ~~Chief Financial~~Principal Accounting Officer

~~March 9, 2018~~




	~~Crowe Horwath LLP~~ ~~Independent Member Crowe Horwath International~~


								December 31,
	December 31,
(Dollars in thousands, except per share data)	2017			2016
(Dollars in thousands, except per share amounts)							(Dollars in thousands, except per share amounts)	2019		2018
Assets							Assets
Cash and due from banks	$	21,734		$	16,072		Cash and due from banks	$	25,969	$	26,156
Interest-bearing deposits with banks	8,073			14,201			Interest-bearing deposits with banks	30,493		45,664
Federal funds sold							Federal funds sold	—		16,995
Cash and cash equivalents	29,807			30,273			Cash and cash equivalents	56,462		88,815
Restricted investments in bank stocks	9,997			7,970			Restricted investments in bank stocks	16,184		10,842
Securities available for sale	415,308			400,154
Loans held for sale	6,089			2,768
Securities available for sale (amortized cost of $490,993 and $469,607 at December 31, 2019 and 2018, respectively)							Securities available for sale (amortized cost of $490,993 and $469,607 at December 31, 2019 and 2018, respectively)	490,386		465,844
Loans held for sale, at fair value							Loans held for sale, at fair value	9,364		—
Loans held for sale, at cost							Loans held for sale, at cost	—		3,340
Loans	1,010,012			883,391			Loans	1,644,330		1,247,657
Less: Allowance for loan losses	(12,796		)	(12,775		)	Less: Allowance for loan losses	(14,655)		(14,014)
Net loans	997,216			870,616			Net loans	1,629,675		1,233,643
Premises and equipment, net	34,809			34,871			Premises and equipment, net	37,524		38,201
Cash surrender value of life insurance	33,570			32,102			Cash surrender value of life insurance	63,613		41,327
Goodwill							Goodwill	19,925		12,592
Other intangible assets, net							Other intangible assets, net	7,180		3,910
Accrued interest receivable	5,048			4,672			Accrued interest receivable	6,040		5,927
Other assets	27,005			31,078			Other assets	46,921		29,947
Total assets	$	1,558,849		$	1,414,504		Total assets	$	2,383,274	$	1,934,388
Liabilities							Liabilities
Deposits:							Deposits:
Noninterest-bearing	$	162,343		$	150,747		Noninterest-bearing	$	249,450	$	204,843
Interest-bearing	1,057,172			1,001,705			Interest-bearing	1,626,072		1,353,913
Total deposits	1,219,515			1,152,452			Total deposits	1,875,522		1,558,756
Short-term borrowings	93,576			87,864			Short-term borrowings	154,869		64,069
Long-term debt	83,815			24,163			Long-term debt	63,067		83,450
Accrued interest and other liabilities	17,178			15,166
Subordinated notes							Subordinated notes	31,847		31,859
Other liabilities							Other liabilities	34,720		22,821
Total liabilities	1,414,084			1,279,645			Total liabilities	2,160,025		1,760,955

Commitments and contingencies							Commitments and contingencies

Shareholders’ Equity							Shareholders’ Equity
Preferred stock, $1.25 par value per share; 500,000 shares authorized; no shares issued or outstanding	0			0
Common stock, no par value—$0.05205 stated value per share 50,000,000 shares authorized; 8,347,856 and 8,343,435 shares issued; 8,347,039 and 8,285,733 shares outstanding	435			437
Preferred stock, $1.25 par value per share; 500,000 shares authorized; 0 shares issued or outstanding							Preferred stock, $1.25 par value per share; 500,000 shares authorized; 0 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							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	584		491
Additional paid—in capital	125,458			124,935			Additional paid—in capital	188,365		151,678
Retained earnings	16,042			11,669			Retained earnings	35,246		24,472
Accumulated other comprehensive income (loss)	2,845			(1,165		)
Treasury stock—common, 817 and 57,702 shares, at cost	(15		)	(1,017		)
Accumulated other comprehensive loss							Accumulated other comprehensive loss	(480)		(2,972)
Treasury stock— 20,730 and 9,031 shares, at cost, at December 31, 2019 and 2018, respectively							Treasury stock— 20,730 and 9,031 shares, at cost, at December 31, 2019 and 2018, respectively	(466)		(236)
Total shareholders’ equity	144,765			134,859			Total shareholders’ equity	223,249		173,433
Total liabilities and shareholders’ equity	$	1,558,849		$	1,414,504		Total liabilities and shareholders’ equity	$	2,383,274	$	1,934,388


									Years Ended Years Ended December 31,
	Years Ended December 31,
(Dollars in thousands, except per share information)	2017		2016		2015
Interest and dividend income
Interest and fees on loans	$	40,185	$	33,916	$	30,798
Interest and dividends on investment securities
Taxable	7,478		6,012		6,697
Tax-exempt	3,134		1,826		1,059
(Dollars in thousands, except per share amounts)								(Dollars in thousands, except per share amounts)	2019		2018		2017
Interest income								Interest income
Loans								Loans	$	75,071	$	50,632	$	40,623
Investment securities - taxable								Investment securities - taxable	14,530		10,858		7,478
Investment securities - tax-exempt								Investment securities - tax-exempt	2,054		3,850		3,134
Short term investments	218		208		81			Short term investments	1,339		327		218
Total interest and dividend income	51,015		41,962		38,635
Total interest income								Total interest income	92,994		65,667		51,453
Interest expense								Interest expense
Interest on deposits	6,134		4,811		3,606
Interest on short-term borrowings	784		187		295
Interest on long-term debt	726		419		400
Deposits								Deposits	19,310		10,229		6,134
Short-term borrowings								Short-term borrowings	623		1,577		784
Long-term debt								Long-term debt	1,779		1,632		726
Subordinated notes								Subordinated notes	1,987		73		—
Total interest expense	7,644		5,417		4,301			Total interest expense	23,699		13,511		7,644
Net interest income	43,371		36,545		34,334			Net interest income	69,295		52,156		43,809
Provision for loan losses	1,000		250		(603		)	Provision for loan losses	900		800		1,000
Net interest income after provision for loan losses	42,371		36,295		34,937			Net interest income after provision for loan losses	68,395		51,356		42,809
Noninterest income								Noninterest income
Service charges on deposit accounts	5,675		5,445		5,226			Service charges on deposit accounts	3,404		3,233		3,057
Interchange income								Interchange income	3,281		2,821		2,618
Other service charges, commissions and fees	1,008		994		1,223			Other service charges, commissions and fees	805		907		570
Loan swap referral fees								Loan swap referral fees	1,197		—		—
Trust and investment management income	6,400		5,091		4,598			Trust and investment management income	7,255		6,576		6,400
Brokerage income	1,896		1,933		2,025			Brokerage income	2,426		2,035		1,896
Mortgage banking activities	2,919		3,412		2,747			Mortgage banking activities	3,049		2,663		2,919
Earnings on life insurance	1,109		1,099		1,025
Income from life insurance								Income from life insurance	2,044		1,463		1,109
Other income	190		345		410			Other income	331		320		190
Investment securities gains	1,190		1,420		1,924			Investment securities gains	4,749		1,006		1,190
Total noninterest income	20,387		19,739		19,178			Total noninterest income	28,541		21,024		19,949
Noninterest expenses								Noninterest expenses
Salaries and employee benefits	30,145		26,370		24,056			Salaries and employee benefits	39,495		32,524		30,145
Occupancy	2,806		2,491		2,221			Occupancy	4,325		3,084		2,806
Furniture and equipment	3,434		3,335		3,061			Furniture and equipment	4,723		4,079		3,434
Data processing	2,271		2,378		2,026			Data processing	3,599		2,674		2,271
Telephone and communication	647		740		692

Automated teller and interchange fees	767		748		798			Automated teller and interchange fees	1,015		806		767
Advertising and bank promotions	1,600		1,717		1,564			Advertising and bank promotions	1,967		1,592		1,600
FDIC insurance	606		775		859			FDIC insurance	367		681		606
Legal fees	802		850		1,440			Legal fees	585		413		802
Other professional services	1,571		1,332		1,262			Other professional services	2,369		1,434		1,571
Directors' compensation	996		969		737			Directors' compensation	1,003		984		996
Collection and problem loan	186		238		447
Real estate owned	69		239		162

Taxes other than income	866		767		916			Taxes other than income	1,018		1,012		866
Regulatory settlement	0		1,000		0
Intangible asset amortization								Intangible asset amortization	1,570		286		102

Merger related and branch consolidation expenses								Merger related and branch consolidation expenses	8,964		3,197		—
Insurance claim receivable write off								Insurance claim receivable write off	615		—		—
Other operating expenses	3,564		4,191		4,366			Other operating expenses	5,687		5,169		4,364
Total noninterest expenses	50,330		48,140		44,607			Total noninterest expenses	77,302		57,935		50,330
Income before income tax expense	12,428		7,894		9,508			Income before income tax expense	19,634		14,445		12,428
Income tax expense	4,338		1,266		1,634			Income tax expense	2,710		1,640		4,338
Net income	$	8,090	$	6,628	$	7,874		Net income	$	16,924	$	12,805	$	8,090

Per share information:								Per share information:
Basic earnings per share	$	1.00	$	0.82	$	0.97		Basic earnings per share	$	1.63	$	1.53	$	1.00
Diluted earnings per share	0.98		0.81		0.97			Diluted earnings per share	1.61		1.50		0.98
Dividends per share	0.42		0.35		0.22
Dividends paid per share								Dividends paid per share	0.60		0.51		0.42


																			Years Ended December 31, 2019, 2018, and 2017
(Dollars in thousands, except per share amounts)																		(Dollars in thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Total Shareholders’ Equity
	Years Ended December 31, 2017, 2016, and 2015
(Dollars in thousands, except per share data)	Common Stock			Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Shareholders’ Equity

Balance, January 1, 2015	$	430		$	123,392	$	1,887		$	1,576		$	(20	)	$	127,265
Net income	0			0		7,874			0			0			7,874
Total other comprehensive loss, net of taxes	0			0		0			(377		)	0			(377		)
Cash dividends ($0.22 per share)	0			0		(1,822		)	0			0			(1,822		)
Share-based compensation plans:
Issuance of stock (50,686 shares), including compensation expense of $740	5			835		0			0			0			840
Issuance of stock through dividend reinvestment plan (5,239 shares)	0			90		0			0			0			90
Acquisition of treasury stock (47,077 shares)	0			0		0			0			(809		)	(809		)
Balance, December 31, 2015	435			124,317		7,939			1,199			(829		)	133,061
Net income	0			0		6,628			0			0			6,628
Total other comprehensive loss, net of taxes	0			0		0			(2,364		)	0			(2,364		)
Cash dividends ($0.35 per share)	0			0		(2,898		)	0			0			(2,898		)
Share-based compensation plans:
Issuance of stock (22,956 common shares and 25,834 treasury shares), including compensation expense of $958	2			618		0			0			443			1,063
Acquisition of treasury stock (35,648 shares)	0			0		0			0			(631		)	(631		)
Balance, December 31, 2016	437			124,935		11,669			(1,165		)	(1,017		)	134,859
Balance, January 1, 2017																		Balance, January 1, 2017	$	437	$	124,935	$	11,669	$	(1,165)	$	(1,017)	$	134,859
Net income	0			0		8,090			0			0			8,090			Net income	—		—		8,090		—		—		8,090
Reclassification of disproportionate tax effects from accumulated other comprehensive income (loss) to retained earnings	0			0		(229		)	229			0			0			Reclassification of disproportionate tax effects from accumulated other comprehensive income (loss) to retained earnings	—		—		(229)		229		—		—
Total other comprehensive income, net of taxes	0			0		0			3,781			0			3,781			Total other comprehensive income, net of taxes	—		—		—		3,781		—		3,781
Cash dividends ($0.42 per share)	0			0		(3,488		)				0			(3,488		)	Cash dividends ($0.42 per share)	—		—		(3,488)		—		—		(3,488)

Share-based compensation plans:																		Share-based compensation plans:
Issuance of stock (4,421 net common shares and 56,885 treasury shares issued), including compensation expense of $1,386	(2		)	523		0			0			1,002			1,523
4,421 net common shares issued and 56,885 net treasury shares issued, including compensation expense totaling $1,386																		4,421 net common shares issued and 56,885 net treasury shares issued, including compensation expense totaling $1,386	(2)		523		—		—		1,002		1,523

Balance, December 31, 2017	$	435		$	125,458	$	16,042		$	2,845		$	(15	)	$	144,765		Balance, December 31, 2017	435		125,458		16,042		2,845		(15)		144,765
Net income																		Net income	—		—		12,805		—		—		12,805

Total other comprehensive loss, net of taxes																		Total other comprehensive loss, net of taxes	—		—		—		(5,817)		—		(5,817)
Cash dividends ($0.51 per share)																		Cash dividends ($0.51 per share)	—		—		(4,375)		—		—		(4,375)
Issuance of stock (1,052,635 common shares) to acquire Mercersburg Financial Corporation																		Issuance of stock (1,052,635 common shares) to acquire Mercersburg Financial Corporation	55		24,998		—		—		—		25,053
Share-based compensation plans:																		Share-based compensation plans:
38,764 net common shares issued and 8,214 net treasury shares acquired, including compensation expense totaling $1,493																		38,764 net common shares issued and 8,214 net treasury shares acquired, including compensation expense totaling $1,493	1		1,222		—		—		(221)		1,002

Balance, December 31, 2018																		Balance, December 31, 2018	491		151,678		24,472		(2,972)		(236)		173,433
Net income																		Net income	—		—		16,924		—		—		16,924

Total other comprehensive income, net of taxes																		Total other comprehensive income, net of taxes	—		—		—		2,492		—		2,492
Cash dividends ($0.60 per share)																		Cash dividends ($0.60 per share)	—		—		(6,150)		—		—		(6,150)
Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.																		Issuance of stock (1,765,704 common shares) to acquire Hamilton Bancorp, Inc.	92		36,530		—		—		—		36,622
Share-based compensation plans:																		Share-based compensation plans:
15,645 net common shares issued and 11,699 net treasury shares acquired, including compensation expense totaling $1,586																		15,645 net common shares issued and 11,699 net treasury shares acquired, including compensation expense totaling $1,586	1		157		—		—		(230)		(72)

Balance, December 31, 2019																		Balance, December 31, 2019	$	584	$	188,365	$	35,246	$	(480)	$	(466)	$	223,249


	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)
December 31, 2019
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	5,872	$	8,086

Multi-family	—		—		—		345		569
Non-owner occupied residential	—		—		—		235		422



Commercial and industrial	—		—		—		1,763		3,361
Residential mortgage:
First lien	425		425		36		2,165		3,164
Home equity—term	—		—		—		13		15
Home equity—lines of credit	—		—		—		733		1,077
Installment and other loans	—		—		—		85		97
	$	425	$	425	$	36	$	11,211	$	16,791
December 31, 2018
Commercial real estate:
Owner-occupied	$	—	$	—	$	—	$	1,880	$	2,576

Multi-family	—		—		—		131		336
Non-owner occupied residential	—		—		—		309		632



Commercial and industrial	—		—		—		286		457
Residential mortgage:
First lien	743		743		38		2,134		2,727
Home equity—term	—		—		—		16		23
Home equity—lines of credit	—		—		—		798		1,081

	$	743	$	743	$	38	$	5,554	$	7,832


	2019				2018
	Number��of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
Accruing:
Commercial real estate:
Owner-occupied	1	$	30	1	$	39



Residential mortgage:
First lien	9	931		11	1,069
Home equity - lines of credit	1	18		1	24
	11	979		13	1,132
Nonaccruing:
Commercial real estate:
Owner-occupied	4	1,909		1	37



Residential mortgage:
First lien	5	359		8	658

	9	2,268		9	695
	20	$	3,247	22	$	1,827


	Number of Contracts	Pre- Modification Investment Balance		Post- Modification Investment Balance
December 31, 2019
Commercial real estate:
Owner-occupied	3	$	1,866	$	1,881

















December 31, 2017
Commercial real estate:
Owner-occupied	2	$	119	$	119


			Days Past Due
	Current		30-59		60-89		90+ (still accruing)		Total Past Due		Non- Accrual		Total Loans
December 31, 2019
Commercial real estate:
Owner-occupied	$	158,723	$	144	$	—	$	—	$	144	$	5,842	$	164,709
Non-owner occupied	359,425		480		—		—		480		—		359,905
Multi-family	105,865		—		—		—		—		345		106,210
Non-owner occupied residential	116,370		841		66		69		976		235		117,581
Acquisition and development:
1-4 family residential construction	15,587		278		—		—		278		—		15,865
Commercial and land development	40,403		1,135		—		—		1,135		—		41,538
Commercial and industrial	208,668		315		—		—		315		1,763		210,746
Municipal	47,057		—		—		—		—		—		47,057
Residential mortgage:
First lien	314,473		9,092		1,234		150		10,476		1,659		326,608
Home equity – term	13,993		—		4		—		4		13		14,010
Home equity – lines of credit	163,907		417		275		—		692		715		165,314
Installment and other loans	50,224		236		37		—		273		85		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	6,015		—		129		31		160		—		6,175
Non-owner occupied	564		—		—		581		581		—		1,145
Multi-family	683		—		—		—		—		—		683
Non-owner occupied residential	1,710		105		111		531		747		—		2,457



Commercial and industrial	3,792		—		—		16		16		—		3,808

Residential mortgage:
First lien	6,308		1,857		745		854		3,456		—		9,764
Home equity – term	16		4		—		—		4		—		20

Installment and other loans	131		22		—		—		22		—		153
Subtotal	19,219		1,988		985		2,013		4,986		—		24,205
	$	1,613,914	$	14,926	$	2,601	$	2,232	$	19,759	$	10,657	$	1,644,330


	2019		2018
Accretable yield, beginning of period	$	2,065	$	—
New loans purchased	3,497		2,243
Accretion of income	(2,336)		(178)
Reclassifications from nonaccretable difference due to improvement in expected cash flows	2,444		—
Other changes, net	1,280		—
Accretable yield, end of period	$	6,950	$	2,065



(Dollars in thousands)

Balance, beginning of year	$	677
New loans	311
Repayments	(315		)
Balance, end of year	$	673


Cash paid for operating lease liabilities	$	1,122
Operating lease right-of-use assets ⁽¹⁾	$	10,485
Weighted-average remaining lease term (in years)	17.6
Weighted-average discount rate	4.5		%




2020	$	1,279
2021	1,147
2022	727
2023	748
2024	738
Thereafter	10,549
	15,188
Less: imputed interest	5,500
Total lease liabilities	$	9,688


	2019						2018
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets:
Core deposit intangibles	$	8,390	$	1,493	$	3,840	$	190
Other client relationship intangibles	524		338		931		671
Non-compete agreement	290		193		—		—
Total	$	9,204	$	2,024	$	4,771	$	861


2020	$	1,591
2021	1,313
2022	1,137
2023	960
2024	784
Thereafter	1,395
	$	7,180



Due in Years Ending December 31
(Dollars in thousands)
2018	$	574
2019	528
2020	496
2021	334
2022	230
Thereafter	474
	$	2,636


	Shares		Weighted Average Grant Date Fair Value			Shares	Weighted Average Grant Date Fair Value

Nonvested shares, beginning of year	227,337		$	16.88	Nonvested shares, beginning of year	275,412	$	20.33
Granted	67,753		22.52		Granted	114,893	20.24
Forfeited	(13,079	)	18.36		Forfeited	(36,069)	19.42
Vested	(13,600	)	17.95		Vested	(125,478)	17.65
Nonvested shares, end of year	268,411		$	18.18	Nonvested shares, end of year	228,758	$	21.90


	Shares	Weighted Average Exercise Price

Outstanding, beginning of year	40,984	$	24.34

Expired	(10,425)	32.47

Options outstanding and exercisable, end of year	30,559	$	21.56