SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------------- ----------------------
Commission file number 0-28366
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Norwood Financial Corp.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2828306
------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation of organization)
717 Main Street, Honesdale, Pennsylvania 18431
---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570) 253-1455
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N/A
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Former name, former address and former fiscal year,
if changed since last report.
Indicate by check (x) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or non-accelerated filer. See definition of
"accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of Exchange Act): Yes [ ] No [x]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of November 13, 2006
--------------------------------------- -----------------------------------
Common stock, par value $0.10 per share 2,795,335
NORWOOD FINANCIAL CORP.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
INDEX
Page
Number
------
PART I - CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD
FINANCIAL CORP.
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 1A. Risk Factors 28
Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases
of Equity Securities 28
Item 3. Defaults upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 29
Item 6. Exhibits 29
Signatures 30
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
----------------------------
NORWOOD FINANCIAL CORP.
Consolidated Balance Sheets
(dollars in thousands, except per share data)
September 30, December 31,
2006 2005
-------- --------
(Unaudited)
ASSETS
Cash and due from banks $ 9,448 $ 9,746
Interest bearing deposits with banks 141 70
Federal funds sold 1,525 -
-------- --------
Cash and cash equivalents 11,114 9,816
Securities available for sale 112,402 115,814
Securities held to maturity, fair value 2006:
$976, 2005: $1,480
954 1,452
Loans receivable (net of unearned income) 313,678 290,890
Less: Allowance for loan losses 3,828 3,669
-------- --------
Net loans receivable 309,850 287,221
Investment in FHLB Stock, at cost 1,634 1,620
Bank premises and equipment, net 5,489 5,393
Accrued interest receivable 2,086 1,812
Other assets 9,641 10,428
-------- --------
TOTAL ASSETS $453,170 $433,556
======== ========
LIABILITIES
Deposits:
Non-interest bearing demand $ 63,331 $ 50,891
Interest bearing 301,275 289,712
-------- --------
Total deposits 364,606 340,603
Short-term borrowings 15,086 18,564
Other borrowings 18,000 23,000
Accrued interest payable 2,277 1,691
Other liabilities 2,142 1,590
-------- --------
TOTAL LIABILITIES 402,111 385,448
STOCKHOLDERS' EQUITY
Common stock, $.10 par value, authorized 10,000,000
shares, issued 2006: 2,840,872, 2005: 2,705,715 284 270
Surplus 10,123 5,648
Retained earnings 42,187 43,722
Treasury stock at cost: 2006: 42,900 shares, 2005: 21,189 (1,246) (633)
Unearned ESOP shares - (127)
Accumulated other comprehensive loss (289) (772)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 51,059 48,108
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $453,170 $433,556
======== ========
See accompanying notes to the consolidated financial statements
3
NORWOOD FINANCIAL CORP.
Consolidated Statements of Income (unaudited)
(dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
----------------- -----------------
September 30, September 30,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
INTEREST INCOME
Loans receivable, including fees $ 5,506 $ 4,527 $15,651 $12,735
Securities 1,105 993 3,221 3,054
Other 36 58 121 75
------- ------- ------- -------
Total interest income 6,647 5,578 18,993 15,864
INTEREST EXPENSE
Deposits 2,032 1,262 5,360 3,351
Short-term borrowings 235 83 585 294
Other borrowings 278 299 991 919
------- ------- ------- -------
Total interest expense 2,545 1,644 6,936 4,564
------- ------- ------- -------
NET INTEREST INCOME 4,102 3,934 12,057 11,300
PROVISION FOR LOAN LOSSES 45 90 170 280
------- ------- ------- -------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,057 3,844 11,887 11,020
OTHER INCOME
Service charges and fees 616 648 1,850 1,830
Income from fiduciary activities 89 78 261 254
Net realized gains on sales of securities 45 3 66 83
Gain on sale of loans and servicing rights 3 8 110 63
Other 141 171 434 463
------- ------- ------- -------
Total other income 894 908 2,721 2,693
OTHER EXPENSES
Salaries and employee benefits 1,482 1,360 4,344 4,081
Occupancy, furniture & equipment, net 329 356 1,078 1,105
Data processing related 185 161 511 474
Taxes, other than income 110 19 334 226
Professional fees 62 102 279 350
Other 562 629 1,791 1,719
------- ------- ------- -------
Total other expenses 2,730 2,627 8,337 7,955
INCOME BEFORE INCOME TAXES 2,221 2,125 6,271 5,758
INCOME TAX EXPENSE 699 643 1,940 1,703
------- ------- ------- -------
NET INCOME $ 1,522 $ 1,482 $ 4,331 $ 4,055
======= ======= ======= =======
BASIC EARNINGS PER SHARE $ 0.54 $ 0.53* $ 1.55 $ 1.45*
======= ======= ======= =======
DILUTED EARNINGS PER SHARE $ 0.53 $ 0.52* $ 1.52 $ 1.42*
======= ======= ======= =======
See accompanying notes to the consolidated financial statements
*References to share amounts and per-share amounts reflect the 5% stock dividend
distributed to shareholders on May 26, 2006.
4
NORWOOD FINANCIAL CORP.
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
(dollars in thousands, except per share (data)
Accumulated
Number of Unearned Other
shares Common Retained Treasury ESOP Comprehensive
issued Stock Surplus Earnings Stock Shares Income (Loss) Total
------ ----- ------- -------- ----- ------ ------------- -----
Balance December 31, 2004 2,705,715 $270 $5,336 $40,222 ($149) ($327) $333 $45,685
Comprehensive Income:
Net Income 4,055 4,055
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax effects (874) (874)
-------
Total comprehensive income 3,181
-------
Cash dividends declared, $.51 per share (1,437) (1,437)
Stock options exercised (78) 229 151
Tax benefit of stock options exercised 18 18
Release of treasury stock for ESOP 22 22
Acquisition of treasury stock (570) (570)
Release of earned ESOP shares 269 128 397
--------- ---- ------ ------- ----- ----- ----- -------
Balance, September 30, 2005 2,705,715 $270 $5,545 $42,840 ($468) ($199) ($541) $47,447
========= ==== ====== ======= ===== ===== ===== =======
Accumulated
Number of Unearned Other
shares Common Retained Treasury ESOP Comprehensive
issued Stock Surplus Earnings Stock Shares Income (Loss) Total
------ ----- ------- -------- ----- ------ ------------- -----
Balance December 31, 2005 2,705,715 $270 $5,648 $43,722 ($633) ($127) ($772) $48,108
Comprehensive Income:
Net Income 4,331 4,331
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax effects 483 483
-------
Total comprehensive income 4,814
-------
Cash dividends declared, $.62 per share (1,727) (1,727)
5% Stock dividend at $30.59 per share 135,157 14 4,121 (4,139) (4)
Acquisition of treasury stock (671) (671)
Stock option (26) 58 32
Tax benefit of stock options exercised 1 1
Compensation expense related to stock options 85 85
Release of earned ESOP shares 294 127 421
--------- ---- ------ ------- ----- ----- ----- -------
Balance, September 30, 2006 2,840,872 $284 $10,123 $42,187 ($1,246) $ - ($289) $51,059
========= ==== ====== ======= ===== ===== ===== =======
See accompanying notes to the consolidated financial statements
5
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Nine Months Ended September 30,
-------------------------------
2006 2005
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 4,331 $ 4,055
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 170 280
Depreciation 372 387
Amortization of intangible assets 39 39
Deferred income taxes 145 (430)
Net amortization of securities premiums and discounts 243 327
Net realized gain on sales of securities (66) (83)
Earnings on life insurance policy (197) (190)
Net gain on sale of mortgage loans (110) (63)
Gain on sale of bank premises and equipment and foreclosed real estate (5) (5)
Mortgage loans originated for sale (572) (6,508)
Proceeds from sale of mortgage loans and servicing rights 682 6,571
Tax benefit of stock options exercised 1 18
Release of ESOP shares 421 419
Compensation expense related to stock options 85 -
(Increase) decrease in accrued interest receivable and other assets 613 (241)
Increase in accrued interest payable and other liabilities 676 919
-------- --------
Net cash provided by operating activities 6,828 5,495
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 96 5,097
Proceeds from maturities and principal reductions on mortgage-backed securities 20,616 9,386
Purchases (16,750) (12,342)
Securities held to maturity- proceeds 505 2,920
(Increase) decrease in investment in FHLB stock (14) 514
Net increase in loans (22,910) (27,668)
Purchase of bank premises and equipment (468) (359)
Proceeds from sale of bank premises and equipment and foreclosed real estate 29 12
-------- --------
Net cash used in investing activities (18,896) (22,440)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 24,003 21,786
Net decrease in short-term borrowings (3,294) (11,467)
Repayments of long-term debt (5,000) (5,000)
Proceeds from other borrowings - 5,000
Stock options exercised 32 151
Acquisition of treasury stock (671) (570)
Cash dividends paid (1,704) (1,439)
-------- --------
Net cash provided by financing activities 13,366 8,461
-------- --------
Increase (decrease) in cash and cash equivalents 1,298 (8,484)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 9,816 20,666
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,114 $ 12,182
======== ========
See accompanying notes to the consolidated financial statements
6
Notes to Unaudited Consolidated Financial Statements
----------------------------------------------------
1. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of Norwood
Financial Corp. (Company) and its wholly-owned subsidiary, Wayne Bank (Bank) and
the Bank's wholly-owned subsidiaries, WCB Realty Corp., Norwood Investment Corp.
and WTRO Properties. All significant intercompany transactions have been
eliminated in consolidation.
2. Estimates
---------
The accompanying unaudited consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In preparing the
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ from those estimates. The financial statements reflect, in the opinion of
management, all normal, recurring adjustments necessary to present fairly the
financial position of the Company. The operating results for the three and nine
month periods ended September 30, 2006 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2006 or any other
future interim period.
These statements should be read in conjunction with the consolidated
financial statements and related notes which are incorporated by reference in
the Company's Annual Report on Form 10-K for the year-ended December 31, 2005.
3. Earnings Per Share
------------------
On April 11, 2006, the Company declared a 5% stock dividend on common
stock outstanding payable May 26, 2006 to shareholders of record on May 12,
2006. The stock dividend resulted in the issuance of 135,157 additional common
shares. All per share data has been adjusted for the effect of the stock
dividend.
Basic earnings per share represents income available to common
stockholders divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflects 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.
The following table sets forth the computations of basic and diluted
earnings per share:
(in thousands)
Three Months Ended Nine Months Ended
------------------ ------------------
September 30, September 30,
----------------- ------------------
2006 2005 2006 2005
----- ----- ----- -----
Basic EPS weighted average shares outstanding 2,794 2,801* 2,794 2,801*
Dilutive effect of stock options 59 56* 58 60*
----- ----- ----- -----
Diluted EPS weighted average shares outstanding 2,853 2,857 2,852 2,861
===== ===== ===== =====
* References to share amounts and per-share amounts reflect the 5% stock
dividend distributed to shareholders on May 26, 2006.
7
4. Stock-Based Compensation
------------------------
In December 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123(R), "Share-Based Payment." Statement No. 123(R)
replaces Statement No. 123, "Accounting for Stock-Based Compensation," and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Statement No. 123(R) requires the fair value of share-based payment transactions
to be recognized as compensation costs in the financial statements over the
period than an employee provides service in exchange for the award. The fair
value of the share-based payments is estimated using the Black-Scholes
option-pricing model. The Company adopted Statement No. 123(R) effective January
1, 2006, using the modified-prospective transition method. Under the modified
prospective method, companies are required to record compensation cost for new
and modified awards over the related vesting period of such awards and record
compensation cost prospectively for the unvested portion, at the date of
adoption, of previously issued and outstanding awards over the remaining vesting
period of such awards. No change to prior periods presented is permitted under
the modified prospective method. The Company did not issue any stock options in
2005 (1) As outstandng options as of December 31, 2005 was fully vested. The
Company's shareholders approved the Norwood Financial Corp 2006 Stock Option
Plan at the annual meeting on April 25, 2006. As a result, the Company awarded
25,200 options, all of which have a twelve month vesting period. Included in the
results for the three and nine months ended September 30, 2006 were $51,000 and
$85,000 respectively in compensation costs relating to the adoption of Statement
No. 123(R). Net income for the three and nine months ended September 30, 2006
was reduced by approximately $34,000 and $56,000 respectively. As of September
30, 2006, there was approximately $119,000 of total unrecognized compensation
cost related to nonvested options under the plan.
The following table illustrates the effect on net income and earnings
per share, for the three and nine months ended September 30, 2005, if the
Company had applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation to stock-based compensation:
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
------------------ ------------------
(in thousands, except for per share data)
Net income as reported $1,482 $4,055
Total stock-based employee compensation cost, net of
tax, which would have been included in the determination
of net income if the fair value based method had been applied
to all awards (49) (147)
------ ------
Pro forma net income $1,433 $3,908
====== ======
Earnings per share (basic)
As Reported $ .53* $ 1.45*
Pro forma .51* 1.40*
Diluted earnings per share (assuming dilution)
As Reported .52* 1.42*
Pro forma .50* 1.37*
* References to share amounts and per-share amounts reflect the 5% stock
dividend distributed to shareholders on May 26, 2006.
8
Weighted- Weighted-
Average Average
Exercise Remaining
Options Price Term (in years)
------- ----- ---------------
Outstanding at the beginning of the year 140,296 $18.45
Granted................................. 25,200 30.38
Exercised............................... (1,988) 17.05
Forfeited................................ - -
Outstanding as of September 30, 2006 163,508 20.72 5.6
Exercisable as of September 30, 2006 138,308 18.96 4.9
The fair value of options granted for the period ended September 30,
were estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions:
Nine Months Ended September 30
------------------------------
2006
----
Dividend yield...................................... 2.71%
Expected life....................................... 7 years
Expected volatility................................. 25.4%
Risk-free interest rate............................. 4.99%
Weighted average fair value of options granted..... $8.12
There were no new options granted for the nine months ended September 30, 2005.
5. Cash Flow Information
---------------------
For the purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, interest-bearing deposits with
banks and federal funds sold.
Cash payments for interest for the nine months ended September 30, 2006
and 2005 were $6,340,000 and $4,395,000 respectively. Cash payments for income
taxes in 2006 were $1,873,000 compared to $1,746,000 in 2005. Non-cash investing
activities for 2006 and 2005 included foreclosed mortgage loans and repossession
of other assets of $111,000 and $76,000, respectively.
6. Comprehensive Income
--------------------
Accounting principles generally accepted in the United States of
America require that recognized revenue, expenses, gains and losses be included
in net income. Although certain changes in assets and liabilities such as
unrealized gains and losses on available for sale securities, are reported as a
separate component of the equity section of the balance sheet, such items, along
with net income, are components of comprehensive income. The components of other
comprehensive income and related tax effects are as follows:
9
(in thousands) Three Months Nine Months
------------ -----------
Ended September 30, Ended September 30,
------------------- -------------------
2006 2005 2006 2005
------- ------- ------- -------
Unrealized holding gains/(losses)
on available for sale securities $ 1,285 $ (664) $ 799 $(1,248)
Reclassification adjustment for gains
realized in net income (45) (3) (66) (83)
------- ------- ------- -------
Net unrealized gains/(losses) 1,240 (667) 733 (1,331)
Income tax (benefit) 423 (229) 250 (457)
------- ------- ------- -------
Other comprehensive income (loss) $ 817 $ (438) $ 483 $ (874)
======= ======= ======= =======
7. Off-Balance Sheet Financial Instruments and Guarantees
------------------------------------------------------
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the Bank's financial instrument commitments is as follows:
(in thousands)
Sept. 30 Dec. 31
-------- -------
2006 2005
------- -------
Commitments to grant loans $15,993 $16,078
Unfunded commitments under lines of credit 34,507 29,969
Standby letters of credit 7,290 6,791
------- -------
$57,790 $52,838
======= =======
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. The Bank evaluates each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed
10
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the customer and generally consists of real estate.
The Bank does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Generally, all letters
of credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Bank, generally, holds
collateral and/or personal guarantees supporting these commitments. Management
believes that the proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the potential amount of
future payment required under the corresponding guarantees. The current amount
of the liability as of September 30, 2006 and December 31,2005 for guarantees
under standby letters of credit issued is not material.
8. New Accounting Pronouncements
-----------------------------
FAS 157
In September 2006, the FASB issued FASB Statement No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
FASB Statement No. 157 applies to other accounting pronouncements that require
or permit fair value measurements. The new guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and for
interim periods within those fiscal years. We are currently evaluating the
potential impact, if any, of the adoption of FASB Statement No. 157 on our
consolidated financial position, results of operations and cash flows.
FAS 158
On September 29, 2006, the Financial Accounting Standards Board "FASB" issued
SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans ("SFAS 158"), which amends SFAS 87 and SFAS 106 to require
recognition of the overfunded or underfunded status of pension and other
postretirement benefit plans on the balance sheet. Under SFAS 158, gains and
losses, prior service costs and credits, and any remaining transition amounts
under SFAS 87 and SFAS 106 that have not yet been recognized through net
periodic benefit cost will be recognized in accumulated other comprehensive
income, net of tax effects, until they are amortized as a component of net
periodic cost. The measurement date - the date at which the benefit obligation
and plan assets are measured - is required to be the company's fiscal year end.
SFAS 158 is effective for publicly-held companies for fiscal years ending after
December 15, 2006, except for the measurement date provisions, which are
effective for fiscal years ending after December 15, 2008. The Company is
currently analyzing the effects of SFAS 158 but does not expect its
implementation will have a significant impact on the Company's financial
condition or results of operations.
SAB 108
On September 13, 2006, the Securities and Exchange Commission "SEC" issued Staff
Accounting Bulleting No. 108 ("SAB 108"). SAB 108 provides interpretive guidance
on how the effects of the carryover or reversal of prior year misstatements
should be considered in quantifying a potential current year misstatement. Prior
to SAB 108, Companies might evaluate the materiality of financial-statement
misstatements using either the income statement or balance sheet approach, with
the income statement approach focusing on new misstatements added in the current
year, and the balance sheet approach focusing on the cumulative amount of
misstatement present in a company's balance
11
sheet. Misstatements that would be material under one approach could be viewed
as immaterial under another approach and not be corrected. SAB 108 now requires
that companies view financial statement misstatements as material if they are
material according to either the income statement or balance sheet approach. The
Company has analyzed SAB 108 and determined that upon adoption it will have no
impact on the reported results of operations or financial condition.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
--------------------------
The Private Securities Litigation Reform Act of 1995 contains safe
harbor provisions regarding forward-looking statements. When used in this
discussion, the words believes, anticipates, contemplates, expects, and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties, which could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risks associated with the effect of opening a new
branch, the ability to control costs and expenses, demand for real estate and
general economic conditions. The Company undertakes no obligation to publicly
release the results of any revisions to those forward-looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
Critical Accounting Policies
----------------------------
Note 2 to the Company's consolidated financial statements (incorporated
by reference in Item 8 of the form 10-K) lists significant accounting policies
used in the development and presentation of its financial statements. This
discussion and analysis, the significant accounting policies, and other
financial statement disclosures identify and address key variables and other
qualitative and quantitative factors that are necessary for an understanding and
evaluation of the Company and its results of operations.
Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for loan
losses, accounting for stock options, the valuation of deferred tax assets and
the determination of other-than-temporary impairment losses on securities.
Please refer to the discussion of the allowance for loan losses calculation
under "Non-performing Assets and Allowance for Loan Losses" in the "Financial
Condition" section. For periods ending prior to January 1, 2006, the Company
accounted for stock option plans under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees",
and related interpretations. No stock-based employee compensation was reflected
in net income, as all options granted had an exercise price equal to the market
value of the underlying common stock on the grant date. The Company adopted SFAS
No. 123(R), "Share-Based Payment" as of January 1, 2006. However, no stock
options were awarded in 2005 or for the three months ended March 31, 2006. The
Norwood Financial Corp. 2006 Stock Option Plan was approved on April 25, 2006.
The Company granted 25,200 options in the second quarter of 2006. See Note 4 for
a discussion of this pronouncement's impact on the Company's consolidated
financial statements.
12
The deferred income taxes reflect temporary differences in the
recognition of the revenue and expenses for tax reporting and financial
statement purposes, principally because certain items are recognized in
different periods for financial reporting and tax return purposes. Although
realization is not assured, the Company believes it is more likely than not that
all deferred tax assets will be realized.
In estimating other-than-temporary impairment losses on securities, the
Company considers 1) the length of time and extent to which the fair value has
been less than cost 2) the financial condition of the issuer and 3) the intent
and ability of the Company to hold the security to allow for a recovery to fair
value.
Changes in Financial Condition
------------------------------
General
-------
Total assets as of September 30, 2006 were $453.2 million compared to
$433.6 million as of December 31, 2005, an increase of $19.6 million, or 4.5%.
Securities
----------
The fair value of securities available for sale as of September 30,
2006 was $112.4 million compared to $115.8 million as of December 31, 2005. The
Company purchased $16.8 million of securities to offset $20.6 million of
maturities and principal reductions on mortgage-backed securities. The purchases
were principally in short-term U.S. Government sponsored agencies and
pass-through mortgage-backed securities. The additional proceeds not reinvested
were used to fund loan growth.
The Company has securities in an unrealized loss position. In
Management's opinion, the unrealized losses reflect changes in interest rates
subsequent to the acquisition of specific securities. The Company's
available-for-sale portfolio has an average repricing term of 1.8 years.
Interest rates in the 2-3 year section of the treasury yield curve have
increased over 100 basis points over the life of the securities impacting the
fair value of individual securities. Management believes that the unrealized
losses represent temporary impairment of the securities, as a result of changes
in interest rates. The Company has the intent and ability to hold these
investments until maturity or market price recovery.
Loans Receivable
----------------
Loans receivable before allowance totaled $313.7 million compared to
$290.9 million as of December 31, 2005. Commercial real estate loans increased
$6.0 million with growth primarily in the third quarter, which offset the pay
off of a short-term $6.7 million loan originated in the first quarter of 2005.
Commercial term loans and lines of credit also increased $6.2 million. The $12.8
million growth in residential real estate loans has principally been in fixed
-rate first lien residential mortgages and home equity loans. The Company does
not originate any non-traditional mortgage products such as interest-only loans
or option adjustable-rate mortgages, nor offer any terms over 30 years.
13
Set forth below is selected data relating to the composition of the loan
portfolio at the dates indicated:
Types of loans
(dollars in thousands) September 30, 2006 December 31, 2005
---------------------- -----------------------
$ % $ %
-------- ----- -------- ------
Real Estate-Residential 113,514 36.1 100,705 34.6
Commercial 139,532 44.5 133,495 45.8
Construction 5,762 1.8 5,944 2.0
Commercial, financial and agricultural 32,910 10.5 26,755 9.2
Consumer loans to individuals 22,340 7.1 24,353 8.4
------- ----- ------- ------
Total loans 314,058 100.0 291,252 100.0
Deferred fees (net) (380) (362)
------- -------
313,678 290,890
Allowance for loan losses (3,828) (3,669)
------- -------
Net loans receivable 309,850 287,221
======= =======
Allowance for Loan Losses and Non-performing Assets
---------------------------------------------------
Following is a summary of changes in the allowance for loan losses for
the periods indicated:
Three Months Nine Months
------------------ ------------------
Ended September 30 Ended September 30
------------------ ------------------
(dollars in thousands) 2006 2005 2006 2005
------ ------ ------ ------
Balance, beginning $3,794 $3,600 $3,669 $3,448
Provision for loan losses 45 90 170 280
Charge-offs (34) (66) (84) (143)
Recoveries 23 19 73 58
------ ------ ------ ------
Net charge-offs (11) (47) (11) (85)
------ ------ ------ ------
Balance, ending $3,828 $3,643 $3,828 $3,643
====== ====== ====== ======
Allowance to total loans 1.22% 1.29% 1.22% 1.29%
Net charge-offs to average loans
(annualized) .01% .07% .-% .04%
The allowance for loan losses totaled $3,828,000 as of September 30,
2006 and represented 1.22% of total loans compared to $3,669,000 and 1.26% as of
December 31, 2005. Net charge-offs for the nine months ended September 30, 2006
totaled $11,000 declining from net charge-offs of $85,000 for the similar period
in 2005. The decrease was principally due to the lower level of repossessed
automobiles, as the Company has lowered its exposure to indirect automobile
lending. As a result of the lower net charge-offs, the provision for loan losses
was less for the nine months ended September 30, 2006, $170,000, compared to
$280,000 for the similar period in 2005.
14
The Company assesses the adequacy of the allowance for loan losses on
a quarterly basis. The process includes an analysis of the risks inherent in the
loan portfolio. It includes an analysis of impaired loans and a historical
review of credit losses by loan type. Other factors considered include:
concentration of credit in specific industries; economic and industry
conditions; trends in delinquencies and loan risk-rated classifications, large
dollar exposures and loan growth. Management considers the allowance adequate at
September 30, 2006 based on the Company's criteria. However, there can be no
assurance that the allowance for loan losses will be adequate to cover
significant losses, if any that might be incurred in the future.
As of September 30, 2006, non-performing loans totaled $395,000,
which is .13% of total loans compared to $353,000, or .12% of total loans at
December 31, 2005. The following table sets forth information regarding
non-performing loans and foreclosed real estate at the dates indicated:
September 30, 2006 December 31, 2005
------------------ -----------------
(dollars in thousands)
Loans accounted for on a non accrual basis:
Commercial and all other $ - $ -
Real Estate 332 330
Consumer 10 11
---- ----
Total 342 341
Accruing loans which are contractually
past due 90 days or more 53 12
---- ----
Total non-performing loans 395 353
Foreclosed real estate - -
---- ----
Total non-performing assets $395 $353
==== ====
Allowance for loan losses
coverage of non-performing loans 9.7x 10.4x
Non-performing loans to total loans .13% .12%
Non-performing assets to total assets .09% .08%
Deposits
--------
Total deposits as of September 30, 2006 were $364.6 million
increasing from $340.6 million as of December 31, 2005. Non-interest bearing
demand deposits increased $12.4 million or 24.4%. The increase in non-interest
bearing demand deposits is due in part to new commercial accounts and the
seasonality of certain corporate and municipal accounts. Savings have decreased
$5.9 million as customers have moved funds to short-term time deposits which
have higher yields. Time deposits less than $100,000 increased $17.0 million,
principally due to promotional efforts in short-term certificates of deposit.
15
The following table sets forth deposit balances as of the dates indicated.
(dollars in thousands) September 30, 2006 December 31, 2005
------------------ -----------------
Non-interest bearing demand $63,331 $50,891
Interest bearing demand 37,830 40,738
Money Market 56,703 52,194
Savings 47,329 53,311
Time deposits <$100,000 111,637 94,612
Time deposits >$100,000 47,776 48,857
-------- --------
Total $364,606 $340,603
======== ========
Short-term Borrowings
---------------------
Short-term borrowings as of September 30, 2006 were $15.1 million
compared to $18.6 million as of December 31, 2005.
Short-term borrowings consist of the following:
(dollars in thousands)
September 30, 2006 December 31, 2005
------------------ -----------------
Securities sold under agreements to repurchase $14,086 $12,464
Federal Funds purchased - 5,100
U.S. Treasury demand notes 1,000 1,000
------- -------
$15,086 $18,564
======= =======
Other Borrowings
----------------
Other borrowings consist of notes from the Federal Home Loan Bank of Pittsburgh.
Other borrowings consist of the following: (dollars in thousands)
September 30, 2006 December 31, 2005
------------------ -----------------
Convertible note due December 2006 at 6.19% $5,000 $5,000
Fixed rate note due April 2008 at 4.17% 5,000 5,000
Convertible note due April 2009 at 4.83% 5,000 5,000
Convertible note due April 2009 at 5.07% - 5,000
Convertible note due January 2011 at 5.24% 3,000 3,000
------- -------
$18,000 $23,000
======= =======
16
Off-Balance Sheet Arrangements
------------------------------
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the contractual amount of the Company's financial
instrument commitments is as follows:
September 30, December 31,
2006 2005
---- ----
(in thousands)
Commitments to grant loans $15,993 $16,078
Unfunded commitments under lines of credit 34,507 29,969
Standby letters of credit 7,290 6,791
------- -------
$57,790 $52,838
======= =======
Stockholders' Equity and Capital Ratios
---------------------------------------
At September 30, 2006, total stockholders' equity totaled $51.1
million, compared to $48.1 million as of December 31, 2005. The net change in
stockholders' equity was primarily due to $4,331,000 in net income, that was
partially offset by $1,727,000 of cash dividends declared. In addition,
accumulated other comprehensive loss decreased $483,000 due to an increase in
fair value of securities in the available for sale portfolio. This increase in
fair value is the result of a change in interest rates, which may impact the
fair value of the securities. Because of interest rate volatility, the Company's
accumulated other comprehensive loss could materially fluctuate for each interim
and year-end period.
A comparison of the Company's regulatory capital ratios is as follows:
September 30, 2006 December 31, 2005
------------------ -----------------
Tier 1 Capital
(To average assets) 11.31% 11.05%
Tier 1 Capital
(To risk-weighted assets) 15.32% 15.29%
Total Capital
(To risk-weighted assets) 16.62% 16.63%
The minimum capital requirements imposed by the FDIC on the Bank for
leverage, Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Company
has similar capital requirements imposed by the Board of Governors of the
Federal Reserve System (FRB). The Bank is also subject to more stringent
Pennsylvania
17
Department of Banking (PDB) guidelines. The Bank's capital ratios do not differ
significantly from the Company's ratios. Although not adopted in regulation
form, the PDB utilizes capital standards requiring a minimum of 6.5% leverage
capital and 10% total capital. The Company and the Bank were in compliance with
the FRB, FDIC and PDB capital requirements as of September 30, 2006 and December
31, 2005.
Liquidity
---------
As of June 30, 2006, the Company had cash and cash equivalents of
$11.1 million in the form of cash, due from banks, federal funds sold and
short-term deposits with other institutions. In addition, the Company had total
securities available for sale of $112.4 million which could be used for
liquidity needs. This totals $123.5 million and represents 27.3% of total assets
compared to $125.6 million and 29% of total assets as of December 31, 2005. The
Company also monitors other liquidity measures, all of which were within the
Company's policy guidelines as of September 30, 2006 and December 31, 2005.
Based upon these measures, the Company believes its liquidity is adequate.
The Company maintains established lines of credit with the Federal
Home Loan Bank of Pittsburgh (FHLB), the Atlantic Central Bankers Bank (ACBB)
and other correspondent banks, which are available to support liquidity needs.
There were no outstandings on the lines of credit as of September 30, 2006
compared to $5.1 million as of December 31, 2005. The approximate borrowing
capacity from the FHLB was $174 million, with $18 million outstanding as of
September 30, 2006, compared to $23 million outstanding as of December 31, 2005.
18
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Three Months Ended September 30,
-----------------------------------------------------------------------
2006 2005
--------------------------------- -------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 2,801 $ 35 5.00% $ 6,546 $ 56 3.42%
Interest bearing deposits with banks 71 1 5.63 180 2 4.44
Securities held-to-maturity (1) 954 22 9.22 3,090 102 13.20
Securities available for sale:
Taxable 100,510 945 3.76 95,534 757 3.17
Tax-exempt 16,520 221 5.35 18,559 255 5.50
-------- ------ -------- ------
Total securities available for sale (1) 117,030 1,166 3.99 114,093 1,012 3.55
Loans receivable (4) (5) 305,081 5,554 7.28 279,060 4,565 6.54
-------- ------ -------- ------
Total interest earning assets 425,937 6,778 6.37 402,969 5,737 5.69
Non-interest earning assets:
Cash and due from banks 9,219 8,990
Allowance for loan losses (3,820) (3,631)
Other assets 16,967 16,279
-------- --------
Total non-interest earning assets 22,366 21,638
-------- --------
Total Assets $448,303 $424,607
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $ 99,693 461 1.85% $ 99,857 278 1.11%
Savings 49,330 58 0.47 56,699 67 0.47
Time 145,595 1,513 4.16 126,681 917 2.90
-------- ------ -------- ------
Total interest bearing deposits 294,618 2,032 2.76 283,237 1,262 1.78
Short-term borrowings 20,646 235 4.55 11,639 83 2.85
Other borrowings 20,793 278 5.35 23,000 299 5.20
-------- ------ -------- ------
Total interest bearing liabilities 336,057 2,545 3.03 317,876 1,644 2.07
Non-interest bearing liabilities:
Demand deposits 58,392 56,543
Other liabilities 3,792 2,883
-------- --------
Total non-interest bearing liabilities 62,184 59,426
Stockholders' equity 50,062 47,305
-------- --------
Total Liabilities and Stockholders' Equity $448,303 $424,607
======== ========
Net interest income (tax equivalent basis) 4,233 3.34% 4,093 3.63%
Tax-equivalent basis adjustment (131) ==== (159) ====
------- ------
Net interest income $ 4,102 $3,934
======= ======
Net interest margin (tax equivalent basis) 3.98% 4.06%
==== ====
(1) Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
(2) Average balances have been calculated based on daily balances.
(3) Annualized
(4) Loan balances include non-accrual loans and are net of unearned income.
(5) Loan yields include the effect of amortization of deferred fees, net of
costs.
19
Rate/Volume Analysis. The following table shows the fully taxable equivalent
effect of changes in volumes and rates on interest income and interest expense.
Changes in net interest income that could not be specifically identified as
either a rate or volume change were allocated proportionately to changes in
volume and changes in rate.
Increase/(Decrease)
-------------------
Three Months Ended September 30, 2006 Compared to
-------------------------------------------------
Three Months Ended September 30, 2005
-------------------------------------
Variance due to
---------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest earning assets:
Federal funds sold $ (126) $ 105 $ (21)
Interest bearing deposits with banks (4) 3 (1)
Securities held to maturity (56) (24) (80)
Securities available for sale:
Taxable 41 147 188
Tax-exempt securities (27) (7) (34)
------- ------- -------
Total securities 14 140 154
Loans receivable 447 542 989
------- ------- -------
Total interest earning assets 275 766 1,041
Interest bearing liabilities:
Interest-bearing demand and money market (3) 186 183
Savings (9) - (9)
Time 152 444 596
------- ------- -------
Total interest bearing deposits 140 630 770
Short-term borrowings 86 66 152
Other borrowings (69) 48 (21)
------- ------- -------
Total interest bearing liabilities 157 744 901
------- ------- -------
Net interest income (tax-equivalent basis) $ 118 $ 22 $ 140
======= ======= =======
20
Comparison of Operating Results for The Three Months Ended September 30, 2006 to
--------------------------------------------------------------------------------
September 30, 2005
------------------
General
-------
For the three months ended September 30, 2006, net income totaled
$1,522,000, an increase of $40,000, or 2.7% over the $1,482,000 earned in the
similar period of 2005. Earnings per share for the current period were $.54
basic and $.53 on a diluted basis compared to $.53 basic and $.52 on a diluted
basis for the three months ended September 30, 2005. The resulting annualized
return on average assets and return on average equity for the three months ended
September 30, 2006 were 1.35% and 12.06%, respectively, compared to 1.38% and
12.43% respectively, for the similar period in 2005.
The following table sets forth changes in net income:
(dollars in thousands) Three Months Ended
------------------
September 30, 2006 to September 30, 2005
----------------------------------------
Net income three months ended September 30, 2005 $1,482
------
Net interest income 168
Provision for loan losses 45
Net realized gains on sales of securities 42
Gains on sale of mortgage loans and servicing rights (5)
All other income (51)
Salaries and employee benefits (122)
All other expenses 19
Income tax effect (56)
------
Net income three months ended September 30, 2006 $1,522
======
Net Interest Income
-------------------
Net interest income on a fully taxable equivalent basis (fte) for the
three months ended September 30, 2006 totaled $4,233,000, an increase of
$140,000 or 3.4% over the similar period in 2005. The fte net interest spread
and net interest margin were 3.34% and 3.98%, respectively, compared to 3.63%
and 4.06%, respectively, for the three months ended September 30, 2005. The
decrease in net interest margin was principally due to the increase in the cost
of interest-bearing liabilities from 2.07% in the 2005 period to 3.03% in the
current period.
Interest income (fte) totaled $6,778,000 with an average yield of
6.37% on average earning assets for the three months ended September 30, 2006,
increasing from $5,737,000 and 5.69% for the similar period in 2005. The
increase was due in part to growth in the loan portfolio. Average loans
increased $26.0 million and represented 71.6% of average earning assets
increasing from 70.6% of average earning assets for the 2005 period. The higher
level of loans improves the yield on earning assets as loans typically have
higher yields than securities. The increase was also partly due to the rise in
the prime interest rate which was 8.25% as of September 30, 2006 compared to
6.75% as of September 30, 2005. The increase in prime rate increased the yield
on the Company's floating rate commercial loan portfolio and its home equity
lines of credit.
21
Interest expense for the three months ended September 30, 2006
totaled $2,545,000 at an average cost of 3.03% increasing from $1,644,000 and
2.07% for the similar period in 2005. The rising cost was principally the result
of the increase in short-term interest rates. Since the 2005 period, the Company
has increased rates paid on its money market accounts, short-term certificates
of deposit (CDs) and cash management accounts, which are included in short-term
borrowings. The cost of time deposits increased to 4.16% in the current period
compared to 2.90% for the similar period in 2005. The Company expects the cost
of time deposits to continue to increase in 2006 due to competitive pressures
and the repricing of lower rate instruments to the current higher interest
rates. Deposits have also shifted to higher costing instruments. Average savings
deposits, which have an average cost of .47%, decreased $7.4 million, which has
been offset by $18.9 million in higher costing time deposits.
Other Income
------------
Other income totaled $894,000 for the three months ended September
30, 2006, compared to $908,000 for the similar period in 2005. The decrease was
principally due to a lower level of service charges and fees. Other decreased
$30,000 to $141,000 principally due to $20,000 lower level of commissions on
annuities and mutual funds in the current period. This was offset by a higher
level of net realized gains on the sales of securities, $45,000 for the 2006
period compared to $3,000 in such gains for the similar period in 2005. The
Company took gains on equity holdings in other financial institutions which
appeared to be fairly valued.
Other Expenses
--------------
Other expenses for the three months ended September 30, 2006 totaled
$2,730,000, an increase of $103,000 or 3.9%, over the $2,627,000 for the similar
period in 2005. Salaries and employee benefit expenses increased $122,000
principally due to increased costs related to health care insurance and $51,000
expense recognition of stock options in 2006. In the 2005 period, the Bank made
a $100,000 charitable contribution (included in Other). The Contribution
qualified for the PA Educational Improvement Tax Credit. As a result, a $90,000
tax credit was recorded against PA Shares Tax Liability (included in Taxes,
other than Income). The Company expects to make a similar contribution in the
4th quarter of 2006.
The FDIC has adopted a new risk-based deposit insurance assessment
system that will require all FDIC-insured institutions to pay quarterly premiums
beginning in 2007. Annual premiums will range from 5 and 7 basis points of
deposits for well-capitalized banks with the highest examination ratings to 43
basis points for undercapitalized institutions.. The Bank will be able to offset
the premium with an estimated assessment credit of $320,000 for premiums paid
prior to 1996.
Income Tax Expense
------------------
Income tax expense totaled $699,000 for the three months ended
September 30, 2006, for an effective tax rate of 31.5% compared to $643,000 and
an effective tax rate of 30.2% for the similar period in 2005. The increase in
the marginal rate was due in part to a lower level of tax exempt income as a
result of maturities of tax-exempt municipal bonds.
22
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Nine Months Ended September 30,
----------------------------------- --------------------------------
2006 2005
----------------------------------- --------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 3,100 $ 118 5.08% $ 3,053 $ 72 3.14%
Interest bearing deposits with banks 106 3 3.77 126 3 3.17
Securities held-to-maturity (1) 989 68 9.17 4,174 353 11.28
Securities available for sale:
Taxable 99,573 2,704 3.62 98,498 2,315 3.13
Tax-exempt 17,526 715 5.44 18,601 767 5.50
-------- ------- -------- -------
Total securities available for sale (1) 117,099 3,419 3.89 117,099 3,082 3.51
Loans receivable (4) (5) 297,175 15,780 7.08 269,761 12,841 6.35
-------- ------- -------- -------
Total interest earning assets 418,469 19,388 6.18 394,213 16,351 5.53
Non-interest earning assets:
Cash and due from banks 8,713 8,397
Allowance for loan losses (3,769) (3,569)
Other assets 16,931 15,807
-------- --------
Total non-interest earning assets 21,875 20,635
-------- --------
Total Assets $440,344 $414,848
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $ 99,308 1,270 1.71% $ 92,965 654 0.94%
Savings 51,198 178 0.46 58,313 205 0.47
Time 138,965 3,912 3.75 124,992 2,492 2.66
-------- ------- -------- -------
Total interest bearing deposits 289,471 5,360 2.47 276,270 3,351 1.62
Short-term borrowings 18,557 585 4.20 15,415 294 2.54
Other borrowings 25,465 991 5.19 23,000 919 5.33
-------- ------- -------- -------
Total interest bearing liabilities 333,493 6,936 2.77 314,685 4,564 1.93
Non-interest bearing liabilities:
Demand deposits 54,402 51,315
Other liabilities 3,208 2,244
-------- --------
Total non-interest bearing liabilities 57,610 53,559
Stockholders' equity 49,241 46,604
-------- --------
Total Liabilities and Stockholders' Equity $440,344 $414,848
======== ========
Net interest income (tax equivalent basis) 12,452 3.40% 11,787 3.60%
Tax-equivalent basis adjustment (395) ==== (487) ====
------- -------
Net interest income $12,057 $11,300
======= =======
Net interest margin (tax equivalent basis) 3.97% 3.99%
==== ====
(1) Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
(2) Average balances have been calculated based on daily balances.
(3) Annualized
(4) Loan balances include non-accrual loans and are net of unearned income.
(5) Loan yields include the effect of amortization of deferred fees, net of
costs.
23
Rate/Volume Analysis
The following table shows the fully taxable equivalent effect of changes in
volumes and rates on interest income and interest expense. Changes in net
interest income that could not be specifically identified as either a rate or
volume change were allocated proportionately to changes in volume and changes in
rate.
Increase/(Decrease)
-------------------
Nine Months Ended September 30, 2006 Compared to
------------------------------------------------
Nine Months Ended September 30, 2005
------------------------------------
Variance due to
---------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest earning assets:
Federal funds sold $ 1 $ 45 $ 46
Interest bearing deposits with banks (1) 1 -
Securities held to maturity (229) (56) (285)
Securities available for sale:
Taxable 26 363 389
Tax-exempt securities (44) (8) (52)
------- ------- -------
Total securities (18) 355 337
Loans receivable 1,375 1,564 2,939
------- ------- -------
Total interest earning assets 1,128 1,909 3,037
Interest bearing liabilities:
Interest-bearing demand and money market 47 569 616
Savings (25) (2) (27)
Time 303 1,117 1,420
------- ------- -------
Total interest bearing deposits 325 1,684 2,009
Short-term borrowings 69 222 291
Other borrowings 109 (37) 72
------- ------- -------
Total interest bearing liabilities 503 1,869 2,372
------- ------- -------
Net interest income (tax-equivalent basis) $ 625 $ 40 $ 665
======= ======= =======
Comparison of Operating Results for Nine Months Ended September 30, 2006 and
--------------------------------------------------------------------------------
September 30, 2005
------------------
General
-------
Net income for the nine months ended September 30, 2006 totaled
$4,331,000, increasing $276,000, or 6.8% over the $4,055,000 earned in the
similar period in 2005. Basic and diluted earnings per share were $1.55 and
$1.52, respectively, in the 2006 period compared to $1.45 and $1.42,
respectively, for the similar period in 2005. The resulting annualized return on
average assets for the nine months ended September 30, 2006 was 1.31%, with an
annualized return on average equity of 11.76% compared to 1.31% and 11.63%
respectively, for the similar period in 2005.
24
The following table sets forth changes in net income:
(dollars in thousands)
Net income nine months ended September 30, 2005 $ 4,055
-------
Net interest income 757
Provision for loan losses 110
Net realized gains on sales of securities (17)
Gains on sales of mortgage loans and servicing rights 47
All other income (2)
Salaries and employee benefits (263)
All other expenses (119)
Income tax effect (237)
-------
Net income nine months ended September 30, 2006 $ 4,331
=======
Net Interest Income
-------------------
Net interest income on an fte basis for the nine months ended
September 30, 2006 totaled $12,452,000, an increase of $665,000 or 5.6% over
$11,787,000 for the similar period in 2005. The fte net interest spread and net
interest margin were 3.40% and 3.97%, respectively, compared to 3.60% and 3.99%,
respectively, in 2005.
Interest income (fte) totaled $19,388,000 with an average yield on
average earning assets of 6.18% for the nine months ended September 30, 2006
increasing from $16,351,000 and 5.53% for the similar period in 2005. The
increase in income and yield was principally due to $27.4 million growth in
average loans. For the 2006 period, average loans totaled $297.2 million and
represented 71.0% of average earning assets increasing from $269.8 million and
68.4% for the similar period 2005. The higher level of loans improves the yield
on earning assets as loans typically have a higher yields than securities. The
average yield on loans also increased to 7.08% for the 2006 period from 6.35%
for the similar period in 2005. The increase was principally due to the rise in
the prime rate of interest which was 8.25% as of September 30, 2006 compared to
6.75% as of September 30, 2005. The increase in prime rate increases the yield
on the Company's floating rate commercial loan portfolio and on home equity
lines of credit. The yields on the securities available for sale portfolio
increased to 3.89% in the 2006 period from 3.51% in the similar period in 2005.
The improvement in yield was due to the reinvestment of the proceeds from
maturities into higher yielding instruments.
Interest expense for the nine months ended September 30, 2006 totaled
$6,936,000 at an average cost of interest bearing liabilities of 2.77% compared
to $4,564,000 and 1.93% for the similar period in 2005. The increase is
principally due to rising short-term interest rates which have caused an
increase in rates paid on money market accounts, time deposits and short-term
borrowings. The cost of time deposits averaged 3.75% for the 2006 period
compared to 2.66% for the similar period in 2005. The Company expects the cost
of time deposits to continue to increase in 2006 due to competitive pressure and
the repricing of lower rate instruments to the current higher interest rates.
Deposits have also shifted to higher costing instruments as savings accounts
have decreased and short-term CDs have increased.
25
Other Income
------------
Other income totaled $2,721,000 for the nine months ended September
30, 2006 compared to $2,693,000 for the similar period in 2005. Gains on sales
of mortgage loans and servicing rights totaled $110,000 in the 2006 period
compared to $63,000 in such gains in 2005 period. The gain in 2006 was primarily
due to the sale of $13.7 million of mortgage servicing rights to a third party,
on loans previously sold in the secondary market to FNMA. Net realized gain on
the sales of securities was $66,000 decreasing from such gains of $83,000 for
the 2005 period.
Other Expense
-------------
Other expense totaled $8,337,000 for the nine months ended September
30, 2006, an increase of $382,000, or 4.8%, over $7,955,000 for the similar
period in 2005. Salaries and employee benefit costs increased $263,000 due to
escalating health insurance, up $95,000, and expense recognition related to
stock options of $85,000. The 2006 period included a $50,000 robbery loss and a
$40,000 potential loss related to a possible fraudulent check.
Income Tax Expense
------------------
Income tax expense totaled $1,940,000 for an effective tax rate of
30.9% for the nine months ended September 30, 2006 compared to $1,703,000 and an
effective tax rate of 29.6% for the similar period in 2005. The increase in
taxes was principally due to $513,000, or 8.9%, increase in pre-tax income and a
lower level of tax exempt income. The decrease in tax-exempt income was
principally due to maturities of tax-exempt municipal bonds.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Risk
-----------
Interest rate sensitivity and the repricing characteristics of assets
and liabilities are managed by the Asset and Liability Management Committee
(ALCO). The principal objective of ALCO is to maximize net interest income
within acceptable levels of risk, which are established by policy. Interest rate
risk is monitored and managed by using financial modeling techniques to measure
the impact of changes in interest rates.
Net interest income, which is the primary source of the Company's
earnings, is impacted by changes in interest rates and the relationship of
different interest rates. To manage the impact of the rate changes, the balance
sheet must be structured so that repricing opportunities exist for both assets
and liabilities at approximately the same time intervals. The Company uses net
interest simulation to assist in interest rate risk management. The process
includes simulating various interest rate environments and their impact on net
interest income. As of September 30, 2006, the level of net interest income at
risk in a 200 basis points change in interest rates was within the Company's
policy limits. The Company's policy allows for a decline of no more than 8% of
net interest income.
Imbalance in repricing opportunities at a given point in time reflect
interest-sensitivity gaps measured as the difference between rate-sensitive
assets and rate-sensitive liabilities. These are static gap measurements that do
not take into account any future activity, and as such are principally used as
early indications of potential interest rate exposures over specific intervals.
As of September 30, 2006, the Bank had a positive 90 day interest
sensitivity gap of $42.0 million or 9.3% of total assets, increasing from $24.4
million, 5.6% of total assets as of December 31, 2005. The change was
principally due to a decrease of $9.7 million of other borrowings repricable
within three months and $6.6 million less in time deposits maturing within three
months. A positive gap means that rate-sensitive assets are greater than
rate-sensitive liabilities at the time interval. This would indicate that in a
rising rate environment, the yield on interest-earning assets would increase
faster than the cost of interest-bearing liabilities in the 90 day time frame.
The repricing intervals are managed by ALCO strategies, including adjusting the
average life of the investment portfolio, pricing of deposit liabilities to
attract longer or shorter term time deposits, loan pricing to encourage variable
or fixed rate products and evaluation of loan sales of long-term fixed rate
mortgages.
26
September 30, 2006
------------------
Rate Sensitivity Table
----------------------
(dollars in thousands)
3 Months 3-12 Months 1 to 3 Years 3 Years Total
-------- ----------- ------------ ------- -----
Federal funds sold and interest bearing deposits $ 1,666 $ - $ - $ - $ 1,666
Securities 21,207 36,416 35,755 19,978 113,356
Loan Receivable 94,697 45,275 78,467 95,239 313,678
-------- --------- -------- -------- --------
Total RSA 117,570 81,691 114,222 115,217 428,700
Non-maturity interest-bearing deposits 22,731 24,196 64,481 30,454 141,862
Time deposits 35,576 85,185 31,149 7,503 159,413
Other 17,231 4,653 11,202 - 33,086
-------- --------- -------- -------- --------
Total RSL 75,538 114,034 106,832 37,957 334,361
Interest Sensitivity Gap $ 42,032 $ (32,343) $ 7,390 $ 77,260 $ 94,339
Cumulative gap 42,032 9,689 17,079 94,339
RSA/RSL-Cumulative 155.6% 105.1% 105.8% 128.2%
December 31, 2005
Interest Sensitivity Gap $ 24,402 $ (5,676) $ 1,642 $ 56,582 $ 76,950
Cumulative gap 24,402 18,726 20,368 76,950
RSA/RSL-cumulative 126.6% 110.7% 107.1% 123.2%
Item 4. Controls and Procedures
The Company's management evaluated, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, the effectiveness
of the Company's disclosure controls and procedures, as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer concluded that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
There were no changes in the Company's internal control over
financial reporting that occurred during the Company's last fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 1A. Risk Factors
There have been no material changes in the risk factors affecting the Company
that were identified in Item 1A of Part I of the Company's Form 10-K for the
year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer
Purchases of Equity Securities
Issuer Purchases of
-------------------
Equity Securities
-----------------
Maximum number
--------------
Total number Average price Total number of of shares (or approximate
------------ ------------- --------------- -------------------------
of shares paid per shares purchased dollar value) that may yet
--------- -------- ---------------- --------------------------
purchased share as part of publicly be purchased
--------- ----- ------------------- ------------
announced plans under the plans
--------------- ---------------
or programs or programs
----------- -----------
July 1 - July 31, 2006 - - - -
August 1 - August 31, 2006 3,500 $31.60 3,500 99,863
September 1 - September 30, 2006 - - - -
----- ------ ----- ------
3,500 $31.60 3,500 99,863
===== ====== ===== ======
(1) On June 15, 2005, the Registrant announced its intention to repurchase up to
5% of its outstanding common stock (approximately 134,000 shares) in the open
market.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
28
Item 5. Other Information
None
Item 6. Exhibits
(a) 3(i) Articles of Incorporation of Norwood Financial Corp.*
3(ii) Bylaws of Norwood Financial Corp.*
4.0 Specimen Stock Certificate of Norwood Financial Corp.*
10.1 Amended Employment Agreement with William W. Davis, Jr.***
10.2 Amended Employment Agreement with Lewis J. Critelli ***
10.3 Form of Change-In-Control Severance Agreement with seven key employees of the Bank*
10.4 Consulting Agreement with Russell L. Ridd**
10.5 Wayne Bank Stock Option Plan*
10.6 Salary Continuation Agreement between the Bank and William W. Davis, Jr.***
10.7 Salary Continuation Agreement between the Bank and Lewis J. Critelli***
10.8 Salary Continuation Agreement between the Bank and Edward C. Kasper***
10.9 1999 Directors Stock Compensation Plan***
10.10 Salary Continuation Agreement between the Bank and Joseph A. Kneller****
10.11 Salary Continuation Agreement between the Bank and John H. Sanders****
10.12 2006 Stock Option Plan*****
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
32 Section 1350 Certification
___________________________
* Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10 Registration Statement initially filed with
the Commission on April 29, 1996.
** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 31,
1997.
*** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 20,
2000.
**** Incorporated herein by reference to the identically numbered exhibit
to the Registrant's Form 10-K filed with the Commission on March 22,
2004.
***** Incorporated herein by reference to the Registrant's Form 8-K filed
with the Commission on April 25, 2006.
29
Signatures
----------
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.
NORWOOD FINANCIAL CORP.
Date: November 13, 2006 By: /s/William W. Davis, Jr.
-------------------------------------
William W. Davis, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 13, 2006 By: /s/Lewis J. Critelli
-------------------------------------
Lewis J. Critelli
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
30