Norwood Financial (NWFL) 10-Q 2014 Q1 Quarterly report

UNITED STATES

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 March 31, 2014

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

Norwood Financial Corp.

(Exact name of Registrant as specified in its charter)

Pennsylvania	23-2828306
(State or other jurisdiction of Incorporation or organization)	(I.R.S. employer identification no.)

717 Main Street, Honesdale, Pennsylvania	18431
(Address of principal executive offices)	(Zip Code)

(570) 253-1455

(Registrant’s telephone number, including area code)

NA

(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 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes  [X]   No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  [  ]                                                                Accelerated filer   [ X]

Non-accelerated filer   [  ]                                                                Smaller reporting company   [  ]

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    [ ]  Yes   [X] No

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 May 1, 2014
Common stock, par value $0.10 per share	3,637,971

1

NORWOOD FINANCIAL CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2014

		Page Number
PART I -	CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD FINANCIAL CORP.
Item 1.	Financial Statements (unaudited)	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40
Item 4.	Controls and Procedures	41
PART II -	OTHER INFORMATION
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults upon Senior Securities	42
Item 4.	Mine Safety Disclosures	42
Item 5.	Other Information	42
Item 6.	Exhibits	42
Signatures		44

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PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

NORWOOD FINANCIAL CORP.

Consolidated Balance Sheets  (unaudited)

(dollars in thousands, except share and per share data)

	March 31,			December 31,
	2014			2013
ASSETS
Cash and due from banks	$	8,607		$	7,528
Interest bearing deposits with banks		142			335
Cash and cash equivalents		8,749			7,863
Securities available for sale, at fair value		156,165			158,132
Securities held to maturity, fair value 2014: $176
2013: $177		175			174
Loans receivable (net of unearned income)		496,016			503,097
Less:  Allowance for loan losses		5,727			5,708
Net loans receivable		490,289			497,389
Regulatory stock, at cost		2,741			2,877
Bank premises and equipment, net		7,031			7,125
Bank owned life insurance		17,930			17,790
Accrued interest receivable		2,330			2,422
Foreclosed real estate owned		1,364			1,009
Goodwill		9,715			9,715
Other intangibles		477			510
Deferred tax asset		4,294			4,819
Other assets		1,974			1,409
TOTAL ASSETS	$	703,234		$	711,234
LIABILITIES
Deposits:
Non-interest bearing demand	$	93,400		$	92,684
Interest-bearing		446,676			448,498
Total deposits		540,076			541,182
Short-term borrowings		40,373			49,914
Other borrowings		23,373			23,761
Accrued interest payable		973			1,022
Other liabilities		4,239			3,491
TOTAL LIABILITIES		609,034			619,370
STOCKHOLDERS’ EQUITY
Common stock, $.10 par value per share,
authorized 10,000,000 shares; issued 3,708,718  shares		371			371
Surplus		35,050			35,010
Retained  earnings		61,671			60,798
Treasury stock at cost: 2014: 71,297 shares,
2013: 64,628 shares		(1,892	)		(1,713	)
Accumulated other comprehensive loss		(1,000	)		(2,602	)
TOTAL STOCKHOLDERS’ EQUITY		94,200			91,864
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	703,234		$	711,234

See accompanying notes to the unaudited consolidated financial statements.

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NORWOOD FINANCIAL CORP.

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share data)

	Three Months Ended
	March 31,
	2014		2013
INTEREST INCOME
Loans receivable, including fees	$	5,980	$	6,186
Securities		987		868
Other		1		3
Total interest income		6,968		7,057
INTEREST EXPENSE
Deposits		635		754
Short-term borrowings		22		12
Other borrowings		166		190
Total interest expense		823		956
NET INTEREST INCOME		6,145		6,101
PROVISION FOR LOAN LOSSES		420		800
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		5,725		5,301
OTHER INCOME
Service charges and fees		576		592
Income from fiduciary activities		104		85
Net realized gains on sales of securities		95		138
Gains on sale of loans and servicing rights		39		11
Earnings and proceeds on bank owned life insurance		168		925
Other		71		126
Total other income		1,053		1,877
OTHER EXPENSES
Salaries and employee benefits		2,165		2,211
Occupancy, furniture & equipment, net		578		529
Data processing related		212		221
Taxes, other than income		165		174
Professional fees		165		187
Federal Deposit Insurance Corporation insurance assessment		114		111
Foreclosed real estate owned		65		191
Other		668		677
Total other expenses		4,132		4,301
INCOME BEFORE INCOME TAXES		2,646		2,877
INCOME TAX EXPENSE		682		569
NET INCOME	$	1,964	$	2,308
BASIC EARNINGS PER SHARE	$	0.54	$	0.64
DILUTED EARNINGS PER SHARE	$	0.54	$	0.63

See accompanying notes to the unaudited consolidated financial statements.

4

NORWOOD FINANCIAL CORP

Consolidated Statements of Comprehensive Income (unaudited)

(dollars in thousands)

	Three Months Ended			Three Months Ended
	March 31, 2014			March 31, 2013
Net income	$	1,964		$	2,308
Other comprehensive income (loss):
Investment securities available for sale:
Unrealized holding gains (losses)		2,525			(864	)
Tax effect		(860	)		293
Reclassification of gains recognized in net income		(95	)		(138	)
Tax effect		32			47
Other comprehensive income (loss)		1,602			(662	)
Comprehensive Income	$	3,566		$	1,646

See accompanying notes to the unaudited consolidated financial statements.

5

NORWOOD FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity (unaudited)

Three Months Ended March 31, 2014

(dollars in thousands, except share and per share data)

																			Accumulated
																			Other
	Common Stock								Retained				Treasury Stock						Comprehensive
	Shares		Amount			Surplus			Earnings				Shares		Amount				(Loss)				Total
Balance December 31, 2013		3,708,718		$	371		$	35,010		$	60,798			64,628		$	(1,713	)		$	(2,602	)		$	91,864
Net Income											1,964														1,964
Other comprehensive income																					1,602				1,602
Cash dividends declared ($.30 per share)											(1,091	)													(1,091	)
Acquisition of  treasury  stock														6,669			(179	)							(179	)
Compensation expense related to stock options								40																	40
Balance, March 31, 2014		3,708,718		$	371		$	35,050		$	61,671			71,297		$	(1,892	)		$	(1,000	)		$	94,200

See accompanying notes to the unaudited consolidated financial statements.

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NORWOOD FINANCIAL CORP.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)	Three Months Ended March 31
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	1,964		$	2,308
Adjustments to reconcile net income to net cash provided by operating  activities:
Provision for loan losses		420			800
Depreciation		147			149
Amortization of intangible assets		33			37
Deferred income taxes		(303	)		12
Net amortization of securities premiums and discounts		211			298
Net realized gain on sales of securities		(95	)		(138	)
Gain on life insurance policy		-			(770	)
Net increase in value of life insurance		(168	)		(155	)
Loss on sale of bank premises and equipment and foreclosed real estate		19			97
Net gain on sale of mortgage loans		(41	)		(11	)
Mortgage loans originated for sale		(1,110	)		(1,101	)
Proceeds from sale of mortgage loans originated for sale		1,151			1,112
Compensation expense related to stock options		40			39
Decrease in accrued interest receivable and other assets		(445	)		(530	)
Increase in accrued interest payable and other liabilities		701			732
Net cash provided by operating activities		2,524			2,879
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		12,080			7,403
Proceeds from maturities and principal reductions on mortgage-backed securities		3,150			5,093
Purchases		(10,950	)		(16,867	)
Purchase of FHLB stock		(504	)		-
Redemption of FHLB stock		640			97
Net decrease (increase) in loans		6,297			(2,964	)
Proceeds from life insurance policy		-			1,859
Purchase of bank premises and equipment		(53	)		(14	)
Proceeds from sale of bank premises and equipment and foreclosed real estate		9			127
Net cash provided by (used in) investing activities		10,669			(5,266	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (decrease) increase in deposits		(1,106	)		11,207
Net decrease in short-term borrowings		(9,541	)		(6,838	)
Repayments of other borrowings		(388	)		(144	)
Proceeds from other borrowings		-			3,000
Stock options exercised		-			142
Tax benefit of stock options exercised		-			11
Acquisition of treasury stock		(179	)		(319	)
Cash dividends paid		(1,093	)		(1,022	)
Net cash (used in) provided by financing activities		(12,307	)		6,037
Increase in cash and cash equivalents		886			3,650
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		7,863			12,295
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	8,749		$	15,945

See accompanying notes to the unaudited consolidated financial statements.

7

NORWOOD FINANCIAL CORP.

Consolidated Statements of Cash Flows (Unaudited) (continued)

(dollars in thousands)	Three Months Ended March 31,
	2014			2013
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest on deposits and borrowings		$	872		$	1,116
Income taxes paid, net of refunds			204			(3	)
Supplemental Schedule of Noncash Investing Activities
Transfers of loans to foreclosed real estate and repossession of other assets			383			486

See accompanying notes to the unaudited consolidated financial statements.

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Notes to the Unaudited Consolidated Financial Statements

1.         Basis of Presentation

The unaudited 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., Norwood Settlement Services, LLC,  and WTRO Properties.   All significant intercompany transactions have been eliminated in consolidation.

The accompanying unaudited consolidated  financial statements have been prepared in conformity with generally accepted accounting principles for interim financial statements and with instructions to Form 10-Q. 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 and results of operations of the Company.  The operating results for the three month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 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, 2013.

2.         Earnings Per Share

Basic earnings per share represents income available to common stockholders divided by the weighted average number of common shares outstanding during the period.  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.

The following table sets forth the weighted average shares outstanding used in the computations of basic and diluted earnings per share.

(in thousands)

	Three Months Ended
	March 31,
	2014	2013
Basic EPS weighted average shares outstanding	3,643	3,628
Dilutive effect of stock options	10	9
Diluted EPS weighted average shares outstanding	3,653	3,637

Stock options which had no intrinsic value, because their effect would be anti-dilutive and therefore would not be included in the diluted EPS calculation were 20,700 and 40,700 as of March 31, 2014 and 2013, respectively, based upon the closing prices of Norwood common stock of $28.60 and $27.82 per share on March 31, 2014 and 2013, respectively.

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3.         Stock-Based Compensation

The Company’s shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the annual meeting on April 25, 2006.  No awards were granted during the three month period ending March 31, 2014. As of March 31, 2014, there was $117,000 of total unrecognized compensation cost related to non-vested options granted in 2013 under the plan, which will be fully amortized by December 31, 2014.

A summary of stock options from all plans, adjusted for stock dividends declared, is shown below.

		Weighted
		Average Exercise		Weighted Average	Aggregate
		Price		Remaining	Intrinsic Value
	Options	Per Share		Contractual Term	($000)
Outstanding at January 1, 2014	219,540	$	26.64	6.1 Yrs.	$	147
Granted	-		-	- Yrs.		-
Exercised	-		-	- Yrs.		-
Forfeited	-		-	- Yrs.		-
Outstanding at March 31, 2014	219,540	$	26.64	5.8 Yrs.	$	431
Exercisable at March 31, 2014	192,040	$	26.58	5.2 Yrs.	$	388

Intrinsic value represents the amount by which the market price of the stock on the measurement date exceeded the exercise price of the option.  The stock price was $28.60 as of March 31, 2014 and $26.90 as of December 31, 2013.

4.         Accumulated Other Comprehensive Income

The following table presents the changes in accumulated other comprehensive income (in thousands) by component net of tax for the three months ended March 31, 2014 and 2013:

	Unrealized gains (losses) on
	available for sale
	securities (a)
Balance as of December 31, 2013		$	(2,602	)
Other comprehensive loss before reclassification			1,665
Amount reclassified from accumulated other comprehensive income (loss)			(63	)
Total other comprehensive loss			1,602
Balance as of March 31, 2014		$	(1,000	)

	Unrealized gains (losses) on
	available for sale
	securities (a)
Balance as of December 31, 2012		$	2,797
Other comprehensive loss before reclassification			(571	)
Amount reclassified from accumulated other comprehensive income (loss)			(91	)
Total other comprehensive loss			(662	)
Balance as of March 31, 2013		$	2,135

(a)  All amounts are net of tax.  Amounts in parentheses indicate debits.

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The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) (in thousands) for the three months ended March 31, 2014 and 2013:

	From Accumulated				Affected Line Item in
	Other				the Statement Where
	Comprehensive				Net Income is
Details about other comprehensive income	Income (a)				Presented
		Three months		Three months
		ended		ended
		March 31,		March 31,
		2014		2013
Unrealized gains on available for sale securities	$	95	$	138	Net realized gains on sales of securities
		(32)		(47)	Income tax expense
	$	63	$	91	Net of tax

(a)  Amounts in parentheses indicate debits to net income

5.         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)	March 31,
	2014		2013
Unfunded availability under loan commitments	$	24,728	$	22,836
Unfunded commitments under lines of credit		46,360		49,433
Standby letters of credit		5,700		6,128
	$	76,788	$	78,397

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

11

collateral obtained, if deemed 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 payments required under the corresponding guarantees.  The current amount of the liability as of March 31, 2014 for guarantees under standby letters of credit issued is not material.

6.         Securities

The amortized cost and fair value of securities were as follows:

	March 31, 2014
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Available for Sale:
U.S. Government agencies	$	27,762	$	5	$	(675	)	$	27,092
States and political subdivisions		62,177		1,239		(833	)		62,583
Corporate obligations		3,646		81		(27	)		3,700
Mortgage-backed securities-
government sponsored entities		63,798		132		(1,485	)		62,445
Equity securities-financial services		292		53		-			345
	$	157,675	$	1,510	$	(3,020	)	$	156,165
Held to Maturity:
States and political subdivisions	$	175	$	1	$	-		$	176

	December 31, 2013
				Gross			Gross
	Amortized			Unrealized			Unrealized				Fair
	Cost			Gains			Losses				Value
	(In Thousands)
Available for Sale:
U.S. Government agencies		$	34,471		$	-		$	(1,058	)		$	33,413
States and political subdivisions			60,174			650			(1,794	)			59,030
Corporate obligations			3,667			84			(40	)			3,711
Mortgage-backed securities-government
sponsored entities			63,467			81			(1,898	)			61,650
Equity securities-financial services			293			50			(15	)			328
		$	162,072		$	865		$	(4,805	)		$	158,132
Held to Maturity:
States and political subdivisions		$	174		$	3		$	-			$	177

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The following tables show the Company’s investments’ gross unrealized losses and fair value aggregated by length of time that individual securities have been in a continuous unrealized loss position (in thousands):

	March 31, 2014
	Less than 12 Months							12 Months or More							Total
	Fair Value			Unrealized Losses				Fair Value			Unrealized Losses				Fair Value			Unrealized Losses
U.S. government agencies		$	23,010		$	(622	)		$	947		$	(53	)		$	23,957		$	(675	)
States and political subdivisions			15,113			(506	)			5,406			(327	)			20,519			(833	)
Corporate Obligations			1,151			(27	)			-			-				1,151			(27	)
Mortgage-backed securities-government sponsored agencies			31,166			(632	)			16,545			(853	)			47,711			(1,485	)
		$	70,440		$	(1,787	)		$	22,898		$	(1,233	)		$	93,338		$	(3,020	)

	December 31, 2013
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government agencies	$	32,481	$	(990	)	$	932	$	(68	)	$	33,413	$	(1,058	)
States and political subdivisions		26,281		(1,415	)		4,228		(379	)		30,509		(1,794	)
Corporate obligations		1,145		(40	)		-		-			1,145		(40	)
Mortgage-backed securities-government sponsored agencies		47,014		(1,524	)		7,478		(374	)		54,492		(1,898	)
Equity securities - financial services		170		(15	)		-		-			170		(15	)
	$	107,091	$	(3,984	)	$	12,638	$	(821	)	$	119,729	$	(4,805	)

At March 31, 2014, the Company has 80 debt securities in an unrealized loss position in the less than twelve months category and 24 debt securities in the twelve months or more category.  In Management’s opinion the unrealized losses reflect changes in interest rates subsequent to the acquisition of specific securities.  No other-than-temporary-impairment charges were recorded in 2014.  Management believes that all unrealized losses represent temporary impairment of the securities as the Company does not have the intent to sell the securities and it is more likely than not that it will not have to sell the securities before recovery of its cost basis.

The amortized cost and fair value of debt securities as of March 31, 2014 by contractual maturity are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

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	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)
Due in one year or less	$	-	$	-	$	175	$	176
Due after one year through five years		16,825		16,692		-		-
Due after five years through ten years		28,352		28,041		-		-
Due after ten years		48,408		48,642		-		-
Mortgage-backed securities-government sponsored agencies		63,798		62,445		-		-
	$	157,383	$	155,820	$	175	$	176

Gross realized gains and gross realized losses on sales of securities available for sale were as follows (in thousands):

	Three Months
	Ended March 31,
	2014			2013
Gross realized gains		$	95		$	156
Gross realized losses			-			(18	)
Net realized gain		$	95		$	138
Proceeds from sales of securities		$	12,080		$	7,403

7.        Loans Receivable and Allowance for Loan Losses

Set forth below is selected data relating to the composition of the loan portfolio at the dates indicated:

	Types of loans
	(dollars in thousands)
	March 31, 2014					December 31, 2013
Real Estate-Residential	$	156,651		31.5	%	$	158,842		31.6	%
Commercial		265,571		53.5			273,144		54.2
Construction		21,400		4.3			20,551		4.1
Commercial, financial and agricultural		37,606		7.6			35,745		7.1
Consumer loans to individuals		15,245		3.1			15,295		3.0
Total loans		496,473		100.0	%		503,577		100.0	%
Deferred fees, net		(457	)				(480	)
Total loans receivable		496,016					503,097
Allowance for loan losses		(5,727	)				(5,708	)
Net loans receivable	$	490,289				$	497,389

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Changes in the accretable yield for purchased credit-impaired loans were as follows for the three months ended March 31 (in thousands):

	2014			2013
Balance at beginning of period	$	20		$	76
Accretion		(7	)		(23	)
Reclassification and other		-			-
Balance at end of period	$	13		$	53

The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):

	March 31, 2014			December 31, 2013
Outstanding Balance		$	1,098		$	1,110
Carrying Amount		$	1,085		$	1,090

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and March 31, 2014.  There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of May 31, 2011. In addition, there has been no allowance for loan losses on these loans reversed.  For loans that were acquired without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation.

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans.  Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers.  Specific loan loss allowances are established for identified losses based on a review of such information.  A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probably that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans identified as impaired are evaluated independently.  We do not aggregate such loans for evaluation purposes.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider.  Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk.

15

The following table shows the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:

	Real Estate Loans
										Commercial			Consumer
	Residential			Commercial			Construction			Loans			Loans			Total
March 31, 2014	(In thousands)
Individually evaluated for  impairment		$	-		$	10,634		$	-		$	-		$	-		$	10,634
Loans acquired with deteriorated credit quality			237			848			-			-			-			1,085
Collectively evaluated for impairment			156,414			254,089			21,400			37,606			15,245			484,754
Total Loans		$	156,651		$	265,571		$	21,400		$	37,606		$	15,245		$	496,473

	Real Estate Loans
										Commercial			Consumer
	Residential			Commercial			Construction			Loans			Loans			Total
	(In thousands)
December 31, 2013
Individually evaluated for impairment		$	-		$	11,519		$	-		$	-		$	-		$	11,519
Loans acquired with deteriorated credit quality			242			848			-			-			-			1,090
Collectively evaluated for impairment			158,600			260,777			20,551			35,745			15,295			490,968
Total Loans		$	158,842		$	273,144		$	20,551		$	35,745		$	15,295		$	503,577

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The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable.  Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.

			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
March 31, 2014			(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	237	$	245	$	-
Commercial		9,310		12,631		-
Subtotal		9,547		12,876		-
With an allowance recorded:
Real Estate Loans
Commercial		2,172		2,882		203
Subtotal		2,172		2,882		-
Total:
Real Estate Loans
Residential		237		245		-
Commercial		11,482		15,513		203
Total Impaired Loans	$	11,719	$	15,758	$	203

			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2013			(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	242	$	251	$	-
Commercial		10,644		14,400		-
Subtotal		10,886		14,651		-
With an allowance recorded:
Real Estate Loans
Commercial		1,723		1,723		53
Subtotal		1,723		1,723		53
Total:
Real Estate Loans
Residential		242		251		-
Commercial		12,367		16,123		53
Total Impaired Loans	$	12,609	$	16,374	$	53

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The following information for impaired loans is presented (in thousands) for the three months ended March 31, 2014 and 2013:

	Average Recorded						Interest Income
	Investment						Recognized
	2014			2013			2014			2013
Total:
Real Estate Loans
Residential		$	240		$	262		$	1		$	1
Commercial			11,754			10,839			57			19
Total Loans		$	11,994		$	11,101		$	58		$	20

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.  As of March 31, 2014, troubled debt restructured loans totaled $9.1 million and resulted in specific reserves of $203,000.  As of December 31, 2013, troubled debt restructured loans totaled $9.2 million and resulted in specific reserves of $53,000.  For the periods ended March 31, 2014 and 2013, there were no new loans identified as troubled debt restructurings, nor were there any loan modifications classified as troubled debt restructurings that subsequently defaulted during the period.

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio.  The first four categories are considered not criticized, and are aggregated as “Pass” rated.  The criticized rating categories utilized by management generally follow bank regulatory definitions.  The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  All loans greater than 90 days past due are considered Substandard.  Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event.  The Company’s Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis.  Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration.  Loan Review also annually reviews relationships of $500,000 and over to assign or re-affirm risk ratings.  Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of  March 31, 2014 and December 31, 2013 (in thousands):

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			Special				Doubtful
	Pass		Mention		Substandard		and Loss		Total
March 31, 2014
Commercial real estate loans	$	244,455	$	3,752	$	17,364	$	-	$	265,571
Commercial loans		37,606		-		-		-		37,606
Total	$	282,061	$	3,752	$	17,364	$	-	$	303,177

			Special				Doubtful
	Pass		Mention		Substandard		and Loss		Total
December 31, 2013
Commercial real estate loans	$	250,566	$	3,651	$	18,927	$	-	$	273,144
Commercial loans		35,745		-		-		-		35,745
Total	$	286,311	$	3,651	$	18,927	$	-	$	308,889

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits.  The following table presents the recorded investment in the loan classes based on payment activity as of March 31, 2014 and December 31, 2013 (in thousands):

	Performing			Nonperforming			Total
March 31, 2014
Residential real estate loans		$	155,022		$	1,629		$	156,651
Construction			21,400			-			21,400
Consumer loans			15,245			-			15,245
Total		$	191,667		$	1,629		$	193,296

	Performing			Nonperforming			Total
December 31, 2013
Residential real estate loans		$	157,138		$	1,704		$	158,842
Construction			20,551			-			20,551
Consumer loans			15,295			-			15,295
Total		$	192,984		$	1,704		$	194,688

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of March 31, 2014 and December 31, 2013 (in thousands):

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non- Accrual		Total Loans
March 31, 2014
Real Estate loans
Residential	$	154,518	$	377	$	127	$	-	$	1,629	$	2,133	$	156,651
Commercial		257,381		287		-		-		7,903		8,190		265,571
Construction		21,400		-		-		-		-		-		21,400
Commercial  loans		37,584		22		-		-		-		22		37,606
Consumer  loans		15,134		96		15		-		-		111		15,245
Total	$	486,017	$	782	$	142	$	-	$	9,532	$	10,456	$	496,473

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	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non- Accrual		Total Loans
December 31, 2013
Real Estate loans
Residential	$	156,066	$	1,018	$	54	$	-	$	1,704	$	2,776	$	158,842
Commercial		263,837		977		487		-		7,843		9,307		273,144
Construction		20,551		-		-		-		-		-		20,551
Commercial  loans		35,717		28		-		-		-		28		35,745
Consumer  loans		15,228		57		10		-		-		67		15,295
Total	$	491,399	$	2,080	$	551	$	-	$	9,547	$	12,178	$	503,577

The following table presents the allowance for loan losses by the classes of the loan portfolio:

(In thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial		Consumer			Total
Beginning balance, December 31, 2013	$	1,441		$	3,025		$	898		$	184	$	160	��	$	5,708
Charge Offs		(75	)		(329	)		-			-		(11	)		(415	)
Recoveries		-			-			-			-		14			14
Provision Expense		(34	)		1,146			(667	)		-		(25	)		420
Ending balance, March 31, 2014	$	1,332		$	3,842		$	231		$	184	$	138		$	5,727
Ending balance individually evaluated for impairment	$	-		$	203		$	-		$	-	$	-		$	203
Ending balance collectively evaluated for impairment	$	1,332		$	3,639		$	231		$	184	$	138		$	5,524

(In thousands)	Residential Real Estate			Commercial Real Estate			Construction		Commercial			Consumer			Total
Beginning balance, December 31, 2012	$	1,797		$	3,183		$	119	$	223		$	180		$	5,502
Charge Offs		(250	)		(313	)		-		-			(19	)		(582	)
Recoveries		-			-			-		-			6			6
Provision Expense		427			420			5		(47	)		(5	)		800
Ending balance, March 31, 2013	$	1,974		$	3,290		$	124	$	176		$	162		$	5,726
Ending balance individually evaluated for impairment	$	-		$	-		$	-	$	-		$	-		$	-
Ending balance collectively evaluated for impairment	$	1,974		$	3,290		$	124	$	176		$	162		$	5,726

The Company’s primary business activity as of March 31, 2014 and December 31, 2013 is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy.

As of March 31, 2014, the Company considered its concentration of credit risk to be acceptable.  The highest concentrations are in the hospitality lodging industry, automobile dealers, property owners associations and resorts with loans outstanding of $37.2 million, or 42.8% of capital, to the hospitality lodging industry,

20

$14.3 million, or 16.5% of capital to automobile dealers, $12.1 million, or 13.9% of capital, to property owners associations and $9.1 million, or 10.6% of capital, to the resort industry.  During the current period, the Company recorded a write down of $300,000 on a motel property.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $42,000 and $0, respectively, in the first three months of 2014 compared to $18,000 and $7,000, respectively, in the same period in 2013.  The proceeds from the sales of residential mortgage loans totaled $1.1 million for each of the three month periods ended March 31, 2014 and 2013, respectively.

8.         Fair Value Measurements

Fair value estimates are based on quoted market prices, if available, quoted market prices of similar assets or liabilities, or the present value of expected future cash flows and other valuation techniques.  These valuations are significantly affected by discount rates, cash flow assumptions and risk assumptions used.  Therefore, fair value estimates may not be substantiated by comparison to independent markets and are not intended to reflect the proceeds that may be realizable in an immediate settlement of the instruments.

Fair value is determined at one point in time and is not representative of future value.  These amounts do not reflect the total value of a going concern organization.  Management does not have the intention to dispose of a significant portion of its assets and liabilities and therefore, the unrealized gains or losses should not be interpreted as a forecast of future earnings and cash flows.

The following is a discussion of assets and liabilities measured at fair value on a recurring basis and valuation techniques applied:

Securities:

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.

Impaired loans (generally carried at fair value):

The Company measures impairment generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the lowest level of input that is significant to the fair value measurements.

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Foreclosed real estate owned (carried at fair value):

Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less estimated cost to sell.  Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral.  These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2014 and December 31, 2013 are as follows:

	Fair Value Measurement Using
	Reporting Date
Description	Total		Level 1		Level 2		Level 3
	(In thousands)
March 31, 2014
Available for Sale:
US Government agencies	$	27,092	$	-	$	27,092	$	-
States and political subdivisions		62,583		-		62,583		-
Corporate obligations		3,700		-		3,700		-
Mortgage-backed securities-government
sponsored agencies		62,445		-		62,445		-
Equity securities-financial services		345		345		-		-
Total	$	156,165	$	345	$	155,820	$	-
December 31, 2013
Available for Sale:
US Government agencies	$	33,413	$	-	$	33,413	$	-
States and political subdivisions		59,030		-		59,030		-
Corporate obligations		3,711		-		3,711		-
Mortgage-backed securities-government
sponsored agencies		61,650		-		61,650		-
Equity securities-financial services		328		328		-		-
Total	$	158,132	$	328	$	157,804	$	-

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2014 and December 31, 2013 are as follows:

				Fair Value Measurement Reporting Date using
(In thousands)
Description	Total			Level 1			Level 2			Level 3
March 31, 2014
Impaired Loans		$	11,516		$	-		$	-		$	11,516
Foreclosed Real Estate Owned			1,364			-			-			1,364
December 31, 2013
Impaired Loans		$	12,556		$	-		$	-		$	12,556
Foreclosed Real Estate Owned			1,009			-			-			1,009

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The following tables present 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
(In thousands)	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
March 31, 2014
Impaired loans	$	11,516	Appraisal of collateral(1)	Appraisal adjustments(2)		10% (10.0)	%
Foreclosed real estate owned	$	1,364	Appraisal of collateral(1)	Liquidation Expenses(2)		10	%

	Quantitative Information about Level 3 Fair Value Measurements
(In thousands)	Fair Value Estimate			Valuation Techniques	Unobservable Input	Range (Weighted Average)
December 31, 2013
Impaired loans		$	12,556	Appraisal of collateral(1)	Appraisal adjustments(2)		10-15% (10.67)	%
Foreclosed real estate owned		$	1,009	Appraisal of collateral(1)	Liquidation Expenses(2)		10	%

(1)   Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable, less any associated allowance.

(2)   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.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.  The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at March 31, 2014 and December 31, 2013.

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Cash and cash equivalents (carried at cost):

The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities:

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.

Loans receivable (carried at cost):

The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired loans (generally carried at fair value):

The Company measures impairment generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the lowest level of input that is significant to the fair value measurements.

As of March 31, 2014, the fair value investment in impaired loans totaled $11,516,000 which included two loans for $2,172,000 for which a valuation allowance of $203,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and fifteen loans for $9,547,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of March 31, 2014, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $3,847,000 over the life of the loans.

As of December 31, 2013, the fair value investment in impaired loans totaled $12,556,000 which included one loan for $1,723,000 for which a valuation allowance of $53,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and twenty loans for $10,886,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of December 31, 2013, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $3,714,000 over the life of the loans.

Mortgage servicing rights (generally carried at cost)

The Company utilizes a third party provider to estimate the fair value of certain loan servicing rights.  Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation.

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Foreclosed real estate owned (carried at fair value):

Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

Restricted investment in Federal Home Loan Bank stock (carried at cost):

The Company, as a member of the Federal Home Loan Bank (FHLB) system is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula. This regulatory stock has no quoted market value and is carried at cost.

Bank owned life insurance (carried at cost):

The fair value is equal to the cash surrender value of the Bank owned life insurance.

Accrued interest receivable and payable (carried at cost):

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit liabilities (carried at cost except certificates of deposit which are at fair value):

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings (carried at cost):

The carrying amounts of short-term borrowings approximate their fair values.

Other borrowings (carried at cost):

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Off-balance sheet financial instruments (disclosed at cost):

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

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The estimated fair values of the Bank’s financial instruments were as follows at March 31, 2014 and December 31, 2013. (In thousands)

	Fair Value Measurements at March 31, 2014
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	8,749	$	8,749	$	8,749	$	-	$	-
Securities		156,340		156,341		345		155,996		-
Loans receivable, net		490,289		505,518		-		-		505,518
Mortgage servicing rights		286		286		286		-		-
Regulatory Stock		2,741		2,741		2,741		-		-
Bank owned life insurance		17,930		17,930		17,930		-		-
Accrued interest receivable		2,330		2,330		2,330		-		-
Financial liabilities:
Deposits		540,076		540,858		331,722		-		209,136
Short-term borrowings		40,373		40,373		40,373		-		-
Other borrowings		23,373		25,181		-		-		25,181
Accrued interest payable		973		973		973		-		-
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding letters of credit		-		-		-		-		-

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	Fair Value Measurements at December 31, 2013
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	7,863	$	7,863	$	7,863	$	-	$	-
Securities		158,306		158,309		328		157,981		-
Loans receivable, net		497,389		506,113		-		-		506,113
Mortgage servicing rights		289		289		-		289		-
Regulatory stock		2,877		2,877		2,877		-		-
Bank owned life insurance		17,790		17,790		17,790		-		-
Accrued interest receivable		2,422		2,422		2,422		-		-
Financial liabilities:
Deposits		541,182		542,123		329,753		-		212,370
Short-term borrowings		49,914		49,914		49,914		-		-
Other borrowings		23,761		25,923		-		-		25,923
Accrued interest payable		1,022		1,022		1,022		-		-
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding letters of  credit		-		-		-		-		-

9.           New and Recently Adopted Accounting Pronouncements

In June 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-08, Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements. The amendments in this Update affect the scope, measurement, and disclosure requirements for investment companies under U.S. GAAP. The amendments do all of the following: 1. Change the approach to the investment company assessment in Topic 946, clarify the characteristics of an investment company, and provide comprehensive guidance for assessing whether an entity is an investment Company. 2. Require an investment company to measure non-controlling ownership interests in other investment companies at fair value rather than using the equity method of accounting. 3. Require the following additional disclosures: (a) the fact that the entity is an investment company and is applying the guidance in Topic 946, (b) information about changes, if any, in an entity’s status as an investment company, and (c) information about financial support provided or contractually required to be provided by an investment company to any of its investees. The amendments in this Update are effective for an entity’s interim and annual reporting periods in fiscal years that begin after December 15, 2013. Earlier application is prohibited. This ASU is not expected to have a significant impact on the Company’s financial statements.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry forward, a Similar Tax Loss, or a Tax Credit Carry forward Exists. This Update applies to all entities that have unrecognized tax benefits when a net operating loss carry forward, a similar tax loss, or a tax credit carry forward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry forward, a similar tax loss, or a

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tax credit carry forward, except as follows. To the extent a net operating loss carry forward, a similar tax loss, or a tax credit carry forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.  This ASU is not expected to have a significant impact on the Company’s financial statements.

In January 2014, FASB issued ASU 2014-01, Investments – Equity Method and Join Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. The amendments in this Update permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits  received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit).  The amendments in this Update should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this Update are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014.  Early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method.  The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

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

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subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. Those risks and uncertainties are as follows:

• our ability to realize the anticipated benefits from our acquisition of North Penn Bancorp, Inc.

• possible future impairment of intangible assets

• our ability to effectively manage future growth

• loan losses in excess of our allowance

• risks inherent in commercial lending

• real estate collateral which is subject to declines in value

• potential other-than-temporary impairments

• higher deposit insurance premiums

• soundness of other financial institutions

• increased compliance burden under new financial reform legislation

• current market volatility

• potential liquidity risk

• availability of capital

• regional economic factors

• loss of senior officers

• comparatively low legal lending limits

• risks of new capital requirements

• limited market for the Company’s stock

• restrictions on ability to pay dividends

• common stock may lose value

• competitive environment

• issuing additional shares may dilute ownership

• extensive and complex governmental regulation and associated cost

• interest rate risks

Norwood Financial Corp. 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 for the year ended December 31, 2013 (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, the valuation of deferred tax assets, the fair value of financial instruments, the determination of goodwill impairment and the determination of other-than-temporary impairment on securities.  Please refer to the discussion of the allowance for loan losses calculation under “Allowance for Loan Losses and Non-performing Assets” in the “Changes in Financial Condition” section.

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The Company uses the modified prospective transition method to account for stock based compensation.  Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.

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 that it is more likely than not that all deferred tax assets will be realized.

Bonds, notes and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the term of the security.

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each Consolidated Balance Sheet date.

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, the Company considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis.  The Company believes that the unrealized loss on all other securities at March 31, 2014 and December 31, 2013 represent temporary impairment of the securities, related to changes in interest rates.

The Company, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula.  This restricted stock has no quoted market value and is carried at cost.

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB.

Management considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and the new shares of FHLB stock continue to change hands at the $100 par value.  Management believes no impairment charge is necessary related to FHLB stock as of March 31, 2014.

In connection with the acquisition of North Penn Bancorp, Inc. (“North Penn”), we recorded goodwill in the amount of $9.7 million, representing the excess of amounts paid over the fair value of net assets of the institutions acquired in purchase transactions, at its fair value at the date of acquisition.  Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value.  The value of the goodwill can change in the future.  We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Bank.  If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss.

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Changes in Financial Condition

General

Total assets as of March 31, 2014 were $703.2 million compared to $711.2 million as of December 31, 2013, a decrease of $8.0 million due to a  $7.1  million reduction in loans outstanding.

Securities

The fair value of securities available for sale as of March 31, 2014 was $156.2 million compared to $158.1 million as of December 31, 2013.  The Company purchased $10.9 million of securities principally using the proceeds from $15.2  million of sales, calls, maturities and principal reductions of securities.

The carrying value of the Company’s securities portfolio (Available-for Sale and Held-to Maturity) consisted of the following:

	March 31, 2014					December 31, 2013
(dollars in thousands)	Amount		% of portfolio			Amount		% of portfolio
US Government agencies	$	27,092		17.3	%	$	33,413		21.1	%
States and political subdivisions		62,758		40.1			59,204		37.4
Corporate obligations		3,700		2.4			3,711		2.3
Mortgage-backed securities-
government sponsored entities		62,445		39.9			61,650		39.0
Equity securities-financial services		345		0.2			328		0.2
Total	$	156,340		100.0	%	$	158,306		100.0	%

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 holds a small amount of equity securities in other financial institutions, the value of which has been impacted by the weakening conditions of the financial markets.  Management believes that the unrealized losses on all holdings represent temporary impairment of the securities, as the Company has the intent and ability to hold these investments until maturity or market price recovery.

Loans

Loans receivable totaled $496.0 million at March 31, 2014 compared to $503.1 million as of December 31, 2013.  The $7.1 million decrease recorded in the three month period ending March 31, 2014 was attributed to a $7.6 million decrease in commercial real estate loans and a $2.2 million decrease in residential mortgage loans.  Commercial loans increased $1.9 million during the period while other loans increased $800,000.

The allowance for loan losses totaled $5,727,000 as of March 31, 2014 and represented 1.15% of total loans, compared to $5,708,000, or 1.13% of total loans, at December 31, 2013, and $5,726,000, or 1.20% of total loans, as of March 31, 2013.  The Company had net charge-offs for the three months ended March 31, 2014 of $401,000 compared to $576,000 in the comparable period in 2013.  The Company’s loan review process assesses the adequacy of the allowance for loan losses on a quarterly basis.  The process includes an

31

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 classifications, large dollar exposures and loan growth.  Management considers the allowance adequate at March 31, 2014 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 March 31, 2014, non-performing loans totaled $9.5 million, or 1.92% of total loans compared to $9.5 million, or 1.90% of total loans at December 31, 2013. At March 31, 2014, non-performing assets totaled $10.9 million, or 1.55%, of total assets compared to $10.6 million, or 1.48%, of total assets at December 31, 2013.  The increase reflects the transfer of four properties into foreclosed real estate owned with a carrying value of $383,000.

The following table sets forth information regarding non-performing loans and foreclosed real estate at the dates indicated:

(dollars in thousands)	March 31, 2014			December 31, 2013
Loans accounted for on a non-accrual basis:
Commercial and all other	$	-		$	-
Real Estate		9,532			9,547
Total non-accrual loans *		9,532			9,547
Accruing loans which are contractually			��
past due 90 days or more		-			-
Total non-performing loans		9,532			9,547
Foreclosed real estate		1,364			1,009
Total non-performing assets	$	10,896		$	10,556
Allowance for loans losses	$	5,727		$	5,708
Coverage of non-performing loans		0.60	x		0.60	x
Non-performing loans to total loans		1.92	%		1.90	%
Non-performing loans to total assets		1.36	%		1.34	%
Non-performing assets to total assets		1.55	%		1.48	%

*Includes non-accrual TDRs of $6.2 million as of March 31, 2014 and December 31, 2013. The Company also had $3.0 million of accruing TDRs on those dates.

Deposits

During the period, total deposits decreased $1.1 million due primarily to a $3.7 million decrease in certificates of deposit over $100,000 as municipalities utilized funds to meet cash flow needs.  All other deposit products increased $2.6 million, net.

The following table sets forth deposit balances as of the dates indicated:

(dollars in thousands)	March 31, 2014		December 31, 2013
Non-interest bearing demand	$	93,400	$	92,684
Interest bearing demand		46,059		45,444
Money market deposit accounts		120,907		122,423
Savings		71,356		69,202
Time deposits <$100,000		132,382		131,793
Time deposits >$100,000		75,972		79,636
Total	$	540,076	$	541,182

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Borrowings

Short-term borrowings as of March 31, 2014 totaled $40.4 million compared to $49.9 million as of December 31, 2013.  Short-term borrowings, which consisted of securities sold under agreements to repurchase and overnight borrowings from the FHLB, decreased $9.5 million principally due to the seasonality of municipal cash management accounts and a reduced level of overnight borrowings due to loan payoffs.

Other borrowings consisted of the following:

(dollars in thousands)

	March 31, 2014		December 31, 2013
Notes with the FHLB:
Fixed rate note due July 2015 at 4.34%	$	7,254	$	7,301
Convertible note due January 2017 at 4.71%		10,000		10,000
Amortizing fixed rate borrowing due January, 2018 at 0.91%		2,312		2,460
Amortizing fixed rate borrowing due December, 2018 at 1.425%		3,807		4,000
	$	23,373	$	23,761

The convertible notes contain an option which allows the FHLB, at quarterly intervals to change the note to an adjustable-rate advance at three month LIBOR plus 19 to 22 basis points.  If the notes are converted, the option allows the Bank to put the funds back to the FHLB at no charge.  The fixed rate borrowing due July 2015 includes a $254,000 fair value adjustment recorded at the time of the North Penn acquisition.

Off-Balance Sheet Arrangements

The Bank is 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.  Commitments to grant loans totaled $24.7 million as of March 31, 2014 compared to $22.8 million as of December 31, 2013.

A summary of the contractual amount of the Company’s financial instrument commitments is as follows:

	March 31, 2014		December 31, 2013
	(in thousands)
Unfunded availability under loan commitments	$	24,728	$	22,845
Unfunded commitments under lines of credit		46,360		42,575
Standby letters of credit		5,700		5,701
	$	76,788	$	71,121

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Stockholders’ Equity and Capital Ratios

As of March 31, 2014, stockholders’ equity totaled $94.2 million, compared to $91.9 million as of December 31, 2013.   The net change in stockholders’ equity included $2.0 million of net income that was partially offset by $1.1 million of dividends declared, a $179,000 reduction due to an increase in Treasury Stock, and a $40,000 increase due to the exercise and vesting of stock options.  In addition, total equity increased $1.6 million due to an increase in the fair value of securities in the available for sale portfolio, net of tax.  This increase in fair value is the result of a change in interest rates and spreads, which may impact the value of the securities. Because of interest rate volatility, the Company’s accumulated other comprehensive income could materially fluctuate for each interim and year-end period.

A comparison of the Company’s regulatory capital ratios is as follows:

	March 31, 2014			December 31, 2013
Tier 1 Capital
(To average assets)		12.19	%		12.09	%
Tier 1 Capital
(To risk-weighted assets)		16.86	%		16.53	%
Total Capital
(To risk-weighted assets)		18.00	%		17.66	%

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 Department of Banking and Securities (PDB&S) guidelines.  The Bank’s capital ratios do not differ significantly from the Company’s ratios.  Although not adopted in regulation form, the PDB&S utilizes capital standards requiring a minimum of 6.5% leverage capital and 10% total capital.  The Company and the Bank were in compliance with FRB, FDIC and PDB&S capital requirements as of March 31, 2014 and December 31, 2013.

Liquidity

As of March 31, 2014, the Company had cash and cash equivalents of $8.7 million in the form of cash, due from banks and short-term deposits with other institutions.  In addition, the Company had total securities available for sale of $156.2 million which could be used for liquidity needs.  This totals $164.9 million of liquidity and represents 23.4% of total assets compared to $166.0 million and 23.3% of total assets as of December 31, 2013.  The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of March 31, 2014 and December 31, 2013.  Based upon these measures, the Company believes its liquidity is adequate.

Capital Resources

The Company has a line of credit commitment available from the Federal Home Loan Bank (FHLB) of Pittsburgh for borrowings of up to $20,000,000 which expires in December 2016.  Borrowings under this line were $5.9 million and $13.4 million at March 31, 2014 and December 31, 2013, respectively.

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The Company has a line of credit commitment from Atlantic Central Bankers Bank for $7,000,000 which expires June 30, 2014.  There were no borrowings under this line as of March 31, 2014 and December 31, 2013.

The Company has a line of credit commitment available which has no stated expiration date from PNC Bank for $16,000,000.  There were no borrowings under this line as of March 31, 2014 and December 31, 2013.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $287,228,000 as of March 31, 2014, of which $29,300,000 and $37,200,000 was outstanding at March 31, 2014 and December 31, 2013 respectively.  Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.

Non-GAAP Financial Measures

This report contains or references fully taxable-equivalent (fte) interest income and net interest income, which are non-GAAP financial measures.  Interest income (fte) and net interest income (fte) are derived from GAAP interest income and net interest income using an assumed tax rate of 34%.  We believe the presentation of interest income (fte) and net interest income (fte) ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.  Net interest income (fte) is reconciled to GAAP net interest income on page 36.  Although the Company believes that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP measures.

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Results of Operations

NORWOOD FINANCIAL CORP.

Consolidated Average Balance Sheets with Resultant Interest and Rates

(Tax-Equivalent Basis, dollars in thousands)	Three Months Ended March 31,
	2014									2013
	Average						Average			Average						Average
	Balance			Interest			Rate			Balance			Interest			Rate
		(2)			(1)			(3)			(2)			(1)			(3)
Assets
Interest-earning assets:
Interest bearing deposits with banks	$	854		$	1			0.47	%	$	3,983		$	3			0.30	%
Securities held-to-maturity		175			3			6.86			173			3			6.94
Securities available for sale:
Taxable		99,840			488			1.96			89,946			400			1.78
Tax-exempt (1)		59,990			753			5.02			54,973			706			5.14
Total securities available for sale (1)		159,830			1,241			3.11			144,919			1,106			3.05
Loans receivable (1) (4) (5)		500,182			6,040			4.83			478,170			6,231			5.21
Total interest earning assets		661,041			7,285			4.41			627,245			7,343			4.68
Non-interest earning assets:
Cash and due from banks		7,638									8,835
Allowance for loan losses		(5,886	)								(5,580	)
Other assets		42,204									44,199
Total non-interest earning assets		43,956									47,454
Total Assets	$	704,997								$	674,699
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market	$	168,265		$	79			0.19		$	167,514		$	111			0.27
Savings		69,963			9			0.05			69,178			17			0.10
Time		210,543			547			1.04			210,035			626			1.19
Total interest bearing deposits		448,771			635			0.57			446,727			754			0.68
Short-term borrowings		41,929			22			0.21			22,137			12			0.22
Other borrowings		23,575			166			2.82			24,734			190			3.07
Total interest bearing liabilities		514,275			823			0.64			493,598			956			0.77
Non-interest bearing liabilities:
Demand deposits		92,593									83,618
Other liabilities		3,995									4,073
Total non-interest bearing liabilities		96,588									87,691
Stockholders' equity		94,134									93,410
Total Liabilities and Stockholders' Equity	$	704,997								$	674,699
Net interest income (tax equivalent basis)					6,462			3.77	%					6,387			3.91	%
Tax-equivalent basis adjustment					(317	)								(286	)
Net interest income				$	6,145								$	6,101
Net interest margin (tax equivalent basis)								3.91	%								4.07	%

(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.

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Rate/Volume Analysis.  The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense.

	Increase/(Decrease)
	Three months ended March 31, 2014 Compared to
	Three months ended March 31, 2013
	Variance due to
	Volume			Rate			Net
	(dollars in thousands)
Interest earning assets:
Interest bearing deposits with banks	$	(9	)	$	7		$	(2	)
Securities held to maturity		-			-			-
Securities available for sale:
Taxable		46			42			88
Tax-exempt securities		140			(93	)		47
Total securities		186			(51	)		135
Loans receivable		1,336			(1,527	)		(191	)
Total interest earning assets		1,513			(1,571	)		(58	)
Interest bearing liabilities:
Interest-bearing demand and money market		3			(35	)		(32	)
Savings		1			(9	)		(8	)
Time		10			(89	)		(79	)
Total interest bearing deposits		14			(133	)		(119	)
Short-term borrowings		13			(3	)		10
Other borrowings		(9	)		(15	)		(24	)
Total interest bearing liabilities		18			(151	)		(133	)
Net interest income (tax-equivalent basis)	$	1,495		$	(1,420	)	$	75

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.

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Comparison of Operating Results for The Three Months Ended March 31, 2014 to March 31, 2013

General

For the three months ended March 31, 2014, net income totaled $1,964,000 compared to $2,308,000 earned in the similar period in 2013.  The decrease in net income for the three months ended March 31, 2014 was due primarily to $770,000 of proceeds from a bank-owned life insurance policy that was recorded in the first quarter of 2013, some of which was offset by higher core earnings and a reduced provision for loan losses in the current year.  Earnings per share for the current period were $.54 for basic and fully diluted compared to $.64 per share basic and $.63 fully diluted for the three months ended March 31, 2013.  The resulting annualized return on average assets and annualized return on average equity for the three months ended March 31, 2014 were 1.13% and 8.46%, respectively, compared to 1.39% and 10.02%, respectively, for the similar period in 2013.

The following table sets forth changes in net income:

(dollars in thousands)	Three months ended
	March 31, 2014 to March 31, 2013
Net income three months ended March 31, 2013	$	2,308
Change due to:
Net interest income		44
Provision for loan losses		380
Gain on sales of loans and securities		(15	)
Earnings and proceeds on bank-owned life insurance		(757	)
Other income		(52	)
Salaries and employee benefits		46
Occupancy, furniture and equipment		(49	)
Foreclosed real estate owned		126
All other expenses		46
Income tax expense		(113	)
Net income three months ended March 31, 2014	$	1,964

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the three months ended March 31, 2014 totaled $6,462,000 which was $75,000 higher than the comparable period in 2013.  The increase in net interest income largely reflects the improved mix and growth of the balance sheet which offset the reduced earnings on loans and investments due to repricing in the current low interest rate environment.  The fte net interest spread and net interest margin were 3.77% and 3.91%, respectively, for the three months ended March 31, 2014 compared to 3.91% and 4.07%, respectively, for the similar period in 2013.

Interest income (fte) totaled $7,285,000 with a yield on average earning assets of 4.41% compared to $7,343,000 and 4.68% for the 2013 period. Average loans increased $22.0 million over the comparable period of last year but resulted in a 38 basis point reduction in the yield earned, resulting in a $191,000 reduction in fte loan income.  Reduced yields on tax-free securities were offset by higher yields on taxable securities and increased balances, resulting in a $135,000 increase in earnings on securities.  Average earning assets totaled $661.0 million for the three months ended March 31, 2014, an increase of $33.8 million over the average for the similar period in 2013.  This increase in average earning assets helped offset the decline in asset yields.

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Interest expense for the three months ended March 31, 2014 totaled $823,000 at an average cost of 0.64% compared to $956,000 and 0.77% for the similar period in 2013.  As a result of the continued low interest rate environment, the Company further reduced rates paid on its money market and savings accounts.  The cost of time deposits, which is the most significant component of funding, declined to 1.04% from 1.19% for the similar period in the prior year.  As time deposits matured, they repriced at the current lower rates resulting in the decrease.

Provision for Loan Losses

The Company’s provision for loan losses for the three months ended March 31, 2014 was $420,000 compared to $800,000 for the three months ended March 31, 2013.  The Company makes provisions for loan losses in an amount necessary to maintain the allowance for loan losses at an acceptable level.  Net charge-offs were $401,000 for the quarter ended March 31, 2014 compared to $576,000 for the similar period in 2013.

Other Income

Other income totaled $1,053,000 for the three months ended March 31, 2014 compared to $1,877,000 for the similar period in 2013.  Earnings and proceeds from bank-owned life insurance policies decreased due to a non-recurring gain of $770,000 recognized in the first quarter of 2013.  Net gains from the sale of loans and securities decreased $15,000 compared to the same period of 2013 due to reduced activity. All other items of other income decreased $52,000, net, compared to the first quarter of last year.

Other Expense

Other expense for the three months ended March 31, 2014 totaled $4,132,000 or $169,000 lower than the same period of 2013.  Costs associated with foreclosed real estate properties decreased $126,000 while all other operating expenses decreased $43,000, net.

Income Tax Expense

Income tax expense totaled $682,000 for an effective tax rate of 25.8% for the period ending March 31, 2014 compared to $569,000 for an effective tax rate of 19.8% for the similar period in 2013.  The 2013 period included a non-recurring tax-free gain.

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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 March 31, 2014, the level of net interest income at risk in a 200 basis point increase in interest rates was within the Company’s policy limits, while a 200 basis point decrease in rates would result in a net interest fluctuation that exceeds the policy limit.  The Company’s policy allows for a decline of no more than 8% of net interest income for a ± 200 basis point shift in interest rates. Based on the current level of interest rates, the risk in the declining 200 basis point scenario is considered acceptable.

Imbalance in repricing opportunities at a given point in time reflects interest-sensitivity gaps measured as the difference between rate-sensitive assets (RSA) and rate-sensitive liabilities (RSL).  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 March 31, 2014, the Company had a positive 90 day interest sensitivity gap of $54.9 million or 7.8% of total assets, compared to the $51.9 million or 7.3% of total assets as of December 31, 2013.  Rate sensitive assets repricing within 90 days decreased $3.8 million due primarily to a $7.8 million decrease in borrowed funds and a $5.1 million decrease in loans repricing within the period.  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 could 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 term time deposits, loan pricing to encourage variable rate products and evaluation of loan sales of long-term fixed rate mortgages.

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March 31, 2014

Rate Sensitivity Table

(dollars in thousands)

	3 Months			3-12 Months			1 to 3 Years			Over 3 Years			Total
Federal funds sold and interest bearing deposits	$	142		$	-		$	-		$	-		$	142
Securities		9,407			21,362			40,307			85,264			156,340
Loans Receivable		129,346			119,613			138,163			108,894			496,016
Total RSA	$	138,895		$	140,975		$	178,470		$	194,158		$	652,498
Non-maturity interest-bearing deposits	$	38,185		$	43,264		$	114,714		$	42,159		$	238,322
Time Deposits		31,877			64,802			86,532			25,143			208,354
Other		13,895			12,831			34,572			2,448			63,746
Total RSL	$	83,957		$	120,897		$	235,818		$	69,750		$	510,422
Interest Sensitivity Gap	$	54,938		$	20,078		$	(57,348	)	$	124,408		$	142,076
Cumulative Gap		54,938			75,016			17,668			142,076
RSA/RSL-cumulative		165.4	%		136.6	%		104.0	%		127.8	%
December 31, 2013
Interest Sensitivity Gap	$	51,870		$	11,886		$	(48,607	)	$	124,416		$	139,565
Cumulative Gap		51,870			63,756			15,149			139,565
RSA/RSL-cumulative		157.1	%		128.7	%		103.4	%		126.7	%

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.

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 1 of the Company’s Form 10-K for the year ended December 31, 2013.

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

None

Item 3.  Defaults Upon Senior Securities

Not applicable

Item 4.  Mine Safety Disclosures

Not applicable

Item 5.  Other Information

None

Item 6.  Exhibits

No.	Description
3(i)	Articles of Incorporation of Norwood Financial Corp.(1)
3(ii)	Bylaws of Norwood Financial Corp. (2)
4.0	Specimen Stock Certificate of Norwood Financial Corp. (1)
10.1	Employment Agreement with Lewis J. Critelli (2)
10.2	Change in Control Severance Agreement with William S. Lance(2)
10.3	Norwood Financial Corp. Stock Option Plan (3)
10.4	Change in Control Severance Agreement with Robert J. Mancuso(4)
10.5	Salary Continuation Agreement between the Bank and William W. Davis, Jr. (5)
10.6	Salary Continuation Agreement between the Bank and Lewis J. Critelli (5)
10.7	1999 Directors Stock Compensation Plan (3)
10.8	Salary Continuation Agreement between the Bank and John H. Sanders (6)
10.9	2006 Stock Option Plan (7)
10.10	First and Second Amendments to Salary Continuation Agreement with William W. Davis, Jr. (8)
10.11	First and Second Amendments to Salary Continuation Agreement with Lewis J. Critelli (8)
10.12	First and Second Amendments to Salary Continuation Agreement with John H. Sanders (8)
10.13	Change In Control Severance Agreement with James F. Burke(9)
10.14	2014 Equity Incentive Plan(10)
31.1	Rule 13a-14(a)/15d-14(a) Certification of CEO
31.2	Rule 13a-14(a)/15d-14(a) Certification of CFO
32	Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of Sarbanes Oxley Act of 2002

(1)   Incorporated herein by reference into this document from the Exhibits to Form 10, Registration Statement initially filed with the Commission on April 29, 1996, Registration No. 0-28364

(2)   Incorporated by reference into this document from the identically numbered exhibits to the Registrant’s Form 10-K filed with the Commission on March 15, 2010.

(3)   Incorporated herein by reference to the identically numbered exhibits of the Registrant’s Form 10-K filed with the Commission on March 23, 2000.

(4)   Incorporated by reference into this document from the identically numbered exhibit to the Registrant’s Form 10-K filed with the Commission on March 14, 2013, File No. 0-28364.

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(5)   Incorporated by reference into this document from the Exhibits to Form S-8 filed with the Commission on August 14, 1998, File No. 333-61487.

(6)   Incorporated herein by reference to the identically numbered exhibit to the Registrant’s Form 10-K filed with the Commission on March 22, 2004.

(7)   Incorporated by reference to this document from Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-134831) filed with the Commission on June 8, 2006.

(8)   Incorporated herein by reference from the Exhibits to the Registrant’s Current Report on Form 8-K filed on April 4, 2006.

(9)   Incorporated by reference from the identically numbered exhibit to the Registrant’s Form 10-Q filed with the Commission on November 7, 2013.

(10)   Incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-8 (File No. 333-195643) filed with the Commission on May 2, 2014.

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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:	May 9, 2014	By:	/s/ Lewis J. Critelli
			Lewis J. Critelli
			President and Chief Executive Officer
			(Principal Executive Officer)
Date:	May 9, 2014	By:	/s/ William S. Lance
			William S. Lance
			Executive Vice President and
			Chief Financial Officer
			(Principal Financial Officer)

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