PEOPLES FINANCIAL SERVICES CORP. (Form: 10-Q, Received: 05/05/2017 15:59:22)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2017

◻ Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the transition period from

001-36388

(Commission File Number)

PEOPLES FINANCIAL SERVICES CORP.

(Exact name of registrant as specified in its charter)

Pennsylvania	23-2391852
(State of incorporation)	(IRS Employer ID Number)

150 North Washington Avenue, Scranton, PA	18503
(Address of principal executive offices)	(Zip code)

(570) 346-7741

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ◻

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files. Yes ☒ No ◻

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company as defined in Rule 12b-2 of the Exchange Act.


Large accelerated filer	◻	Accelerated filer	☒

Non-accelerated filer	◻	Smaller reporting company	◻
Emerging growth company	◻		

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes ◻ No ☒

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of the registrant’s common stock, as of the latest practicable date: 7,396,163 at April 30, 2017.

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PEOPLES FINANCIAL SERVICES CORP.

FORM 10-Q

For the Quarter Ended March 31, 2017


Contents		Page No.

PART I.	FINANCIAL INFORMATION:

Item 1.	Financial Statements (Unaudited)

	Consolidated Balance Sheets at March 31, 2017 and December 31, 2016	3

	Consolidated Statements of Income and Comprehensive Income for the Three months ended March 31, 2017 and 2016	4

	Consolidated Statements of Changes in Stockholders’ Equity for the Three months ended March 31, 2017 and 2016	5

	Consolidated Statements of Cash Flows for the Three months ended March 31, 2017 and 2016	6

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39

Item 4.	Controls and Procedures	39

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3.	Defaults upon Senior Securities	40

Item 4.	Mine Safety Disclosures	40

Item 5.	Other Information	40

Item 6.	Exhibits	40

	Signatures	41

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Peoples Financial Services Corp.

CONSOLIDATED BALANCE SHEET S (UNAUDITED)

(Dollars in thousands, except share data)


	March 31, 2017		December 31, 2016
Assets:
Cash and due from banks:
Cash and due from banks	$	31,511	$	39,496
Interest-bearing deposits in other banks		304		445
Total cash and due from banks		31,815		39,941
Investment securities:
Available-for-sale		264,644		259,410
Held-to-maturity: Fair value March 31, 2017, $10,359; December 31, 2016, $10,714		10,180		10,517
Total investment securities		274,824		269,927
Loans, net		1,559,867		1,532,965
Less: allowance for loan losses		16,969		15,961
Net loans		1,542,898		1,517,004
Loans held for sale		444
Premises and equipment, net		34,967		33,260
Accrued interest receivable		5,604		6,228
Goodwill		63,370		63,370
Intangible assets, net		3,944		4,211
Other assets		65,640		65,501
Total assets	$	2,023,506	$	1,999,442

Liabilities:
Deposits:
Noninterest-bearing	$	358,538	$	353,686
Interest-bearing		1,257,006		1,235,071
Total deposits		1,615,544		1,588,757
Short-term borrowings		77,475		82,700
Long-term debt		57,615		58,134
Accrued interest payable		457		462
Other liabilities		13,096		12,771
Total liabilities		1,764,187		1,742,824

Stockholders’ equity:
Common stock, par value $2.00, authorized 25,000,000 shares, issued and outstanding 7,396,163 shares at March 31, 2017 and 7,394,143 shares at December 31, 2016		14,792		14,788
Capital surplus		134,884		134,871
Retained earnings		113,621		111,114
Accumulated other comprehensive loss		(3,978)		(4,155)
Total stockholders’ equity		259,319		256,618
Total liabilities and stockholders’ equity	$	2,023,506	$	1,999,442

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOM E (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Interest income:
Interest and fees on loans:
Taxable	$	15,541	$	14,346
Tax-exempt		726		751
Interest and dividends on investment securities:
Taxable		697		687
Tax-exempt		794		875
Dividends		12		10
Interest on interest-bearing deposits in other banks		29		17
Total interest income		17,799		16,686

Interest expense:
Interest on deposits		1,434		1,283
Interest on short-term borrowings		174		77
Interest on long-term debt		348		360
Total interest expense		1,956		1,720
Net interest income		15,843		14,966
Provision for loan losses		1,200		1,200
Net interest income after provision for loan losses		14,643		13,766

Noninterest income:
Service charges, fees and commissions		1,572		1,444
Merchant services income		1,015		914
Commission and fees on fiduciary activities		508		482
Wealth management income		319		412
Mortgage banking income		179		204
Life insurance investment income		189		193
Net gain on sale of investment securities available-for-sale				242
Total noninterest income		3,782		3,891

Noninterest expense:
Salaries and employee benefits expense		6,275		5,332
Net occupancy and equipment expense		2,394		2,437
Merchant services expense		730		632
Amortization of intangible assets		268		305
Other expenses		2,689		2,912
Total noninterest expense		12,356		11,618
Income before income taxes		6,069		6,039
Income tax expense		1,269		1,157
Net income		4,800		4,882

Other comprehensive income:
Unrealized gain on investment securities available-for-sale		273		995
Reclassification adjustment for net gain on sales included in net income				(242)
Other comprehensive income		273		753
Income tax related to other comprehensive income		96		264
Other comprehensive income, net of income taxes		177		489
Comprehensive income	$	4,977	$	5,371

Per share data:
Net income:
Basic	$	0.65	$	0.66
Diluted	$	0.65	$	0.66
Average common shares outstanding:
Basic		7,394,143		7,403,510
Diluted		7,394,143		7,403,510
Dividends declared	$	0.31	$	0.31

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUIT Y (UNAUDITED)

(Dollars in thousands, except per share data)


							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
Balance, January 1, 2017	$	14,788	$	134,871	$	111,114	$	(4,155)	$	256,618
Stock based compensation				17						17
Net income						4,800				4,800
Other comprehensive income, net of income taxes								177		177
Dividends declared: $0.31 per share						(2,293)				(2,293)
Common stock grants awarded, net of unearned compensation of $81: 2,020 shares		4		(4)
Balance, March 31, 2017	$	14,792	$	134,884	$	113,621	$	(3,978)	$	259,319

Balance, January 1, 2016	$	14,821	$	135,371	$	100,701	$	(2,125)	$	248,768
Stock based compensation				18						18
Net income						4,882				4,882
Other comprehensive income, net of income taxes								489		489
Dividends declared: $0.31 per share						(2,295)				(2,295)
Shares retired: 11,308 shares		(22)		(395)						(417)
Balance, March 31, 2016	$	14,799	$	134,994	$	103,288	$	(1,636)	$	251,445

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CASH FLOW S (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Cash flows from operating activities:
Net income	$	4,800	$	4,882
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment		451		392
Amortization of deferred loan costs		211		169
Amortization of intangibles		268		305
Net accretion of purchase accounting adjustments on tangible assets				(275)
Amortization of loss on investment tax credits		117		125
Provision for loan losses		1,200		1,200
Net gain on sale of other real estate owned		(1)		(11)
Loans originated for sale		(5,141)		(5,268)
Proceeds from sale of loans originated for sale		4,734		5,394
Net gain on sale of loans originated for sale		(37)		(204)
Net amortization of investment securities		759		1,041
Net gain on sale of investment securities available-for-sale				(242)
Life insurance investment income		(189)		(193)
Stock based compensation		17		18
Net change in:
Accrued interest receivable		624		341
Other assets		(580)		(583)
Accrued interest payable		(5)		(54)
Other liabilities		308		(404)
Net cash provided by operating activities		7,536		6,633
Cash flows from investing activities:
Proceeds from sales of investment securities available-for-sale				10,271
Proceeds from repayments of investment securities:
Available-for-sale		9,285		10,453
Held-to-maturity		331		418
Purchases of investment securities:
Available-for-sale		(14,999)
Net redemption (purchase) of restricted equity securities		270		(798)
Net increase in lending activities		(27,349)		(69,321)
Investment in low income housing investment tax credits				(2,050)
Purchases of premises and equipment		(2,158)		(1,646)
Purchase of investment in life insurance				(1,500)
Proceeds from sale of other real estate owned		208		83
Net cash used in investing activities		(34,412)		(54,090)
Cash flows from financing activities:
Net increase in deposits		26,787		19,798
Repayment of long-term debt		(519)		(573)
Net (decrease) increase in short-term borrowings		(5,225)		22,025
Retirement of common stock				(417)
Cash dividends paid		(2,293)		(2,295)
Net cash provided by financing activities		18,750		38,538
Net decrease in cash and cash equivalents		(8,126)		(8,919)
Cash and cash equivalents at beginning of period		39,941		32,917
Cash and cash equivalents at end of period	$	31,815	$	23,998

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Supplemental disclosures:
Cash paid during the period for:
Interest	$	1,961	$	1,931
Income taxes
Noncash items:
Transfers of loans to other real estate	$	50	$	524

See notes to consolidated financial statements

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

1. Summary of significan t accounting policies:

Nature of operations:

Peoples Financial Services Corp., a bank holding company incorporated under the laws of Pennsylvania, provides a full range of financial services through its wholly-owned subsidiary, Peoples Security Bank and Trust Company (“Peoples Bank”), including its subsidiary, Peoples Advisors, LLC (collectively, the “Company” or “Peoples”). The Company services its retail and commercial customers through twenty-six full-service community banking offices located within the Lackawanna, Lehigh, Luzerne, Monroe, Montgomery, Northampton, Susquehanna, Wayne and Wyoming Counties of Pennsylvania and Broome County of New York.

Basis of presentation:

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP’) for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. All significant intercompany balances and transactions have been eliminated in consolidation. Prior-period amounts are reclassified when necessary to conform to the current year’s presentation. These reclassifications did not have any effect on the operating results or financial position of the Company. The operating results and financial position of the Company for the three months ended and as of March 31, 2017, are not necessarily indicative of the results of operations and financial position that may be expected in the future.

The preparation of consolidated 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 at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that are particularly susceptible to material change in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, the valuation of deferred tax assets, determination of other-than-temporary impairment losses on securities, impairment of goodwill and fair value of assets acquired and liabilities assumed in business combinations. Actual results could differ from those estimates. For additional information and disclosures required under GAAP, reference is made to the Company’s Annual Report on Form 10-K for the period ended December 31, 2016.

Recent accounting standards:

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” The updated standard is a new comprehensive revenue recognition model that requires revenue to be recognized in a manner that depicts the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 which deferred the effective date of ASU 2014-09 by one year. During 2016, the FASB issued ASU Nos. 2016-10, 2016-12 and 2016-20 that provide additional guidance related to the identification of performance obligations within a contract, assessing collectability, contract costs, and other technical corrections and improvements. ASU 2014-09 will become effective for the Company for the annual period beginning after December 15, 2017 and for interim periods within the annual period. ASU 2014-09 allows for either full retrospective or modified retrospective adoption. The Company has not selected a transition method. The Company has completed an evaluation of its revenue-producing contracts and determined they are primarily agreements that are not within the scope of this standard. As a result, the Company does not expect the adoption of this standard to have a material impact to the Company’s reported revenues and interest income. The Company is continuing to evaluate the impact on other revenue and income sources.

In January 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-01, “Financial Instruments – Overall . ” The guidance in this ASU among other things, (1) requires equity investments with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (2) simplifies the impairment assessment of equity

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (3) eliminates the requirement for public businesses 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, (4) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (5) requires an entity to present separately in other comprehensive income the portion of the change in 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, (6) 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 (7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. The guidance in this ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is in the process of evaluating the impact of the adoption of this guidance on the Company’s financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases”. From the lessee's perspective, the new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessess. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company’s initial findings conclude that the new pronouncement will not have a significant impact on its consolidated financial statements as the current projected minimum lease payments under existing lease contracts subject to the new pronouncement are less than one percent of its current assets.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU will have a significant impact on the Company’s calculation and accounting for its Allowance for Loan Losses as well as credit losses related to investment securities available-for-sale. A summary of significant provisions of this ASU is as follows:

			The ASU requires that a financial asset (or a group of financial assets) measured at amortized cost basis be presented, net of a valuation allowance for credit losses, at an amount expected to be collected on the financial asset(s), and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU require measurement of expected credit losses based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. GAAP in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.
			The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology. In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.



This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down, and limits the amount of the allowance for credit losses to the amount by which the fair value is below amortized cost. For purchased investment securities available-for-sale with a more-than-insignificant

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

amount of credit deterioration since origination, the ASU requires an allowance be determined in a manner similar to other investment securities available-for-sale; however, the initial allowance would be added to the purchase price, with only subsequent changes in the allowance recorded in credit loss expense, and interest income recognized at the effective rate excluding the discount embedded in the purchase price related to estimated credit losses at acquisition.



This ASU will be effective for the Company for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The Company will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.

The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations; however, it is anticipated that the allowance will increase upon adoption and that the increased allowance level will decrease regulatory capital and ratios..

In June 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) –Classification of Certain Cash Receipts and Cash Payments. This Update provides clarification regarding eight specific cash flow issues with the objective of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For the Company, the amendments in this Update are effective beginning in the first quarter 2018. The amendments in this Update should be applied using a retroactive transition method to each period presented. The Company anticipates there will be no adjustments to the Consolidated Statements of Cash Flows, as previously reported, as a result of the clarifications provided in the Update.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Company’s annual and interim goodwill impairment tests beginning in the first quarter of 2020.

2. Other comprehensive income (loss):

The components of other comprehensive loss and their related tax effects are reported in the Consolidated Statements of Income and Comprehensive Income. The accumulated other comprehensive loss included in the Consolidated Balance Sheets relates to net unrealized gains and losses on investment securities available-for-sale and benefit plan adjustments.

The components of accumulated other comprehensive loss included in stockholders’ equity at March 31, 2017 and December 31, 2016 is as follows:


	March 31, 2017		December 31, 2016
Net unrealized gain on investment securities available-for-sale	$	826	$	553
Income tax		289		193
Net of income taxes		537		360
Benefit plan adjustments		(6,946)		(6,946)
Income tax		(2,431)		(2,431)
Net of income taxes		(4,515)		(4,515)
Accumulated other comprehensive loss	$	(3,978)	$	(4,155)

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Other comprehensive income (loss) and related tax effects for the three months ended March 31, 2017 and 2016 is as follows:


Three Months Ended March 31,	2017		2016
Unrealized gain on investment securities available-for-sale	$	273	$	995
Net gain on the sale of investment securities available-for-sale(1)				(242)
Other comprehensive income gain before taxes		273		753
Income tax expense		96		264
Other comprehensive income	$	177	$	489

(1) Represents amounts reclassified out of accumulated comprehensive loss and included in gains on sale of investment securities on the consolidated statements of income and comprehensive income.

3. Earnings per share:

Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method.

There were no shares considered anti-dilutive for the three month periods ended March 31, 2017 and 2016.


	2017				2016
For the Three Months Ended March 31	Basic		Diluted		Basic		Diluted
Net Income	$	4,800	$	4,800	$	4,882	$	4,882
Average common shares outstanding		7,394,143		7,394,143		7,403,510		7,403,510
Earnings per share	$	0.65	$	0.65	$	0.66	$	0.66

4. Investment securities:

The amortized cost and fair value of investment securities aggregated by investment category at March 31, 2017 and December 31, 2016 are summarized as follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
March 31, 2017	Cost		Gains		Losses		Value
Available-for-sale:
U.S. Treasury securities	$	20,050	$	1	$	156	$	19,895
U.S. Government-sponsored enterprises		83,677		72		1,277		82,472
State and municipals:
Taxable		14,663		604				15,267
Tax-exempt		105,894		2,104		461		107,537
Mortgage-backed securities:
U.S. Government agencies		19,321		47		36		19,332
U.S. Government-sponsored enterprises		20,213		46		118		20,141
Total	$	263,818	$	2,874	$	2,048	$	264,644
Held-to-maturity:
Tax-exempt state and municipals	$	6,861	$	86	$	83	$	6,864
Mortgage-backed securities:
U.S. Government agencies		64						64
U.S. Government-sponsored enterprises		3,255		176				3,431
Total	$	10,180	$	262	$	83	$	10,359

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2016	Cost		Gains		Losses		Value
Available-for-sale:
U.S. Treasury securities	$	7,570			$	132	$	7,438
U.S. Government-sponsored enterprises		82,314	$	79		1,480		80,913
State and municipals:
Taxable		14,698		566		39		15,225
Tax-exempt		110,931		2,309		640		112,600
Mortgage-backed securities:
U.S. Government agencies		21,041		48		47		21,042
U.S. Government-sponsored enterprises		22,303		48		159		22,192
Total	$	258,857	$	3,050	$	2,497	$	259,410
Held-to-maturity:
Tax-exempt state and municipals	$	6,862	$	72	$	67	$	6,867
Mortgage-backed securities:
U.S. Government agencies		68		1				69
U.S. Government-sponsored enterprises		3,587		191				3,778
Total	$	10,517	$	264	$	67	$	10,714

The maturity distribution of the fair value, which is the net carrying amount, of the debt securities classified as available-for-sale at March 31, 2017, is summarized as follows:


	Fair
March 31, 2017	Value
Within one year	$	39,613
After one but within five years		118,950
After five but within ten years		49,157
After ten years		17,451
		225,171
Mortgage-backed securities		39,473
Total	$	264,644

The maturity distribution of the amortized cost and fair value, of debt securities classified as held-to-maturity at March 31, 2017, is summarized as follows:


	Amortized		Fair
March 31, 2017	Cost		Value
Within one year
After one but within five years
After five but within ten years
After ten years	$	6,861	$	6,864
		6,861		6,864
Mortgage-backed securities		3,319		3,495
Total	$	10,180	$	10,359

Securities with a carrying value of $142,335 and $144,750 at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits and certain other deposits as required or permitted by law.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Securities and short-term investment activities are conducted with a diverse group of government entities, corporations and state and local municipalities. The counterparty’s creditworthiness and type of collateral is evaluated on a case-by-case basis. At March 31, 2017 and December 31, 2016, there were no significant concentrations of credit risk from any one issuer, with the exception of U.S. Government agencies and sponsored enterprises that exceeded 10.0 percent of stockholders’ equity.

The fair value and gross unrealized losses of investment securities with unrealized losses for which an other-than-temporary impairment (“OTTI”) has not been recognized at March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, are summarized as follows:


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2017	Value		Losses		Value		Losses		Value		Losses
U.S. Treasury securities	$	17,411	$	156					$	17,411	$	156
U.S. Government-sponsored enterprises		62,591		1,277						62,591		1,277
State and municipals:
Taxable
Tax-exempt		51,467		544						51,467		544
Mortgage-backed securities:
U.S. Government agencies		5,769		23	$	1,337	$	13		7,106		36
U.S. Government-sponsored enterprises		13,832		66		2,380		52		16,212		118
Total	$	151,070	$	2,066	$	3,717	$	65	$	154,787	$	2,131


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2016	Value		Losses		Value		Losses		Value		Losses
U.S. Treasury securities	$	7,438	$	132					$	7,438	$	132
U.S. Government-sponsored enterprises		59,460		1,480						59,460		1,480
State and municipals:
Taxable		1,035		39						1,035		39
Tax-exempt		55,166		707	$	226				55,392		707
Mortgage-backed securities:
U.S. Government agencies		5,917		27		1,496	$	20		7,413		47
U.S. Government-sponsored enterprises		16,412		85		2,712		74		19,124		159
Total	$	145,428	$	2,470	$	4,434	$	94	$	149,862	$	2,564

The Company had 150 investment securities, consisting of 93 tax-exempt state and municipal obligations, six U.S. Treasury securities, 23 U.S. Government-sponsored enterprise securities, and 28 mortgage-backed securities that were in unrealized loss positions at March 31, 2017. Of these securities, eight mortgage-backed securities were in a continuous unrealized loss position for twelve months or more. Management does not consider the unrealized losses on the debt securities, as a result of changes in interest rates, to be OTTI based on historical evidence that indicates the cost of these securities is recoverable within a reasonable period of time in relation to normal cyclical changes in the market rates of interest. Moreover, because there has been no material change in the credit quality of the issuers or other events or circumstances that may cause a significant adverse impact on the fair value of these securities, and management does not intend to sell these securities and it is unlikely that the Company will be required to sell these securities before recovery of their amortized cost basis, which may be maturity, the Company does not consider the unrealized losses to be OTTI at March 31, 2017. There was no OTTI recognized for the three months ended March 31, 2017 and 2016.

The Company had 163 investment securities, consisting of 107 tax-exempt state and municipal obligations, two taxable state and municipal obligation, two U.S. Treasury securities, 22 U.S. Government-sponsored enterprise securities and 30 mortgage-backed securities that were in unrealized loss positions at December 31, 2016. Of these securities, nine

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

mortgage-backed securities and two tax-exempt state and municipal securities were in a continuous unrealized loss position for twelve months or more.

5. Loans, net and allowance for loan losses:

The major classifications of loans outstanding, net of deferred loan origination fees and costs at March 31, 2017 and December 31, 2016 are summarized as follows. Net deferred loan costs were $494 and $579 at March 31, 2017 and December 31, 2016.


		March 31, 2017		December 31, 2016
Commercial	$	431,164	$	408,814
Real estate:
Commercial		703,194		700,144
Residential		286,389		289,781
Consumer		139,120		134,226
Total	$	1,559,867	$	1,532,965

The changes in the allowance for loan losses account by major classification of loan for the three months ended March 31, 2017 and 2016 are summarized as follows:


			Real estate
March 31, 2017	Commercial		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning Balance January 1, 2017	$	3,799	$	5,847	$	4,707	$	1,608	$		$	15,961
Charge-offs				(125)		(15)		(171)				(311)
Recoveries		7		33		22		57				119
Provisions		323		536		264		77				1,200
Ending balance	$	4,129	$	6,291	$	4,978	$	1,571	$		$	16,969

			Real estate
March 31, 2016	Commercial		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning Balance January 1, 2016	$	3,042	$	4,245	$	4,082	$	1,583	$	23	$	12,975
Charge-offs		(3)		(55)				(65)				(123)
Recoveries		2		16		25		63				106
Provisions		281		410		252		65		192		1,200
Ending balance	$	3,322	$	4,616	$	4,359	$	1,646	$	215	$	14,158

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The allocation of the allowance for loan losses and the related loans by major classifications of loans at March 31, 2017 and December 31, 2016 is summarized as follows:


			Real estate
March 31, 2017	Commercial		Commercial		Residential		Consumer		Unallocated	Total
Allowance for loan losses:
Ending balance	$	4,129	$	6,291	$	4,978	$	1,571	$	$	16,969
Ending balance: individually evaluated for impairment		404		513		484		23			1,424
Ending balance: collectively evaluated for impairment		3,725		5,778		4,494		1,548			15,545
Ending balance: loans acquired with deteriorated credit quality	$		$		$		$		$	$
Loans receivable:
Ending balance	$	431,164	$	703,194	$	286,389	$	139,120	$	$	1,559,867
Ending balance: individually evaluated for impairment		2,311		3,849		3,359		207			9,726
Ending balance: collectively evaluated for impairment		428,476		698,008		282,996		138,913			1,548,393
Ending balance: loans acquired with deteriorated credit quality	$	377	$	1,337	$	34	$		$	$	1,748



			Real estate
December 31, 2016	Commercial		Commercial		Residential		Consumer		Unallocated	Total
Allowance for loan losses:
Ending balance	$	3,799	$	5,847	$	4,707	$	1,608	$	$	15,961
Ending balance: individually evaluated for impairment		225		1,197		520					1,942
Ending balance: collectively evaluated for impairment		3,574		4,650		4,187		1,608			14,019
Ending balance: loans acquired with deteriorated credit quality	$		$		$		$		$	$
Loans receivable:
Ending balance	$	408,814	$	700,144	$	289,781	$	134,226	$	$	1,532,965
Ending balance: individually evaluated for impairment		1,724		5,820		3,543		155			11,242
Ending balance: collectively evaluated for impairment		406,127		692,987		286,201		134,071			1,519,386
Ending balance: loans acquired with deteriorated credit quality	$	963	$	1,337	$	37	$		$	$	2,337

The Company segments loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information,

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

and current economic trends, among other factors. Loans are individually analyzed for credit risk by classifying them within the Company’s internal risk rating system. The Company’s risk rating classifications are defined as follows:

Pass- A loan to borrowers with acceptable credit quality and risk that is not adversely classified as Substandard, Doubtful, Loss nor designated as Special Mention.

Special Mention- A loan that has potential weaknesses that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date. Special Mention loans are not adversely classified since they do not expose the Company to sufficient risk to warrant adverse classification.

Substandard- A loan that is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

Doubtful – A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make the collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss- A loan classified as Loss is considered uncollectible and of such little value that its continuance as bankable loan is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

The following tables present the major classification of loans summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system at March 31, 2017 and December 31, 2016:


			Special
March 31, 2017	Pass		Mention		Substandard		Doubtful	Total
Commercial	$	422,506	$	4,698	$	3,960	$	$	431,164
Real estate:
Commercial		680,231		10,409		12,554			703,194
Residential		279,384		205		6,800			286,389
Consumer		138,853		—		267			139,120
Total	$	1,520,974	$	15,312	$	23,581	$	$	1,559,867


			Special
December 31, 2016	Pass		Mention		Substandard		Doubtful	Total
Commercial	$	398,867	$	6,222	$	3,725	$	$	408,814
Real estate:
Commercial		674,914		10,392		14,838			700,144
Residential		282,737		233		6,811			289,781
Consumer		133,983				243			134,226
Total	$	1,490,501	$	16,847	$	25,617	$	$	1,532,965

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Information concerning nonaccrual loans by major loan classification at March 31, 2017 and December 31, 2016 is summarized as follows:


		March 31, 2017		December 31, 2016
Commercial	$	1,532	$	934
Real estate:
Commercial		4,701		7,016
Residential		2,821		3,003
Consumer		207		155
Total	$	9,261	$	11,108

The major classifications of loans by past due status are summarized as follows:


					Greater								Loans > 90
	30-59 Days		60-89 Days		than 90		Total Past						Days and
March 31, 2017	Past Due		Past Due		Days		Due		Current		Total Loans		Accruing
Commercial	$	440	$	33	$	1,532	$	2,005	$	429,159	$	431,164
Real estate:
Commercial		1,257		779		4,809		6,845		696,349		703,194	$	108
Residential		2,766		904		2,945		6,615		279,774		286,389		124
Consumer		864		168		437		1,469		137,651		139,120		230
Total	$	5,327	$	1,884	$	9,723	$	16,934	$	1,542,933	$	1,559,867	$	462


					Greater								Loans > 90
	30-59 Days		60-89 Days		than 90		Total Past						Days and
December 31, 2016	Past Due		Past Due		Days		Due		Current		Total Loans		Accruing
Commercial	$	249	$	75	$	934	$	1,258	$	407,556	$	408,814
Real estate:
Commercial		4,782		527		7,016		12,325		687,819		700,144
Residential		2,100		354		3,561		6,015		283,766		289,781	$	558
Consumer		962		259		441		1,662		132,564		134,226		286
Total	$	8,093	$	1,215	$	11,952	$	21,260	$	1,511,705	$	1,532,965	$	844

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The following tables summarize information concerning impaired loans as of and for the three months ended March 31, 2017 and March 31, 2016, and as of and for the year ended, December 31, 2016 by major loan classification:


							For the Quarter Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
March 31, 2017	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	765	$	1,386			$	1,585	$	4
Real estate:
Commercial		3,715		4,368				3,039		4
Residential		2,349		2,533				2,277		4
Consumer		184		184				170
Total		7,013		8,471				7,071		12
With an allowance recorded:
Commercial		1,923		1,923	$	404		1,103		13
Real estate:
Commercial		1,471		1,471		513		3,132		6
Residential		1,044		1,044		484		1,210		4
Consumer		23		23		23		12
Total		4,461		4,461		1,424		5,457		23
Commercial		2,688		3,309		404		2,688		17
Real estate:
Commercial		5,186		5,839		513		6,171		10
Residential		3,393		3,577		484		3,487		8
Consumer		207		207		23		182
Total	$	11,474	$	12,932	$	1,424	$	12,528	$	35


							For the Year Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
December 31, 2016	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	2,404	$	3,213			$	1,461	$	48
Real estate:
Commercial		2,364		3,018				4,300		71
Residential		2,205		2,388				2,133		35
Consumer		155		155				147
Total		7,128		8,774				8,041		154
With an allowance recorded:
Commercial		283		283	$	225		859
Real estate:
Commercial		4,793		4,793		1,197		2,366		2
Residential		1,375		1,376		520		1,185		7
Consumer								50
Total		6,451		6,452		1,942		4,460		9
Commercial		2,687		3,496		225		2,320		48
Real estate:
Commercial		7,157		7,811		1,197		6,666		73
Residential		3,580		3,764		520		3,318		42
Consumer		155		155				197
Total	$	13,579	$	15,226	$	1,942	$	12,501	$	163

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)


							For the Quarter Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
March 31, 2016	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	1,173	$	2,383			$	1,263	$	17
Real estate:
Commercial		3,162		3,832				2,947		32
Residential		2,216		2,399				2,632		1
Consumer		89		89				60
Total		6,640		8,703				6,902		50
With an allowance recorded:
Commercial		1,141		1,141	$	1,040		968
Real estate:
Commercial		3,028		3,028		541		2,836
Residential		992		992		533		1,455		2
Consumer		89		89		89		103
Total		5,250		5,250		2,203		5,362		2
Commercial		2,314		3,524		1,040		2,231		17
Real estate:
Commercial		6,190		6,860		541		5,783		32
Residential		3,208		3,391		533		4,087		3
Consumer		178		178		89		163
Total	$	11,890	$	13,953	$	2,203	$	12,264	$	52

Included in the commercial loan and commercial and residential real estate categories are troubled debt restructurings that are classified as impaired. Troubled debt restructurings totaled $2,226 at March 31, 2017, $1,909 at December 31, 2016 and $2,834 at March 31, 2016.

Troubled debt restructured loans are loans with original terms, interest rate, or both, that have been modified as a result of a deterioration in the borrower’s financial condition and a concession has been granted that the Company would not otherwise consider. Unless on nonaccrual, interest income on these loans is recognized when earned, using the interest method. The Company offers a variety of modifications to borrowers that would be considered concessions. The modification categories offered generally fall within the following categories:

Rate Modification - A modification in which the interest rate is changed to a below market rate.

Term Modification - A modification in which the maturity date, timing of payments or frequency of payments is changed.

Interest Only Modification - A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification - A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification - Any other type of modification, including the use of multiple categories above.

There was one loan modified as a troubled debt restructuring for the three months ended March 31, 2017, in the amount of $345. There was one loan modified as a troubled debt restructuring for the three months ended March 31, 2016, in the amount of $75. During the three months ended March 31, 2017, there were no payment defaults on restructured loans; there were two payment defaults on restructured residential real estate loans during the three months ended March 31, 2016 totaling $208.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

6. Other assets:

The components of other assets at March 31, 2017, and December 31, 2016 are summarized as follows:


		March 31, 2017		December 31, 2016
Other real estate owned	$	236	$	393
Investment in residential housing program		8,194		8,312
Mortgage servicing rights		698		698
Bank owned life insurance		33,261		33,073
Restricted equity securities		6,781		7,051
Other assets		16,470		15,974
Total	$	65,640	$	65,501

7. Fair value estimates:

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosure under GAAP. Fair value estimates are calculated without attempting to estimate the value of anticipated future business and the value of certain assets and liabilities that are not considered financial. Accordingly, such assets and liabilities are excluded from disclosure requirements.

In accordance with FASB ASC 820, “Fair Value Measurements and Disclosures,” fair value is the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. In many cases, these values cannot be realized in immediate settlement of the instrument.

Current fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction that is not a forced liquidation or distressed sale between participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

In accordance with GAAP, the Company groups its assets and liabilities generally measured at fair value into three levels based on market information or other fair value estimates in which the assets and liabilities are traded or valued and the reliability of the assumptions used to determine fair value. These levels include:

Level 1: Unadjusted quoted prices of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value estimate.

The following methods and assumptions were used by the Company to calculate fair values and related carrying amounts of financial instruments:

Cash and cash equivalents: The carrying values of cash and cash equivalents as reported on the balance sheet approximate fair value.

Investment securities: The fair values of U.S. Treasury securities and marketable equity securities are based on quoted market prices from active exchange markets. The fair values of debt securities are based on pricing from a matrix pricing model.

Loans held for sale: The fair values of loans held for sale are based upon current delivery prices in the secondary mortgage market.

Net loans: For adjustable-rate loans that re-price frequently and with no significant credit risk, fair values are based on carrying values. The fair values of other non-impaired loans are estimated using discounted cash flow analysis, using interest rates currently offered in the market for loans with similar terms to borrowers of similar credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis determined by the loan review function or underlying collateral values, where applicable.

Loans acquired in connection with business combinations are recorded at their acquisition date fair value. In order to record the loans at fair value, management made three different types of fair value adjustments. A market rate adjustment was made to adjust for the movement in market interest rates, irrespective of credit adjustments, compared to the stated rates of the acquired loans. A credit adjustment was made on pools of homogeneous loans representing the changes in credit quality of the underlying borrowers from the loan inception to the acquisition date. The credit adjustment on distressed loans represents the portion of the loan balance that has been deemed uncollectible based on the management’s expectations of future cash flows for each respective loan.

Mortgage servicing rights: To determine the fair value, the Company estimates the present value of future cash flows incorporating assumptions such as cost of servicing, discount rates, prepayment speeds and default rates.

Accrued interest receivable: The carrying value of accrued interest receivable as reported on the balance sheet approximates fair value.

Restricted equity securities: The carrying values of restricted equity securities approximate fair value, due to the lack of marketability for these securities.

Deposits: The fair values of noninterest-bearing deposits and savings, NOW and money market accounts are the amounts payable on demand at the reporting date. The fair value estimates do not include the benefit that results from such low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The carrying values of adjustable-rate, fixed-term time deposits approximate their fair values at the reporting date. For fixed-rate time deposits, the present value of future cash flows is used to estimate fair values. The discount rates used are the current rates offered for time deposits with similar maturities.

The fair value assigned to the core deposit intangible asset represents the future economic benefit of the potential cost savings from acquiring core deposits in the 2013 Penseco merger compared to the cost of obtaining alternative funding such as brokered deposits from market sources. Management utilized an income valuation approach to present value the estimated future cash savings in order to determine the fair value of the intangible asset.

Short-term borrowings: The carrying values of short-term borrowings approximate fair value.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Long-term debt: The fair value of fixed-rate long-term debt is based on the present value of future cash flows. The discount rate used is the current rate offered for long-term debt with the same maturity.

Accrued interest payable: The carrying value of accrued interest payable as reported on the balance sheet approximates fair value.

Off-balance sheet financial instruments:

The majority of commitments to extend credit, unused portions of lines of credit and standby letters of credit carry current market interest rates if converted to loans. Because such commitments are generally unassignable of either the Company or the borrower, they only have value to the Company and the borrower. None of the commitments are subject to undue credit risk. The estimated fair values of off-balance sheet financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet financial instruments was not material at March 31, 2017 and December 31, 2016.

Assets and liabilities measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016 are summarized as follows:


	Fair Value Measurement Using
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
			Identical Assets		Inputs		Inputs
March 31, 2017	Amount		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury securities	$	19,895	$	19,895			$
U.S. Government-sponsored enterprises		82,472			$	82,472
State and Municipals:
Taxable		15,267				15,267
Tax-exempt		107,537				107,537
Mortgage-backed securities:
U.S. Government agencies		19,332				19,332
U.S. Government-sponsored enterprises		20,141				20,141
Total	$	264,644	$	19,895	$	244,749	$


	Fair Value Measurement Using
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
			Identical Assets		Inputs		Inputs
December 31, 2016	Amount		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury securities	$	7,438	$	7,438			$
U.S. Government-sponsored enterprises		80,913			$	80,913
State and Municipals:
Taxable		15,225				15,225
Tax-exempt		112,600				112,600
Mortgage-backed securities:
U.S. Government agencies		21,042				21,042
U.S. Government-sponsored enterprises		22,192				22,192
Total	$	259,410	$	7,438	$	251,972	$

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016 are summarized as follows:

Fair Value Measurement Using

Quoted Prices in

Significant

Active Markets for

Other Observable

Unobservable

Identical Assets

Inputs

March 31, 2017

Amount

(Level 1)

(Level 2)

(Level 3)

Impaired loans

2,474

Other real estate owned

236

Fair Value Measurement Using

Quoted Prices in

Significant Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

December 31, 2016

Amount

(Level 1)

(Level 2)

(Level 3)

Impaired loans

3,193

Other real estate owned

371

Fair values of impaired loans are based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:


	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value				Range
March 31, 2017	Estimate		Valuation Techniques	Unobservable Input	(Weighted Average)
Impaired loans	$	2,474	Appraisal of collateral	Appraisal adjustments	3.7% to 97.0% (63.0)%
				Liquidation expenses	3.0% to 6.0% (4.9)%
Other real estate owned	$	236	Appraisal of collateral	Appraisal adjustments	20.0% to 40.0% (34.9)%
				Liquidation expenses	3.0% to 6.0% (5.0)%


	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value				Range
December 31, 2016	Estimate		Valuation Techniques	Unobservable Input	(Weighted Average)
Impaired loans	$	3,193	Appraisal of collateral	Appraisal adjustments	18.0% to 97.0% (74.5)%
				Liquidation expenses	3.0% to 6.0% (5.3)%
Other real estate owned	$	371	Appraisal of collateral	Appraisal adjustments	25.0% to 54.6% (43.1)%
				Liquidation expenses	3.0% to 6.0% (5.0)%

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 Inputs which are not identifiable.

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The carrying and fair values of the Company’s financial instruments at March 31, 2017 and December 31, 2016 and their placement within the fair value hierarchy are as follows:


					Fair Value Hierarchy
					Quoted
					Prices in
					Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
March 31, 2017	Value		Value		(level 1)		(level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	31,815	$	31,815	$	31,815
Investment securities:
Available-for-sale		264,644		264,644		19,895	$	244,749
Held-to-maturity		10,180		10,359				10,359
Loans held for sale		444		453				453
Net loans		1,542,898		1,529,464					$	1,529,464
Accrued interest receivable		5,604		5,604				5,604
Mortgage servicing rights		698		1,587				1,587
Restricted equity securities		6,781		6,781				6,781
Total	$	1,863,064	$	1,850,707
Financial liabilities:
Deposits	$	1,615,544	$	1,614,470			$	1,614,470
Short-term borrowings		77,475		77,475				77,475
Long-term debt		57,615		58,484				58,484
Accrued interest payable		457		457				457
Total	$	1,751,091	$	1,750,886


					Fair Value Hierarchy
					Quoted
					Prices in
					Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
December 31, 2016	Value		Value		(level 1)		(level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	39,941	$	39,941	$	39,941
Investment securities:
Available-for-sale		259,410		259,410	$	7,438	$	251,972
Held-to-maturity		10,517		10,714				10,714
Loans held for sale
Net loans		1,517,004		1,507,936					$	1,507,936
Accrued interest receivable		6,228		6,228				6,228
Mortgage servicing rights		698		1,587				1,587
Restricted equity securities		7,051		7,051				7,051
Total	$	1,840,849	$	1,832,867
Financial liabilities:
Deposits	$	1,588,757	$	1,587,701			$	1,587,701
Short-term borrowings		82,700		82,700				82,700
Long-term debt		58,134		58,987				58,987
Accrued interest payable		462		462				462
Total	$	1,730,053	$	1,729,850

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

8. Employee benefit plans:

The Company provides an Employee Stock Ownership Plan (“ESOP”) and a Retirement Profit Sharing Plan. The Company also maintains a Supplemental Executive Retirement Plan (“SERP”), an Employees’ Pension Plan, which is currently frozen, and a Postretirement Plan Life Insurance plan which was curtailed in 2013.

For the three months ended March 31, salaries and employee benefits expense includes approximately $296 in 2017 and $274 in 2016 relating to the employee benefit plans.

Components of net periodic benefit cost are as follows:



	Pension Benefits
Three Months Ended March 31,	2017	2016
Components of net periodic pension cost:
Interest cost	$	$	166
Expected return on plan assets			(223)
Amortization of unrecognized net gain			52
Net periodic other benefit cost	$	$	(5)

The 2008 long-term incentive plan (“2008 Plan”) allows for eligible participants to be granted equity awards. The plan was a legacy plan of Penseco Financial Services Corporation. Under the 2008 Plan the Compensation Committee of the board of directors has broad authority with respect to awards granted under the 2008 Plan, including, without limitation, the authority to:

Designate the individuals eligible to receive awards under the 2008 Plan.

Determine the size, type and date of grant for individual awards, provided that awards approved by the Committee are not effective unless and until ratified by the board of directors.

Interpret the 2008 Plan and award agreements issued with respect to individual participants.

Persons eligible to receive awards under the 2008 Plan include directors, officers, employees, consultants and other service providers of the Company and its subsidiaries, except that incentive stock option may be granted only to individuals who are employees on the date of grant.

As of March 31, 2017, there were 120,116 shares of the Company’s common stock available for grant as awards pursuant to the 2008 Plan. If any outstanding awards are forfeited by the holder or canceled by the Company, the underlying shares would be available for regrant to others.

The 2008 Plan authorizes grants of stock options, stock appreciation rights, dividend equivalents, performance awards, restricted stock and restricted stock units.

During the three months ended March 31, 2017, the Company awarded 2,020 shares of non-performance-based restricted stock, bringing the total of nonvested restricted stock awards to 14,382 shares, and 7,071 performance-based restricted stock units under the 2008 Plan. During the three months ended March 31, 2016, the Company did not make any awards under the 2008 Plan.

The non-performance restricted stock grants made during the three months ended March 31, 2017 vest equally over three years from the grant date. Grants of restricted stock made in prior periods cliff vest after five years. The performance-based restricted stock units vest three years after the grant date and include conditions based on the Company’s three-

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATE D FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

year cumulative diluted earnings per share and three-year average return on equity that determines the number of restricted stock units that may vest.

The Company expenses the fair value of all-share based compensation over the requisite service period commencing at grant date. The fair value of restricted stock is expensed on a straight-line basis. The Company periodically assesses the probability of achievement of the performance criteria and adjusts the amount of compensation expense accordingly. Compensation is recognized over the vesting period and adjusted for the probability of achievement of the performance criteria. The Company classifies share-based compensation for employees within “salaries and employee benefits expense” on the Consolidated Statements of Income and Comprehensive Income.

The Company did not recognize any compensation expense for the three months ended March 31, 2017 and 2016, respectively for awards granted under the 2008 Plan. As of March 31, 2017, the Company had $365 of unrecognized compensation expense associated with awards. That cost is expected to be recognized over a weighted average vesting period of 3 years.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Item 2. Management’s Discussio n and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this report, and with our audited consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the year ended December 31, 2016.

Cautionary Note Regarding Forward-Looking Statements:

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties. These statements are based on assumptions and may describe future plans, strategies and expectations of Peoples Financial Services Corp. and its direct and indirect subsidiaries. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Important factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to: risks associated with business combinations; changes in interest rates; economic conditions, particularly in our market area; legislative and regulatory changes and the ability to comply with the significant laws and regulations governing the banking and financial services business; monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System; credit risk associated with lending activities and changes in the quality and composition of our loan and investment portfolios; demand for loan and other products; deposit flows; competition; changes in the values of real estate and other collateral securing the loan portfolio, particularly in our market area; changes in relevant accounting principles and guidelines; inability of third party service providers to perform; and our ability to prevent, detect and respond to cyberattacks. Additional factors that may affect our results are discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, and in reports we file with the Securities and Exchange Commission from time to time.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, Peoples Financial Services Corp. does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Notes to the Consolidated Financial Statements referred to in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are incorporated by reference into the MD&A. Certain prior period amounts may have been reclassified to conform with the current year’s presentation. Any reclassifications did not have any effect on the operating results or financial position of the Company.

Critical Accounting Policies:

Disclosure of our significant accounting policies are included in Note 1 to the consolidated financial statements of the Annual Report on Form 10-K for the year ended December 31, 2016. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions.

Operating Environment:

The Federal Open Market Committee (“FOMC”), as telegraphed, increased the overnight rate 25 basis points during the first quarter of 2017 as well as projected two more rate hikes for 2017. In doing so, the FOMC cited improvement in labor markets and the move in recent quarters to the committee’s long-term desired 2 percent level. The initial reading of first quarter 2017 gross domestic product (“GDP”), the value of all goods and services produced in the Nation, came in at an annualized rate of 0.7%, down from the final reading of 2.1% in the fourth quarter of 2016 while the consumer price index (“CPI”) increased only moderately for the 12 months ended March 31, 2017 at 2.4% from 2.1% for the 12 months ended December 31, 2016. Moreover, the core personal consumption expenditure price index, which ignores food and energy, averaged 2.0% for the 12 months ended March 31, 2017. In fact, the consumer was a major factor in

Table of Contents

Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

the slowdown in GDP for the first quarter of 2017. Personal consumption fell from 3.5% in the fourth quarter of 2016 to just 0.3% in the first quarter of 2017.

Review of Financial Position:

Total assets increased $24,064, or 4.9% annualized, to $2,023,506 at March 31, 2017, from $1,999,442 at December 31, 2016. Loans, net increased to $1,559,867 at March 31, 2017, compared to $1,532,965 at December 31, 2016, an increase of $26,902 or 7.1% annualized. The increase in loans, net during 2017 has been funded through an increase in deposits. Deposits increased $26,787 or 6.8% annualized in the first quarter of 2017. Interest-bearing deposits increased $21,935 while noninterest-bearing deposits increased $4,852. Total stockholders’ equity increased $2,701 or at an annual rate of 4.3%, from $256,618 at year-end 2016 to $259,319 at March 31, 2017. For the three months ended March 31, 2017, total assets averaged $2,004,553, an increase of $152,910 from $1,851,643 for the same period of 2016.

Investment Portfolio:

The majority of the investment portfolio is classified as available-for-sale, which allows for greater flexibility in using the investment portfolio for liquidity purposes by allowing securities to be sold when market opportunities occur. Investment securities available-for-sale totaled $264,644 at March 31, 2017, an increase of $5,234, or 2.0% from $259,410 at December 31, 2016. The increase was the result of current balance sheet strategy aimed at increasing the level of investment securities held for liquidity purposes. Investment securities held-to-maturity totaled $10,180 at March 31, 2017, a decrease of $337 or 3.2% from $10,517 at December 31, 2016 due to payments received from mortgage backed holdings.

For the three months ended March 31, 2017, the investment portfolio averaged $274,940, a decrease of $12,267 or 4.3% compared to $287,207 for the same period last year. The tax-equivalent yield on the investment portfolio increased 3 basis points to 2.89% for the three months ended March 31, 2017, from 2.86% for the comparable period of 2016.

Securities available-for-sale are carried at fair value, with unrealized gains or losses net of deferred income taxes reported in the accumulated other comprehensive income (loss) component of stockholders’ equity. We reported net unrealized gains, included as a separate component of stockholders’ equity of $537, net of deferred income taxes of $289, at March 31, 2017, and $360, net of deferred income taxes of $193, at December 31, 2016.

Our Asset/Liability Committee (“ALCO”) reviews the performance and risk elements of the investment portfolio quarterly. Through active balance sheet management and analysis of the securities portfolio, we endeavor to maintain sufficient liquidity to satisfy depositor requirements and meet the credit needs of our customers.

Loan Portfolio:

Loan growth was strong in the three month period ended March 31, 2017. Loans, net increased to $1,559,867 at March 31, 2017 from $1,532,965 at December 31, 2016, an increase of $26,902 or 7.1% annualized. The growth reflected increases in commercial loans, commercial real estate loans and consumer loans, partially offset by a decrease in residential real estate loans. Commercial loans increased $22,350, or 22.2% annualized, to $431,164 at March 31, 2017 compared to $408,814 at December 31, 2016. Commercial real estate loans increased $3,050 or 1.8% annualized, to $703,194 at March 31, 2017 compared to $700,144 at December 31, 2016. Consumer loans increased $4,894, or 14.8% on an annualized basis, to $139,120 at March 31, 2017 compared to $134,226 at December 31, 2016. The primary contributor to the growth in consumer loans was our indirect loan portfolio which increased $5,961.

Residential real estate loans decreased $3,392, or 4.7% on an annualized basis, to $286,389 at March 31, 2017 compared to $289,781 at December 31, 2016. The majority of residential real estate loans originated are sold into the secondary market instead of being carried in the portfolio to mitigate interest rate risk in the current low rate environment.

For the three months ended March 31, 2017, loans, net averaged $1,534,765, an increase of $153,948 or 11.1% compared to $1,380,817 for the same period of 2016. The tax-equivalent yield on the loan portfolio was 4.40% for the three months ended March 31, 2017, a 12 basis point decrease from the comparable period last year. The tax-equivalent yield on the loan portfolio increased 7 basis points for the first quarter of 2017 as compared to 4.33% for the fourth quarter of 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

In addition to the risks inherent in our loan portfolio, in the normal course of business, we are also a party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These instruments include legally binding commitments to extend credit, unused portions of lines of credit and commercial letters of credit made under the same underwriting standards as on-balance sheet instruments, and may involve, to varying degrees, elements of credit risk and interest rate risk (“IRR”) in excess of the amount recognized in the financial statements.

Unused commitments at March 31, 2017, totaled $369,695, consisting of $338,753 in unfunded commitments of existing loan facilities and $30,942 in standby letters of credit. Due to fixed maturity dates, specified conditions within these instruments, and the ultimate needs of our customers, many will expire without being drawn upon. We believe that amounts actually drawn upon can be funded in the normal course of operations and therefore, do not represent a significant liquidity risk to us. In comparison, unused commitments at December 31, 2016 totaled $324,713, consisting of $293,662 in unfunded commitments of existing loans and $31,051 in standby letters of credit.

Asset Quality:

National, Pennsylvania, New York and market area unemployment rates at March 31, 2017 and 2016, are summarized as follows:


	2017		2016
United States	4.7	%	4.9	%
New York (statewide)	4.8		5.2
Pennsylvania (statewide)	5.3		5.6
Broome County	6.3		6.1
Bucks County	4.5		4.8
Lackawanna County	5.6		6.0
Lehigh County	5.4		5.5
Luzerne County	6.6		6.8
Monroe County	6.3		6.5
Montgomery County	4.0		4.2
Northampton County	5.4		5.4
Susquehanna County	6.0		6.9
Wayne County	6.6		7.0
Wyoming County	6.4	%	7.4	%

The employment conditions improved for the Nation, Pennsylvania, and New York and in all but two of the eleven counties representing our market areas in Pennsylvania and New York from one year ago. Unemployment rates remained elevated relative to historical as well as national and state levels within many of our market areas.

Our asset quality improved in the first quarter of 2017. Nonperforming assets decreased $2,068 or 14.5% to $12,144 at March 31, 2017, from $14,212 at December 31, 2016. We experienced a decrease in nonaccrual and restructured loans, accruing loans past due 90 days or more and other real estate owned. As a percentage of loans, net and foreclosed assets, nonperforming assets equaled 0.78% at March 31, 2017 compared to 0.93% at December 31, 2016.

Loans on nonaccrual status decreased $1,847 to $9,261 at March 31, 2017 from $11,108 at December 31, 2016. The majority of the decrease from year end was due to a decrease of $2,315 in commercial real estate loans. Nonaccrual commercial loans increased $598, residential real estate loans decreased $182, and nonaccrual consumer loans increased $52. Accruing loans past due 90 days or more showed a decrease of $382 to $462 at March 31, 2017 from $844 at December 31, 2016 and other real estate owned decreased $157 to $236 at March 31, 2017 from $393 at December 31, 2016.

Generally, maintaining a high loan to deposit ratio is our primary goal in order to maximize profitability. However, this objective is superseded by our attempts to ensure that asset quality remains strong. We continued our efforts to maintain sound underwriting standards for both commercial and consumer credit. Most commercial lending is done primarily with locally owned small businesses.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to specifically identified loans, as well as probable incurred loan losses inherent in the remainder of the loan portfolio as of the balance sheet date. The allowance for loan losses is based on past events and current economic conditions. We employ the Federal Financial Institutions Examination Council Interagency Policy Statement, as amended December 13, 2006, and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310, “Receivables,” for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, “Contingencies,” for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment.

We follow our systematic methodology in accordance with procedural discipline by applying it in the same manner regardless of whether the allowance is being determined at a high point or a low point in the economic cycle. Each quarter, credit administration identifies those loans to be individually evaluated for impairment and those loans collectively evaluated for impairment utilizing a standard criteria. We consistently use loss experience from the latest twelve quarters in determining the historical loss factor for each pool collectively evaluated for impairment. Qualitative factors are evaluated in the same manner each quarter and are adjusted within a relevant range of values based on current conditions. For additional disclosure related to the allowance for loan losses refer to the note entitled, “Loans, net and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements to this Quarterly Report.

The allowance for loan losses increased $1,008 to $16,969 at March 31, 2017, from $15,961 at the end of 2016. For the three months ended March 31, 2017, net charge-offs were $192 or 0.05% of average loans outstanding, a $175 increase compared to $17 or 0.01% of average loans outstanding in the same period of 2016.

Deposits:

We attract the majority of our deposits from within our ten county market area that stretches from Montgomery County in Pennsylvania to Broome County in the Southern Tier of New York State through the offering of various deposit instruments including demand deposit accounts, NOW accounts, money market deposit accounts, savings accounts, and time deposits, including certificates of deposit and IRA’s. For the three months ended March 31, 2017, total deposits increased to $1,615,544 from $1,588,757 at December 31, 2016. Interest-bearing deposits increased $21,935 and noninterest-bearing deposits increased $4,852. Interest-bearing transaction accounts, including NOW and money market accounts, increased $13,682, or 9.9% annualized, to $569,010 at March 31, 2017, from $555,328 at December 31, 2016. savings accounts increased $8,750, or 9.0% annualized to $402,783 as of March 31, 2017 from $394,033 at December 31, 2016 and time deposits less than $100 increased $36, or 0.1% annualized, to $164,186 at March 31, 2017, from $164,150 at December 31, 2016. Time deposits $100 or more decreased $495, or 1.7% annualized to $121,028 at March 31, 2017 from $121,523 at year end 2016.

For the three months ended March 31, 2017 interest-bearing deposits averaged $1,244,021 in 2017 compared to $1,159,159 in 2016, an increase of $84,862, or 7.3%. The cost of interest-bearing deposits was 0.47% in 2017 compared to 0.45% for the same period last year. For the first three months, the overall cost of interest-bearing liabilities including the cost of borrowed funds, was 0.57% in 2017 and 0.54% in 2016.

Borrowings:

The Bank utilizes borrowings as a secondary source of liquidity for its asset/liability management. Advances are available from the Federal Home Loan Bank of Pittsburgh (“FHLB”) provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB.

Total short-term borrowings at March 31, 2017, totaled $77,475 compared to $82,700 at December 31, 2016, a decrease of $5,225. Long-term debt was $57,615 at March 31, 2017, compared to $58,134 at year end 2016. Cash and due from bank balances were used to reduce our short-term borrowing whereas the decline in long-term debt was a product of monthly contractual amortized payments made during the three months ended March 31, 2017.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Market Risk Sensitivity:

Market risk is the risk to our earnings or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily “IRR” associated with our lending, investing and deposit-gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. Interest rate changes also affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value and provide a basis for the expected change in future earnings related to interest rates. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

As a result of economic uncertainty and a prolonged era of historically low market rates, it has become challenging to manage IRR. Due to these factors, IRR and effectively managing it are very important to both bank management and regulators. Bank regulations require us to develop and maintain an IRR management program, overseen by the Board of Directors and senior management, that involves a comprehensive risk management process in order to effectively identify, measure, monitor and control risk. Should bank regulatory agencies identify a material weakness in our risk management process or high exposure relative to our capital, bank regulatory agencies may take action to remedy these shortcomings. Moreover, the level of IRR exposure and the quality of our risk management process is a determining factor when evaluating capital adequacy.

The ALCO, comprised of members of our Board of Directors, senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures, and utilizes computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate-sensitive assets (“RSA”) and rate-sensitive liabilities (“RSL”), and overall operating results and financial position. One such technique utilizes a static gap model that considers repricing frequencies of RSA and RSL in order to monitor IRR. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by a RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by a RSA/RSL ratio of less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes.

Our cumulative one-year RSA/RSL ratio equaled 1.69% at March 31, 2017. Given the length of time that market rates have been at historical lows and the potential for rates to increase in the future, the focus of ALCO has been to create a positive static gap position. With regard to RSA, we predominantly offer medium- term, fixed-rate loans as well as adjustable rate loans. With respect to RSL, we offer longer term promotional certificates of deposit in an attempt to increase duration. The current position at March 31, 2017, indicates that the amount of RSA repricing within one year would exceed that of RSL, thereby causing net interest income to increase as market rates increase. However, these forward-looking statements are qualified in the aforementioned section entitled “Forward-Looking Discussion” in this Management’s Discussion and Analysis.

Static gap analysis, although a standard measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity table presents a one-day position. Variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such a table.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

As the static gap report fails to address the dynamic changes in the balance sheet composition or prevailing interest rates, we utilize a simulation model to enhance our asset/liability management. This model is used to create pro forma net interest income scenarios under various interest rate shocks. Model results at March 31, 2017, produced results similar to those indicated by the one-year static gap position. In addition, parallel and instantaneous shifts in interest rates under various interest rate shocks resulted in changes in net interest income that were well within ALCO policy limits. We will continue to monitor our IRR throughout 2017 and endeavor to employ deposit and loan pricing strategies and direct the reinvestment of loan and investment repayments in order to manage our IRR position.

Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us, however we believe that our exposure to inflation can be mitigated through asset/liability management.

Liquidity:

Liquidity management is essential to our continuing operations and enables us to meet financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Financial obligations include, but are not limited to, the following:

Funding new and existing loan commitments;

Payment of deposits on demand or at their contractual maturity;

Repayment of borrowings as they mature;

Payment of lease obligations; and

Payment of operating expenses.

These obligations are managed daily, thus enabling us to effectively monitor fluctuations in our liquidity position and to adapt that position according to market influences and balance sheet trends. Future liquidity needs are forecasted and strategies are developed to ensure adequate liquidity at all times.

Historically, core deposits have been the primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available for sale securities and mortgage loans held for sale. We believe liquidity is adequate to meet both present and future financial obligations and commitments on a timely basis.

We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to determine the extent of our reliance on noncore funds to fund our investments and loans maturing after March 31, 2017. Our noncore funds at March 31, 2017, were comprised of time deposits in denominations of $100 or more and other borrowings. These funds are not considered to be a strong source of liquidity because they are very interest rate sensitive and are considered to be highly volatile. At March 31, 2017, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 13.8%, while our net short-term noncore funding dependence ratio, noncore funds maturing within one-year, less short-term investments to long-term assets equaled 6.3%. Comparatively, our overall noncore dependence ratio at year-end 2016 was 14.4% and our net short-term noncore funding dependence ratio was 6.5%, indicating that our reliance on noncore funds has decreased.

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents, consisting of cash on hand, cash items in the process of collection, deposit balances with other banks and federal funds sold, decreased $8,126 during the three months ended March 31, 2017. Cash and cash equivalents decreased $8,919 for the same period last year. For the three months ended March 31, 2017, net cash inflows of $7,536 from operating activities and $18,750 from financing activities were more than offset by net cash outflows of $34,412 from investing activities. For the same period of 2016, net cash inflows of $6,633 from

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

operating activities and $38,538 from financing activities were more than offset by net cash outflows of $54,090 from investing activities.

Operating activities provided net cash of $7,536 for the three months ended March 31, 2017, and $6,633 for the corresponding three months of 2016. Net income, adjusted for the effects of gains and losses along with noncash transactions such as depreciation and the provision for loan losses, is the primary source of funds from operations.

Investing activities primarily include transactions related to our lending activities and investment portfolio. Investing activities used net cash of $34,412 for the three months ended March 31, 2017, compared to using net cash $54,090 for the same period of 2016. In 2017 and 2016, an increase in lending activities was the primary factor causing the net cash outflow from investing activities.

Financing activities provided net cash of $18,750 for the three months ended March 31, 2017, and provided net cash of $38,538 for the corresponding three months of 2016. Deposit gathering is our predominant financing activity. Deposits increased for the three months ended March 31, 2017 and 2016. The net increase in deposits totaled $26,787 in the three months ended March 31, 2017. Comparatively, deposits increased $19,798 for the same period of 2016. We continued to attract deposits from new markets and customers as well as existing customers, including municipalities and school districts. Another source of financing is our short term borrowings which decreased $5,225 in the three months ended March 31, 2017 compared to an increase of $22,025 in the first quarter of 2016.

We believe that our future liquidity needs will be satisfied through maintaining an adequate level of cash and cash equivalents, by maintaining readily available access to traditional funding sources, and through proceeds received from the investment and loan portfolios. The current sources of funds will enable us to meet all cash obligations as they come due.

Capital:

Stockholders’ equity totaled $259,319 or $35.07 per share at March 31, 2017, compared to $256,618 or $34.71 per share at December 31, 2016. Net income of $4,800 for the three months ended March 31, 2017 was the primary factor leading to the improved capital position. Stockholders’ equity was also affected by cash dividends declared of $2,293, stock based compensation of $17, and other comprehensive income resulting from market value fluctuations in the investment portfolio of $177.

Dividends declared equaled $0.31 per share for the first quarter of 2017 and 2016. The dividend payout ratio was 47.7% for the three months ended March 31, 2017 and 47.0% for the same period of 2016. The merger agreement pursuant to which we merged with Penseco in 2013 contemplates that, unless 80 percent of our board of directors determines otherwise, we will pay a quarterly cash dividend in an amount no less than $0.31 per share through 2018, provided that sufficient funds are legally available, and that Peoples and Peoples Bank remain “Well-capitalized” in accordance with applicable regulatory guidelines. It is the intention of the Board of Directors to continue to pay cash dividends in the future. However, these decisions are affected by operating results, financial and economic decisions, capital and growth objectives, appropriate dividend restrictions and other relevant factors.

In July 2013, the Board of Directors of the FRB approved the Basel III interim final rule (“Basel III”) which is intended to strengthen the quality and increase the required level of regulatory capital for a more stable and resilient banking system. The changes include: (i) a new regulatory capital measure, Common Equity Tier 1 (“CET1”), which is limited to capital elements of the highest quality; (ii) a new definition and increase of tier 1 capital which is now comprised of CET1 and Additional Tier 1; (iii) changes in calculation of some risk-weighted assets and off-balance sheet exposure; and (iv) a capital conservation buffer that will limit capital distributions, stock redemptions, and certain discretionary bonus payments if the institution does not maintain capital in excess of the minimum capital requirements. These new capital rules took effect for our Bank on January 1, 2015 and reporting began with the quarter ended March 31, 2015. Under the final capital rules that became effective on January 1, 2015, there was a requirement for a CET1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016.

The adequacy of capital is reviewed on an ongoing basis with reference to the size, composition and quality of resources and regulatory guidelines. We seek to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. At March 31, 2017, the Bank’s Tier 1 capital to total average assets was 9.89% as compared to 9.88% at December 31, 2016. The Bank’s Tier 1 capital to risk weighted asset ratio was 11.96% and the total capital to risk weighted asset ratio was 13.02% at March 31, 2017. These ratios were 12.14% and 13.16% at December 31, 2016. The Bank’s common equity Tier 1 to risk weighted asset ratio was 11.96% at March 31, 2017 compared to 12.14% at December 31, 2016. The Bank was deemed to be well-capitalized under regulatory standards at March 31, 2017. Additionally, as of March 31, 2017, the Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if all such requirements were currently in effect.

Review of Financial Performance:

Net income for the first quarter of 2017 equaled $4,800 or $0.65 per share compared to $4,882 or $0.66 per share for the first quarter of 2016. Return on average assets (“ROA”) measures our net income in relation to total assets. Our ROA was 0.97% for the first quarter of 2017 compared to 1.06% for the same period of 2016. Return on average equity (“ROE”) indicates how effectively we can generate net income on the capital invested by stockholders. Our ROE was 7.51% for the first quarter of 2017 compared to 7.85% for the comparable period in 2016. There were no gains on sale of investment securities for the three months ended March 31, 2017 while gains on sale of investment securities were $242 for the same period in 2016.

Net Interest Income:

Net interest income is the fundamental source of earnings for commercial banks. Fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits, short-term and long-term borrowings comprise interest-bearing liabilities. Net interest income is impacted by:

Variations in the volume, rate and composition of earning assets and interest-bearing liabilities;

Changes in general market rates; and

The level of nonperforming assets.

Changes in net interest income are measured by the net interest spread and net interest margin. Net interest spread, the difference between the average yield earned on earning assets and the average rate incurred on interest-bearing liabilities, illustrates the effects changing interest rates have on profitability. Net interest margin, net interest income as a percentage of earning assets, is a more comprehensive ratio, as it reflects not only the spread, but also the change in the composition of interest-earning assets and interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax yields lower than their taxable counterparts. Therefore, in order to make the analysis of net interest income more comparable, tax-exempt income and yields are reported herein on a tax-equivalent basis using the prevailing federal statutory tax rate of 35.0% in 2017 and 2016.

For the three months ended March 31, tax-equivalent net interest income increased $821 to $16,662 in 2017 from $15,841 in 2016. The net interest spread decreased to 3.60% for the three months ended March 31, 2017 from 3.68% for the three months ended March 31, 2016. The tax-equivalent net interest margin decreased to 3.73% for the first quarter of 2017 from 3.81% for the comparable period of 2016. The tax-equivalent net interest margin for the fourth quarter of 2016 was 3.67%. Loan accretion in the first quarter of 2017 related to loans acquired in the 2013 Penseco merger was $187, resulting in an increase in the tax-equivalent net interest margin of 4 basis points. Comparatively, loan accretion recognized on these loans in the first quarter of 2016 was $215 resulting in an increase in the tax-equivalent net interest margin of 5 basis points. Without such loan accretion, the tax equivalent net interest margin for the three months ended March 31 would have been 3.69% in 2017 and 3.76% in 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

For the three months ended March 31, tax-equivalent interest income on earning assets increased $1,057, to $18,618 in 2017 as compared to $17,561 in 2016. The overall yield on earning assets, on a fully tax-equivalent basis, decreased 5 basis points for the three months ended March 31, 2017 to 4.17% as compared to 4.22% for the three months ended March 31, 2016. The decrease in the yield on earning assets resulted from loans being originated or renewed at market rates, which are lower than those maturing and amortizing. The overall yield earned on loans decreased 12 basis points for the first quarter of 2017 to 4.40% from 4.52% for the first quarter of 2016. Average loans increased to $1,534,765 for the quarter ended March 31, 2017 compared to $1,380,817 for the same period in 2016. The resulting tax-equivalent interest earned on loans was $16,658 for the three month period ended March 31, 2017 compared to $15,501 for the same period in 2016, an increase of $1,157.

Total interest expense increased $236, to $1,956 for the three months ended March 31, 2017 from $1,720 for the three months ended March 31, 2016. An unfavorable volume variance caused the increase. An increase in the average volume of interest bearing liabilities of $111,220 coupled with the 3 basis point increase to the cost of funds comparing the three months ended March 31, 2017 and 2016 caused the increase.

The average balances of assets and liabilities, corresponding interest income and expense and resulting average yields or rates paid are summarized as follows. Averages for earning assets include nonaccrual loans. Investment averages include available-for-sale securities at amortized cost. Income on investment securities and loans is adjusted to a tax equivalent basis using the prevailing federal statutory tax rate of 35%.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)


	Three months ended
	March 2017						March 2016
	Average		Interest Income/		Yield/		Average		Interest Income/		Yield/
	Balance		Interest		Rate		Balance		Interest		Rate
Assets:
Earning assets:
Loans:
Taxable	$	1,429,323	$	15,541	4.41	%	$	1,276,491	$	14,346	4.52	%
Tax-exempt		105,442		1,117	4.30			104,326		1,155	4.45
Investments:
Taxable		159,593		737	1.87			159,584		697	1.76
Tax-exempt		115,347		1,222	4.30			127,623		1,346	4.24
Interest-bearing deposits		349		1	1.16			4,686		17	1.46
Federal funds sold
Total earning assets		1,810,054		18,618	4.17	%		1,672,710		17,561	4.22	%
Less: allowance for loan losses		16,361						13,410
Other assets		210,860						192,343
Total assets	$	2,004,553		18,618			$	1,851,643		17,561
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Money market accounts	$	240,756		272	0.46	%	$	206,602		177	0.34	%
NOW accounts		321,755		338	0.43			293,002		278	0.38
Savings accounts		398,273		125	0.13			389,230		175	0.18
Time deposits less than $100		160,537		416	1.05			165,389		435	1.06
Time deposits $100 or more		122,700		283	0.94			104,936		218	0.84
Short-term borrowings		82,002		174	0.86			53,436		77	0.58
Long-term debt		57,856		348	2.44			60,064		360	2.41
Total interest-bearing liabilities		1,383,879		1,956	0.57			1,272,659		1,720	0.54
Noninterest-bearing deposits		346,567						313,908
Other liabilities		14,872						15,755
Stockholders’ equity		259,235						249,321
Total liabilities and stockholders’ equity	$	2,004,553		1,956			$	1,851,643		1,720
Net interest income/spread			$	16,662	3.60	%			$	15,841	3.68	%
Net interest margin					3.73	%					3.81	%
Tax-equivalent adjustments:
Loans			$	391					$	404
Investments				428						471
Total adjustments			$	819					$	875

Provision for Loan Losses:

We evaluate the adequacy of the allowance for loan losses account on a quarterly basis utilizing our systematic analysis in accordance with procedural discipline. We take into consideration certain factors such as composition of the loan portfolio, volumes of nonperforming loans, volumes of net charge-offs, prevailing economic conditions and other relevant factors when determining the adequacy of the allowance for loan losses account. We make monthly provisions to the allowance for loan losses account in order to maintain the allowance at the appropriate level indicated by our evaluations. Based on our most current evaluation, we believe that the allowance is adequate to absorb any known and inherent losses in the portfolio as of March 31, 2017.

For the three months ended March 31, the provision for loan losses totaled $1,200 in both 2017 and 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Noninterest Income:

For the three months ended March 31, 2017, noninterest income totaled $3,782, a decrease of $109 or 2.8% from $3,891 for the comparable period of 2016. Service charges, fees and commissions increased $128, or 8.9% to $1,572 through three months in 2017 from $1,444 for the same period in 2016. Merchant services income increased $101 to $1,015 for the three months ended March 31, 2017 from $914 for the same period last year as a result of an increase in the number of merchant accounts serviced. Income generated from commissions and fees on fiduciary activities increased $26 to $508 for the three months ended March 31, 2017 in comparison to $482 for the same period in 2016 due to additional executor fees generated in 2017. Income generated from our wealth management division decreased $93 to $319 through the first three months of 2017 in comparison to $412 over that same period in 2016 due to servicer conversion fees generated in 2016 which were not replicated in the current period. Mortgage banking income decreased $25 to $179 for the first three months of 2017 compared to $204 for the comparable period in 2016 as the volume of loans originated for sale declined. Life insurance investment income decreased $4 to $189 for the three months ended March 31, 2017 from $193 for the same period in 2016. There were no gains recognized from the sale of investment securities available-for-sale in the first quarter of 2017 compared to $242 for the three months ended March 31, 2016.

Noninterest Expenses:

In general, noninterest expense is categorized into three main groups: employee-related expenses, occupancy and equipment expenses and other expenses. Employee-related expenses are costs associated with providing salaries, including payroll taxes and benefits, to our employees. Occupancy and equipment expenses, the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income, and utility costs. Other expenses include general operating expenses such as advertising, contractual services, insurance, including FDIC assessment, other taxes and supplies. Several of these costs and expenses are variable while the remainder are fixed. We utilize budgets and other related strategies in an effort to control the variable expenses.

For the first quarter, noninterest expense increased $738 or 6.4% to $12,356 in 2017 from $11,618 in 2016. Personnel costs increased 17.7%, net occupancy and equipment costs decreased 1.8%, merchant services expense increased 15.5% and other expenses decreased by 7.7% comparing year-to-date 2017 and 2016.

Salaries and employee benefits expense, which comprise the majority of noninterest expense, totaled $6,275 for the first quarter of 2017, an increase of $943 or 17.7% when compared to the first quarter of 2016. Costs related to our build out of our expansion plan in the Lehigh Valley and King of Prussia, as well as standard merit increases, contributed to the increase. Further, the year ago period included a one-time credit of $208 to offset salary and employee benefits for mortgage servicing rights retained by the bank.

We experienced a $43 or 1.8% decrease in net occupancy and equipment expense comparing $2,394 for the first quarter of 2017 and $2, 437 for the same period in 2015. Mild winter conditions led to a decrease in heating costs as well as a decrease in costs associated with snow removal during the first part of 2017 when compared to the first three months of 2016. Additionally, certain cost containment measures have been implemented to curtail occupancy and equipment expenditures.

Merchant services expense increased $98 or 15.5% to $730 for the three months ended March 31, 2017 from $632 for the same period in 2016. The increase is due to higher volumes and correlates directly to the increase in merchant services income for the quarter ended March 31, 2017 when compared to the same year ago period.

For the three months ended March 31, other expenses decreased $223 or 7.7% to $2,689 from $2,912 comparing 2017 to 2016. FDIC assessments decreased $141, or 52.6% when comparing the first quarter of 2017 to the same period in 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Income Taxes:

We recorded income tax expense of $1,269 or 20.9% of pre-tax income, and $1,157 or 19.2% of pre-tax income for the three months ended March 31, 2017 and 2016. The three months ended March 31, 2017 includes before tax investment tax credits of $270 compared to $306 for that same period last year.

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Item 3. Quantitative and Qualitativ e Disclosures about Market Risk.

Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily interest rate risk (“IRR”), which arises from our lending, investing and deposit gathering activities. Our market risk sensitive instruments consist of non-derivative financial instruments, none of which are entered into for trading purposes. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in reported earnings and/or the market value of net worth. Variations in interest rates affect the underlying economic value of assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value, and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries.

A bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

The projected impacts of instantaneous changes in interest rates on our net interest income and economic value of equity at March 31, 2017, based on our simulation model, as compared to our ALCO policy limits are summarized as follows:


	March 31, 2017
	% Change in
Changes in Interest Rates (basis points)	Net Interest Income		Economic Value of Equity
	Metric	Policy	Metric	Policy
+400	4.4	(20.0)	6.4	(40.0)
+300	3.7	(20.0)	5.6	(30.0)
+200	2.6	(10.0)	4.2	(20.0)
+100	1.5	(10.0)	3.3	(10.0)
Static
(100)	(5.0)	(10.0)	(9.4)	(10.0)

Our simulation model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months ending March 31, 2017, would increase at 1.5 percent from model results using current interest rates. Additional disclosures about market risk are included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, under the heading “Market Risk Sensitivity,” and are incorporated into this Item 3 by reference. There were no material changes in our market risk from December 31, 2016.

Item 4. Control s and Procedures.

(a) Evaluation of disclosure controls and procedures.

At March 31, 2017, the end of the period covered by this Quarterly Report on Form 10-Q, the Chief Executive Officer (“CEO”) and Interim Principal Financial and Accounting Officer (“IPFAO”) evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based upon that evaluation, the CEO and IPFAO concluded that the disclosure controls and procedures, at March 31, 2017, were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules

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and forms, and to provide reasonable assurance that information required to be disclosed in such reports is accumulated and communicated to the CEO and IPFAO to allow timely decisions regarding required disclosure.

(b) Changes in internal control.

There were no changes made in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceeding s.

The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. In the opinion of management, there were no legal proceedings that had or might have a material effect on the consolidated results of operations, liquidity, or the financial position of the Company during the three-months ended March 31, 2017 and through the date of this quarterly report on Form 10-Q.

Item 1A. Risk Factors .

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2. Unregistered Sale s of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults upo n Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information .

None.

Item 6. Exhibits .


10.1	Peoples Security Bank and Trust Company Employee Stock Ownership Plan restated effective January 1, 2015, as amended.

31.1	Chief Executive Officer certification pursuant to Rule 13a-14(a)/15d-14(a).

31.2	Interim Principal Financial and Accounting Officer certification pursuant to Rule 13a-14(a)/15d-14(a).

32	Chief Executive Officer and Interim Principal Financial and Accounting Officer certifications pursuant to Section 1350.

101+	Interactive Data File

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+	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

SIGNATURE S

Pursuant to the requirements 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.

	Peoples Financial Services Corp.
	(Registrant)

Date: May 5, 2017	/s/ Craig W. Best
	Craig W. Best
	President and Chief Executive Officer
	(Principal Executive Officer)

Date: May 5, 2017	/s/ John R. Anderson, III
	John R. Anderson, III
	Interim Principal Financial and Accounting Officer
	(Interim Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

Item Number	Description	Page

10.1	Peoples Security Bank and Trust Company Employee Stock Ownership Plan restated effective January 1, 2015, as amended.

31.1	CEO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a).	43

31.2	IPFAO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a).	44

32	CEO and IPFAO Certifications Pursuant to Section 1350.	45

101	The following materials from Peoples Financial Services Corp. Quarterly Report on Form 10-Q for the period ended March 31, 2017, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements.

Exhibit 10.1

PEOPLES SECURITY BANK & TRUST CO.

EMPLOYEE STOCK OWNERSHIP PLAN

Originally Effective

January 1, 1984

As Amended And Restated Effective

January 1, 2015

TABLE OF CONTENTS

	Page
Article I - DEFINITIONS	5
Section 1.1. - References	5
Section 1.2. - Compensation	5
Section 1.3. - Dates	6
Section 1.4. - Employee	7
Section 1.5. - Employer	9
Section 1.6. - Fiduciaries	9
Section 1.7. - Participant/Beneficiary/Spouse	9
Section 1.8. - Participant Accounts	10
Section 1.9. - Plan	10
Section 1.10. - Service	10
Section 1.11. -Trust	13
Section 1.12. - ESOP Specific Definitions	13

Article II - PARTICIPATION	14
Section 2.1. - Eligibility Service	14
Section 2.2. - Plan Participation	14
Section 2.3. - Termination of Participation	16
Section 2.4. - Re-Participation or Re-Employment (Break in Service Rules)	16

Article III - ALLOCATIONS TO PARTICIPANT ACCOUNTS	16
Section 3.1. - General Provisions	16
Section 3.2. - Employer Contributions	18
Section 3.3. - Rollover/Transfer Contributions	19
Section 3.4. - Allocation of Investment Results	19

Article IV - PAYMENT OF PARTICIPANT ACCOUNTS	21
Section 4.1. - Vesting Service Rules	21
Section 4.2. - Vesting of Participant Accounts (a) Determination of Vesting	22
Section 4.3. - Payment of Participant Accounts	26
Section 4.4. - In-Service Payments	30
Section 4.5. - Distributions under Domestic Relations Orders	31

Article V - ADDITIONAL QUALIFICATION RULES	31
Section 5.1. - Limitations on Allocations under Code Section 415	31
Section 5.2. - Joint and Survivor Annuity Requirements	36
Section 5.3. - Distribution Requirements	38
Section 5.4. - Top Heavy Provisions	43
Section 5.5. - ESOP Distribution Options	47

Article VI -ADMINISTRATION OF THE PLAN	50
Section 6.1. - Fiduciary Responsibility	50
Section 6.2. - Plan Administrator	51

Section 6.3. - Claims Procedure	53
Section 6.4. - Trust Fund	55
Section 6.5. - Investment Policy	56
Section 6.6. - Prohibitions Against Allocations	57
Section 6.7. - Valuation of the Trust Fund	62
Section 6.8. - Voting Corporate Stock	63
Section 6.9. - ESOP Loans	64
Section 6.10. - Current Obligations	65

Article VII -AMENDMENT AND TERMINATION OF PLAN	65
Section 7.1. - Right to Discontinue and Amend	65
Section 7.2. - Amendments	65
Section 7.3. - Protection of Benefits in Case of Plan Merger	67
Section 7.4. - Termination of Plan	67

Article VIII - MISCELLANEOUS PROVISIONS	67
Section 8.1. - Exclusive Benefit - Non-Reversion	67
Section 8.2. - Inalienability of Benefits	68
Section 8.3. - Employer-Employee Relationship	68
Section 8.4. - Binding Agreement	68
Section 8.5. - Separability	69
Section 8.6. - Construction	69
Section 8.7. - Copies of Plan	69
Section 8.8. - Interpretation	69
Section 8.9. - Securities and Exchange Commission Approval	69
Section 8.10. - Nonterminable Right of Certain Holders	69

PREAMBLE

This amended and restated plan, executed on the date indicated at the end hereof, is made effective as of January 1, 2015, except as provided otherwise in Section 1.3(c), by Peoples Security Bank arid Trust Company, a corporation, with its principal office located in Scranton, Pennsylvania.

WITNESSETH:

WHEREAS, effective January 1, 1984, the employer established the employee stock ownership plan for its employees and desires to continue to maintain a permanent qualified plan in order to enable its employees to share in the growth and prosperity of the corporation and to provide its employees and their beneficiaries with financial security in the event of retirement, disability, or death; and

WHEREAS, it is desired to amend said plan;

NOW THEREFORE, the premises considered, the original plan is hereby replaced by this amended and restated plan, and the following are the provisions of the qualified plan of the employer as restated herein; provided, however, that each employee who was previously a participant shall remain a participant, and no employee who was a participant in the plan before the date of amendment shall receive a benefit under this amended plan that is less than the benefit he was then entitled to receive under the plan as of the day prior to the amendment.

Article I - DEFINITIONS

Section 1.1. - References

(a) Code means the Internal Revenue Code of 1986, as it may be amended from time to time.

(b) ERISA means the Employee Retirement Income Security Act of 1974, as amended.

Section 1.2. - Compensation

(a) Compensation means, except as provided in Section 1.2(b) hereof, any earnings reportable as W-2 wages for federal income tax withholding purposes, plus elective contributions, for the determination period. For this purpose, the determination period is the plan year. Such earnings shall include any amount contributed to a Roth elective deferral account under any qualified plan. However, compensation shall not include any earnings reportable as W-2 wages that are payable following the termination of employment pursuant to a severance agreement.

Elective contributions are amounts excludable from the employee’s gross income and contributed by the employer, at the employee’s election to:

A cafeteria plan (excludable under Code section 125 and as provided in Section 5.1(c)(2));

A Code section 401(k) arrangement (excludable under Code section 402(e)(3));

A simplified employee pension (excludable under Code section 402(h));

A tax sheltered annuity (excludable under Code section 403(b));

A deferred compensation plan excludable under Code section 457(b); or

A Code section 132(f)(4) qualified transportation fringe benefit plan.

Any reference in this plan to compensation shall be a reference to the definition in this Section 1.2, unless the plan reference specifies a modification to this definition. The plan administrator shall take into account only compensation actually paid by the employer for the relevant period. A compensation payment includes compensation by the employer through another person under the common paymaster provisions in Code sections 3121 and 3306. Compensation from an employer that is not a participating employer under this plan shall be excluded.

(b) Exclusions From Compensation - Notwithstanding the provisions of Section 1.2(a), the following types of remuneration shall be excluded from the participant’s compensation:

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Deferrals under or distributions from a nonqualified deferred compensation plan

Moving expenses

Expense allowances or reimbursements

Taxable fringe benefits (group term life insurance in excess of $50,000, auto insurance, etc.), whether cash or noncash

Welfare benefits to the extent includable in compensation

(c) Limitations on Compensation - The plan administrator shall take into account $200,000 (as adjusted for cost-of-living increases in accordance with Code section 401(a)(17)(B) for plan years beginning on or after January 1, 2003) of any participant’s annual compensation for determining all benefits provided under the plan. Contributions and allocations made before January 1, 2002 were made subject to the limitations of Code section 401(a)(17) as then in effect and described in prior statements of the plan document. The compensation dollar limitation for a plan year shall be the limitation amount in effect on January 1 of the calendar year in which the plan year begins. Annual compensation means compensation during the plan year or such other 12-consecutive-month period over which compensation is otherwise determined under the plan (the determination period for purposes of Section 1.2). If the plan should determine compensation on a period of time that contains less than 12 calendar months (such as for a short plan year), the annual compensation dollar limitation shall be an amount equal to the compensation dollar limitation for the plan year multiplied by the ratio obtained by dividing the number of full months in the period by 12.

(d) Compensation for Nondiscrimination Testing - For purposes of determining whether the plan discriminates in favor of highly compensated employees, compensation means compensation as defined in this Section 1.2. For this purpose, compensation shall include compensation paid by the employer as defined under Section 1.5(b). Notwithstanding the above, the employer may amend this plan to exclude from this nondiscrimination definition of compensation any items of compensation excludable under Code section 414(s) and the applicable Treasury regulations, provided such adjusted definition conforms to the nondiscrimination requirements of those regulations.

Section 1.3. - Dates

(a) Accounting Date means the date(s) on which investment results are allocated to participants’ accounts as set forth below:

March 31, June 30, September 30, and December 31

(b) Allocation Date means the date(s) as of which any contribution is allocated to participants’ accounts. The employer contribution and forfeitures shall be allocated as of December 31. The allocation period for the employer contribution shall be the plan year.

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The effective date of this amendment and restatement is January 1, 2015; provided, however, that the plan provision required to comply with the plan provisions required to comply with the American Jobs Creation Act of 2004 shall generally be effective for distributions with respect to S corporation stock made after December 31, 1997; the plan provisions required to comply with the Pension Protection Act of 2006 shall generally be effective as of the first day of the first day of the first plan year beginning on or after January 1, 2008 (except that the provisions that are required to be effective prior to the first day of the first plan year beginning on or after January 1, 2008 shall be effective as of the first day of the first plan year beginning on or after January 1, 2006); the plan provisions required to comply with the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART) shall be effective for limitation years beginning on or after January 1, 2007; the plan provisions required to comply with the final regulations issued under Code section 415 shall generally be effective as of the first day of the first limitation years beginning on or after July 1, 2007; the plan provisions required to comply with the Workers Retirees and Employers Relief Act of 2008 shall be effective as of January 1, 2009; and the plan provisions required to comply with the Cumulative Lists as published by the Internal Revenue Service with respect to the years 2004 through 2010 shall generally be effective as of the first day of the plan year with respect to which the List was published, except as specified otherwise in this plan or in said Acts.

(d) Plan Entry Date means the participation date(s) specified in Article II.

(e) Plan Year means the 12-consecutive-month period beginning on January 1 and ending on December 31.

(f) Limitation Year means the 12-consecutive-month period beginning on January 1 and ending on December 31.

Section 1.4. - Employee

(a) (1) Employee means any person employed by the employer, including an owner-employee or other self-employed individual (as defined in Section 1.4(a)(3)). The term employee shall include any employee of the employer as defined in Section 1.5(b). The term employee shall also include any leased employee deemed to be an employee of any such employer as provided in Code section 414(n) or (o) and as defined in Section 1.4(a)(2).

(2) Leased Employee means an individual (who otherwise is not an employee of the employer) who, pursuant to a leasing agreement between the employer and any other person, has performed services for the employer (or for the employer and any persons related to the employer within the meaning of Code section 414(n)(6)) on a substantially full time basis for at least one year and such services are performed under the primary direction or control of the employer. If a leased employee is treated as an employee by reason of this Section 1.4(a)(2), compensation from the leasing organization that is attributable to services performed for the employer shall be considered as compensation under the plan. Contributions or benefits provided a leased employee by the leasing organization that are attributable to services performed for the employer shall be treated as provided by the employer.

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Safe harbor plan exception - The plan shall not treat a leased employee as an employee if the leasing organization covers the employee in a safe harbor plan and, prior to application of this safe harbor plan exception, 20% or less of the employer’s nonhighly compensated employees are leased employees. A safe harbor plan is a money purchase pension plan providing immediate participation, full and immediate vesting, and a nonintegrated contribution formula equal to at least 10% of the employee’s compensation without regard to employment by the leasing organization on a specified date. The safe harbor plan must determine the 10% contribution on the basis of compensation as defined in Section 5.1(c)(2).

(b) Highly Compensated Employee means any employee who:

(1) was a more than 5% owner of the employer (applying the constructive ownership rules of Code section 318, and applying the principles of Code section 318, for an unincorporated entity) at any time during the current plan year or the look-back year; or

(2) for the look-back year -

(A) had compensation from the employer (as defined under Section 1.5(b)) in excess of $80,000 (as adjusted by the Commissioner of Internal Revenue pursuant to Code section 415(d), except that the base period shall be the calendar quarter ending September 30, 1996), and

(B) if the employer elects the application of this Subparagraph for such look-back year, was in the top-paid group of employees for such look-back year. For this purpose, an employee is in the top-paid group of employees for any look-back year if such employee is in the group consisting of the top 20% of the employees when ranked on the basis of compensation paid during such look- back year.

The look-back year is the twelve-month period immediately preceding the current plan year. The term highly compensated employee also includes any former employee who separated from service (or has a deemed separation from service, as determined under Treasury regulations) prior to the plan year, performs no service for the employer during the plan year, and was a highly compensated employee either for the separation plan year or any plan year ending on or after his 55th birthday, based on the applicable rules in effect for such plan year.

For purposes of determining who is a highly compensated employee under this Section 1.4(b), compensation means compensation as defined in Section 1.2(a) without regard to Section 1.2(b). The plan administrator shall make the determination of who is a highly compensated employee.

This Section 1.4(b) is effective for plan years beginning after December 31, 1996, except that, in determining whether an employee is a highly compensated employee in 1997, this provision shall be treated as having been in effect for the last plan year beginning before January 1, 1997.

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Section 1.5. - Employer

(a) Employer means Peoples Security Bank and Trust Company or any successor entity by merger, purchase, consolidation, or otherwise; or an organization affiliated with the employer that may assume the obligations of this plan with respect to its employees by becoming a party to this plan.

(b) Employer for Compliance Testing - For purposes of determining whether the plan satisfies the participation coverage requirements of Code section 410(b) and the limitations on benefits and allocations under Code section 415, employer shall mean the employer that adopts this plan as set forth in Section 1.5(a), and all members of a controlled group of corporations (as defined in Code section 414(b)), all commonly controlled trades or businesses (as defined in Code section 414(c)) or affiliated service groups (as defined in Code section 414(m)) of which the adopting employer is a part, and any other entity required to be aggregated with the employer pursuant to regulations under Code section 414(o).

(c) Exclusive Benefit - In compliance with the exclusive benefit requirements of Code section 401 (a), the sponsorship of this plan may not be transferred to an unrelated entity if the transfer is not in connection with a transfer of business assets or operations from the employer to such entity.

Section 1.6. - Fiduciaries

(a) Named Fiduciary means the person or persons having fiduciary responsibility for the management and control of plan assets.

(b) Plan Administrator means the person or persons appointed by the named fiduciary to administer the plan.

(c) Trustee means the trustee named in the trust agreement executed pursuant to this plan, or any duly appointed successor trustee.

(d) Investment Manager means a person or corporation other than the trustee appointed for the investment of plan assets.

Section 1.7. - Participant/Beneficiary/Spouse

(a) Participant means an eligible employee of the employer who becomes a member of the plan pursuant to the provisions of Article II, or a former employee who has an accrued benefit under the plan. A participant shall be treated as benefiting under the plan for any plan year during which the participant received or is deemed to receive an allocation in accordance with Regulation section 1.410(b)-3(a).

(b) Beneficiary means a person designated by a participant who is or may become entitled to a benefit under the plan. A beneficiary who becomes entitled to a benefit under the plan remains a beneficiary under the plan until the trustee has fully distributed his benefit to him. A beneficiary’s right to (and the plan administrator’s, or a trustee’s duty to provide to the

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beneficiary) information or data concerning the plan shall not arise until he first becomes entitled to receive a benefit under the plan.

(c) Spouse means the person married to the participant at the time of the determination as evidenced by a certified copy of the marriage certificate valid under the marriage licensing laws of the place of issuance.

Section 1.8. - Participant Accounts

(a) Employer Contribution Account means the balance of the separate account derived from the employer’s contributions, including forfeitures (if any) (if so provided under Section 3.2).

(b) Rollover/Transfer Account means the balance of the separate account derived from rollover contributions and/or transfer contributions (if so provided under Section 3.3).

(c) Accrued Benefit means the total of the participant’s account balances as of the accounting date falling on or before the day on which the accrued benefit is being determined.

Section 1.9. - Plan

Plan means Peoples Security Bank & Trust Co. Employee Stock Ownership Plan as set forth herein and as it may be amended from time to time.

Section 1.10. - Service

(a) Service means any period of time the employee is in the employ of the employer, including any period the employee is on an unpaid leave of absence authorized by the employer under a uniform, nondiscriminatory policy applicable to all employees. Separation from service means that the employee no longer has an employment relationship with the employer.

(b) (1) Hour of Service means:

(A) Each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer. These hours shall be credited to the employee for the computation period in which the duties are performed; and

(B) Each hour for which an employee is paid, or entitled to payment, by the employer on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. No more than 501 hours of service shall be credited under this Subparagraph (B) for any single continuous period (whether or not such period occurs in a single computation period). An hour of service shall not be credited to an employee under this Subparagraph (B) if the employee is paid, or entitled to payment, under a plan maintained solely for the purpose of complying with applicable worker’s compensation or unemployment compensation or disability insurance laws. Hours under this Subparagraph (B) shall be calculated and credited pursuant to section

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2530.200b-2 of the Department of Labor Regulations that is incorporated herein by this reference; and

(C) Each hour for which back pay, irrespective of mitigation of damages, is either awarded or agreed to by the employer. The same hours of service shall not be credited both under Subparagraph (A) or Subparagraph (B), as the case may be, and under this Subparagraph (C). These hours shall be credited to the employee for the computation period or periods to which the award or agreement pertains rather than the computation period in which the award, agreement, or payment is made.

Hours of service shall be determined on the basis of actual hours for which an employee is paid or entitled to payment. The above provisions shall be construed so as to resolve any ambiguities in favor of crediting employees with hours of service.

If, for the purposes of the plan, an employee’s records are maintained on other than an hourly basis, the plan administrator, according to uniform rules applicable to a class of employees, may apply the following equivalencies for the purpose of crediting hours of service:

Basis Upon Which Records Are Maintained		Credit Granted to Individual if Individual Earns One or More Hours of Service During Period

Shift		Actual hours of full shift
Day		10 hours of service
Week		45 hours of service
Semi-Monthly Payroll Period		95 hours of service
Months of Employment		190 hours of service

(2) Solely for purposes of determining whether a break in service for participation and vesting purposes has occurred in a computation period, an individual who is absent from work for maternity or paternity reasons shall receive credit for the hours of service that would otherwise have been credited to such individual but for such absence, or in any case in which such hours cannot be determined, 8 hours of service per day of such absence. For purposes of this paragraph, an absence from work for maternity or paternity reasons means an absence (A) by reason of the pregnancy of the individual, (B) by reason of a birth of a child of the individual, (C) by reason of the placement of a child with the individual in connection with the adoption of such child by such individual, or (D) for purposes of caring for such child for a period beginning immediately following such birth or placement. The hours of service credited under this paragraph shall be credited: (A) in the computation period in which the absence begins if the crediting is necessary to prevent a break in service in that period, or (B) in all other cases, in the following computation period. No more than 501 hours of service shall be credited under this paragraph for any single continuous period (whether or not such period occurs in a single computation period).

(3) Solely for purposes of determining whether a break in service for participation and vesting purposes has occurred in a computation period, an individual who is absent from work on unpaid leave under the Family and Medical Leave Act shall receive credit

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for the hours of service that would otherwise have been credited to such individual but for such absence, or in any case in which such hours cannot be determined, 8 hours of service per day of such absence. Such an individual shall be treated as actively employed for the purposes of participation and eligibility for an allocation of any employer contribution that may be provided under this plan. Notwithstanding the preceding, this paragraph shall not apply if the employer or the particular employee is not subject to the requirements of the Family and Medical Leave Act at the time of the absence.

(4) Hours of service shall be credited for employment with the employer as defined in Section 1.5(b). Hours of service shall also be credited for any leased employee who is considered an employee for purposes of this plan under Code section 414(n) or Code section 414(p).

(c) (1) Year of Service means a 12-consecutive-month computation period during which the employee completes the required number of hours of service with the employer as specified in Sections 2.1 or 4.1. No more than one year of service will be credited for any 12 consecutive-month period unless otherwise required by Sections 2.1(c) and 4.1(c).

(2) Service with Related Employers - For purposes of crediting years of service, hours of service credited in accordance with Section 1.10(b)(4) shall be taken into account.

(3) Predecessor Service - If the employer maintains the plan of a predecessor employer, service with such predecessor employer shall be treated as service for the employer. If the employer does not maintain the plan of a predecessor employer, then service as an employee of a predecessor employer shall not be considered as service under the plan, except as noted below:

Effective as of the date of acquisition, with respect to an employee employed by the predecessor employer as of the day immediately prior, service as an employee of acquired predecessor employer Peoples Neighborhood Bank shall be considered as service under the plan for the purposes of determining eligibility years of service (under Section 2.1) and vesting years of service (under Section 4.1).

(d) Break in Service (or One Year Break in Service) means a 12-consecutive-month computation period during which a participant or former participant does not complete the specified number of hours of service with the employer as set forth in Sections 2.1(b) and 4.1(b).

(e) Qualified Military Service - Notwithstanding any provision of this plan to the contrary, effective December 12, 1994, contributions, benefits, and service credit with respect to qualified military service will be provided in accordance with Code section 414(u). An employee reemployed after qualified military service shall not be treated as having incurred a break in service, for purposes of vesting and benefit accruals, solely because of an absence due to qualified military service.

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Effective with respect to deaths occurring on or after January 1, 2007, in the case of a participant who dies while performing qualified military service, the beneficiary(ies) of the participant shall be entitled to any benefits payable under Section 4.2(a)(5) (other than contributions relating to the period of qualified military service) that would have been payable had the participant resumed and then immediately terminated employment on account of death.

Section 1.11. -Trust

(a) Trust means the qualified trust created under the employer’s plan.

(b) Trust Fund means all property held or acquired by the plan.

Section 1.12. - ESOP Specific Definitions

(a) ESOP means an employee stock ownership plan that meets the requirements of Code section 4975(e)(7) and Regulation section 54.4975-11.

(b) Corporate Stock means common stock issued by the employer (or by a corporation that is a member of the controlled group of corporations of which the employer is a member) that is readily tradable on an established securities market. If there is no common stock that meets the foregoing requirement, the term corporate stock means common stock issued by the employer (or by a corporation that is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of: (1) that class of common stock of the employer (or of any other such corporation) having the greatest voting power, and (2) that class of stock of the employer (or of any other such corporation) having the greatest dividend rights. Noncallable preferred stock shall be deemed to be corporate stock if such stock is convertible at any time into stock that constitutes corporate stock hereunder and if such conversion is at a conversion price that (as of the date of the acquisition by the trust) is reasonable. For purposes of the preceding sentence, pursuant to Code regulations, preferred stock shall be treated as noncallable if after the call there will be a reasonable opportunity for a conversion that meets the requirements of the preceding sentence.

(1) C Corporation means an incorporated entity that has not elected to be an S corporation.

(2) S Corporation means a small business corporation for which an election under Code section 1362(a) is in effect for the current plan year.

(d) Exempt Loan means a loan made to the plan by a disqualified person or a loan to the plan that is guaranteed by a disqualified person and that satisfies the requirements of Department of Labor Regulation section 2550.408b-3, Treasury Regulation section 54.4975-7(b), and Section 6.9 of this plan.

(e) Investment Accounts - For investment purposes, a participant’s accounts may be placed in three accounts as described herein.

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(1) Corporate Stock Account means the investment account of a participant that is credited with the shares of corporate stock purchased and paid for by the trust fund or contributed to the trust fund.

(2) Other Investment Account means the investment account of a participant that is credited with his share of the net gain (or loss) of the plan, forfeitures, and employer contributions in other than corporate stock and that is debited with payments made to pay for corporate stock.

(3) Directed Investment Account means the investment account of a participant that he elects under the provisions of Section 3.4(c) and that is credited with the net gain (or loss) on his directed investments.

(f) Unallocated Corporate Stock Suspense Account means an account containing corporate stock that was acquired with the proceeds of an exempt loan and that has not been released from the account and allocated to the participants’ corporate stock accounts.

Article II - PARTICIPATION

Section 2.1. - Eligibility Service

(a) Eligibility Year of Service means an eligibility computation period during which the employee completes at least 1,000 hours of service with the employer.

(b) One Year Break in Service means for the purposes of this Article II an eligibility computation period during which the participant or former participant does not complete more than 500 hours of service with the employer.

(c) Eligibility Computation Period - The initial eligibility computation period shall be the 12-consecutive- month period beginning with the day on which the employee first performs an hour of service for the employer (employment commencement date).

Succeeding eligibility computation periods shall coincide with the plan year, beginning with the first plan year that commences prior to the first anniversary of the employee’s employment commencement date regardless of whether the employee is credited with the required number of hours of service during the initial eligibility computation period. An employee who is credited with the required number of hours of service in both the initial eligibility computation period and the first plan year that commences prior to the first anniversary of the employee’s employment commencement date shall be credited with two years of service for purposes of eligibility to participate.

Section 2.2. - Plan Participation

(a) Eligibility

(1) Age/service requirements - An employee who is a member of the eligible class of employees shall be eligible for plan participation after he has satisfied the following participation requirement(s):

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(A) Completion of 1 year of service.

(B) Attainment of age 21.

(2) Eligible class of employees - All employees of the employer shall be eligible to be covered under the plan except for employees in the following categories:

Individuals not directly employed by the employer as defined in Section 1.5(a). An employee of the employer as that term is defined in Section 1.5(b) with respect to the sponsoring employer shall not participate in this plan unless such employee’s direct employer affirmatively elects to become a participating employer hereunder.

An employee prohibited from receiving an allocation of certain corporate stock pursuant to Section 6.6(a).

Employees who became employees as the result of a “Code section 410(b)(6)(C) transaction.” These employees shall be excluded during the period beginning on the date of the transaction and ending on the last day of the first plan year beginning after the date of the transaction. A “Code section 410(b)(6)(C) transaction” is an asset or stock acquisition, merger, or similar transaction involving a change in the employer of the employees of a trade or business.

Leased employees who are considered employees under the plan.

Employees who are non-resident aliens (as defined in Code section 7701 (b)(1)(B)) and who receive no earned income (as defined in Code section 911(d)(2)) from the employer that constitutes income from sources within the United States (as defined in Code section 861(a)(3)).

(b) Entry Date - An eligible employee shall participate in the plan on the earlier of the March 31, June 30, September 30, or December 31 coinciding with or immediately following the date on which he has met the age and service requirements, provided he is employed on that date. Prior to January 1, 2015, an eligible employee shall participate in the plan on the earlier of the June 30 or December 31 entry date coinciding with or immediately following the date on which he has met the age and service requirements.

If an employee who is not a member of the eligible class of employees becomes a member of the eligible class, such employee shall participate immediately, if he has satisfied the age and service requirements and would have otherwise previously become a participant.

(c) Election Not To Participate - An employee may file a written election not to participate in the plan before his plan entry date. The employer shall not make a contribution under any plan of the employer for such employee for the plan year for which the election is effective, nor for any succeeding plan year. An employee who has elected not to participate in

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the plan shall not re-participate in this plan, nor shall he participate in any other qualified retirement plan sponsored by the employer.

Section 2.3. - Termination of Participation

A participant shall continue to be an active participant of the plan so long as he is a member of the eligible class of employees and he does not terminate employment. He shall become an inactive participant when he terminates employment or ceases to be a member of the eligible class of employees. He shall cease participation completely upon the later of his receipt of a total distribution of his nonforfeitable account balance(s) under the plan or the forfeiture of the nonvested portion of the account balance(s).

Section 2.4. - Re-Participation or Re-Employment (Break in Service Rules)

(a) Vested Participant - A former participant who had a nonforfeitable right to all or a portion of his account balance derived from employer contributions at the time of his termination from service shall become a participant immediately upon returning to the employ of the employer, if he is a member of the eligible class of employees.

(b) Nonvested Participant or Employee - In the case of an employee who does not have any nonforfeitable right to his account balance derived from employer contributions at the time of his termination from service, years of service before a period of consecutive one-year breaks in service shall not be taken into account in computing eligibility service if the number of consecutive one-year breaks in service in such period equals or exceeds the greater of 5 or the aggregate number of years of service before such breaks in service. Such aggregate number of years of service shall not include any years of service disregarded under the preceding sentence by reason of prior breaks in service.

If an employee’s years of service before termination from service are disregarded pursuant to the preceding paragraph, he shall be considered a new employee for eligibility purposes. If such employee’s years of service before termination from service may not be disregarded pursuant to the preceding paragraph, he shall participate immediately upon returning to the employ of the employer, if he is a member of the eligible class of employees and has otherwise satisfied the age and service requirements of Section 2.2.

(c) Return to Eligible Class - If a participant becomes an inactive participant, because he is no longer a member of the eligible class of employees, but does not incur a break in service; such inactive participant shall become an active participant immediately upon returning to the eligible class of employees. If such participant incurs a break in service, eligibility shall be determined under the re-participation rules in Section 2.4(a) and (b) above.

Article III - ALLOCATIONS TO PARTICIPANT ACCOUNTS

Section 3.1. - General Provisions

(a) Maintenance of Participant Accounts - The plan administrator shall maintain separate accounts covering each participant under the plan as herein described. Such accounts shall be increased by contributions, reallocation of forfeitures (if any), investment income, and

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market value appreciation of the fund. They shall be decreased by market value depreciation of the fund, forfeiture of nonvested amounts, benefit payments, withdrawals, and expenses.

(b) Amount and Payment of Employer Contribution

(1) Amount of Contribution - For each plan year, the employer contribution to the plan shall be the amount that is determined under the provisions of this Article and Section 6.9. However, for any plan year with respect to which employer contributions are applied to repay principal on a loan made to the plan under Section 6.9, the total amount of employer contributions shall not exceed 25% of the aggregate participant compensation for the plan year. The employer may contribute any amount in excess of the maximum for the plan year, without limitation, for the purpose of paying interest on such loans. Further, the employer contribution shall not exceed the maximum amount deductible under Code section 404, subject to the provisions for a nondeductible contribution without penalty as permitted under Code section 4972(c)(6).

The employer contributes to this plan on the conditions that its contribution is not due to a mistake of fact and that the Internal Revenue Service will not disallow the deduction for its contribution. The trustee, upon written request from the employer, shall return to the employer the amount of the employer’s contribution made due to a mistake of fact or the amount of the employer’s contribution disallowed as a deduction under Code section 404. The trustee shall not return any portion of the employer’s contribution under the provisions of this paragraph more than one year after the earlier of: (A) The date on which the employer made the contribution due to a mistake of fact; or (B) The time of disallowance of the contribution as a deduction, and then, only to the extent of the disallowance. The trustee will not increase the amount of the employer contribution returnable under this Section for any earnings attributable to the contribution, but the trustee will decrease the employer contribution returnable for any losses attributable to it. The trustee may require the employer to furnish whatever evidence it deems necessary to confirm that the amount the employer has requested be returned is properly returnable under ERISA.

(2) Payment of Contribution - The employer shall make its contribution to the plan in cash or corporate stock within the time prescribed by the Code or applicable Treasury regulations. Subject to the consent of the trustee, the employer may make its contribution in other property, provided the contribution is discretionary and the property contributed is unencumbered. Corporate stock and other property will be valued at fair market value at the time of actual contribution. Notwithstanding the preceding, the employer shall make its contribution solely in cash if it is obligated to contribute a specified dollar amount either by the terms of a loan described in Section 6.9 or an action of its board of directors.

(c) Limitations and Conditions - Notwithstanding the allocation procedures set forth in this Article, the allocations otherwise contributable to participants’ accounts under this plan shall be limited or reduced as provided in Section 5.1.

In any limitation year in which the allocations otherwise contributable to a participant’s account under this plan would exceed the maximum permissible amount as defined in Section 5.1 due to a contribution otherwise allocable to the participant under the Peoples Security Bank

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401 (k) Profit Sharing Plan that the employer also sponsors, the allocation shall first be limited or reduced under such other sponsored plan so that the annual additions for the limitation year will equal the maximum permissible amount.

Section 3.2. - Employer Contributions

(a) Amount of Contribution - The employer shall determine, in its sole discretion, the amount of employer contribution to be made to the plan each year; provided, however, that the employer shall contribute such amount as may be required for restoration of a forfeited amount under Section 4.2.

(b) Conditions for Allocations - A participant shall be eligible for an allocation of the employer contribution and forfeitures as of an allocation date, provided that he satisfies the following condition(s):

(1) He completed at least 1,000 hours of service during the current plan year unless his employment terminated during the plan year by reason of retirement, disability, or death, except that the hours of service requirement shall not apply with respect to any minimum top-heavy allocation as provided in Section 5.4.

AND

(2) He is employed by the employer on the last day of the plan year unless his employment terminated during the plan year by reason of retirement, disability, or death.

Notwithstanding the preceding, an otherwise eligible participant shall not receive any allocation in a nonallocation year if he is prohibited from receiving an allocation of corporate stock pursuant to Section 6.6(b).

The employer contribution and forfeitures for the plan year shall be allocated to the employer contribution account of each eligible participant in the ratio that such participant’s compensation bears to the compensation of all participants.

(2) Top-Heavy Plan Years

In any plan year in which this plan is top-heavy (as defined in Section 5.4(d)(2) when aggregated with the Peoples Security Bank 401 (k) Profit Sharing Plan and the Peoples Security Bank and Trust Company Employees’ Pension Plan that the employer also sponsors, the top-heavy minimum benefit requirement shall be met under the Peoples Security Bank 401 (k) Profit Sharing Plan.

For such a plan year, the contribution on behalf of each participant who is a non-key employee and who participates in the aggregated plans shall be increased as necessary under such other sponsored defined contribution plan to equal 3% of such participant’s compensation.

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If a participant only participates in this plan, the contributions and forfeitures allocable to the employer contribution account shall be increased as necessary for compliance with the top-heavy minimum benefit requirement. The total of the contributions and forfeitures allocated to such account for such a participant shall not be less than an amount equal to 3% of his compensation or the largest percentage of employee 401 (k) elective deferral contribution, employer contribution, and forfeiture allocated under the aggregated plans on behalf of any key employee for that year, whichever is less.

(3) Compensation - For purposes of the allocation of the employer contribution, compensation means compensation as defined in Section 1.2(a) and (b) (subject to the limitations of Section 1.2(c)) for the plan year, but limited to the employee’s compensation for the portion of the plan year in which the employee actually is a member of the eligible class of employees as defined in Section 2.2. However, for purposes of the top-heavy contribution, compensation means compensation as defined in Section 5.1(c)(2), subject to the limitations of Section 1.2(c).

Section 3.3. - Rollover/Transfer Contributions

Rollover and transfer contributions shall not be permitted under this plan and no amount shall be credited to the rollover/transfer account.

Section 3.4. - Allocation of Investment Results

(a) Corporate Stock Account - The corporate stock account of each participant shall be credited as of each allocation date with forfeitures of corporate stock and his allocable share of corporate stock (including fractional shares) purchased and paid for by the plan or contributed in kind by the employer. Stock dividends on corporate stock held in his corporate stock account shall be credited to his corporate stock account when paid.

Corporate stock acquired by the plan with the proceeds of an exempt loan shall be allocated to each participant’s corporate stock account upon release from the unallocated corporate stock suspense account as provided in Section 6.9. Corporate stock acquired with the proceeds of an exempt loan shall be an asset of the trust fund and maintained in the unallocated corporate stock suspense account.

(b) Other Investments Account - As of each allocation date, prior to the allocation of employer contributions and forfeitures, any earnings or losses (net appreciation or net depreciation) of the trust fund shall be allocated in the same proportion that each participant’s other investments account bears to the total of all participants’ other investment accounts as of such date. For this purpose, each account balance shall be equal to the average balance for the period commencing on the day following the prior accounting date and ending on the current accounting date.

Cash dividends on corporate stock made after the first month of the plan year shall not share in any earnings or losses of the trust fund for such year. However, the plan administrator may direct that cash dividends on corporate stock be segregated into a separate account and invest such segregated account in a federally insured savings account, certificate of deposit in a bank or savings and loan association, money market certificate, or other short term debt security

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acceptable to the trustee until such time as the dividends and any earnings or losses thereon are: (1) applied to the payment of a loan in accordance with Section 6.9(d); or (2) allocated to each participant’s other investment account as of the plan year allocation date in accordance with the corporate stock held in the participant’s corporate stock account and then distributed pursuant to Section 4.3(c)(6) (with any allocable earnings or losses). The dividend shall be 100% vested, regardless of any vesting schedule applicable to the employer contribution account.

Earnings or losses include the increase (or decrease) in the fair market value of assets of the trust fund (other than corporate stock in the participants’ corporate stock accounts) since the preceding allocation date. Earnings or losses do not include the interest paid under any installment contract or loan used for the purchase of corporate stock by the trust. Further, earnings and losses do not include income received by the trust with respect to corporate stock acquired with the proceeds of an exempt loan to the extent the income is used to repay the loan. At the discretion of the plan administrator, all such income may be used to repay such loan with the exception of non-applicable dividends as described in Section 6.9(d).

(1) Each qualified participant, for plan years beginning after December 31, 1986, may elect within 90 days after the close of each plan year during the qualified election period to direct the trustee in writing as to the investment of 25% of the total number of shares of corporate stock acquired by or contributed to the plan after December 31, 1986 that have ever been allocated to such qualified participant’s corporate stock account (reduced by the number of shares of corporate stock previously invested pursuant to a prior election). In the case of the election year in which the participant can make his last election, the preceding sentence shall be applied by substituting “50%” for “25%.” For this purpose, a participant’s corporate stock account shall be segregated into two accounts: (A) the Pre-1987 corporate stock account and (B) the Post-1986 corporate stock account. If the qualified participant elects to direct the trustee as to the investment of his Post-1986 corporate stock account, such direction shall be effective no later than 180 days after the close of the plan year to which such direction applies.

(2) For the purposes of this Section 3.4(c) the following definitions shall apply:

(A) Qualified participant means any participant or former participant who has completed ten years of participation and has attained age 55.

(B) Qualified election period means the six plan year period beginning with the later of: (i) the first plan year in which the participant first became a qualified participant, or (ii) the first plan year beginning after December 31, 1986.

(3) If a qualified participant elects to direct the investment of his Post-1986 corporate stock account, the trustee shall convert the designated amount of corporate stock to its fair market value cash equivalent and shall distribute such cash to the participant. The participant shall be permitted to elect to roll the cash to an eligible retirement plan.

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Article IV - PAYMENT OF PARTICIPANT ACCOUNTS

Section 4.1. - Vesting Service Rules

(a) Vesting Year of Service means a vesting computation period during which the employee completes at least 1,000 hours of service with the employer. All of an employee’s years of service with the employer shall be counted to determine the nonforfeitable percentage in the employee’s account balance derived from employer contributions, except:

(1) Years of service disregarded under the break in service rules in Section 4.1(d) below. (Post-ERISA break in service rules)

(2) Years of service before the effective date of ERISA if such service would have been disregarded under the break in service rules of the prior plan in effect from time to time before such date. For this purpose, break in service rules are rules that result in the loss of prior vesting or benefit accruals, or that deny an employee eligibility to participate, by reason of separation or failure to complete a required period of service within a specified period of time. (Pre-ERISA break in service rules)

(b) One Year Break in Service means for the purposes of this Article IV a vesting computation period during which the employee or former employee does not complete more than 500 hours of service with the employer.

(d) Break in Service Rules

(1) Vested Participant - A former participant who had a nonforfeitable right to all or a portion of his account balance derived from employer contributions at the time of his termination from service shall retain credit for all vesting years of service prior to a break in service as that term is defined in Section 4.1(b).

(2) Nonvested Participant or Employee - In the case of a former participant or employee who did not have any nonforfeitable right to his account balance derived from employer contributions at the time of his termination from service, years of service before a period of consecutive one-year breaks in service shall not be taken into account in computing service if the number of consecutive one-year breaks in service in such period equals or exceeds the greater of 5 or the aggregate number of years of service before such breaks in service. Such aggregate number of years of service shall not include any years of service disregarded under the preceding sentence by reason of prior breaks in service.

(3) Vesting for Pre-Break and Post-Break Accounts - In the case of a participant or employee who has 5 or more consecutive one-year breaks in service, all years of service after such breaks in service shall be disregarded for the purpose of vesting the employer-derived account balance that accrued before such breaks in service. Whether or not such pre-break service counts in vesting the post-break employer-derived account balance shall be determined according to the rules set forth in Section 4.1(d)(1) and (2) above. Separate accounts

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shall be maintained for the participant’s pre- break and post-break employer-derived account balances. All accounts shall share in the investment earnings and losses of the fund.

Section 4.2. - Vesting of Participant Accounts (a) Determination of Vesting

(1) Normal Retirement - An employee’s right to his account balance shall be 100% vested and nonforfeitable upon the attainment of age 65, the normal retirement age. The vesting of an inactive participant who terminates employment prior to normal retirement age shall remain subject to the provisions of the vesting schedule following attainment of such specified age. Distributions shall be administered in accordance with termination from employment provisions of Section 4.3(a)(3).

(2) Late Retirement - If a participant remains employed after his normal retirement age, his account balance shall remain 100% vested and nonforfeitable. Such participant shall continue to receive allocations to his account as he did before his normal retirement age.

(3) Early Retirement - In the case of a participant who has attained age 62 before his normal retirement age, the participant’s right to his account balance shall be 100% vested and nonforfeitable. Such participant may retire before his normal retirement age without the consent of the employer and receive payment of benefits from the plan. If a participant separates from service before satisfying the age requirement for early retirement, the participant shall be entitled to elect an early retirement benefit upon satisfaction of such age requirement.

(4) Disability - If a participant separates from service due to disability, such participant’s right to his account balance as of his date of disability shall be 100% vested and nonforfeitable. Disability means the participant has been determined by the Social Security Administration to be eligible for either full or partial Social Security disability benefits.

(5) (A) Death - In the event of the death of a participant who has an accrued benefit under the plan (whether or not he is an active participant), 100% of the participant’s account balance as of the date of death shall be paid to his surviving spouse; except that, if there is no surviving spouse, or if the surviving spouse has already consented in a manner that is (or conforms to) a qualified election under the joint and survivor annuity provisions of Code section 417(a) and regulations issued pursuant thereto and as set forth in Section 5.2, then such balance shall be paid to the participant’s designated beneficiary. The payment options available to the beneficiary shall be those payment options available to the participant under Section 4.3(b), subject to any restriction created by the participant through the beneficiary designation form.

(B) Beneficiary Designation - Subject to the spousal consent requirements of Section 5.2, the participant shall have the right to designate his beneficiaries, including a contingent death beneficiary, and shall have the right at any time to change such beneficiaries. The designation shall be made in writing on a form signed by the participant and supplied by and filed with the plan administrator. If the participant fails to designate a beneficiary, or if the designated person or persons predecease the participant, “beneficiary” shall mean the spouse, children, parents, siblings (by the whole blood or adoption), or estate of the

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participant, in the order listed. For this purpose, the terms children, parents, and siblings shall exclude step relationships.

In the absence of a beneficiary designation duly filed with the plan administrator by a designated beneficiary, if a designated beneficiary dies after the participant has died but before the plan has commenced distribution to the designated beneficiary, the plan shall be administered as set forth in this paragraph. The death benefit will be paid to the designated beneficiary’s estate in one lump sum. If the deceased designated beneficiary was not the participant’s surviving spouse, distribution will be completed by December 31 of the fifth year following the participant’s date of death. If the deceased designated beneficiary was the participant’s surviving spouse, distribution will be completed by December 31 of the fifth year following the beneficiary’s date of death.

For purposes of this Section 4.2(a)(5), if a spouse or beneficiary of the participant dies simultaneously with the participant, the participant shall be deemed to be the survivor and to have died subsequent to such spouse or beneficiary. Likewise, if a beneficiary named by a designated beneficiary dies simultaneously with a designated beneficiary, the designated beneficiary shall be deemed to be the survivor and to have died subsequent to the beneficiary named by the designated beneficiary.

If a participant completes or has completed a beneficiary designation form in which the participant designates his spouse as the beneficiary and the participant and such spouse are legally divorced subsequent to the date of such designation; then, the designation shall be administered as if such spouse had predeceased the participant unless the participant, subsequent to the legal divorce, reaffirms the designation by completing a new beneficiary designation form.

(6) Termination From Service

(A) If a portion of a participant’s account is forfeited, corporate stock allocated to the participant’s corporate stock account must be forfeited only after any other investment allocable to the participant has been depleted. If interest in more than one class of corporate stock has been allocated to a participant’s account, the participant must be treated as forfeiting the same proportion of each such class.

(B) If a participant separates from the service of the employer other than by retirement, disability, or death, his vested interest in his employer contribution account shall be equal to the account balance multiplied by the vesting percentage determined based on his vesting years of service as follows:


Years of Service		Vesting Percentage
0 Year		0%
1		20%
2		40%
3		60%
4		80%
5 or More Years		100%

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(b) Forfeitures

(1) Time of Forfeiture - If a participant terminates employment before his account balance derived from employer contributions is fully vested, the nonvested portion of his account shall be forfeited on the earlier of:

(A) The last day of the vesting computation period in which the participant first incurs 5 consecutive one-year breaks in service, or

(B) The date the participant receives his entire vested accrued benefit.

(2) Cashout Distributions and Restoration

(A) Cashout Distribution - If an employee terminates service and the value of his vested account balance derived from employer and employee contributions is not greater than $1,000, the employee shall receive a distribution of the value of the entire vested portion of such account balance and the nonvested portion will be treated as a forfeiture. If an employee would have received a distribution under the preceding sentence but for the fact that the employee’s vested account balance exceeded $1,000 when the employee terminated service and if at a later time such account balance is reduced such that it is not greater than $1,000, the employee will receive a distribution of such account balance and the nonvested portion will be treated as a forfeiture. For purposes of this section, if the value of an employee’s vested account balance is zero, he shall be deemed to have received a distribution of such vested account balance. For the purpose of determining the value of a participant’s vested account balance, prior distributions shall be disregarded if distributions have not commenced under an optional form of payment described in Section 4.3.

Effective for distributions made before March 28, 2005, if an employee terminated service and the value of his vested account balance derived from employer and employee contributions was not greater than $5,000, the employee received a distribution of the value of the entire vested portion of such account balance and the nonvested portion was treated as a forfeiture.

If an employee terminates service and elects, in accordance with the requirements of Section 4.3, to receive the value of his vested account balance, the nonvested portion shall be treated as a forfeiture as of the date of distribution. If the employee elects to have distributed less than the entire vested portion of the account balance derived from employer contributions, the part of the nonvested portion that will be treated as a forfeiture is the total nonvested portion multiplied by a fraction, the numerator of which is the amount of the distribution attributable to employer contributions and the denominator of which is the total value of the vested employer-derived account balance.

(B) Restoration of Accounts - If an employee receives a cashout distribution pursuant to this section and resumes employment covered under this plan before he incurs 5 consecutive one- year breaks in service, his employer-derived account balance shall be restored to the amount on the date of distribution, if he repays to the plan the full amount of the distribution attributable to employer contributions before the earlier of 5 years after the first date on which he is subsequently re-employed by the employer, or the date he incurs 5 consecutive

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one-year breaks in service following the date of the distribution. If an employee is deemed to receive a distribution pursuant to this Section 4.2(b)(2), and he resumes employment covered under this plan before he incurs 5 consecutive one-year breaks in service, upon the reemployment of such employee his employer-derived account balance will be restored to the amount on the date of such deemed distribution.

Any amount required to restore such forfeitures shall be deducted from forfeitures occurring in the plan year of restoration. If forfeitures are insufficient for the restoration, the employer may make a contribution to the plan for such plan year to satisfy the restoration. However, by the end of the plan year following the plan year of restoration, sufficient forfeitures or employer contributions shall be credited to the account to satisfy the restoration.

(c) Disposition of Forfeitures - Forfeitures from employer contribution account shall be reallocated among the eligible active participants at the end of the plan year in which such forfeitures occur in accordance with the allocation procedures set forth in Section 3.2. With respect to the underlying allocation and reallocation of assets, the participant’s corporate stock account shall only be forfeited after the participant’s balance in the other investment account has been exhausted. If interests in more than one class of corporate stock have been allocated to the participant’s account, the participant shall be treated as forfeiting the same proportion of each such class.

(d) Unclaimed Benefits

(1) Forfeiture - The plan does not require the trustee or the plan administrator to search for, or to ascertain the whereabouts of, any participant or beneficiary before a distribution is required under the provisions of Section 5.3. At the time the participant’s or beneficiary’s benefit becomes distributable under the plan, the plan administrator, by certified or registered mail addressed to his last known address of record, shall notify any participant or beneficiary that he is entitled to a distribution under this plan. If the participant or beneficiary fails to claim his distributive share or make his whereabouts known in writing to the plan administrator within twelve months from the date of mailing of the notice, the plan administrator shall treat the participant’s or beneficiary’s unclaimed payable accrued benefit as forfeited and shall reallocate such forfeiture in accordance with Section 4.2(c). A forfeiture under this paragraph shall occur at the end of the notice period or, if later, the earliest date applicable Treasury regulations would permit the forfeiture. These forfeiture provisions apply solely to the participant’s or beneficiary’s accrued benefit derived from employer contributions.

(2) Restoration - If a participant or beneficiary who has incurred a forfeiture of his accrued benefit under the provisions of this Section 4.2(d) makes a claim, at any time, for his forfeited accrued benefit, the plan administrator shall restore the participant’s or beneficiary’s forfeited accrued benefit to the same dollar amount as the dollar amount of the accrued benefit forfeited, unadjusted for any gains or losses occurring after the date of the forfeiture. During the plan year in which the participant or beneficiary makes the claim, the plan administrator shall make the restoration from forfeitures occurring in that plan year. If forfeitures are insufficient for the restoration, the employer shall make a contribution to the plan to satisfy the restoration. The plan administrator shall direct the trustee to distribute the participant’s or beneficiary’s

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restored accrued benefit to him not later than 60 days after the close of the plan year in which the plan administrator restores the forfeited accrued benefit.

Section 4.3. - Payment of Participant Accounts

(a) Time of Payment

(1) Commencement of Benefits - Unless the participant elects otherwise, distribution of benefits shall begin no later than the 60th day after the latest of the close of the plan year in which:

(A) The participant attains age 65 (or normal retirement age, if earlier);

(B) Occurs the 10th anniversary of the year in which the participant commenced participation in the plan; or

(2) Payment Upon Retirement, Disability, or Death - Subject to the provisions set forth in Section 4.3(a)(1), in the Joint and Survivor Requirements of Section 5.2, and in the Distribution Requirements of Section 5.3, if the participant terminates employment due to retirement, disability, or death, his account shall be paid as soon as administratively possible after the occurrence of the event creating the right to a distribution.

(3) Payment Upon Other Termination of Employment - Subject to the provisions set forth in Section 4.3(a)(1) and in the Distribution Requirements of Section 5.3, if the participant terminates employment other than by retirement, disability, or death, his account shall be paid as soon as administratively possible after the accounting date following the date of severance of employment. However, no distribution shall include any corporate stock acquired with the proceeds of an exempt loan until the close of the plan year in which such loan is repaid in full.

(4) Notwithstanding the foregoing, the failure of a participant (or spouse where the spouse’s consent is required) to consent to a distribution while a benefit is immediately distributable, within the meaning of Section 5.2(a), shall be deemed to be an election to defer commencement of payment of any benefit sufficient to satisfy this section.

(b) Period for Distribution of Benefits

(1) The plan administrator, pursuant to the written election of the participant (or if no election has been made prior to the participant’s death, by his beneficiary), shall direct the trustee to distribute to a participant or his beneficiary any amount to which he is entitled under the plan in one of the following methods. If the distribution exceeds $5,000, to the extent it is attributable to corporate stock, the election shall be subject to Section 4.3(b)(2).

If a distribution is required under the Distribution Requirements of Section 5.3, the participant fails to elect a form of payment, and the vested balance of the account exceeds

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$5,000, the trustee shall pay the benefit in installment payments over the period described in Section 4.3(b)(2). However if no portion of the distribution is attributable to corporate stock, the trustee shall pay the benefit in installment payments that meet the requirements of Section 5.3 over the joint life and last survivor expectancy of the participant and his designated beneficiary. If the vested balance of the account(s) does not exceed $5,000, the trustee shall distribute the entire account balance in a lump sum.

(A) A Lump Sum Payment - A lump sum benefit payment. If the vested accrued benefit is no more than $5,000, this shall be the sole payment option. Vested accrued benefits not in excess of $1,000 shall automatically be paid in a lump sum.

(B) Installment Payments over a period of years that meets the Distribution Requirements of Section 5.3 in quarterly installments.

(2) Unless the participant elects in writing a longer distribution period, distributions to a participant or his beneficiary attributable to corporate stock shall be in substantially equal annual installments over a period not longer than five years. In the case of a participant with an account balance attributable to corporate stock in excess of $1,070,000, the 5-year period shall be extended one additional year (but not more than five additional years) for each $210,000 or fraction thereof by which such balance exceeds $1,070,000. These dollar limits shall be adjusted at the same time and in the same manner as provided in Code section 415(d).

(1) Any part of a participant’s benefit that is retained in the plan after the allocation date on which his participation ends will continue to be treated as a corporate stock account, other investment account, or directed investment account subject to Section 4.2(a)(6)(A). However, no further employer contributions or forfeitures will be credited.

(2) All distributions due to be made under this plan shall be made on the basis of the amount to the credit of the participant as of the accounting date coincident with or immediately preceding the occurrence of the event calling for a distribution. If a distributable event occurs after an allocation date and before allocations have been made to the account of the participant, the distribution shall also include the amounts allocable to the account as of such allocation date.

(3) If any person entitled to receive benefits hereunder is physically or mentally incapable of receiving or acknowledging receipt thereof, and if a legal guardian or power of attorney has been appointed for him, the plan administrator may direct the benefit payment to be made to such legal representative. The plan administrator may cause benefits to be paid to any other individual recognized by the state law under which the plan trust has been established.

In the event a distribution is to be made to a minor beneficiary, then the plan administrator may direct that such distribution be paid to the legal guardian, or if none, to a parent of such beneficiary or a responsible adult with whom the beneficiary maintains his residence, or to the custodian for such beneficiary under the Uniform Gift to Minors Act or the

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Gift to Minors Act, if such is permitted by the laws of the state in which said beneficiary resides. Such a payment to the legal guardian, custodian or parent of a minor beneficiary shall fully discharge the trustee, employer, plan administrator, and plan from further liability on account thereof.

(4) Each optional form of benefit provided under the plan shall be made available to all participants on a nondiscriminatory basis. The plan may not retroactively reduce or eliminate optional forms of benefits and any other Code section 411(d)(6) protected benefits, except as provided in Regulation section 1.411(d)-4, Q&A-2(b) and in other relief granted statutorily or by the Commissioner of Internal Revenue.

(5) The participant’s election of a form of benefit payment shall be irrevocable as of the annuity starting date, subject to the notice requirements contained in Section 4.3(e).

(6) Notwithstanding anything herein to the contrary if the board of directors of the corporation acting in a nondiscriminatory manner shall so direct, cash dividends on shares of corporate stock shall be paid directly in cash to the participants in the plan or such dividends shall be paid to the plan and distributed in cash to participants within 90 days after the close of the plan year in which the dividend is paid. In the absence of any direction from the board of directors of the corporation, cash dividends in corporate stock shall be paid to the plan and allocated to participants’ accounts.

(d) Eligible Rollover Distributions

A distributee may elect, at the time and in the manner prescribed by the plan administrator, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover.

(1) Eligible Rollover Distribution - An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee’s designated beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Code section 401(a)(9) including any portion of such distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities); a dividend distributed from the plan; any hardship withdrawal; and any other distribution(s) that is reasonably expected to total less than $200 during a year.

A portion of a distribution shall not fail to be an eligible rollover distribution merely because the portion consists of after-tax employee contributions that are not includible in gross income. However, such portion may be transferred only to: (A) a traditional individual retirement account or annuity described in Code section 408(a) or (b) (traditional IRA) or a Roth individual retirement account or annuity described in Code section 408A (Roth IRA); or (B) a qualified plan or an annuity contract described in Code section 401 (a) and 403(b), respectively,

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that agrees to separately account for amounts so transferred (and earnings thereon), including separately accounting for the portion of such distribution that is includible in gross income and the portion of such distribution that is not so includible.

(2) Eligible Retirement Plan - An eligible retirement plan is a traditional IRA, a Roth IRA, an annuity plan described in Code section 403(a), an annuity contract described in Code section 403(b), a qualified plan described in Code section 401 (a), that accepts the distributee’s eligible rollover distribution, or an eligible plan under Code section 457(b) that is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state and that agrees to separately account for amounts transferred into such plan from this plan. The definition of eligible retirement plan shall also apply in the case of a distribution to a surviving spouse, or to a spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Code section 414(p).

If any portion of an eligible rollover distribution is attributable to payments or distributions from a designated Roth account, an eligible retirement plan with respect to such portion shall include only a designated Roth account or a Roth IRA.

(3) Distributee - A distributee includes an employee or former employee. The employee’s or former employee’s surviving spouse and the employee’s or former employee’s spouse or former spouse who is the alternate payee under a qualified domestic relations order, as defined in Code section 414(p), are distributees with regard to the interest of the spouse or former spouse. For distributions after December 31, 2006, a distributee shall include a nonspouse beneficiary but only with respect to a direct transfer to an inherited traditional or Roth IRA that is established on his behalf for the purpose of receiving the distribution.

(4) Direct Rollover - A direct rollover is a payment by the plan to the eligible retirement plan specified by the distributee.

(e) Payment Election Procedures

As described in Section 5.2(a), an account balance in excess of $1,000 shall not be immediately distributed without the consent of the participant. The participant shall receive the notice required under Regulation section 1.411(a)-11(c) no less than 30 days and no more than 180 days before the annuity starting date with respect to the distribution. The written explanation shall include a description of the consequences of failing to defer receipt of the distribution. For any distribution in excess of $200, the plan administrator shall give the participant notice of his eligible rollover distribution rights. The participant shall receive such notice in the same time period as the 411 notice is required to be provided. If a distribution is one to which Code sections 401(a)(11) and 417 do not apply, such distribution may commence less than 30 days after the 411 notice is given, provided that:

(1) The plan administrator clearly informs the participant that the participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option), and

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(2) The participant, after receiving the notice, affirmatively elects a distribution.

(f) Form of Distribution

(1) Distribution of a participant’s benefit may be made in cash or corporate stock or both, provided, however, that if a participant or beneficiary so demands, such benefit (other than corporate stock reinvested pursuant to Section 3.4(c)) shall be distributed only in the form of corporate stock. Prior to making a distribution of benefits, the plan administrator shall advise the participant or his beneficiary, in writing, of the right to demand that benefits be distributed solely in corporate stock. In the case of a cashout distribution made pursuant to Section 4.2(b)(2)(A), the distribution shall be made in cash.

(2) If a participant or beneficiary demands that benefits be distributed solely in corporate stock, distribution of a participant’s benefit will be made entirely in whole shares or other units of corporate stock. If the corporate stock consists of more than one class, the participant will receive substantially the same proportion of each such class. Any balance in a participant’s other investments account will be applied to acquire for distribution the maximum number of whole shares or other units of corporate stock at the then fair market value. Any fractional unit value unexpended will be distributed in cash.

If corporate stock is not available for purchase by the trustee, then the trustee shall hold such balance until corporate stock is acquired and then make such distribution, subject to Sections 4.3(a)(1), 5.2 and 5.3.

(3) The trustee shall make distribution from the trust only on instructions from the plan administrator.

(4) Put Option - Shares of corporate stock are currently publicly traded securities. In the event the securities cease to be publicly traded or become subject to certain restrictions so that the securities are not freely tradable, then the employer will honor a put option for such securities. The employer’s obligation to purchase distributed corporate stock shall be as described in Section 5.5(e).

(5) Right of First Refusal - There is no right of first refusal at this time with respect to the corporate stock.

Section 4.4. - In-Service Payments

(a) Withdrawals - No payments other than cash dividends on shares of corporate stock paid pursuant to Section 3.4(a) and distributions pursuant to an election under Section 3.4(c) shall be made before separation from service.

(b) Participant Loans - No participant loans shall be permitted under this plan.

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Section 4.5. - Distributions under Domestic Relations Orders

Nothing contained in this plan prevents the trustee, in accordance with the direction of the plan administrator, from complying with the provisions of a qualified domestic relations order (as defined in Code section 414(p)).

This plan specifically permits distribution to an alternate payee under a qualified domestic relations order at any time, irrespective of whether the participant has attained his earliest retirement age (as defined under Code section 414(p)) under the plan. A distribution to an alternate payee prior to the participant’s attainment of earliest retirement age is available only if the order specifies distribution at that time or permits an agreement between the plan and the alternate payee to authorize an earlier distribution. If the present value of the alternate payee’s benefits under the plan exceeds $5,000 and the order requires, the alternate payee must consent to any distribution occurring prior to the participant’s attainment of earliest retirement age.

Nothing in this Section gives a participant a right to receive distribution at a time otherwise not permitted under the plan nor does it permit the alternate payee to receive a form of payment not otherwise permitted under the plan.

The plan administrator shall establish reasonable procedures to determine the qualified status of a domestic relations order. Upon receiving a domestic relations order, the plan administrator promptly will notify the participant and any alternate payee named in the order, in writing, of the receipt of the order and the plan’s procedures for determining the qualified status of the order. Within a reasonable period of time after receiving the domestic relations order, the plan administrator shall determine the qualified status of the order and shall notify the participant and each alternate payee, in writing, of his determination. The plan administrator shall provide notice under this paragraph by mailing to the individual’s address specified in the domestic relations order, or in a manner consistent with Department of Labor regulations.

If any portion of the participant’s nonforfeitable accrued benefit is payable during the period the plan administrator is making his determination of the qualified status of the domestic relations order, the plan administrator shall make a separate accounting of the amounts payable. If the plan administrator determines the order is a qualified domestic relations order within 18 months of the date amounts first are payable following receipt of the order, it shall direct the trustee to distribute the payable amounts in accordance with the order. If the plan administrator does not make his determination of the qualified status of the order within the 18-month determination period, it shall direct the trustee to distribute the payable amounts in the manner the plan would distribute if the order did not exist and shall apply the order prospectively if it later determines the order is a qualified domestic relations order.

Article V - ADDITIONAL QUALIFICATION RULES

Section 5.1. - Limitations on Allocations under Code Section 415

(a) Single Plan Limitations

(1) If the participant does not participate in, and has never participated in another qualified plan maintained by the employer, or a welfare benefit fund (as defined in Code

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section 419(e)) maintained by the employer, or an individual medical account (as defined in Code section 415(l)(2)) maintained by the employer, or a simplified employee pension (as defined in Code section 408(k)) maintained by the employer, that provides an annual addition as defined in Section 5.1(c)(1), the amount of annual additions that may be credited to the participant’s account for any limitation year will not exceed the lesser of the maximum permissible amount or any other limitation contained in this plan. If the employer contribution that would otherwise be contributed or allocated to the participant’s account would cause the annual additions for the limitation year to exceed the maximum permissible amount, the amount contributed or allocated will be reduced so that the annual additions for the limitation year will equal the maximum permissible amount.

(2) Prior to determining the participant’s actual compensation for the limitation year, the employer may determine the maximum permissible amount for a participant on the basis of a reasonable estimation of the participant’s compensation for the limitation year, uniformly determined for all participants similarly situated.

(3) As soon as is administratively feasible after the end of the limitation year, the maximum permissible amount for the limitation year will be determined on the basis of the participant’s actual compensation for the limitation year.

(4) If a participant elects to make employee nondeductible contributions or elective deferrals that together with any contribution the employer is obligated to make under the terms of this plan (including pursuant to any published discretionary contribution) would otherwise cause the annual additions for the limitation year to exceed the maximum permissible amount, the contribution election of the participant shall be limited before any employer contribution is reduced so that the annual additions for the limitation year will equal the maximum permissible amount.

(b) Combined Limitations - Other Defined Contribution Plan

(1) This Section 5.1(b) applies if, in addition to this plan, the participant is covered under another qualified defined contribution plan maintained by the employer, a welfare benefit fund maintained by the employer, an individual medical account maintained by the employer, or a simplified employee pension maintained by the employer, that provides an annual addition as defined in Section 5.1(c)(1), during any limitation year. The annual additions that may be credited to a participant’s account under this plan for any such limitation year will not exceed the maximum permissible amount reduced by the annual additions credited to a participant’s account under the other qualified defined contribution plans, welfare benefit funds, individual medical accounts, and simplified employee pensions for the same limitation year. If the annual additions with respect to the participant under other qualified defined contribution plans, welfare benefit funds, individual medical accounts, and simplified employee pensions maintained by the employer are less than the maximum permissible amount and the employer contribution that would otherwise be contributed or allocated to the participant’s account under this plan would cause the annual additions for the limitation year to exceed this limitation, the amount contributed or allocated will be reduced so that the annual additions under all such plans and funds for the limitation year will equal the maximum permissible amount. If the annual additions with respect to the participant under such other qualified defined contribution plans,

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welfare benefit funds, individual medical accounts, and simplified employee pensions in the aggregate are equal to or greater than the maximum permissible amount, no amount will be contributed or allocated to the participant’s account under this plan for the limitation year.

(2) Prior to determining the participant’s actual compensation for the limitation year, the employer may determine the maximum permissible amount for a participant in the manner described in Section 5.1(a)(2).

(4) If, pursuant to Section 5.1(b)(3) or as a result of the allocation of forfeitures, a participant’s annual additions under this plan and such other plans would result in an excess amount for a limitation year, the excess amount will be deemed to consist of the annual additions last allocated, except that annual additions attributable to a simplified employee pension will be deemed to have been allocated first, followed by annual additions to a welfare benefit fund or individual medical account, regardless of the actual allocation date.

(5) If an allocation date of this plan coincides with an allocation date of another plan and the employee or employer contribution that would otherwise be contributed or allocated to a participant’s account under the plans would cause the annual additions for the limitation year to exceed the maximum permissible amount, Section 3.1(c) shall control which contribution or allocation will be reduced so that the annual additions for the limitation year will equal the maximum permissible amount.

(1) Annual Additions - The sum of the following amounts credited to a participant’s account for the limitation year: (A) employer contributions; (B) employee contributions (excluding catch-up contributions made in accordance with Code section 414(v)); (C) forfeitures; (D) amounts allocated to an individual medical account (as defined in Code section 415(l)(2)), that is part of a pension or annuity plan maintained by the employer are treated as annual additions to a defined contribution plan; and (E) allocations under a simplified employee pension. Also, amounts derived from contributions paid or accrued that are attributable to postretirement medical benefits allocated to the separate account of a key employee (as defined in Code section 419A(d)(3)) under a welfare benefit fund (as defined in Code section 419(e)) maintained by the employer are treated as annual additions to a defined contribution plan.

For this purpose, any excess amount applied under Section 5.1(a)(4) or (b)(6) in the limitation year to increase the accounts of participants who did not have an excess amount or to reduce employer contributions will be considered annual additions for such limitation year.

Restorative payments allocated to a participant’s account including restorative payments made pursuant to Section 4.2(b)(2)(B) and payments made to restore losses to the plan resulting from actions (or a failure to act) by a fiduciary for which there is a reasonable risk of liability

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under ERISA or under other applicable federal or state law (where similarly situated participants are treated similarly) shall not give rise to an annual addition for any limitation year.

To the extent the employer is a C corporation, annual additions shall hot include forfeitures of corporate stock that were purchased with the proceeds of an exempt loan nor shall they include employer contributions applied to the payment of interest on an exempt loan and charged against a participant’s account if no more than one-third of the employer contribution for the limitation year is allocated to the account of highly compensated employees. Further, annual additions shall not include dividends received by the plan with respect to corporate stock as such proceeds constitute earnings on a plan asset and are allocable as such.

Annual additions may be calculated with respect to employer contributions of both principal and interest used to repay an exempt loan; however, if the amount would be less, annual additions shall be determined using the fair market value of corporate stock released from the suspense account on account of the exempt loan repayment and allocated to participants for the limitation year.

(2) Compensation - A participant’s earned income and any earnings reportable as W-2 wages for federal income tax withholding purposes that are paid by the employer. W-2 wages means wages as defined in Code section 3401 (a) but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code section 3401(a)(2)).

For purposes of applying the limitations of this Section 5.1, compensation for a limitation year is the compensation actually paid or includable in gross income during such limitation year. Compensation for a limitation year shall include amounts earned but not paid during the limitation year solely because of the timing of pay periods and pay dates, provided the amounts are paid during the first few weeks of the next limitation year, the amounts are included on a uniform and consistent basis with respect to all similarly situated employees, and no compensation is included in more than one limitation year.

Back pay, within the meaning of Regulation section 1.415(c)-2(g)(8), shall be treated as compensation for the limitation year to which the back pay relates to the extent the back pay represents wages and compensation that would otherwise be included under this definition.

For limitation years beginning after December 31, 2008, compensation for a limitation year shall include amounts paid as differential wages to a participant on qualified military service leave of more than 30 days and otherwise meeting the requirements of Code section 3401 (h)(2).

Compensation in excess of the limitations of Section 1.2(c) shall not be taken into account. In order to be taken into account for a limitation year, compensation must be paid or treated as paid prior to severance from employment with the employer. Effective for limitation years beginning on or after July 1, 2007, an includable payment shall be treated as paid prior to severance from employment if it is paid by the later of 2/4 months after severance or the last day of the limitation year that includes the severance date. For this purpose, includable payments are those that absent the severance would have been paid and are regular compensation for services

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during regular working hours or outside working hours (such as overtime or shift differentials), commissions, bonuses, or other similar compensation. Includable payments shall also include accrued sick, vacation, or other leave if such payments would have been included in compensation as defined in Section 1.2 if they were paid prior to the employee’s severance from employment.

Compensation shall include elective contributions as defined in Section 1.2(a) and elective contributions under a Code section 501(c)(18) plan. Elective contribution amounts under a cafeteria plan excludable under Code section 125 shall include any amounts not available to a participant in cash in lieu of group health coverage solely because the participant is unable to certify that he has other health coverage (deemed section 125 compensation). Amounts are deemed section 125 compensation only if the employer does not request or collect information regarding the participant’s other health coverage as part of the enrollment process for the health plan.

Notwithstanding the preceding, compensation for a participant who is permanently and totally disabled (as defined in Code section 22(e)(3)) is the compensation such participant would have received for the limitation year if the participant had been paid at the rate of compensation paid immediately before becoming permanently and totally disabled; such imputed compensation for the disabled participant may be taken into account only if contributions made on behalf of such participant are nonforfeitable when made.

(3) Defined Contribution Dollar Limitation - $40,000, as adjusted under Code section 415(d).

(4) Employer - For purposes of this Section 5.1, employer shall mean the employer as defined in Section 1.5(b) but including all members of a controlled group of corporations as defined in Code section 414(b) as modified by Code section 415(h) and all commonly controlled trades or businesses as defined in Code section 414(c) as modified by Code section 415(h).

(5) Excess Amount - The excess of the participant’s annual additions for the limitation year over the maximum permissible amount.

(6) Limitation Year - The 12-consecutive-month period defined in Section 1.3(f). All qualified defined contribution plans maintained by the employer must use the same limitation year. If the limitation year is amended to a different 12-consecutive-month period, the new limitation year must begin on a date within the limitation year in which the amendment is made.

(7) Maximum Permissible Amount - The maximum annual addition that may be contributed or allocated to a participant’s account under the plan for any limitation year shall not exceed the lesser of:

(A) the defined contribution dollar limitation as defined in Section 5.1(c)(3); or

(B) 100% of the participant’s compensation for the limitation year.

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The compensation limitation referred to in (B) shall not apply to any contribution for medical benefits after separation from service (within the meaning of Code section 401 (h) or Code section 419A(f)(2)) that is otherwise treated as an annual addition under Code section 415(l)(1) or 419A(d)(2).

If a short limitation year is created because of an amendment changing the limitation year to a different 12-consecutive-month period, the maximum permissible amount will not exceed the defined contribution dollar limitation multiplied by the following fraction:

Number of months in the short limitation year
12

If the plan is terminated as of a date other than the last day of the limitation year, the plan shall be deemed to have been amended to change its limitation year and the maximum permissible amount shall be determined by prorating it for the resulting short limitation year.

Section 5.2. - Joint and Survivor Annuity Requirements

No annuity form of payment is provided under Section 4.3(b) and no direct or indirect transfer is accepted under Section 3.3 from a defined benefit plan, money purchase pension plan (including a target benefit plan), stock bonus or profit sharing plan that would otherwise have provided for a life annuity form of payment to any participant; therefore, the joint and survivor annuity requirements of Code section 401(a)(11) and 417 shall not apply to this plan, except as provided in this Section 5.2.

(a) Restrictions on Immediate Distributions - If the value of a participant’s vested account balance derived from employer and employee contributions exceeds $5,000, and the account balance is immediately distributable, the participant (or where the participant has died, the participant’s spouse) must consent to any distribution of such account balance. For the purpose of determining the value of a participant’s vested account balance, prior distributions shall be disregarded if distributions have not commenced under an optional form of payment described in Section 4.3. The consent of the participant (or the participant’s surviving spouse) shall be obtained in writing within the 180-day period ending on the annuity starting date. The annuity starting date is the first day of the first period for which an amount is paid in any form. The plan administrator shall notify the participant (or the participant’s surviving spouse) of the right to defer any distribution until the participant’s account balance is no longer immediately distributable and the consequences of failing to defer any distribution, as required by Regulation section 1.417(a)(3)-1. Such notification shall include a general description of the material features, an explanation of the optional forms of benefit available under the plan in a manner that would satisfy the notice requirements of Code section 417(a)(3), and a description of the consequences of failing to defer any distribution, and shall be provided no less than 30 days and no more than 1,80 days prior to the annuity starting date. However, distribution may commence less than 30 days after the notice described in the preceding sentence is given, provided the distribution is one to which Code sections 401(a)(11) and 417 do not apply, the plan administrator clearly informs the participant that the participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution

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(and, if applicable, a particular distribution option), and the participant, after receiving the notice, affirmatively elects a distribution.

Notwithstanding the preceding, effective for an account balance that is immediately distributable on or after March 28, 2005, the participant (or his surviving spouse) must consent to any distribution of such account balance in excess of $1,000.

Neither the consent of the participant nor the participant’s spouse shall be required to the extent that a distribution is required to satisfy Code section 401(a)(9) or section 415. In addition, upon termination of this plan if the plan does not offer an annuity option (purchased from a commercial provider) and if the employer or any entity within the same controlled group as the employer does not maintain another defined contribution plan, the participant’s account balance will, without the participant’s consent, be distributed to the participant. However, if any entity within the same controlled group as the employer maintains another defined contribution plan, the participant’s account balance will be transferred, without the participant’s consent, to the other plan if the participant does not consent to an immediate distribution.

An account balance is immediately distributable if any part of the account balance could be distributed to the participant (or surviving spouse) before the participant attains (or would have attained if not deceased) the later of normal retirement age or age 62.

(b) Safe Harbor Rules - This Section 5.2(b) shall apply to a participant in this employee stock ownership plan. This plan satisfies and shall continue to satisfy the following conditions: (1) the participant cannot elect payments in the form of a life annuity; and (2) on the death of a participant, the participant’s vested account balance will be paid to the participant’s surviving spouse, but if there is no surviving spouse, or if the surviving spouse has consented in a manner conforming to a qualified election, then to the participant’s designated beneficiary. The surviving spouse may elect to have distribution of the vested account balance commence within the 180-day period following the date of the participant’s death. The account balance shall be adjusted for gains or losses occurring after the participant’s death in accordance with the provisions of the plan governing the adjustment of account balances for other types of distributions.

(1) The participant may waive the spousal death benefit described in this Section 5.2(b) at any time provided that no such waiver shall be effective unless it satisfies the conditions of Section 5.2(c)(1) that would apply to the participant’s waiver of the qualified preretirement survivor annuity.

(2) For purposes of this Section 5.2(b), vested account balance shall have the same meaning as provided in Section 5.2(c)(3).

(1) Qualified Election - A waiver of a qualified preretirement survivor annuity. Any waiver of a qualified preretirement survivor annuity shall not be effective unless: (a) the participant’s spouse consents in writing to the election; (b) the election designates a specific beneficiary, including any class of beneficiaries or any contingent beneficiaries, that may not be changed without spousal consent (or the spouse expressly permits designations by the

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participant without any further spousal consent); (c) the spouse’s consent acknowledges the effect of the election; and (d) the spouse’s consent is witnessed by a plan representative or notary public. If it is established to the satisfaction of a plan representative that there is no spouse or that the spouse cannot be located, a waiver will be deemed a qualified election.

Any consent by a spouse obtained under this provision (or establishment that the consent of a spouse may not be obtained) shall be effective only with respect to such spouse. A consent that permits designations by the participant without any requirement of further consent by such spouse must acknowledge that the spouse has the right to limit consent to a specific beneficiary, and a specific form of benefit where applicable, and that the spouse voluntarily elects to relinquish either or both of such rights. A revocation of a prior waiver may be made by a participant without the consent of the spouse at any time before the commencement of benefits. The number of revocations shall not be limited.

(2) Spouse (Surviving Spouse) - The spouse or surviving spouse of the participant, provided that a former spouse will be treated as the spouse or surviving spouse and a current spouse will not be treated as the spouse or surviving spouse to the extent provided under a qualified domestic relations order as described in Code section 414(p).

(3) Vested Account Balance - The aggregate value of the participant’s vested account balances derived from employer and employee contributions (including rollovers), whether vested before or upon death, including the proceeds of insurance contracts, if any, on the participant’s life. The provisions of this Section 5.2 shall apply to a participant who is vested in amounts attributable to employer contributions, employee contributions, or both at the time of death or distribution.

Section 5.3. - Distribution Requirements

Subject to Section 5.2 Joint and Survivor Annuity Requirements, the requirements of this Section 5.3 shall apply to any distribution of a participant’s interest and will take precedence over any inconsistent provisions of this plan. All distributions required under this Section 5.3 shall be determined and made in accordance with the regulations under Code section 401(a)(9) and the minimum distribution incidental benefit requirement of Code section 401 (a)(9)(G).

With respect to calendar year 2009, the provisions of Section 5.3 shall be applied subject to Code section 401(a)(9)(H). Although the plan administrator shall calculate any required minimum distribution under Section 5.3 and pay it separately to any participant or beneficiary commencing distribution during 2009, such recipient shall be eligible to deposit such amount in a qualified employer plan or individual retirement account. Any participant receiving or due to commence such distributions (including as a 5% owner) shall not receive a required minimum distribution with respect to 2009 in the absence of an affirmative election. To the extent that a participant’s entire interest is otherwise required to be distributed to a beneficiary by December 31 of the calendar year containing the fifth anniversary of the participant’s death, such 5-year period shall be determined without regard to calendar year 2009.

(a) Required Beginning Date - The entire interest of a participant must be distributed or begin to be distributed no later than the participant’s required beginning date.

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(b) Limits on Distribution Periods - As of the first distribution calendar year, distributions to a participant, if not made in a single sum, may only be made over one of the following periods (or a combination thereof):

(1) the life of the participant;

(2) the joint lives of the participant and a designated beneficiary;

(3) a period certain not extending beyond the life expectancy of the participant; or

(4) a period certain not extending beyond the joint life and last survivor expectancy of the participant and a designated beneficiary.

(c) Death of Participant Before Distributions Begin - If the participant dies before distributions begin, the participant’s entire interest will be distributed, or begin to be distributed, no later than as follows:

(1) If the participant’s surviving spouse is the participant’s sole designated beneficiary, then distributions to the surviving spouse will begin by December 31 of the calendar year immediately following the calendar year in which the participant died, or by December 31 of the calendar year in which the participant would have attained age 70 1 /a, if later. If the surviving spouse so elects, the participant’s entire interest will be distributed to such surviving spouse by December 31 of the calendar year containing the fifth anniversary of the participant’s death. If no election is received, distributions to the surviving spouse will begin by December 31 of the calendar year in which the participant would have attained age 70/4, or the participant’s entire interest will be distributed to such surviving spouse by December 31 of the calendar year containing the fifth anniversary of the participant’s death, if later.

(2) If the participant’s surviving spouse is not the participant’s sole designated beneficiary, then distributions to the designated beneficiary will begin by December 31 of the calendar year immediately following the calendar year in which the participant died. If the designated beneficiary so elects or if no election is received, the participant’s entire interest will be distributed to such designated beneficiary by December 31 of the calendar year containing the fifth anniversary of the participant’s death.

(3) If there is no designated beneficiary as of September 30 of the year following the year of the participant’s death, the participant’s entire interest will be distributed by December 31 of the calendar year containing the fifth anniversary of the participant’s death.

(4) If the participant’s surviving spouse is the participant’s sole designated beneficiary and the surviving spouse dies after the participant but before distributions to the surviving spouse are required to begin, this Section 5.3(c), other than Section 5.3(c)(1), will apply as if the surviving spouse were the participant.

For purposes of this Section 5.3(c) and Section 5.3(f), unless Section 5.3(c)(4) applies, distributions are considered to begin on the participant’s required beginning date. If Section

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5.3(c)(4) applies, distributions are considered to begin on the date distributions are required to begin to the surviving spouse under Section 5.3(c)(1).

(d) Forms of Distribution - Unless the participant’s interest is distributed in a single sum on or before the required beginning date, as of the first distribution calendar year distributions will be made in accordance with Section 5.3(e) and (f).

(e) Required Minimum Distributions During Participant’s Lifetime - If a participant’s benefit is to be distributed over (1) a period not extending beyond the life expectancy of the participant or the joint life and last survivor expectancy of the participant and the participant’s designated beneficiary or (2) a period not extending beyond the life expectancy of the designated beneficiary, the amount required to be distributed for each calendar year, beginning with distributions for the first distribution calendar year, must at least equal the quotient obtained by dividing the participant’s benefit by the applicable life expectancy.

(1) Amount of Required Minimum Distribution For Each Distribution Calendar Year- During the participant’s lifetime, the minimum amount that will be distributed for each distribution calendar year is the lesser of:

(A) The quotient obtained by dividing the participant’s account balance by the distribution period in the Uniform Lifetime Table set forth in Regulation section 1.401(a)(9)-9, using the participant’s age as of the participant’s birthday in the distribution calendar year; or

(B) If the participant’s sole designated beneficiary for the distribution calendar year is the participant’s spouse, the quotient obtained by dividing the participant’s account balance by the number in the Joint and Last Survivor Table set forth in Regulation section 1.401(a)(9)-9, using the participant’s and spouse’s attained ages as of the participant’s and spouse’s birthdays in the distribution calendar year.

(2) Lifetime Required Minimum Distributions Continue Through Year of Participant’s Death - Required minimum distributions will be determined under this Section 5.3(e) beginning with the first distribution calendar year and continuing up to and including the distribution calendar year that includes the participant’s date of death.

(f) Required Minimum Distributions After Participant’s Death

(1) Death On or After Date Distributions Begin - If the participant dies after distribution of his interest has begun, the remaining portion of such interest will continue to be distributed at least as rapidly as under the method of distribution being used prior to the participant’s death.

(A) Participant Survived by Designated Beneficiary - If the participant dies on or after the date distributions begin and there is a designated beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the participant’s death is the quotient obtained by dividing the participant’s account balance by the longer of the remaining life expectancy of the participant or the remaining life expectancy of the participant’s designated beneficiary, determined as follows:

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(i) The participant’s remaining life expectancy is calculated using the age of the participant in the year of death, reduced by one for each subsequent year.

(ii) If the participant’s surviving spouse is the participant’s sole designated beneficiary, the remaining life expectancy of the surviving spouse is calculated for each distribution calendar year after the year of the participant’s death using the surviving spouse’s age as of the spouse’s birthday in that year. For distribution calendar years after the year of the surviving spouse’s death, the remaining life expectancy of the surviving spouse is calculated using the age of the surviving spouse as of the spouse’s birthday in the calendar year of the spouse’s death, reduced by one for each subsequent calendar year.

(iii) If the participant’s surviving spouse is not the participant’s sole designated beneficiary, the designated beneficiary’s remaining life expectancy is calculated using the age of the beneficiary in the year following the year of the participant’s death, reduced by one for each subsequent year.

(B) No Designated Beneficiary - If the participant dies on or after the date distributions begin and there is no designated beneficiary as of September 30 of the year after the year of the participant’s death, the minimum amount that will be distributed for each distribution calendar year after the year of the participant’s death is the quotient obtained by dividing the participant’s account balance by the participant’s remaining life expectancy calculated using the age of the participant in the year of death, reduced by one for each subsequent year.

(2) Death Before Date Distributions Begin

(A) Participant Survived by Designated Beneficiary - If the participant dies before the date distributions begin and there is a designated beneficiary, the minimum amount that will be distributed for each distribution calendar year after the year of the participant’s death is the quotient obtained by dividing the participant’s account balance by the remaining life expectancy of the participant’s designated beneficiary, determined as provided in Section 5.3(f)(1).

(B) No Designated Beneficiary - If the participant dies before the date distributions begin and there is no designated beneficiary as of September 30 of the year following the year of the participant’s death, distribution of the participant’s entire interest will be completed by December 31 of the calendar year containing the fifth anniversary of the participant’s death.

(C) Death of Surviving Spouse Before Distributions to Surviving Spouse Are Required to Begin - If the participant dies before the date distributions begin, the participant’s surviving spouse is the participant’s sole designated beneficiary, and the surviving spouse dies before distributions are required to begin to the surviving spouse under Section 5.3(c), this Section 5.3(f)(2) will apply as if the surviving spouse were the participant.

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(g) Definitions (Code Section 401 (a)(9) Requirements)

(1) Designated Beneficiary - The individual who is designated as the beneficiary of the participant’s interest under the plan and who is the designated beneficiary under Code section 401 (a)(9) and Regulation section 1.401 (a)(9)-4.

(2) Distribution Calendar Year - A calendar year for which a minimum distribution is required. For distributions beginning before the participant’s death, the first distribution calendar year is the calendar year immediately preceding the calendar year that contains the participant’s required beginning date. For distributions beginning after the participant’s death, the first distribution calendar year is the calendar year in which distributions are required to begin pursuant to Section 5.3(c). The required minimum distribution for the participant’s first distribution calendar year will be made on or before the participant’s required beginning date. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the participant’s required beginning date occurs, will be made on or before December 31 of that distribution calendar year.

(3) Life Expectancy - Life expectancy as computed by use of the Single Life Table in Regulation section 1.401(a)(9)-9.

(4) Participant’s Account Balance - The account balance as of the last valuation date in the calendar year immediately preceding the distribution calendar year (valuation calendar year) increased by the amount of any contributions made and allocated or forfeitures allocated to the account balance as of dates in the valuation calendar year after the valuation date and decreased by distributions made in the valuation calendar year after the valuation date. The account balance for the valuation calendar year includes any amounts rolled over or transferred to the plan either in the valuation calendar year or in the distribution calendar year if distributed or transferred in the valuation calendar year.

If any portion of the minimum distribution for the first distribution calendar year is made in the second distribution calendar year on or before the required beginning date, the amount of the minimum distribution made in the second distribution calendar year shall be treated as if it had been made in the immediately preceding distribution calendar year.

(5) Required Beginning Date

(A) Non-5% Owner- The required beginning date is April 1 of the calendar year following the later of: (i) the calendar year in which the participant attains age 70½, or (ii) the calendar year in which the participant retires.

(B) 5% Owner - The required beginning date for a participant who is a 5% owner is April 1 of the calendar year following the calendar year in which the participant attains age 70½. A participant is treated as a 5% owner for purposes of this Section 5.3(g)(5) if such participant is a 5% owner as defined in Code section 416(i) (determined in accordance with section 416 but without regard to whether the plan is top-heavy) at any time during the plan year ending with or within the calendar year in which such participant attains age 70½.

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(C) Once distributions have begun to a 5% owner under this Section 5.3(g)(5), they must continue to be distributed, even if the participant ceases to be a 5% owner in a subsequent year.

Section 5.4. - Top Heavy Provisions

(a) Application of Provisions - If the plan is or becomes top-heavy in any plan year, the provisions of Section 5.4 will supersede any conflicting provisions in the plan.

(b) Minimum Allocation

(1) Except as otherwise provided in Section 5.4(b)(3) and (4) below, the employer contributions and forfeitures allocated on behalf of any participant who is not a key employee shall not be less than the lesser of 3% of such participant’s compensation or in the case where the employer has no defined benefit plan that designates this plan to satisfy Code section 401, the largest percentage of employer contributions and forfeitures, as a percentage of key employee’s compensation that may be taken into account under Section 1.2(c), allocated on behalf of any key employee for that year. The minimum allocation is determined without regard to any Social Security contribution. This minimum allocation shall be made even though, under other plan provisions, the participant would not otherwise be entitled to receive an allocation, or would have received a lesser allocation for the year because of (i) the participant’s failure to complete 1,000 hours of service (or any equivalent provided in the plan), or (ii) the participant’s failure to make mandatory employee contributions to the plan, or (iii) compensation less than a stated amount.

(2) For purposes of computing the minimum allocation, compensation shall mean compensation as defined in Section 5.1 (c)(2), subject to the limitations of Section 1.2(c).

(3) The provision in Section 5.4(b)(1) shall not apply to any participant who was not employed by the employer on the last day of the plan year.

(4) The provision in Section 5.4(b)(1) shall not apply to any participant to the extent the participant is covered under any other plan or plans of the employer and the employer has provided in Section 3.2 that the minimum allocation or benefit requirement applicable to top-heavy plans will be met in the other plan or plans (including another plan that consists solely of a cash or deferred arrangement which meets the requirements of Code section 401 (k)(12) and matching contributions with respect to which the requirements of Code section 401 (m)(11) are met). If this plan is intended to meet the minimum allocation or benefit requirement applicable to another plan or plans, the employer shall so provide in Section 3.2(c).

(5) The minimum allocation required (to the extent required to be nonforfeitable under Code section 416(b)) may not be forfeited under Code section 411(a)(3)(B) or411(a)(3)(D).

(6) Matching Contributions - Employer matching contributions may be taken into account for purposes of satisfying the minimum contribution requirements of Code section 416(c)(2). The preceding sentence shall apply with respect to matching contributions

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under a plan containing a cash or deferred arrangement being used to satisfy the minimum allocation requirements of this plan if such plan so provides.

(c) Minimum Vesting Schedules - For any plan year in which this plan is top-heavy, the following minimum vesting schedule shall automatically apply to the plan:


Years of Service		Vesting Percentage
0 Year		0%
1		20%
2		40%
3		60%
4		80%
5 or More Years		100%

The minimum vesting schedule shall apply to all benefits within the meaning of Code section 411(a)(7) except those attributable to employee contributions, including benefits accrued before the effective date of Code section 416 and benefits accrued before the plan became top-heavy. Further, no decrease in a participant’s nonforfeitable percentage may occur in the event the plan’s status as top-heavy changes for any plan year. However, this Section does not apply to the account balances of any employee who does not have an hour of service after the plan has initially become top-heavy arid such employee’s account balance attributable to employer contributions and forfeitures will be determined without regard to this Section.

If the vesting schedule under the plans shifts in or out of the above schedule for any plan year because of the plan’s top-heavy status, such shift shall constitute an amendment to the vesting schedule and the provisions of Section 7.2(d) and (e) shall apply.

(d) Definitions (Code Section 416 Requirements)

(1) Key Employee - Key employee means any employee or former employee (and the beneficiaries of such employee) who at any time during the determination period is an officer of the employer if such individual’s annual compensation exceeds $130,000 (as adjusted under Code section 416(i)(1) for plan years beginning after December 31, 2002), a 5% owner of the employer, or a 1% owner of the employer who has an annual compensation of more than $150,000. Annual compensation means compensation as defined in Section 5.1(c)(2), but including elective contributions as defined in Section 1.2(a) and elective contributions under a Code section 457 plan or a Code section 501(c)(18) plan for any plan year and subject to the limitations of Section 1.2(c). The determination period is the plan year containing the determination date. In determining whether an employee is a key employee in 2002, this paragraph shall be treated as having been in effect for the last plan year beginning before January 1,2002.

In determining whether a plan is top-heavy for plan years beginning before January 1, 2002, key employee means any employee or former employee (and the beneficiaries of such employee) who at any time during the determination period was an officer of the employer if such individual’s annual compensation exceeded 50% of the dollar limitation under Code section

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415(b)(1)(A), an owner (or considered an owner under Code section 318) of one of the ten largest interests in the employer if such individual’s compensation exceeded 100% of the dollar limitation under Code section 415(c)(1)(A), a 5% owner of the employer, or a 1% owner of the employer who had an annual compensation of more than $150,000. Annual compensation means compensation as defined in Section 5.1(c)(2), but including elective contributions as defined in Section 1.2(a) and elective contributions under a Code section 457 plan or a Code section 501 (c)(18) plan for any plan year and subject to the limitations of Section 1.2(c). The determination period is the plan year containing the determination date and the four preceding plan years.

The determination of who is a key employee will be made in accordance with Code section 416(i)(1) and the applicable regulations and other guidance of general applicability issued thereunder.

(2) Top-Heavy Plan - This plan is top-heavy if any of the following conditions exists:

(A) If the top-heavy ratio for this plan exceeds 60% and this plan is not part of any required aggregation group or permissive aggregation group of plans.

(B) If this plan is a part of a required aggregation group of plans but not part of a permissive aggregation group and the top-heavy ratio for the group of plans exceeds 60%.

(C) If this plan is a part of a required aggregation group and part of a permissive aggregation group of plans and the top-heavy ratio for the permissive aggregation group exceeds 60%.

(3) Top-Heavy Ratio

(A) If the employer maintains one or more defined contribution plans (including any Simplified Employee Pension Plan) and the employer has not maintained any defined benefit plan that during the five-year period ending on the determination date(s) has or has had accrued benefits, the top-heavy ratio for this plan alone or for the required or permissive aggregation group as appropriate is a fraction, the numerator of which is the sum of the account balances of all key employees as of the determination date(s) including any part of any account balance distributed in the one-year period ending on the determination date(s) (five-year period ending on the determination date in the case of a distribution made for a reason other than severance from employment, death or disability and in determining whether the plan is top-heavy for plan years beginning before January 1, 2002), and the denominator of which is the sum of all account balances including any part of any account balance distributed in the one-year period ending on the determination date(s) (five-year period ending on the determination date in the case of a distribution made for a reason other than severance from employment, death or disability and in determining whether the plan is top-heavy for plan years beginning before January 1, 2002), both computed in accordance with Code section 416 and the regulations thereunder. Both the numerator and denominator of the top-heavy ratio are increased to reflect

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any contribution not actually made as of the determination date, but which is required to be taken into account on that date under Code section 416 and the regulations thereunder.

(B) If the employer maintains one or more defined contribution plans (including any Simplified Employee Pension Plan) and the employer maintains or has maintained one or more defined benefit plans that during the five-year period ending on the determination date(s) has or has had any accrued benefits, the top-heavy ratio for any required or permissive aggregation group as appropriate is a fraction, the numerator of which is the sum of account balances under the aggregated defined contribution plan or plans for all key employees, determined in accordance with (A) above, and the-present value of accrued benefits under the aggregated defined benefit plan or plans for all key employees as of the determination date(s), and the denominator of which is the sum of the account balances under the aggregated defined contribution plan or plans for all participants, determined in accordance with (A) above, and the present value of accrued benefits under the defined benefit plan or plans for all participants as of the determination date(s), all determined in accordance with Code section 416 and the regulations thereunder. The accrued benefits under a defined benefit plan in both the numerator and denominator of the top-heavy ratio are increased for any distribution of an accrued benefit made in the one-year period ending on the determination date (five-year period ending on the determination date in the case of a distribution made for a reason other than severance from employment, death or disability and in determining whether the plan is top-heavy for plan years beginning before January 1, 2002).

The accrued benefit of a participant other than a key employee shall be determined under (1) the method, if any, that uniformly applies for accrual purposes under all defined benefit plans maintained by the employer, or (2) if there is no such method, as if such benefit accrued not more rapidly than the slowest accrual rate permitted under the fractional rule of Code section 411(b)(1)(C).

(C) For purposes of Section 5.4(d)(3)(A) and (B) above the value of account balances and the present value of accrued benefits will be determined as of the most recent valuation date that falls within or. ends with the 12-month period ending on the determination date, except as provided in Code section 416 and the regulations thereunder for the first and second plan years of a defined benefit plan. The account balances and accrued benefits of a participant (1) who is not a key employee but who was a key employee in a prior year, or (2) who has not been credited with at least one hour of service with any employer maintaining the plan at any time during the one-year period (five-year period ending on the determination date in the case of a distribution made for a reason other than severance from employment, death or disability and in determining whether the plan is top-heavy for plan years beginning before January 1, 2002) ending on the determination date will be disregarded. The calculation of the top-heavy ratio, and the extent to which distributions, rollovers, and transfers are taken into account will be made in accordance with Code section 416 and the regulations thereunder. Deductible employee contributions will not be taken into account for purposes of computing the top-heavy ratio. When aggregating plans the value of account balances and accrued benefits will be calculated with reference to the determination dates that fall within the same calendar year.

The accrued benefit of a participant other than a key employee shall be determined under (1) the method, if any, that uniformly applies for accrual purposes under all defined benefit plans

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maintained by the employer, or (2) if there is no such method, as if such benefit accrued not more rapidly than the slowest accrual rate permitted under the fractional rule of Code section 411(b)(1)(C).

(4) Permissive Aggregation Group - The required aggregation group of plans plus any other plan or plans of the employer that, when considered as a group with the required aggregation group, would continue to satisfy the requirements of Code sections 401(a)(4) and 410.

(5) Required Aggregation Group - (A) Each qualified plan of the employer in which at least one key employee participates or participated at any time during the determination period (regardless of whether the plan has terminated), and (B) any other qualified plan of the employer that enables a plan described in (A) to meet the requirements of Code sections 401 (a)(4) or 410.

(6) Determination Date - For any plan year subsequent to the first plan year, the last day of the preceding plan year. For the first plan year of the plan, the last day of that year.

(7) Valuation Date - The. last day of the plan year shall be the date as of which account balances or accrued benefits are valued for purposes of calculating the top-heavy ratio.

(8) Present Value - Present value shall be based only on the interest and mortality rates specified in the employer’s defined benefit plan.

(9) Non-Key Employee - Any employee who is not a key employee. Non-key employees include employees who are former key employees.

Section 5.5. - ESOP Distribution Options

The employer retains the ability to amend and interpret the plan so as not to grant a greater right to a form of distribution than is otherwise granted under the regulations issued under Code section 411(d)(6).

(a) Readily Tradable

The terms readily tradable on an established securities market and readily tradable on an established market mean corporate stocks that are traded on a national securities exchange that is registered under section 6 of the Securities Exchange Act of 1934 or are otherwise readily tradable on an established securities market within the meaning of Regulation section 1.401(a)(35)-1(f)(5).

(b) Right to Receive Stock

The right to receive distributions in the form of shares of corporate stock shall be automatically terminated in the event of the sale or other disposition by the trustee of all shares of corporate stock held by the trust where the corporate stock ceases to be readily tradable.

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Implementation of this provision shall only be done in accordance with the nondiscrimination requirements of Code section 401(a)(4).

(1) Notwithstanding anything contained herein to the contrary, if the employer is an S corporation or the employer’s charter or by-laws restrict ownership of substantially all shares of corporate stock to employees and the trust fund, as described in Code section 409(h)(2), the plan administrator shall distribute a participant’s account entirely in cash without granting the participant the right to demand distribution in shares of corporate stock.

(2) Except as otherwise provided herein, corporate stock distributed by the trustee may be restricted as to sale or transfer by the by-laws or articles of incorporation of the employer, provided restrictions are applicable to all corporate stock of the same class. If a participant is required to offer the sale of his corporate stock to the employer before offering to sell his corporate stock to a third party, in no event may the employer pay a price less than that offered to the distributee by another potential buyer making a bona fide offer and in no event shall the trustee pay a price less than the fair market value of the corporate stock.

(d) Right of First Refusal

(1) If any participant, his beneficiary or any other person to whom shares of corporate stock are distributed from the plan (the selling participant) shall, at any time that the stock is not publicly traded, desire to sell some or all of such shares (the offered shares) to a third party; the selling participant shall give written notice of such desire to the employer and the plan administrator. The notice shall contain the number of shares offered for sale, the proposed terms of the sale, and the names and addresses of both the selling participant and third party. Both the trust fund and the employer shall each have the right of first refusal for a period of 14 days from the date the selling participant gives such written notice to the employer and the plan administrator to acquire the offered shares. The 14- day period shall run concurrently against the trust fund and the employer. As between the trust fund and the employer, the trust fund shall have priority to acquire the shares pursuant to the right of first refusal. The selling price and terms shall not be less than the greater of the value of the stock determined under Section 6.7(b) or the price and terms offered by the third party.

(2) If the trust fund and the employer do not exercise their right of first refusal within the required fourteen day period provided above, the selling participant shall have the right, at any time following the expiration of such period, to dispose of the offered shares to the third party; provided, however, that (i) no disposition shall be made to the third party on terms more favorable to the third party than those set forth in the written notice previously given by the selling participant, and (ii) if such disposition shall not be made to a third party on the terms offered to the employer and the trust fund, the offered shares shall again be subject to the right of first refusal set forth above.

(3) The closing pursuant to the exercise of the right of first refusal shall take place at such place agreed upon between the plan administrator and the selling participant, but not later than 10 days after the employer or the trust fund shall have notified the selling

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participant of the exercise of the right of first refusal. At such closing, the selling participant shall deliver certificates representing the offered shares duly endorsed in blank for transfer, or with stock powers attached duly executed in blank with all required transfer tax stamps attached or provided for, and the employer or the trust fund shall deliver the purchase price, or an appropriate portion thereof, to the selling participant.

(e) Put Option

(1) If corporate stock is distributed to a participant and such corporate stock is not readily tradable on an established securities market, a participant has a right to require the employer to repurchase the corporate stock distributed to such participant under a fair valuation formula. Such stock shall be subject to the provisions of Section 5.5(c).

(2) The put option must be exercisable only by a participant, by the participant’s donees, or by a person (including an estate or its distributee) to whom the corporate stock passes by reason of a participant’s death. The put option must permit a participant (or beneficiary) to put the corporate stock to the employer. Under no circumstances may the put option bind the plan. However, it shall grant the plan an option to assume the rights and obligations of the employer at the time that the put option is exercised. If it is known at the time a loan is made that federal or state law will be violated by the employer’s honoring such put option, the put option must permit the corporate stock to be put, in a manner consistent with such law, to a third party (e.g., an affiliate of the employer or a shareholder other than the plan) that has substantial net worth at the time the loan is made and whose net worth is reasonably expected to remain substantial.

The put option shall commence as of the day following the date the corporate stock is distributed to the participant (or beneficiary) and end 60 days thereafter; and, if not exercised within such 60-day period, an additional 60-day option shall commence on the first day of the fifth month of the plan year next following the plan year in which the stock was distributed to the participant (or such other 60-day period as provided in regulations issued under the Code). However, in the case of corporate stock that is publicly traded without restrictions when distributed but ceases to be so traded within either of the 60-day periods described herein after distribution, the employer must notify each holder of such corporate stock in writing on or before the tenth day after the date the corporate stock ceases to be so traded that for the remainder of the applicable 60-day period the corporate stock is subject to the put option. The number of days between the tenth day and the date on which notice is actually given, if later than the tenth day, must be added to the duration of the put option. The notice must inform distributees of the term of the put options that they are to hold. The terms must satisfy the requirements of this Section 5.5(e)(2).

The holder shall exercise the put option by notifying the employer in writing of such exercise. The notice shall state the name and address of the holder and the number of shares to be sold. Upon receipt of a written notification from the holder, the employer shall immediately inform the plan administrator of such notice. The plan administrator shall have 10 days to notify the employer if it wishes the trust fund to assume the rights and obligations of the employer with respect to the required purchase of corporate stock.

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The period during which a put option is exercisable does not include any time when a distributee is unable to exercise it, because the party bound by the put option is prohibited from honoring it by applicable federal or state law. The price at which a put option must be exercisable is the value of the corporate stock determined in accordance with Section 6.7(b) as of the allocation date coincident with or immediately preceding the employer’s receipt of the written notification. The total purchase price shall be paid to the holder within 30 days after the notification, provided however, that the employer may defer such payments on a reasonable basis, if it gives written notice to the holder within the 30-day period. Such deferred payments shall be paid in substantially equal monthly, quarterly, semiannual, or annual installments over a period certain beginning not later than 30 days after the exercise of the put option and not extending beyond 5 years. The deferral of payment is reasonable if adequate security and a reasonable interest rate on the unpaid amounts are provided. The amount to be paid under the put option involving installment distributions must be paid not later than 30 days after the exercise of the put option. Payment under a put option must not be restricted by the provisions of a loan or any other arrangement, including the terms of the employer’s articles of incorporation, unless so required by applicable state law.

For purposes of this Section 5.5(e), total distribution means a distribution to a participant or his beneficiary within one taxable year of the participant’s entire vested account.

(3) An arrangement involving the plan that creates a put option must not provide for the issuance of put options other than as provided under this Section 5.5(e). The plan (and the trust fund) must not otherwise obligate itself to acquire corporate stock from a particular holder thereof at an indefinite time determined upon the happening of an event such as the death of the holder.

(4) The participant and beneficiary rights and protections created under this Section 5.5(e) as they pertain to plan assets acquired with the proceeds of an exempt loan shall be nonterminable. Therefore, such rights and protections shall continue even after such exempt loan has been repaid or this plan ceases to be an ESOP.

Article VI -ADMINISTRATION OF THE PLAN

Section 6.1. - Fiduciary Responsibility

(a) Fiduciary Standards - A fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and -

For the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan;

With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;

By diversifying the investments of the plan not held in corporate stock so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and

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In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of ERISA.

(b) Allocation of Fiduciary Responsibility

(1) It is intended to allocate to each fiduciary, either named or otherwise, the individual responsibility for the prudent execution of the functions assigned to him. None of the allocated responsibilities or any other responsibilities shall be shared by two or more fiduciaries unless specifically provided for in the plan.

(2) When one fiduciary is required to follow the directions of another fiduciary, the two fiduciaries shall not be deemed to share such responsibility. Instead, the responsibility of the fiduciary giving the directions shall be deemed to be his sole responsibility and the responsibility of the fiduciary receiving directions shall be to follow those directions insofar as such instructions on their face are proper under applicable law.

(3) Any person or group of persons may serve in more than one fiduciary capacity with respect to this plan.

(4) A fiduciary under this plan may employ one or more persons, including independent accountants, attorneys and actuaries to render advice with regard to any responsibility such fiduciary has under the plan.

(c) Indemnification by Employer- Unless resulting from the gross negligence, willful misconduct or lack of good faith on the part of a fiduciary who is an officer or employee of the employer, the employer shall indemnify and save harmless such fiduciary from, against, for and in respect of any and all damages, losses, obligations, liabilities, liens, deficiencies, costs and expenses, including without limitation, reasonable attorney’s fees and other costs and expenses incident to any suit, action, investigation, claim or proceedings suffered in connection with his acting as a fiduciary under the plan.

(d) Named Fiduciary - The person or persons named by the employer as having fiduciary responsibility for the management and control of plan assets shall be known as the “named fiduciary” hereunder. Such responsibility shall include the appointment of the plan administrator (Section 6.2(a)) and the investment manager (Section 6.4(b)) and the deciding of benefit appeals (Section 6.3). The employer shall retain the authority to appoint the trustee (Section 6.4(a)). The named fiduciary possesses exclusive authority to monitor the plan’s receipt of contributions and enforce the collection of delinquent contributions to the trust.

Section 6.2. - Plan Administrator

(a) Appointment of Plan Administrator

The named fiduciary shall appoint a plan administrator who may be a person or an administrative committee consisting of no more than five members. Vacancies occurring upon resignation or removal of a plan administrator or a committee member shall be filled promptly by the named fiduciary. Any plan administrator may resign at any time by giving notice of his resignation to the named fiduciary, and any plan administrator may be removed at any time by

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the named fiduciary. The named fiduciary shall review at regular intervals the performance of the plan administrator(s) and shall re-evaluate the appointment of such administrator(s). After the named fiduciary has appointed the plan administrator and has received a written notice of acceptance, the fiduciary responsibility for administration of the plan shall be the responsibility of the plan administrator or plan administrative committee.

(b) Duties and Powers of Plan Administrator

The plan administrator shall have the following duties and discretionary powers and such other duties and discretionary powers as relate to the administration of the plan:

(1) To determine in a non-discriminatory manner all questions relating to the eligibility of employees to . become participants.

(2) To determine in a non-discriminatory manner eligibility for benefits and to determine and certify the amount and kind of benefits payable to participants.

(3) To authorize all disbursements from the fund.

(4) To appoint or employ any independent person to perform necessary plan functions and to assist in the fulfillment of administrative responsibilities as he deems advisable, including the retention of a third party administrator, custodian, auditor, accountant, actuary, or attorney.

(5) When appropriate, to select an insurance company and annuity contracts that, in his opinion, will best carry out the purposes of the plan.

(6) To construe and interpret any ambiguity in the plan and to make, publish, interpret, alter, amend or revoke rules for the regulation of the plan which are consistent with the terms of the plan and with ERISA.

(7) To prepare and distribute, in such manner as determined to be appropriate, information explaining the plan.

(8) To establish and communicate to participants a procedure and method to enable each participant to vote corporate stock allocated to such participant’s corporate stock account pursuant to Section 6.8.

(9) To assist any participant regarding his rights, benefits, or elections available under the plan.

If the plan administrator is a plan administrative committee, the committee shall choose from its members a chairperson and a secretary. The committee may allocate responsibility for those duties and powers listed in Section 6,2(b)(1) and (2) (except determination of qualification for disability retirement) and other purely ministerial duties to one or more members of the

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committee. The committee shall review at regular intervals the performance of any committee member to whom fiduciary responsibility has been allocated and shall re-evaluate such allocation of responsibility. After the plan administrative committee has made such allocations of responsibilities and has received written notice of acceptance, the fiduciary responsibilities for such administrative duties and powers shall then be considered as the responsibilities of such committee member(s).

(d) Miscellaneous Provisions

(1) Plan Administrative Committee Actions - The actions of such committee shall be determined by the vote or other affirmative expression of a majority of its members. Either the chairperson or the secretary may execute any certificate or other written direction on behalf of the committee. A member of the committee who is a participant shall not vote on any question relating specifically to himself. If the remaining members of the committee, by majority vote thereof, are unable to come to a determination of any such question, the named fiduciary shall appoint a substitute member who shall act as a member of the committee for the special vote.

(2) Expenses - The plan administrator shall serve without compensation for service as such. All reasonable expenses of the plan administrator shall be paid by the employer or from the fund.

(3) Examination of Records - The plan administrator shall make available to any participant for examination during business hours such of the plan records as pertain only to the participant involved.

(4) Information to the Plan Administrator - To enable the plan administrator to perform the administrative functions, the employer shall supply full and timely information to the plan administrator on all participants as the plan administrator may require.

Section 6.3. - Claims Procedure

(a) Notification of Claim Determination - The plan administrator shall notify each participant in writing of his determination of benefits. If the plan administrator denies any benefit, such written denial shall include:

The specific reasons for denial;

Reference to provisions on which the denial is based;

A description of and reason for any additional information needed to process the claim; and

A description of the plan’s review procedures and the time limits applicable to such procedures, including a statement of the claimant’s right to bring a civil action under ERISA section 502(a) following an adverse benefit determination on review.

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If a claim is wholly or partially denied, the plan administrator shall notify the claimant of the plan’s adverse benefit determination within a reasonable period of time, but not later than 90 days after receipt of the claim by the plan, unless the plan administrator determines that special circumstances require an extension of time for processing the claim. If the plan administrator determines that an extension of time for processing is required, written notice of the extension shall be furnished to the claimant prior to the termination of the initial 90-day period. In no event shall such extension exceed a period of 90 days from the end of such initial period. The extension notice shall indicate the special circumstances requiring an extension of time and the date by which the plan expects to render the benefit determination.

(b) Appeal - The participant or his duly authorized representative may:

Make a written request for a review of the participant’s case by the named fiduciary;

Review upon request and free of charge, have reasonable access to, and have copies of, all documents, records, and other information relevant to the claimant’s claim for benefits;

Submit written issues, comments, documents, records, and other information relating to the claim for benefits, without regard to whether such information was submitted or considered in the initial benefit determination.

The written request for review must be submitted no later than 60 days after receiving written notification of denial of benefits. A document, record, or other information shall be considered relevant to a claimant’s claim if such document, record, or other information:

Was relied upon in making the benefit determination;

Was submitted, considered, or generated in the course of making the benefit determination, without regard to whether such document, record, or other information was relied upon in making the benefit determination; or

Demonstrates compliance with the administrative processes and safeguards required by law in making the benefit determination.

(1) Except as provided in Section 6.3(c)(2), the named fiduciary must render a decision no later than

60 days after receiving the written request for review, unless circumstances make it impossible to do so; but in no event shall the decision be rendered later than 120 days after the request for review is received. If the named fiduciary determines that an extension of time for processing is required, written notice of the extension shall be furnished to the claimant by the plan administrator prior to the termination of the initial 60-day period. The extension notice

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shall indicate the special circumstances requiring an extension of time and the date by which the plan expects to render the determination on review.

(2) If the named fiduciary is a committee or board of trustees that holds regularly scheduled meetings at least quarterly, Section 6.3(c)(1) shall not apply. The named fiduciary shall instead make a benefit determination no later than the date of the meeting of the committee or board that immediately follows the plan’s receipt of a request for review, unless the request for review is filed within 30 days preceding the date of such meeting. In such case, a benefit determination may be made by no later than the date of the second meeting following the plan’s receipt of the request for review. If special circumstances require a further extension of time for processing, a benefit determination shall be rendered not later than the third meeting of the committee or board following the plan’s receipt of the request for review. If such an extension of time for review is required because of special circumstances, the plan administrator shall provide the claimant with written notice of the extension, describing the special circumstances and the date as of which the benefit determination will be made, prior to the commencement of the extension. The plan administrator shall notify the claimant of the benefit determination as soon as possible, but not later than 5 days after the benefit determination is made.

(3) The review shall take into account all comments, documents, records, and other information submitted by the claimant relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination. If the claim is denied upon review, the written notice of denial shall include the items listed in Section 6.3(a) and the statement required by Regulation section 2560.503-1 (j)(5)(iii) regarding the possible availability of alternative dispute resolution options.

(d) Limitation on Time Period for Litigation of a Benefit Claim - Following receipt of the written rendering of the named fiduciary’s decision under Section 6.3(c), the participant shall have 365 days in which to file suit in the appropriate court. Thereafter, the right to contest the decision shall be waived.

Section 6.4. - Trust Fund

(a) Appointment of Trustee

The named fiduciary shall appoint a trustee for the proper care and custody of all funds, securities and other properties in the trust, and for investment of plan assets (or for execution of such orders as it receives from an investment manager appointed for investment of plan assets). The duties and powers of the trustee shall be set forth in a trust agreement executed by the named fiduciary, which is incorporated herein by reference. The named fiduciary shall review at regular intervals the performance of the trustee and shall re-evaluate the appointment of such trustee. After the named fiduciary has appointed the trustee and the named fiduciary has received a written notice of acceptance of its responsibility, the fiduciary responsibility with respect to the proper care and custody of plan assets shall be considered as the responsibility of the trustee. Unless otherwise allocated to an investment manager, the fiduciary responsibility with respect to investment of plan assets shall likewise be considered as the responsibility of the trustee.

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(b) Appointment of Investment Manager

The named fiduciary may appoint an investment manager who is other than the trustee, which investment manager may be a bank or an investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. Such investment manager, if appointed, shall have sole discretion in the investment of plan assets, subject to the funding policy. The named fiduciary shall review at regular intervals no less frequently than annually, the performance of such investment manager and shall re-evaluate the appointment of such investment manager. After the named fiduciary has appointed an investment manager and has received a written notice of acceptance of its responsibility, the fiduciary responsibility with respect to investment of plan assets shall be considered as the responsibility of the investment manager.

The trust fund may pay the expenses incurred in the administration of the plan and the investment of the fund, provided the cost is reasonable. Such expenses shall include legal fees incurred by the plan administrator or the trustee, provided such fiduciaries are not proven to have committed a prohibited transaction. If the trust fund pays the expenses, the expenses generally shall be allocated against the participant accounts on a pro rata basis. Per participant fees shall be allocated per capita against each participant’s account.

Certain expenses incurred with respect to a particular participant or beneficiary may be allocated against the participant’s account on a direct basis. The plan administrator shall communicate such expense charges to the participant through a written notice.

Section 6.5. - Investment Policy

(a) The plan is designed to invest primarily in corporate stock. It is specifically intended that this employee stock ownership plan qualify and operate as an eligible individual account plan as defined in ERISA section 407(d)(3). As such, and without limiting the generality of the foregoing, the trustee is hereby specifically authorized to:

(1) acquire, hold, sell, and distribute corporate stock that is qualified employer stock.

(2) invest in such corporate stock and not limit its holdings of such stock to 10% of trust assets. The trustee may invest up to 100% of plan assets in corporate stock without regard to any plan or trust agreement requirement to diversify investments as permitted under ERISA section 404(a)(2).

(3) acquire or sell corporate stock in a transaction with a disqualified person or a party in interest (as those terms are defined in ERISA and the Code) provided that no commission is charged and the transaction is for adequate consideration.

(b) With due regard to Section 6.5(a), the plan administrator may also direct the trustee to invest funds under the plan in other property described in the Trust Agreement or in

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life insurance policies to the extent permitted by Section 6.5(c), or the trustee may hold such funds in cash or cash equivalents.

(c) With due regard to Section 6.5(a), the plan administrator may also direct the trustee to invest funds under the plan in insurance policies on the life of any keyman employee. The proceeds of a keyman insurance policy may not be used for the repayment of any indebtedness owed by the plan that is secured by corporate stock but shall be allocated to participants in proportion to their account balances. The amount of employer contribution to be allocated to participants under Section 3.2 shall be reduced by the amount of premiums paid on keyman insurance policies during the plan year. The employer shall contribute an amount each year that is sufficient to pay the required premiums. The proceeds from an exempt loan shall in no event be used to purchase such insurance policies. No insurance company that may issue such policies shall be deemed to be a party to this plan.

(d) The plan may not obligate itself to acquire corporate stock from a particular holder thereof at an indefinite time determined upon the happening of an event such as the death of the holder.

(e) The plan may not obligate itself to acquire corporate stock under a put option binding upon the plan. However, at the time a put option is exercised, the plan may be given an option to assume the rights and obligations of the employer under a put option binding upon the employer.

(f) All purchases of corporate stock shall be made at a price that, in the judgment of the plan administrator, does not exceed the fair market value thereof. All sales of corporate stock shall be made at a price that, in the judgment of the plan administrator, is not less than the fair market value thereof. The valuation rules set forth in Section 6.7 shall be applicable.

Section 6.6. - Prohibitions Against Allocations

(a) Transactions Involving Corporate Stock of a C Corporation - This Section 6.6(a) shall apply to corporate stock of a C corporation acquired by the plan after October 22, 1986 in a sale to which Code section 1042 or, for estates of decedents who died prior to December 20, 1989, Code section 2057 (as in effect December 19, 1989) applies.

(1) No portion of the trust fund attributable to (or allocable instead of) such corporate stock may accrue or be allocated directly or indirectly under any qualified plan maintained by the employer during the nonallocation period, for the benefit of:

(A) Any taxpayer who makes an election under Code section 1042(a) with respect to corporate stock or any decedent if the executor of the estate of the decedent makes a qualified sale to which Code section 2057 applies;

(B) Any individual who is related to the taxpayer or the decedent (as defined in Code section 267(b)); or

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(i) any class of outstanding stock of the employer or affiliated employer which issued such corporate stock; or

(ii) the total value of any class of outstanding stock of the employer or affiliated employer.

For the purpose of determining ownership, the attribution rules of Code section 318(a) shall be applied without regard to the employee trust exception of Code section 318(a)(2)(B)(i).

(2) An individual who is related to the taxpayer (or the decedent) shall not include lineal descendants of the taxpayer, if the aggregate amount allocated to the benefit of all such lineal descendants during the nonallocation period does not exceed more than 5% of the corporate stock (or amounts allocated in their stead) held by the plan which are attributable to a sale to the plan by any person related to such descendants (within the meaning of Code section 267(c)(4)) in a transaction to which Code section 1042 or Code section 2057 is applied.

(3) A person shall be treated as meeting the 25% stock ownership requirement of Section 6.6(a)(1)(C) if such person owns more than 25% of the stock: (A) at any time during the one year period ending on the date of sale of corporate stock to the plan, or (B) on the date as of which corporate stock is allocated to participants in the plan.

(4) For purposes of Section 6.6(a)(1), nonallocation period, for plan years beginning after December 31, 1986, means the period beginning on the date of the sale of the corporate stock and ending on the later of the date which is ten years after the date of sale or the date of the plan allocation attributable to the final payment of acquisition indebtedness incurred in connection with such sale.

(b) Disqualified Persons under Plan Sponsored by S Corporation - This Section 6.6(b) shall be effective for plan years beginning after December 31, 2004. If the corporate stock held by this plan is or becomes the stock of an S corporation, no portion of the trust fund attributable to (or allocable instead of) such corporate stock may accrue or be allocated directly or indirectly under any qualified plan maintained by the employer during a nonallocation year, for the benefit of any disqualified person. Such impermissible allocations shall include any contribution or other annual addition (e.g. forfeiture allocation) under this plan or any other qualified plan (including a release and allocation from the unallocated corporate stock suspense account) that would have otherwise been added to the disqualified person’s account and invested in the stock of the S corporation. Such impermissible accruals shall include all stock of the S corporation and any other plan assets attributable to such stock (including Code section 1368 distributions, sale proceeds, and earnings on either the distributions or the proceeds) held for a disqualified person’s account, whether attributable to current or prior year contributions.

(1) For the purpose of this Section 6.6(b), a disqualified person is any person if:

(A) the number of such person’s deemed-owned ESOP shares of the S corporation is at least 10% of the number of deemed-owned ESOP shares of the S corporation;

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(B) the aggregate number of such person’s deemed-owned ESOP shares and synthetic equity shares of the S corporation is at least 10% of the sum of: (i) the total number of deemed-owned ESOP shares, and (ii) the person’s synthetic equity shares of the S corporation; or

(C) the aggregate number of the S corporation’s deemed-owned ESOP shares of such person and the members of such person’s family is at least 20% of the number of deemed-owned ESOP shares of the S corporation;

(D) the aggregate number of the S corporation’s deemed-owned ESOP shares and synthetic equity shares of such person and the members of such person’s family is at least 20% of the sum of: (i) the total number of deemed-owned ESOP shares, and (ii) the synthetic equity shares of the S corporation owned by such person and the members of such person’s family;

(E) any member of the family of a person described in Section 6.6(b)(1)(C) or (D) with deemed- owned shares if the person is not otherwise treated as a disqualified person.

(2) In order to determine who is a disqualified person for purposes of Section 6.6(b), the following definitions shall apply.

(A) Member of the family means, with respect to any individual: (i) the spouse of the individual;

(i) an ancestor or lineal descendant of the individual or the individual’s spouse;

(ii) (iii) a brother or sister of the individual or the individual’s spouse and any lineal descendant of the brother or sister; and

(iii) the spouse of any individual described in Section 6.6(b)(2)(A)(ii) or (iii).

For these purposes, a spouse of an individual who is legally separated from such individual under a decree of divorce or separate maintenance shall not be treated as such individual’s spouse.

(B) Deemed-owned shares means, with respect to any person:

(i) the stock in the S corporation constituting corporate stock that is allocated to such person under this plan; and

(ii) such person’s share of the corporate stock that is held by the plan but that is not allocated to any participants. A person’s share of unallocated corporate stock is the amount of the unallocated stock that would be allocated to such person if the unallocated stock were allocated to all participants in the same proportions as the most recent stock allocation under the plan. If there has been no prior release and allocation from a suspense

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account, the person’s share of unallocated corporate stock shall be determined in proportion to a reasonable estimate of the shares that would be released and allocated in the first year of a loan repayment.

(3) For the purpose of this Section 6.6(b), a nonallocation year means any plan year if, at any time during such plan year, the plan holds corporate stock that is the stock of an S corporation and disqualified persons own at least 50% of: (i) the number of outstanding shares in the S corporation, including deemed-owned plan shares; or (ii) the sum of the outstanding shares in the S corporation (including deemed-owned plan shares) plus the shares of synthetic equity in the S corporation owned by disqualified persons.

(A) Ownership percentage shall be determined by applying the Code section 318(a) attribution rules with the exception that in applying Code section 318(a)(1), the members of an individual’s family shall include members of the family described in Section 6.6(b)(2)(A) and Code section 318(a)(4) shall not apply. An individual shall be treated as owning deemed-owned shares notwithstanding the employee trust exception in Code section 318(a)(2)(B)(i).

(B) An individual shall be treated as owning corporate stock that the individual has a right to acquire if, at all times during the period when such right is effective, the stock is both issued and outstanding and is held by persons other than this plan, the employer, or a related entity. This rule shall only apply if its application results in a nonallocation year. Further, this rule shall not apply to a right to acquire corporate stock held by a shareholder subject to income tax that would not be taken into account in determining if an S corporation has a second class of stock under Regulation section 1.1361-1(1)(2)(iii) or (1)(4)(iii)(C), provided the principal purpose of the right is not the avoidance or evasion of a nonallocation year.

If any share of corporate stock is treated as being owned by more than one person, then the share shall be counted as a single share. It shall be treated as being owned by a disqualified person if any of the owners is a disqualified person.

(4) For purposes of Section 6.6(b), in the case of a person who owns synthetic equity in the

S corporation, except to the extent provided in regulations, the shares of stock in such corporation on which such synthetic equity is based shall be treated as outstanding stock in such corporation and deemed-owned shares of such person if such treatment of synthetic equity of one or more such persons results in the treatment of any person as a disqualified person or the treatment of any plan year as a nonallocation year.

For purposes of this Section 6.6(b)(4), synthetic equity shall be treated as owned by a person in the same manner as stock is treated as owned by a person, directly or under the attribution rules of Section 6.6(b)(3)(A). If, without regard to this Section 6.6(b)(4), a person is treated as a disqualified person or a plan year is treated as a nonallocation year, this Section 6.6(b)(4) shall not be construed to result in the person or plan year not being so treated.

Synthetic equity means any stock option, warrant, restricted stock, deferred issuance stock right, stock appreciation right payable in stock, or similar interest or right that gives the

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holder the right to acquire or receive stock of the S corporation in the future; however, synthetic stock shall not include stock treated as being owned by the individual pursuant to Section 6.6(b)(3)(B). A right of first refusal to acquire stock held by an ESOP shall not be treated as a right to acquire stock of the S corporation if it meets the requirements of Regulation section 1.409(p)-1 (f)(2)(ii)(B). Synthetic equity shall include: (A) a stock appreciation right, phantom stock unit, or similar right to a future cash (or other non-stock) payment from the S corporation based on the value of such stock or appreciation in such value; (B) a right to acquire stock or similar interests in a related entity as set forth in Regulation section 1.409(p)-1 (f)(2)(iii); and (C) certain nonqualified deferred compensation as set forth in Regulation section 1.409(p)-1 (f)(2)(iv).

A related entity for the purpose of this Section 6.6(b)(4) means any entity in which the S corporation holds an interest and which is a partnership, a trust, an eligible entity that is disregarded as an entity that is separate from its owner under Regulation section 301.7701-3 or a qualified subchapter S subsidiary under Code section 1361 (b)(3).

Synthetic equity does not include shares that are deemed-owned ESOP shares (or any rights with respect to deemed-owned ESOP shares to the extent such rights are specifically provided under Code section 409(h).

The number of synthetic equity stock shares shall be determined by reference to the S corporation shares. The person shall be treated as owning the number of shares deliverable pursuant to the synthetic equity. Where payment is made in cash or other property, the number of synthetic equity shares shall equal the number of shares having an equal fair market value. Where the synthetic equity is a right to purchase or receive shares, the number of shares shall be determined without regard to lapse restrictions or payment to be made for the shares. In the case of synthetic equity that is determined by reference to shares of stock (or similar interests) in a related entity, the person who is entitled to the synthetic equity shall be treated as owning shares of stock of the S corporation with the same aggregate value as the number of shares of stock (or similar interests) of the related entity (with such value determined without regard to any lapse restriction as defined in Regulation section 1.83-3(0).

In the case of any synthetic equity to which the preceding paragraph does not apply, the person who is entitled to the synthetic equity shall be treated as owning on any date a number of shares of stock in the S corporation equal to the present value (on that date) of the synthetic equity (with such value determined without regard to any lapse restriction as defined in Regulation section 1.83-3(i)) divided by the fair market value of a share of the S corporation’s stock as of that date. The determination shall be made as of the first day of the first plan year beginning on or after January 1, 2005. Thereafter, the plan shall use the tri-annual recalculation as permitted under Regulation section 1.409(p)-1(f)(4)(iii)(C), subject to the conditions of Regulation section 1.409(p)-

The number of synthetic shares otherwise determined under this Section 6.6(b)(4) shall be decreased ratably to the extent that shares of the S corporation are owned by a person who is not an ESOP (and who is subject to federal income taxes).

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Notwithstanding any other provision of this Section 6.6(b)(4), if a synthetic equity right includes (directly or indirectly) a right to purchase or receive shares of S corporation stock that have per-share voting rights greater than the per-share voting rights of one or more shares of S corporation stock held under this plan, then the number of shares of deemed owned synthetic equity attributable to such right shall not be less than the number of shares that would have the same voting rights if the shares had the same per-share voting rights as shares held by the plan with the least voting rights.

(5) Impermissible Accrual - There is an impermissible accrual to the extent that this plan holds corporate stock that is the stock of an S corporation and any assets attributable thereto are held under this plan for the benefit of a disqualified person during a nonallocation year. For this purpose, assets attributable to stock in an S corporation owned by this plan include any distributions, within the meaning of Code section 1368, made on S corporation stock held in a disqualified person’s account in this ESOP (including earnings thereon), plus any proceeds from the sale of S corporation securities held for a disqualified person’s account in this ESOP (including any earnings thereon). In the event of a nonallocation year, all S corporation shares and all other assets attributable to S corporation stock, including distributions, sales proceeds, and earnings on either distributions or proceeds, held for the account of such disqualified person in the plan during that year would constitute an impermissible accrual for the benefit of that person, whether attributable to contributions in the current year or in prior years.

(6) Impermissible Allocation - An impermissible allocation occurs during a nonallocation year to the extent that a contribution or other annual addition (within the meaning of Section 5.1(c)(1)) is made with respect to the account of a disqualified person, or the disqualified person otherwise accrues additional benefits, directly or indirectly under this plan or any other qualified plan of the employer (including a release and allocation of assets from a suspense account, as described in Regulation section 54.4975-11 (c) and (d)) that, for the nonallocation year, would have been added to the account of the disqualified person under this plan and invested in corporate stock consisting of stock in an S corporation owned by the plan but for the provisions in this plan that preclude such addition to the account of the disqualified person, and investment in corporate stock during a nonallocation year.

(7) Prevention of Prohibited Allocation - In order to prevent a nonallocation year or a prohibited allocation during a nonallocation year, the account of a disqualified person (or a person reasonably expected to become a disqualified person absent a transfer described in this paragraph) including any corporate stock shall be transferred into either a separate portion of this plan that shall be a profit sharing plan or a non-ESOP, qualified plan of the employer. In the event of such a transfer, the recipient plan shall be subject to tax on unrelated business taxable income with respect to the corporate stock.

Section 6.7. - Valuation of the Trust Fund

(a) The plan administrator shall direct the trustee, as of each allocation date, and at such other date or dates deemed necessary by the plan administrator, herein called valuation date, to determine the net worth of the assets comprising the trust fund as it exists on the valuation date prior to taking into consideration any contribution to be allocated for that plan year. In

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determining such net worth, the trustee shall value the assets comprising the trust fund at their fair market value as of the valuation date and shall deduct all expenses for which the trustee has not yet obtained reimbursement from the employer or the trust fund.

(b) Valuations must be made in good faith and based on all relevant factors for determining the fair market value of securities. In the case of a transaction between a plan and a disqualified person, value must be determined as of the date of the transaction. For all other plan purposes, value must be determined as of the most recent valuation date under the plan. An independent appraisal will not in itself be a good faith determination of value in the case of a transaction between the plan and a disqualified person. However, in other cases, a determination of fair market value based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to the •transaction will be deemed to be a good faith determination of value. Corporate stock not readily tradable on an established securities market shall be valued by an independent appraiser meeting requirements similar to the requirements of the Regulations prescribed under Code section 170(a)(1).

Section 6.8. - Voting Corporate Stock

The trustee shall vote all corporate stock held by it as part of the plan assets at such time and in such manner as the plan administrator shall direct. If the plan administrator shall fail or refuse to give the trustee timely instructions as to how to vote any corporate stock as to which the trustee otherwise has the right to vote, the trustee shall not exercise its power to vote such corporate stock, except as described herein with respect to a tender offer or a corporate matter requiring pass-through voting rights.

Notwithstanding the foregoing, since the employer has a registration-type class of securities, each participant (or beneficiary) shall be entitled to direct the trustee as to the manner in which the corporate stock that is entitled to vote and which is allocated to the corporate stock account of such participant is to be voted., For purposes of this Section 6.8, the term “registration-type class of securities” means: (a) a class of securities required to be registered under Securities Exchange Act of 1934 section 12; and (b) a class of securities which would be required to be so registered except for the exemption from registration provided in section 12(g)(2)(H).

In the event a tender offer is made for shares of corporate stock, each participant (or beneficiary) shall be entitled to direct the trustee as to whether or not the shares of corporate stock allocated to his corporate stock account shall be tendered pursuant to such offer. All shares of corporate stock allocated to accounts for which the trustee did not receive tender instructions from a participant or beneficiary and all shares held in the unallocated corporate stock suspense account will be tendered or not tendered by the trustee in its discretion and in accordance with its fiduciary duties under ERISA. The trustee may not tender any shares that are pledged as security for an exempt loan without first obtaining any required approvals.

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Section 6.9. - ESOP Loans

(a) The employer may direct the trustee to incur a loan on behalf of the trust in a manner and under conditions that will cause the loan to be an “exempt loan” within the meaning of Code section 4975(d)(2) and the regulations thereunder. At the time that the loan is made, the interest rate for the loan and the price of stock to be acquired with the loan proceeds shall not be such that plan assets might be drained off. A loan shall be used primarily for the benefit of participants and their beneficiaries. The proceeds of each such loan shall be used, within a reasonable time after the loan is obtained, only to purchase corporate stock, to repay the loan, or to repay any prior loan. The loan must be at a reasonable rate of interest. The loan must be for a specific term and may not be payable at the demand of any person, except in the case of default.

(b) Any such loan shall be secured solely by shares of corporate stock acquired with the proceeds of the loan and shares of such stock that were used as collateral on a prior loan which was repaid with the proceeds of the current loan. Such stock pledged as collateral shall be placed in the unallocated corporate stock suspense account and released pursuant to Section 6.9(c) as the loan is repaid. Corporate stock released from the suspense account shall be allocated in the manner described in Section 3.4. The payments made with respect to the loan during a plan year shall not exceed an amount equal to the sum of the employer contributions and earnings received during or prior to the year less such payments in prior years. Such contributions and earnings shall be accounted for separately under the plan until the loan is repaid.

No person entitled to payment under a loan made pursuant to this Section 6.9 shall have recourse against any trust fund assets other than the stock used as collateral for the loan, employer contributions of cash that are available to meet obligations under the loan and earnings attributable to such collateral, and the investment of such contributions. With respect to an S corporation, the employer earnings (whether dividends or otherwise) paid to the plan shall not be available to meet the loan obligations unless the corporate stock released from the suspense account and allocated to each eligible participant will have a fair market value of not less than the amount of the employer earnings that would otherwise have been allocated to such participant for the year.

(c) Any pledge of stock as collateral under this Section 6.9 shall provide for the release of shares so pledged upon the payment of any portion of the loan. Shares so pledged shall be released in the proportion that the principal and interest, paid on the loan for the plan year, bears to the aggregate principal and interest, paid for the current plan year and each plan year thereafter, as provided in Regulation section 54.4975- 7(b)(8).

(d) Payments of principal and interest on any loan under this Section 6.9 shall be made by the trustee at the direction of the employer solely from: (i) employer contributions (other than contributions of corporate stock) available to meet obligations under the loan, (ii) earnings from the investment of such contributions, (iii) earnings attributable to stock pledged as collateral for the loan, (iv) applicable dividends on stock, (v) the proceeds of a subsequent loan made to repay the loan, and (vi) the proceeds of the sale of any stock pledged as collateral for the loan. If a dividend is paid with respect to corporate stock that is allocated to a participant, such dividend shall not constitute an applicable dividend and shall not be applied to repay the loan if

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the corporate stock allocable to the participant from the suspense account by reason of any payment made on the loan for the plan year does not have a fair market value equal to or greater than the amount of the dividend. The contributions and earnings available to pay the loan must be accounted for separately by the plan administrator until the loan is repaid.

(e) Subject to the limitations in Section 5.1 on annual additions to a participant’s account, assets released from the suspense account by reason of payment made on a loan shall be allocated immediately upon such payment to the accounts of all participants who then would be entitled to an allocation of contributions if such payment had been made on the last day of the plan year,

(f) In the event of a loan default, the value of plan assets transferred in satisfaction of the loan shall not exceed the amount of default. If the lender is a disqualified person, the terms of the loan shall provide for a transfer of plan assets upon default only upon and to the extent of the failure of the plan to meet the payment schedule of the loan.

Section 6.10. - Current Obligations

Employer contributions in cash and other cash received by the trust fund shall first be applied to pay any current obligations of the trust fund. Current obligations means trust fund expenses and trust obligations arising from the extension of credit to the trust and payable in cash within one year from the date an employer contribution is due. With respect to the estates of decedents who died on or before July 12, 1989, trust obligations shall include the liability for payment of taxes incurred pursuant to Code section 2210(b) and imposed by Code section 2001. Further, the plan administrator shall enter into a written agreement as described in section 2210(e) before such liability shall be payable.

Article VII -AMENDMENT AND TERMINATION OF PLAN

Section 7.1. - Right to Discontinue and Amend

It is the expectation of the employer that it will continue this plan indefinitely and make the payments of its contributions hereunder, but the continuance of the plan is not assumed as a contractual obligation of the employer and the right is reserved by the employer, at any time, to reduce, suspend or discontinue its contributions hereunder.

Section 7.2. - Amendments

Except as herein limited, the employer shall have the right to amend this plan at any time to any extent that it may deem advisable. Such amendment shall be stated in writing. It shall be authorized by action of the board of directors under the corporate by-laws and such authorization shall designate the person to execute the amendment.

The employer’s right to amend the plan shall be limited as follows:

(a) No amendment shall increase the duties or liabilities of the plan administrator, the trustee, or other fiduciary without their respective written consent.

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(b) No amendments shall have the effect of vesting in the employer any interest in or control over any contracts issued pursuant hereto or any other property in the fund.

(c) No amendment to the plan shall be effective to the extent that it has the effect of decreasing a participant’s accrued benefit. This includes a plan amendment that decreases a participant’s accrued benefit, or otherwise places greater restrictions or conditions on a participant’s rights to Code section 411 (d)(6) protected benefits, even if the amendment merely adds a restriction or condition that is permitted under the vesting rules in Code section 411(a)(3) through (11). Notwithstanding the preceding sentence, a participant’s account balance may be reduced to the extent permitted under Code section 412(d)(2) or to the extent permitted under Regulation sections 1.411 (d)-3 and 1.411(d)-4. For purposes of this paragraph, a plan amendment that has the effect of decreasing a participant’s account balance, with respect to benefits attributable to service before the amendment shall be treated as reducing an accrued benefit. Furthermore, if the vesting schedule of a plan is amended, in the case of an employee who is a participant as of the later of the date such amendment is adopted or the date it becomes effective, the nonforfeitable percentage (determined as of such date) of such employee’s right to his employer-derived accrued benefit will not be less than his percentage computed under the plan without regard to such amendment.

(d) A plan amendment may eliminate or restrict the ability of a participant to receive payment of his or her account balance under a particular optional form of benefit if the amendment provides a single-sum distribution form that is otherwise identical to the optional form of benefit being eliminated or restricted. For this purpose, a single-sum distribution form is otherwise identical only if the single-sum distribution form is identical in all respects to the eliminated or restricted optional form of benefit (or would be identical except that it provides greater rights to the participant) except with respect to the timing of payments after commencement. Further, in accordance with Regulation section 1.411{d)-4, A-2(d)(1)(i), the employer through a plan amendment or through the exercise of its discretionary power may eliminate or restrict the ability of a participant to receive payment of his or her account balance in a single-sum and require the participant to receive his distribution in the form of installment payments, provided such action is taken on a nondiscriminatory basis.

(e) No amendment to the vesting schedule adopted by the employer hereunder shall deprive a participant of his vested portion of his employer contribution account to the date of such amendment. If the plan’s vesting schedule is amended, or the plan is amended in any way that directly or indirectly affects the computation of the participant’s nonforfeitable percentage or if the plan is deemed amended by an automatic change to or from a top-heavy vesting schedule, each participant with at least 3 years of service with the employer may elect, within a reasonable period after the adoption of the amendment or change, to have the nonforfeitable percentage computed under the plan without regard to such amendment or change. For participants who do not have at least one hour of service in any plan year beginning after December 31, 1988, “5 years of service” shall be substituted for “3 years of service” in the preceding sentence. The period during which the election may be made shall commence with the date the amendment is adopted or deemed to be made and shall end on the latest of:

(1) 60 days after the amendment is adopted;

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(2) 60 days after the amendment becomes effective; or

(3) 60 days after the participant is issued written notice of the amendment by the employer or plan administrator.

Section 7.3. - Protection of Benefits in Case of Plan Merger

In the event of a merger or consolidation with, or transfer of assets or liabilities to any other plan, each participant will receive a benefit immediately after such merger, consolidation or transfer (if the plan then terminated) that is at least equal to the benefit the participant was entitled to immediately before such merger, consolidation or transfer (if the plan had terminated).

The transfer of amounts from this trust to a nonqualified foreign trust shall be treated as a distribution from this plan. Further, the transfer of assets and liabilities from this plan to a plan that satisfies Puerto Rico Code section 1165 shall also be treated as a distribution from this plan.

Section 7.4. - Termination of Plan

(a) When Plan Terminates - This plan shall terminate upon the happening of any of the following events: legal adjudication of the employer as bankrupt; a general assignment by the employer to or for the benefit of its creditors; the legal dissolution of the employer; or termination of the plan by the employer.

(b) Allocation of Assets - Upon termination, partial termination, or complete discontinuance of employer contributions, the account balance of each affected participant who is an active participant or who is not an active participant but has neither received a complete distribution of his vested accrued benefit nor incurred five one-year breaks in service (as defined in Section 4.1) shall be 100% vested and nonforfeitable. The amount of the fund assets shall be allocated to each participant, subject to provisions for expenses of administration of the liquidation, in the ratio that such participant’s account bears to all accounts. If a participant under this plan has terminated his employment at any time after the first day of the plan year in which the employer made his final contribution to the plan, and if any portion of any account of such terminated participant was forfeited and reallocated to the remaining participants, such forfeiture shall be reversed and the forfeited amount shall be credited to the account of such terminated participant.

Article VIII - MISCELLANEOUS PROVISIONS

Section 8.1. - Exclusive Benefit - Non-Reversion

The plan is created for the exclusive benefit of the employees of the employer and shall be interpreted in a manner consistent with its being a qualified plan as defined in section 401 (a) of the Internal Revenue Code and with ERISA. The corpus or income of the trust may not be diverted to or used for other than the exclusive benefit of the participants or their beneficiaries (except for defraying reasonable expenses of administering the plan).

Notwithstanding the above, a contribution paid by the employer to the trust may be repaid to the employer under the following circumstances:

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(a) Any contribution made by the employer because of a mistake of fact must be returned to the employer within one year of the contribution.

(b) In the event the deduction of a contribution made by the employer is disallowed under Code section 404, such contribution (to the extent disallowed) must be returned to the employer within one year of the disallowance of the deduction.

(c) If the Commissioner of Internal Revenue determines that the plan is not initially qualified under the Internal Revenue Code, any contribution made incident to that initial qualification by the employer must be returned to the employer within one year after the date the initial qualification is denied, but only if the application for the qualification is made by the time prescribed by law for filing the employer’s return for the taxable year in which the plan is adopted, or such later date as the Secretary of the Treasury may prescribe.

Section 8.2. - Inalienability of Benefits

No benefit or interest available hereunder shall be subject to assignment or alienation, either voluntarily or involuntarily. The preceding sentence shall also apply to the creation, assignment, or recognition of a right to any benefit payable with respect to a participant pursuant to a domestic relations order, unless such order is determined to be a qualified domestic relations order as defined in Code section 414(p), or any domestic relations order entered before January 1, 1985.

Notwithstanding the preceding paragraph, effective with respect to judgments, orders, and decrees issued, and settlement agreements entered into, on or after August 5, 1997, a participant’s benefit (and that of his spouse) shall be reduced to satisfy liabilities of the participant to the plan due to (1) the participant being convicted of committing a crime involving the plan, (2) a civil judgment (or consent order or decree) entered by a court in an action brought in connection with a violation of the fiduciary provisions of part 4 of subtitle B of Title I of ERISA, or (3) a settlement agreement between the Secretary of Labor or the Pension Benefit Guaranty Corporation and the participant in connection with a violation of the fiduciary provisions of ERISA. No reduction shall be made pursuant to this paragraph, unless the judgment, order, decree, or settlement agreement shall expressly provide for the offset of all or part of the amount ordered or required to be paid to the plan against the participant’s benefits provided under the plan.

Section 8.3. - Employer-Employee Relationship

This plan is not to be construed as creating or changing any contract of employment between the employer and its employees, and the employer retains the right to deal with its employees in the same manner as though this plan had not been created.

Section 8.4. - Binding Agreement

This plan shall be binding on the heirs, executors, administrators, successors and assigns as such terms may be applicable to any or all parties hereto, and on any participants, present or future.

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Section 8.5. - Separability

If any provision of this plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision hereof and this plan shall be construed and enforced as if such provision had not been included.

Section 8.6. - Construction

The plan shall be construed in accordance with the laws of the state in which the employer was incorporated and with ERISA.

Section 8.7. - Copies of Plan

This plan may be executed in any number of counterparts, each of which shall be deemed as an original, and said counterparts shall constitute but one and the same instrument that may be sufficiently evidenced by any one counterpart.

Section 8.8. - Interpretation

Wherever appropriate, words used in this plan in the singular may include the plural or the plural may be read as singular, and the masculine may include the feminine.

Section 8.9. - Securities and Exchange Commission Approval

The employer may request an interpretative letter from the Securities and Exchange Commission stating that the transfers of corporate stock contemplated hereunder do not involve transactions requiring a registration of such corporate stock under the Securities Act of 1933. In the event that a favorable interpretative letter is not obtained, the employer reserves the right to amend the plan and trust retroactively to their effective dates in order to obtain a favorable interpretative letter or to terminate the plan.

Section 8.10. - Nonterminable Right of Certain Holders

No corporate stock, except as provided.in Section 5.5, acquired with the proceeds of an exempt loan may be subject to a put, call, or other option, or buy-sell or similar arrangement when held by and when distributed from the trust, whether or not the plan is then an ESOP. This right is nonterminable. Such right shall continue to exist under the terms of this plan so long as any corporate stock acquired with the proceeds of such a loan is held by the trust or by any participant or beneficiary; and neither the repayment of such loan nor the failure of the plan to be an ESOP, nor an amendment of the plan shall cause a termination of said right.

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IN WITNESS WHEREOF, the Employer has caused this plan to be executed this 30th day of December , 2014 .


Employer:

Peoples Security Bank and Trust Company

By:	/s/	Michael Jake

Title:		EVP/Chief Risk Officer

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2016 COMPLIANCE AMENDMENT
TO THE
PEOPLES SECURITY BANK AND TRUST CO.
EMPLOYEE STOCK OWNERSHIP PLAN

As authorized by Section 7.2 of the Peoples Security Bank and Trust Co. Employee Stock Ownership Plan (“Plan”) as amended and restated effective January 1, 2015, the employer, Peoples Security Bank and Trust Company, hereby amends the Plan to clarify the administrative Operation of the Plan. This amendment shall supersede the provisions of the Plan to the extent those provisions are inconsistent with the provisions of this amendment. The employer hereby amends the Plan in the following manner:

FIRST: Directed Investment Account

Section 3.4(c) is amended to clarify that a participant’s election made in writing may be made electronically if the Plan Administrator established such a procedure. Further, the annual period for making the election is extended to allow time for the Plan to provide to the qualified participants the current fair market stock value based on the applicable independent appraisal. As amended, the first paragraph of Section 3.4(c)(1) shall read as follows:

(1) Each qualified participant, for plan years beginning after December 31, 1986, may elect within the annual diversification election period for the plan year during the qualified election period to direct the trustee in writing (either on a form signed by the participant and supplied by and filed with the plan administrator or through an electronic procedure established by the plan administrator) as to the investment of 25% of the total number of shares of corporate stock acquired by or contributed to the plan after December 31, 1986 that have ever been allocated to such qualified participant’s corporate stock account (reduced by the number of shares of corporate stock previously invested pursuant to a prior election). In the case of the election year in which the participant can make his last election, the preceding sentence shall be applied by substituting “50%” for “25%.” For this purpose, a participant’s corporate stock account shall be segregated into two accounts: (A) the Pre-1987 corporate stock account and (B) the Post-1986 corporate stock account. lf the qualified participant elects to direct the trustee as to the investment of his Post-1986 corporate stock account, such direction shall be effective no later than 180 days after the close of the plan year to which such direction applies.

As amended, Section 3.4(c)(2) shall contain an additional subparagraph (C) that shall read as follows:

(C) Annual diversification election period means the period commencing as of the day after the end of each plan year in the qualified election period and ending 90 days after the date that the value of the shares subject to the diversification election is provided to the qualified participant.

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SECOND: Beneficiary Designation

Section 4.2(a)(5)(8) is amended to expand the methods by which a beneficiary may be designated, where spousal consent is not required. As amended, Section 4.2(a)(5)(8) shall read as follows:

(B) Beneficiary Designation – Subject to the spousal consent requirements of Section 5.2, the participant shall have the right to designate his beneficiaries, including a contingent death beneficiary, and shall have the right at any time to change such beneficiaries. The designation shall be made in writing, either on a form signed by the participant and supplied by and filed with the plan administrator or through an electronic procedure established by the plan administrator for the designation of a beneficiary where no spousal consent is required by Section 5.2. If the participant fails to designate a beneficiary, or if the designated person or persons predecease the participant, “beneficiary” shall mean the spouse, children, parents, siblings (by the whole blood or adoption), or estate of the participant, in the order listed. For this purpose, the terms children, parents, and siblings shall exclude step relationships.

ln the absence of a beneficiary designation duly filed or otherwise recorded, if a designated beneficiary dies after the participant has died but before the plan has commenced distribution to the designated beneficiary, the plan shall be administered as set forth in this paragraph. The death benefit will be paid to the designated beneficiary’s estate in one lump sum. If the deceased designated beneficiary was not the participant’s surviving spouse, distribution will be completed by December 31 of the fifth year following the participant’s date of death. If the deceased designated beneficiary was the participant’s surviving spouse, distribution will be completed by December 31 of the fifth year following the beneficiary’s date of death.

lf a participant designates his spouse as the beneficiary and the participant and such spouse are legally divorced subsequent to the date of such designation; then, the designation shall be administered as if such spouse had predeceased the participant unless the participant, subsequent to the legal divorce, reaffirms the designation by completing a new beneficiary designation and duly filing or otherwise recording it with the plan administrator.

THIRD: Unclaimed Benefits

Section 4.2(d) is amended to remove the requirement that the participant (or beneficiary) make his whereabouts known in writing. As amended, Section 4.2(d)(1) shall read as follows:

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(1) Forfeiture – The plan does not require the trustee or the plan administrator to search for, or to ascertain the whereabouts of, any participant or beneficiary. At the time the participant’s or beneficiary’s benefit becomes distributable under the plan, the plan administrator, by certified or registered mail addressed to his last known address of record, shall notify any participant or beneficiary that he is entitled to a distribution under this plan. If the participant or beneficiary falls to claim his distributive share or make his whereabouts known to the plan administrator within twelve months from the date of mailing of the notice, the plan administrator shall treat the participant’s or beneficiary’s unclaimed payable accrued benefit as forfeited and shall reallocate such forfeiture in accordance with Section 4.2(c). A forfeiture under this paragraph shall occur at the end of the notice period or, if later, the earliest date applicable Treasury regulations would permit the forfeiture. These forfeiture provisions apply solely to the participant’s or beneficiary’s accrued benefit derived from employer contributions.

FOURTH: Effective Date

These amendments are effective as of January 1, 2016, except as otherwise provided herein.

FIFTH: Remaining Plan Provisions

All other provisions of the Plan remain in full force and effect.

Executed this 16th day of December , 2016 by the duly authorized agent of Peoples Security Bank and Trust Company.


	/s/ Michael Jake
	Title: EVP

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Peoples Financial Services Corp.

Exhibit 31.1

CERTIFICATION

I, Craig W. Best, certify that:

I have reviewed this quarterly report on Form 10-Q for the period ended March 31, 2017, of Peoples Financial Services Corp.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13A-15(f) and 15d-15(f)) for the registrant and have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

disclosed in the quarterly report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s Board of Directors (or persons performing the equivalent functions):

all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


/s/ Craig W. Best
President and Chief Executive Officer
(Principal Executive Officer)

Date: May 5, 2017

Peoples Financial Services Corp.

Exhibit 31.2

CERTIFICATION

I, John R. Anderson, III, certify that:

I have reviewed this quarterly report on Form 10-Q for the period ended March 31, 2017, of Peoples Financial Services Corp.;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


/s/ John R. Anderson, III
Interim Principal Financial and Accounting Officer
(Interim Principal Financial Officer and Principal Accounting Officer)

Date: May 5, 2017

Peoples Financial Services Corp.

Exhibit 32

SECTION 1350 CERTIFICATIONS

In connection with the Quarterly Report on Form 10-Q of Peoples Financial Services Corp. (the “Company”) for the period ended March 31, 2017, as filed with the Securities and Exchange Commission (the “Report”), I, Craig W. Best, President and Chief Executive Officer, of the Company, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. To my knowledge, the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.

/s/ Craig W. Best
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 5, 2017

/s/ John R. Anderson, III
Interim Principal Financial and Accounting Officer
(Interim Principal Financial Officer and Principal Accounting Officer)
Date: May 5, 2017

A signed copy of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.