OVERVIEW

Orrstown Financial Services, Inc. (the "Company") is a financial holding company with a wholly-owned bank subsidiary, Orrstown Bank (the "Bank"). The following is a discussion of our consolidated financial condition at September 30, 2012 and results of operations for the three and nine months ended September 30, 2012. Throughout this discussion, the yield on earning assets is stated on a fully taxable-equivalent basis and balances represent average daily balances unless otherwise stated. The discussion and analysis should be read in conjunction with our Condensed Consolidated Financial Statements (Unaudited) and Notes thereto presented elsewhere in this report. Certain prior period amounts, presented in this discussion and analysis, have been reclassified to conform to current period classifications.

Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management's current views as to likely future developments, and use words like "may," "will," "expect," "estimate," "anticipate" or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Company has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the Company's cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, including changes resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations, changes in the rate of inflation, changes in technology, our ability to attract skilled personnel and retain key members of our senior management team, the intensification of competition within the Company's market area, the outcome of litigation against the Company and other similar factors. For a discussion of these forward-looking statements and important factors that could cause results to differ materially from the forward-looking statements contained in this Report, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" contained in our Annual Report on Form 10-K for the year ended December 31, 2011 and contained in our Quarterly Reports for the quarters ended March 31, 2012, June 30, 2012 and this Report.

Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and follow general practices within the financial services industry in which it operates. Management, in order to prepare the Company's consolidated financial statements, is required to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the balance sheet date through the date the financial statements are filed with the SEC. As this information changes, the consolidated financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources.

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other 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, assumptions, and estimates underlying those amounts, the Company has identified the adequacy of the allowance for loan losses and accounting for income taxes as critical accounting policies.

The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet.

The Company recognizes deferred tax assets and liabilities for the future effects of temporary differences and tax credits. Enacted tax rates 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 operations in the period in which they are enacted. Deferred tax assets must be reduced by a valuation allowance if in management's judgment it is "more likely than not" that some portion of the asset will not be realized. Management may need to modify their judgments 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. Based upon the Company's continued taxable losses, projections for future taxable income and other available evidence, management believed it was not more likely than not that the net deferred tax asset would be realized at September 30, 2012, and accordingly, recorded a full valuation allowance of $19,872,000 at September 30, 2012.

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

SUMMARY OF FINANCIAL RESULTS

The Company recorded a net loss of $21,352,000 for the third quarter of 2012 compared to net income of $4,314,000 for the same period in 2011. Basic and diluted earnings (loss) per share (EPS) for the third quarter of 2012 were $(2.65), compared to $0.54 for the third quarter of 2011. On a year-to-date basis, the net loss recorded for the period was $39,484,000 for 2012, compared to a net loss of $2,482,000 for the same period in 2011. Basic and diluted earnings (loss) per share totaled $(4.90) for the nine months ended September 30, 2012 compared to $(0.31) for the same period in 2011.

Included below are ratios for the return on average tangible assets (ROTA) and return on average tangible equity (ROTE) which exclude intangibles from the balance sheet and related amortization and tax expense from net income due to the associated goodwill and intangibles from the acquisition of companies and purchased deposits.

                                          Three Months Ended                                  Nine Months Ended
                               September, 30,             September, 30,          September, 30,            September, 30,
                                    2012                       2011                    2012                      2011
Return on average assets                  (6.50 )%                   1.11 %                 (3.80 )%                  (0.22 )%
Return on average
tangible assets                           (6.50 )%                   1.13 %                 (3.80 )%                  (0.21 )%
Return on average equity                 (79.60 )%                  10.82 %                (44.87 )%                  (2.06 )%
Return on average
tangible equity                          (80.22 )%                  12.54 %                (45.12 )%                  (2.27 )%
Average equity / average
assets                                     8.16 %                   10.22 %                  8.47 %                   10.50 %

Supplemental Reporting of Non-GAAP-based Financial Measures

Return on average tangible assets and return on average tangible equity are non-GAAP-based financial measures calculated using non-GAAP-based amounts. The most directly comparable measure is return on average assets and return on average equity, which are calculated using GAAP-based amounts. The Company calculates the return on average tangible assets and equity by excluding the balance of

intangible assets and their related amortization expense, net of tax, from the calculation of return on average assets and equity. Management uses the return on average tangible assets and equity to assess the Company's core operating results and believes that this is a better measure of our operating performance as it is based on the Company's tangible assets and capital. We believe that excluding the impact of purchase accounting adjustments allows for a meaningful comparison with the Company's peers; particularly those that may not have acquired other companies. Lastly, the exclusion of goodwill and other intangible assets is consistent with the treatment by bank regulatory agencies on the calculation of risk-based capital ratios, which excludes these amounts. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. A reconciliation of return on average assets and equity to the return on average tangible assets and equity, is set forth below.

                                               September 30, 2012               September 30, 2011
For Quarter Ended:
Return on Average Assets (GAAP
basis)                                                       (6.50 )%                          1.11 %
Effect of excluding average
intangible assets and related
amortization, net of tax                                      0.00 %                           0.02 %

Return on Average Tangible Assets                            (6.50 )%                          1.13 %

Return on Average Equity (GAAP
basis)                                                      (79.60 )%                         10.82 %
Effect of excluding average
intangible assets and related
amortization, net of tax                                     (0.62 )%                          1.72 %

Return on Average Tangible Equity                           (80.22 )%                         12.54 %

                                              September 30, 2012              September 30, 2011
For Nine Months Ended:
Return on Average Assets (GAAP
basis)                                                      (3.80 )%                        (0.22 )%
Effect of excluding average
intangible assets and related
amortization, net of tax                                     0.00 %                          0.01 %

Return on Average Tangible Assets                           (3.80 )%                        (0.21 )%

Return on Average Equity (GAAP
basis)                                                     (44.87 )%                        (2.06 )%
Effect of excluding average
intangible assets and related
amortization, net of tax                                    (0.25 )%                        (0.21 )%

Return on Average Tangible Equity                          (45.12 )%                        (2.27 )%

(Dollars in thousands, except per share data)    September 30, 2012       December 31, 2011
Common shareholders' equity                     $             87,320     $           128,197
Less: Intangible assets                                          884                   1,041

Tangible common equity                          $             86,436     $           127,156

Total assets                                    $          1,269,319     $         1,444,097
Less: Intangible assets                                          884                   1,041

Tangible assets                                 $          1,268,435     $         1,443,056

Tangible book value per share is computed by dividing shares outstanding into tangible common equity. Management uses tangible book value per share because it believes such ratio is useful in understanding the Company's capital position and ratios. A reconciliation of book value per share to tangible book value per share is as follows:

                                       September 30, 2012       December 31, 2011
   Book value per share                $             10.83     $             15.92
   Less: Intangible assets per share                  0.11                    0.13

   Tangible book value per share       $             10.72     $             15.79

Tax equivalent net interest income is derived from GAAP interest income and net interest income using an assumed tax rate of 35%. We believe the presentation of net interest income on a tax-equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. The following reconciles net interest income on a fully taxable equivalent basis:

                                                September 30,       September 30,
   (Dollars in thousands)                           2012                2011
   For Quarter Ended:
   Net interest income                         $         9,029     $        12,825
   Effect of tax exempt income                             545                 720

   Net interest income, tax equivalent basis   $         9,574     $        13,545


   For Nine Months Ended:
   Net interest income                         $        29,417     $        38,023
   Effect of tax exempt income                           1,780               2,122

   Net interest income, tax equivalent basis   $        31,197     $        40,145

RESULTS OF OPERATIONS

QUARTER ENDED SEPTEMBER 30, 2012 COMPARED TO QUARTER ENDED

SEPTEMBER 30, 2011

Net Interest Income

The primary component of the Company's revenue is net interest income, which is the difference between interest income and fees on interest-earning assets and interest expense on interest-bearing liabilities. Earning assets include loans, securities and federal funds sold. Interest bearing liabilities include deposits and borrowed funds. To compare the tax-exempt yields to taxable yields, amounts are adjusted to pretax equivalents based on a 35% federal corporate tax rate.

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. The "net interest spread" and "net interest margin" (NIM) are two common statistics related to changes in net interest income. The net interest spread represents the difference between the yields earned on interest-earning assets and the rates paid for interest-bearing liabilities. The net interest margin is defined as the ratio of net interest income to average earning assets. Through the use of demand deposits and stockholders' equity, the net interest margin exceeds the net interest spread, as these funding sources are non-interest bearing.

The "Average Balances and Interest Rates" table below presents net interest income on a fully taxable equivalent basis, net interest spread and net interest margin for the quarters ended September 30, 2012 and 2011.

For the three months ended September 30, 2012, net interest income measured on a fully tax equivalent basis decreased $3,971,000 to $9,574,000 from $13,545,000 in the corresponding period in 2011. The primary reason for the decrease in net interest income was a decrease in average earning assets from $1,460,536,000 for the third quarter of 2011 to $1,229,190,000 for the same period in 2012. In addition, net interest margin decreased by 56 basis points, from 3.66% for the three months ended September 30, 2011 to 3.10% for the same period in 2012. The net interest spread for the three months ended September 30, 2012 was 3.02%, compared to 3.54% for the same period in 2011.

Interest income earned on loans decreased from $12,719,000 for the quarter ended September 30, 2011 to $9,937,000 for the same period in 2012, a $2,782,000 decline. Several factors have contributed to the decline. First, the average balance of impaired loans, which generally are in nonaccrual status, increased from $57,883,000 for the third quarter of 2011 to $59,980,000 for the same period in 2012. Additionally, the Company settled two floating for fixed rate interest rate swaps last year, and therefore there was no interest income from the swaps to enhance 2012's yield. As a result of these two factors, combined with generally lower interest rates, the yield on loans declined from 4.97% for the third quarter of 2011 to 4.78% for the third quarter of 2012. In addition to lower yields, the average volume of loans declined from $1,002,964,000 for the three months ended September 30, 2011 to $827,553,000 for the same period in 2012. The Company has temporarily curbed its loan growth in order to address and enhance credit administration and underwriting processes and procedures.

Securities interest income also declined in 2012 and totaled $1,268,000 for the quarter ended September 30, 2012, a decrease of $2,182,000, compared to $3,450,000 for the same period in 2011. The average balance on securities has declined from $408,951,000 in the third quarter of 2011 to $295,578,000 for the same period in 2012, and is a reason for the decrease in securities interest income. As a result of the recent regulatory climate related to nontraditional funding sources, management anticipates that it will not utilize brokered deposits to the extent it has in the past, and as such, as the brokered deposits matured, security proceeds were used to fund the payoff. In addition, the low interest rate environment has resulted in increased refinancing activity. This refinancing has resulted in accelerated prepayments on mortgage backed securities, many of which have premiums associated with them. As the prepayments have accelerated, the amortization of the premiums has been faster than in the past, which has placed pressure on the yields earned on the securities. Further, the proceeds from the sales or maturities of securities have been reinvested at lower interest rates, also negatively impacting the yield earned on securities. The yields earned on securities were 1.71% for the third quarter of 2012, a 167 basis point decline as compared to 3.38% for the third quarter of 2011.

Interest expense on deposits and borrowings for the three months ended September 30, 2012 was $1,702,000, a decrease of $964,000, from the $2,666,000 expensed in the same period in 2011. The Company's cost of funds on interest bearing liabilities has declined from 0.84% for the quarter ended September 30, 2011 to 0.63% for the same period in 2012. The interest rate environment has allowed the Company to lower the rates offered on its demand deposits, including interest bearing demand, money market and savings in 2012 compared to 2011, and as time deposits and long-term debt mature, it has also been able to replace the funds at slightly lower rates.

The Company's net interest spread of 3.02% declined 52 basis points in the quarter ended September 30, 2012 as compared to the same period in 2011. Net interest margin for the quarter ended September 30, 2012 was 3.10%, a 56 basis point decline from 3.66% for the quarter ended September 30, 2011. Management anticipates continued pressure on the net interest margin in future quarters as the level of nonaccrual loans will continue to impact rates earned on loans and securities will continue to pay off or mature, and be reinvested at lower interest rates.

The table that follows shows average balances and interest yields on a fully taxable equivalent basis (FTE):

Average Balances and Interest Rates



                                                                            Three Months Ended
                                                  September 30, 2012                                 September 30, 2011
                                                         Tax               Tax                              Tax               Tax
                                       Average        Equivalent       Equivalent         Average        Equivalent       Equivalent
(Dollars in thousands)                 Balance         Interest           Rate            Balance         Interest           Rate
Assets
Federal funds sold & interest
bearing bank balances                $   106,059               71             0.27 %    $    46,621     $         42             0.34 %
Securities                               295,578            1,268             1.71          408,951            3,450             3.38
Loans                                    827,553            9,937             4.78        1,002,964           12,719             4.97

Total interest-earning assets          1,229,190           11,276             3.65        1,460,536           16,211             4.38

Other assets                              77,234                                             87,511

Total                                $ 1,306,424                                        $ 1,548,047

Liabilities and Shareholders'
Equity
Interest bearing demand deposits     $   495,095              248             0.20      $   503,972     $        415             0.33
Savings deposits                          73,757               31             0.17           72,845               36             0.20
Time deposits                            439,628            1,240             1.12          585,030            1,871             1.27
Short term borrowings                     20,647               20             0.39           53,015               68             0.51
Long term debt                            38,006              163             1.71           43,192              276             2.55

Total interest bearing liabilities     1,067,133            1,702             0.63        1,258,054            2,666             0.84

Non-interest bearing demand
Deposits                                 122,050                                            121,749
Other                                     10,611                                             10,094

Total Liabilities                      1,199,794                                          1,389,897
Shareholders' Equity                     106,630                                            158,150

Total                                $ 1,306,424                              0.55 %    $ 1,548,047                              0.72 %

Net interest income (FTE)/ net
interest spread                                             9,574             3.02 %                          13,545             3.54 %

Net interest margin                                                           3.10 %                                             3.66 %

Tax-equivalent adjustment                                    (545 )                                             (720 )

Net interest income                                  $      9,029                                       $     12,825

NOTES: Yields and interest income on tax-exempt assets have been computed on a fully taxable equivalent basis assuming a 35% tax rate.

For yield calculation purposes, nonaccruing loans are included in the average loan balance.

Provision for Loan Losses

The provision for loan losses for the three months ended September 30, 2012 totaled $5,100,000 , a decrease from the third quarter of 2011's provision of $7,900,000. As further discussed in the "Allowance for Loan Losses" section, the 2012 provision levels were impacted by several factors. During the third quarter of 2012, the Company's risk elements, impaired loans, and net loan charge-offs continued to trend favorably. Total risk assets remained relatively constant when compared to June 30, 2012 increasing $1,031,000, or 1.6%, to $64,391,000. When compared to December 31, 2011, risk assets have decreased $49,388,000 or 43.4%. Impaired loans also remained relatively constant when compared to June 30, 2012, increasing $1,835,000 or 3.1% to $60,894,000. When compared to December 31, 2011, impaired loans have decreased $48,861,000, or 44.5%. During the third quarter of 2012, net loan charge-offs totaled $4,635,000, which is a decrease of $10,286,000 or 68.9% when compared to the second quarter of 2012. When compared to the third quarter of 2011, net loan charge-offs have decreased $4,800,000 or 50.9%. Over the past four quarters ended June 30, 2012, the Company has experienced less favorable credit metrics overall, resulting in increased provisioning for loan losses during this period. As a result of the increased provision over the past four quarters accompanied with the reduced loan charge-offs, continued overall loan contraction, and relatively flat risk assets on a linked quarter basis, the Company did not require as large of a provision for loan loss when compared to the quarter ended September 30, 2011.

See further discussion in the "Allowance for Loan Losses" section.

Noninterest Income

Noninterest income, excluding securities gains, totaled $4,882,000 for the three months ended September 30, 2012, compared to $6,600,000 for the same period in 2011. The net decline in revenues can be attributed to several factors, including the following:

• The Company sold its merchant service business in 2011, which had accounted for a $1,161,000 decrease in income for the third quarter of 2012 when compared to the same period in 2011.

. . .