Two Thousand and Four
NORWOOD FINANCIAL CORP.
Annual Report to Shareholders
[GRAPHIC OMITTED]
WE'RE NOT SIMPLY ABOUT IMPROVING HOMES, RETIREMENTS AND BUSINESSES,
WE'RE ABOUT IMPROVING LIVES
Summary of Operations
NORWOOD FINANCIAL CORP
Selected Financial Data
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
For the years ended Dec. 31, 2004 2003 2002 2001 2000
-----------------------------------------------------------------------------------------------
Net interest income $14,012 $ 13,322 $ 13,951 $ 13,554 $ 13,067
Provision for loan losses 455 660 630 695 480
-----------------------------------------------------------------------------------------------
Other income 3,088 2,801 2,577 2,590 2,454
Net realized gains on sales of securities 458 692 427 212 35
Other expense 10,090 9,808 10,349 9,858 9,712
-----------------------------------------------------------------------------------------------
Income before income taxes 7,013 6,347 5,976 5,803 5,364
Income tax expense 2,003 1,694 1,623 1,601 1,504
Net Income $ 5,010 $ 4,653 $ 4,353 $ 4,202 $ 3,860
-----------------------------------------------------------------------------------------------
Net income per share-Basic $ 1.89 $ 1.79 $ 1.70 $ 1.67 $ 1.55
Net income per share-Diluted $ 1.85 $ 1.75 $ 1.68 $ 1.65 $ 1.54
Cash dividends declared* $ 0.69 $ 0.65 $ 0.60 $ 0.55 $ 0.47
Dividend pay-out ratio 36.5% 36.3% 35.3% 32.9% 30.3%
-----------------------------------------------------------------------------------------------
Return on average assets 1.27% 1.22% 1.21% 1.25% 1.21%
Return on average equity 11.39% 11.24% 11.60% 12.54% 13.75%
-----------------------------------------------------------------------------------------------
BALANCES AS OF YEAR-END
Total assets $411,626 $387,483 $367,468 $346,029 $326,731
Loans receivable 254,757 233,733 217,970 214,194 216,477
Allowance for loan losses 3,448 3,267 3,146 3,216 3,300
Total deposits 318,645 306,669 291,852 274,923 252,959
Shareholders' equity 45,685 42,831 40,125 35,116 31,370
Trust assets under management 83,397 73,991 60,102 57,533 54,542
-----------------------------------------------------------------------------------------------
Book value per share $ 16.95 $ 15.96 $ 15.09 $ 13.37 $ 11.99
Tier 1 Capital to risk-adjusted assets 15.91 15.58% 15.06% 13.78% 12.78%
Total Capital to risk-adjusted assets 17.34% 17.09% 16.57% 15.30% 14.27%
Allowance for loan losses to total loans 1.35% 1.40% 1.44% 1.50% 1.52%
Non-performing assets to total assets 0.02% 0.04% 0.07% 0.21% 0.22%
-----------------------------------------------------------------------------------------------
2004 ANNUAL REPORT
NORWOOD FINANCIAL CORP
AN INTRODUCTION
Happiness is greasing the wheels of joy for every one of your customers. At
Wayne Bank, we strive to go beyond meeting the basic needs of our account
holders. We treat each of our customers as an individual. We address their
dreams of home ownership, an expanded business, a comfortable retirement, and we
help them to make those dreams a reality. No matter which of the counties we
serve or which type of account an individual holds, Wayne Bank gives each
customer prompt, knowledgeable service, high-quality products and the
friendliness that turns a customer into a customer for life. In this year's
Annual Report, Wayne Bank would like to introduce you to some of the people we
are proud to call customers and friends.
[GRAPHIC OMITTED] PRESIDENT'S LETTER 2-3
HOME IMPROVEMENT 4-5
FINANCIAL SERVICES 6-7
COMMERCIAL LOANS 8-9
NEWEST BRANCH 10
AREA MAP 11
BOARD OF DIRECTORS 12
FINANCIAL SECTION 13-44
NORWOOD FINANCIAL CORP ANNUAL REPORT 2004: THREE COUNTIES, THREE TYPES OF
CUSTOMERS, ONE MESSAGE. AT WAYNE BANK, EVERY CUSTOMER COUNTS
In this report you will meet Tom and Ben Hogan of Hogan Homes, a father-son
team who produce beautifully crafted homes in the fast-growing Milford area of
Pike County, and who like to direct their buyers to Wayne Bank for a good
mortgage.
Meet Justin and Marilyn O'Donnell, who planned their estate and set up
trust accounts with Wayne Bank as part of their retirement on wild, pristine
Lake Underwood in Wayne County.
Meet Dr. Mahesh Chhabria and Dr. James Kerrigan of Neurology Associates of
Monroe County, who secured a commercial loan from Wayne Bank to build state of
the art medical offices, which in turn allowed them to expand the services they
offer to patients.
Wayne Bank is proud to be a part of the communities we serve. We believe
that our internal atmosphere of good communication, service and a desire to do
well by one another shows through to the community. Those traits are what the
people you will meet in this report mean when they say Wayne Bank treats them
the way they should be treated -- like people.
1
[GRAPHIC OMITTED]
SENIOR MANAGEMENT TEAM NORWOOD FINANCIAL CORP
FROM LEFT TO RIGHT
Joseph A. Kneller William W. Davis, Jr. Lewis J. Critelli
Senior Vice President President & Chief Executive Officer Executive Vice President &
Chief Financial Officer
John H. Sanders Wayne D. Wilcha Edward C. Kasper
Senior Vice President Senior Vice President & Trust Officer Senior Vice President
2
A LETTER TO OUR SHAREHOLDERS
We are extremely pleased to report to you that your Company surpassed two
milestones in 2004. We passed $400,000,000 in total assets for the first time.
Even more importantly, our net income for the year exceeded the $5,000,000 mark
for the first time. Norwood Financial Corp and its subsidiary Wayne Bank earned
$5,010,000 for the year ended December 31, 2004, which represents a 7.7%
increase over the $4,653,000 earned in 2003. Earnings per share on a fully
diluted basis were $1.85 in 2004 compared to $1.75 in 2003. Cash dividends
declared in 2004 totaled $.69 per share, an increase of 6.2% over the $.65 per
share declared in the prior year. The return on average assets for the year was
a strong 1.27%, with a return on average equity of 11.39%.
Total assets as of December 31, 2004, were $411.6 million, with loans
receivable of $254.8 million, deposits of $318.6 million and shareholders'
equity of $45.7 million. Total assets have increased $24.1 million when compared
to December 31, 2003.
Loans receivable increased $21 million, or 9% from the prior year. We had
another year of strong commercial real estate growth, with the portfolio
increasing over 15%. We also had a very successful home equity loan campaign
conducted throughout our branch network. In fact, home equity outstandings grew
over 50% in 2004. The growth in these types of loans was partially offset by the
continued planned decline in indirect auto lending as we are focusing more on
real estate lending through our branch network. Asset quality ratios are
excellent. We had a lower level of non-performing loans for the year and, even
more importantly, our net charge-offs in 2004 declined 49% to $274,000 compared
to the $539,000 charged off in 2003.
Net interest income on a fully taxable equivalent basis for the year
totaled $14,653,000, an increase of 5.1% over 2003. The net interest margin for
2004 increased five basis points to 3.91%. This growth in net interest was due
to the increase in short-term interest rates in 2004, and an improvement in
asset mix, as we had more loans on the balance sheet in 2004. Other income,
excluding gains on sales of securities, totaled $3,088,000 in 2004 compared to
$2,801,000. Our Wealth Management and Trust Division had a record year with over
$300,000 in revenue. We introduced our popular Overdraft Manager program in the
third quarter, which has also increased our revenue. Operating expenses
increased 2.9% to $10,090,000 for the year. We liquidated the final vehicles
from our leasing portfolio in September, and we are now completely out of the
automobile leasing business.We would ask that you read the financial section for
a complete report on our 2004 results.
We had a very productive year. Our Marshalls Creek branch had its grand
opening in August. The staff is busy meeting many new customers, as well as
servicing existing customers. Our new title insurance company, Norwood
Settlement Services, made a positive contribution to our net income. In July, we
introduced the Overdraft Manager Service, which has quickly become very popular
with our customers. During the year, we also redecorated our Milford Branch
lobby and did outside work at our Willow, Lords Valley and Waymart offices.
Technology strategies employed in recent years have enabled Wayne Bank to
grow, improve service quality and increase competitiveness while containing
costs. Service enhancements, new products, and growth in service facilities
achieved in 2004 exemplify the leveraging of our technology resources.
Our 2003 project to convert paper files to digital form for retention and
retrieval efficiencies continued throughout 2004. With this technology, all
community offices can retrieve accurate reproductions of transactions through
our data network in a fraction of the time and effort that was required in the
past. Customers using our Direct Link Internet Banking service are enjoying the
convenience of viewing paid check images 24 hours a day, 7 days a week.
In 1996, Wayne Bank initiated conversion of checks to digital images to
improve customer service and add efficiencies to daily operations. Wayne Bank
was a pioneer in the conversion of checks to digital images which has received
widespread acceptance over time. Recognizing nationwide benefits in digital
imaging technology, Congress enacted the "Check 21" Act on October 28, 2004,
which will bring the check payments system to a whole new level of electronic
clearing and settlement. Wayne Bank, due to its early efforts, is experienced
and well positioned for this new era of nationwide electronic check clearing.
It is particularly pleasing to note that during the past year the following
employees were promoted: John Carmody to Vice President of Commercial Lending;
The Community Office Manager of our Milford Office and Regional Branch
Coordinator of our Pike County Offices, Mary Alice Petzinger was promoted to
Vice President. Karen Gasper was named Internal Auditor and Assistant Vice
President. Marianne Glamann was appointed Assistant Manager of our new office in
Marshalls Creek. Two new managers joined our staff in 2004. Renee Wyant was
named Stroud Mall Office Manager and also the Regional Branch Coordinator for
all Monroe County offices. Sandra Cella is responsible for managing both the
Lords Valley and Shohola Offices.
It also should be noted that Ralph Matergia joined the Norwood Financial
Corp and Wayne Bank Boards of Directors in 2004. Ralph brings to our Board a
wide range of business experience, as well as legal expertise and an in-depth
knowledge of Monroe County. He's been an attorney in the Monroe County area for
over 25 years and is the founding partner of the law firm, Matergia and Dunn.
We look forward to 2005 and plan to continue to look for ways to enhance
your investment in Norwood Financial. We sincerely appreciate your support, and
as always, we welcome any comments or suggestions you may have on how to enhance
your investment. And, thank you for also being a customer of Wayne Bank.
Sincerely yours,
/s/ William W. Davis, Jr. /s/ Russell L. Ridd
William W. Davis, Jr., President and Chief Executive Officer Russell L. Ridd, Chairman of the Board
3
[GRAPHIC OMITTED]
4
Happiness is Handing the New Owners
THE KEYS TO A BEAUTIFUL HOME
That You Built for Them.
The bright, spacious house is almost finished. After seven months of work,
weather, sourcing an unusual countertop material, obtaining permits, and precise
attention to detail in every area, the 3,000 square foot home is just a few days
away from completion. Ben's crew will complete the mantel over the fireplace and
finish painting the hallway. Tom will call the buyers and make sure they have
wrapped up the last details of the closing. There are plenty of variables in
completing and closing on a house, but the Hogans know at least one thing is
certain: the bank will be ready and have the details right. They know it because
they have worked with Wayne Bank for years.
[GRAPHIC OMITTED] "I ONLY BUILD HOUSES FOR PEOPLE I LIKE," SAYS TOM
HOGAN. "AND BECAUSE I LIKE THEM, I SEND THEM TO
WAYNE BANK FOR THEIR MORTGAGE, BECAUSE I KNOW
THEY'LL BE TREATED RIGHT THERE."
"WE ALWAYS SEND OUR BUYERS TO WAYNE BANK, BECAUSE WE KNOW BILL MURPHY WILL GIVE
THEM A FAIR DEAL. WE DO OUR OWN BANKING WITH WAYNE BANK, SO WE KNOW THEY ARE
INFINITELY MORE FRIENDLY THAN OTHER BANKS, AND THEY REALLY DO THINK OF YOU AS
PEOPLE, NOT JUST AN ACCOUNT NUMBER."
The father and son team at Hogan Homes builds fifteen to twenty houses a
year. Tom started the business in 1967 because he liked to work outdoors, and he
enjoyed tools. His oldest son, Ben, took to the work too and has become the
supervisor of the construction crews. Located in the rapidly growing town of
Milford, in Pike County, Hogan Homes is a family business connecting the wave of
new residents to the community's already strong roots in institutions like Wayne
Bank. What do the Hogans and the bank have in common? Craftsmanship, attention
to detail, a strong work ethic and an understanding that communities are made of
real people.
"I only build houses for people I like," says Tom Hogan, whose crisp shirt
with a handful of pens in the breast pocket speaks of quick energy and readiness
to get down to business. "And because I like them, I send them to Wayne Bank for
their mortgage. Because I know they'll be treated right there. I tell my buyers,
`Building a home can be a great experience. You have to approach it with the
right mindset.' Bill Murray, the lending officer, and Mary Alice Petzinger at
the Milford Branch understand that."
Tom turns philosophical for a moment. "When you build a home, you have to
pay attention to detail. You have to do things right. Back when Pike County was
quiet, we were doing things right, and now that we're in the middle of this
growth, we're still doing things right. You have to be patient and get the
details right. That's what we're about. Not slapping things together and rushing
on to the next thing. Doing it right."
It's not hard to see why the Hogans work well with Wayne Bank. They share
the values of quality service, quality products and treating each customer as an
individual and a real person. It's natural that they should work together to
build their community.
"You can't blame people for wanting to live here!" Tom exclaims. "It's
pretty and it was a nice place to raise my kids. Of course everybody wants that.
They feel safe here, and they can build a beautiful house like this...." He
looks around at the new home, and Ben nods with satisfaction. It's a job well
done, and the Hogans know it. They will be happy to hand the keys to the new
owners next Wednesday, and even though they do it twenty times a year, when they
see how excited the new residents are, the Hogans will smile.
5
[GRAPHIC OMITTED]
6
Happiness is Marilyn,
A BUCKET FULL OF PUPPIES,
and Otters in Your Lake.
Justin O'Donnell comes into the sun room and puts a square bucket on the slate
floor. Four Brittany Spaniel puppies climb over each other to get out. In half a
minute, they are everywhere, under the furniture, wandering over to look at the
fireplace, headed for Marilyn's fresh-baked cherry cake in the kitchen. Justin
chuckles. The little bird dogs will grow up learning to hunt in the woods around
Lake Underwood in Wayne County, where Justin trained their parents and where he
raises his own quail to host hunts for friends. Otters frolic in the pristine
waters just behind the house, and maroon-headed mergansers dive under the water
and reappear farther down the lake.
[GRAPHIC OMITTED] LAKE UNDERWOOD COULD NOT HAVE A MORE
APPRECIATIVE AUDIENCE THAN MARILYN
AND JUSTIN O'DONNELL.
WE STILL HAD ACCOUNTS IN VIRGINIA, AND IT WAS INCONVENIENT TO SAY THE LEAST.
PLUS WHEN YOU'RE DEALILNG WITH A BIG BANK, YOU'RE JUST ANOTHER CUSTOMER. WHEN
YOU DEAL WITH WAYNE BANK, THEY LET YOU KNOW YOU'RE IMPORTANT TO THEM. WITH ALL
MY YEARS IN BANKING, I KNOW THE DIFFERENCE BETWEEN GOOD SERVICE AND...NOT GOOD
SERVICE. AND WAYNE BANK GIVES US GREAT SERVICE.
Justin says, "I started to come up here with a friend to hunt and fish.
Then a piece of land became available. I brought Marilyn up to see it. It was an
early summer morning, and the mountain laurel was in bloom. The kids decided to
take their first swim. Marilyn said, `This would be a great place to retire.'"
He continues, "I started to build a hunting camp, and Marilyn took one look
at the foundation and said, `That's not big enough for the family!' I said,
`It's supposed to be a hunting camp...' but she just shook her head." Justin
laughs. "So I expanded it. We came up here every long weekend. Then when we
wanted a house with fewer steps to climb, Marilyn designed what she wanted, and
I built it myself." Justin now divides his time between hunting and running a
small excavation business he started as a hobby.
In addition to making their home beautiful with antiques and lovely
photographs of their seven children and thirteen grandchildren, Marilyn says she
keeps busy with a local sewing group. "And the telephone," Justin adds. "You
won't see any children around here today, but she's always mothering people over
the telephone." With a modest smile Marilyn says, "Our children have all done so
well. We've been blessed."
And how did the O'Donnells come to Wayne Bank? Justin says, "I spent
thirty-five years as a banker and retired as CEO of First Virginia Bank. When we
moved here, we decided to move our accounts to Wayne Bank because they had a
branch here in Lakewood. I called to congratulate Bill Davis when he became
president of the Bank, and he introduced me to Wayne Wilcha, the Trust Officer.
I've been impressed with the bank from a quality standpoint. Then too, I
think well of Bill and Wayne. Wayne is very professional, very attentive. He
helped us revise our wills and prepare an estate plan. Set up some trust
accounts."
Justin smiles fondly at his wife. "People think we're strange, wanting to
be up here. All our friends are in Florida! But we prefer the weather here,
prefer the scenery."
Marilyn nods in agreement and smiles back at him. "Yes." At the same time,
they both add, "We're very comfortable here, it's paradise."
7
[GRAPHIC OMITTED]
8
Happiness is No Steps,
DOUBLING YOUR MRI CAPABILITIES
and Optimum Space for Your Staff.
A fountain murmurs soothingly in the lobby of Neurology Associates of
Monroe County. As patients arrive for their consultations, the water provides a
refreshing sound and sight: the gentle splashing brings a moment of peace to
minds sometimes suffering the turmoil of illness. The fountain is just one
example of how Dr. Mahesh Chhabria and Dr. James Kerrigan's medical practice
embraces patients, staff and doctors as individual people with needs beyond
basic space and survival. Every aspect of the doctors' new facility in Monroe
County has been designed with the benefit of the user in mind: comfort for
patients and an efficient and pleasant space for staff members.
[GRAPHIC OMITTED] DR. CHHABRIA SAYS, "WE HAVE DEPOSIT ACCOUNTS AND
OUR LOAN WITH WAYNE BANK, AND WE FIND THE PEOPLE AT
THE BANK EXCELLENT IN ALL POSSIBLE WAYS."
WITH A COMMERCIAL LOAN FROM WAYNE BANK, DRS. CHHABRIA AND KERRIGAN BUILT A STATE
OF THE ART MEDICAL OFFICE. THEIR NEW SPACE ALLOWED THEM TO ADD THREE PHYSICIANS
TO THE PRACTICE, AS WELL AS DOUBLE THEIR MRI CAPABILITIES. THE NEW FACILITY SEES
MORE THAN 10,000 PATIENTS A YEAR.
Dr. Kerrigan says, "We interviewed several banks in the process of building
the new center. The officers at Wayne Bank -- Bill Henigan at Stroudsburg, Bill
Davis and Ed Kasper -- were notably personable, accommodating and easy to work
with."
Dr. Chhabria concurs. "The people at Wayne Bank went out of their way to
customize our loan to meet our needs, and their rates were very attractive. We
also have deposit accounts with Wayne Bank, and we find the people at the bank
excellent in all possible ways."
Neurology Associates draws most of its patient base from a substantial
portion of the area served by Wayne Bank: Monroe and Pike Counties. Patients
also travel from Carbon and Northhampton Counties and from New Jersey. The new
facility rewards their trip. In addition to the five doctors in the practice,
expanded space in the new building has permitted the group to add a physician's
assistant and a neuroradiologist. The facility provides ample space for other
members of the staff to enjoy a pleasant work space designed for efficiency.
"It's a significant improvement over our old facilities," says Dr.
Kerrigan. "It's like night and day."
Dr. Chhabria notes that the facility has inspired new dreams for the
physicians. "We are planning both a Sleep Center and a Pain Center here, fueled
by the abilities of the new doctors we have been able to add since our move. We
will be able to serve patients in exciting new ways."
Dr. Kerrigan adds, "We chose this location because there are many other
doctors' offices nearby, which is very convenient for our patients. Even
apparently small things like good parking mean a lot. Many people have commented
how much they like having no steps to climb when they come to see us!"
"We have the largest neurology practice in the area," Dr. Chhabria says
reflectively. "That was possible because Wayne Bank was so receptive, so willing
to help us."
9
A Steaming Cup of Coffee
A PLATE OF WARM MUFFINS AND A
Steady Flow of New Accounts At Marshalls Creek.
Since the railroad first connected Monroe County to New York City in 1856,
people from the metropolitan area have been coming to the Poconos. They come
first to visit, but when they encounter the natural beauty and the hometown
atmosphere, many decide to stay. Recent growth in Monroe County has been fueled
by people moving west from the New York City area to settle in the mountains.
[GRAPHIC OMITTED] [GRAPHIC OMITTED]
MONROE COUNTY IS THE SECOND MARSHALL'S CREEK IS WAYNE BANK'S
FASTEST GROWING COUNTY IN PENNSYLVANIA NEWEST COMMUNITY OFFICE
The Marshalls Creek branch of Wayne Bank opened on July 19, 2004. Located
in fast-growing Middle Smithfield Township in Monroe County, the Marshalls Creek
branch serves a growing community with a full complement of banking services,
including checking and savings accounts, CDs, mortgages and home equity loans.
Marianne Glamann, assistant manager of the Marshalls Creek office, reports
that most of their customers moved to the area within the past two years. "We're
seeing a lot of new customers who have switched from other banks because they
were not happy with all the fees there, and they felt like just a number. When
they come in here, we make them feel at home. We have three tellers, one
customer service representative, and me. We are all friendly and knowledgeable
and caring, and people really respond to that. The other day I was helping
someone open a new account, and we had cups of coffee and some muffins from
Perkins. People love that personal touch."
A steady and growing flow of business attests to the success of Marianne's
approach. In addition to the excellent banking products and quality customer
service, Marianne says the bank appeals strongly to the growing Hispanic
community in the area, because many of the staff speak Spanish. "If people can
come in and do their banking in Spanish, that makes them feel very comfortable."
The personal touch starts at the top at Wayne Bank. CEO Bill Davis drops in
to say hello whenever he's passing through the area, and Marianne says she can
always email him with a question and expect to hear back soon. "I've been with
the bank ten years, first as a customer service representative at the Milford
branch, and now as assistant manager here. We're a different kind of bank. I
have customers come in all the time and tell me they like Wayne Bank because we
treat them like people, the way they should be treated."
10
[MAP OF WAYNE, PIKE & MONROE COUNTIES, PENNSYLVANIA
SHOWING BRANCH LOCATIONS APPEARS HERE]
OUR BRANCH LOCATIONS
ADMINISTRATIVE OFFICE:
Belmont & Water Streets Route 370 & Lake Como Road
717 Main Street Waymart, PA 18472 Lakewood, PA 18439
P.O. Box 269
Honesdale, PA 18431 Route 6 Stroud Mall
Hawley, PA 18428 Stroudsburg, PA 18360
COMMUNITY OFFICES:
111 West Harford Street Route 739,
717 Main Street Milford, PA 18337 Lords Valley Shopping Plaza
Honesdale, PA 18431 Lords Valley, PA 18428
Weis Market, Route 590
245 Willow Avenue Hamlin, PA 18427 Route 209
Honesdale, PA 18431 5165 Milford Road
Richardson Avenue Marshalls Creek, PA 18335
Shohola, PA 18458
11
[GRAPHIC OMITTED]
OUR BOARD OF DIRECTORS NORWOOD FINANCIAL CORP
FROM LEFT TO RIGHT
Dr. Kenneth A. Phillips Russell L. Ridd Gary P. Rickard
Member since 1988 Chairman of the Board Member since 1978
Member since 1980
Charles E. Case Richard L. Snyder John E. Marshall
Member since 1970 Member since 2000 Secretary of the Board
Member since 1983
Ralph A. Matergia William W. Davis, Jr. Daniel J. O'Neill
Member since 2004 President & Chief Executive Officer Member since 1985
Member since 1996
12
NORWOOD
FINANCIAL CORP
- ---------------------------------------------------------------------
CONSOLIDATED FINANCIAL REPORTS 04
- ---------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS 15-30
BALANCE SHEETS 31
STATEMENTS OF INCOME 32
STATEMENTS OF STOCKHOLDERS' EQUITY 34
STATEMENTS OF CASH FLOWS 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 36-55
INVESTOR INFORMATION 56
[PAGE INTENTIONALLY LEFT BLANK]
MANAGEMENT'S DISCUSSION AND ANALYSIS
INTRODUCTION
This Management's Discussion and Analysis and related financial data are
presented to assist in the understanding and evaluation of the financial
condition and results of operations for Norwood Financial Corp (The Company) and
its subsidiary Wayne Bank (the Bank) as of December 31, 2004 and 2003, and for
the three years in the period ended December 31, 2004. This section should be
read in conjunction with the consolidated financial statements and related
footnotes.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward-looking statements. When used in this discussion,
the words believes, anticipates, contemplates, expects, and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties, which could cause actual results to differ
materially from those projected. Those risks and uncertainties include changes
in interest rates, risks associated with the effect of opening a new branch, the
ability to control costs and expenses, and general economic conditions. The
Company undertakes no obligation to publicly release the results of any
revisions to those forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
CRITICAL ACCOUNTING POLICIES
Note 2 to the Company's consolidated financial statements (incorporated by
reference in Item 8 of the 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.
The most significant estimates in the preparation of the Company's
financial statements are for the allowance for loan losses and accounting for
stock options. Please refer to the discussion of the allowance for loan losses
calculation under "Non-performing Assets and Allowance for Loan Losses" in the
"Financial Condition" section. The Company accounts for its stock option plans
under the recognition and measurement principles of APB opinion No. 25,
"Accounting for Stock Issued to Employees", and related Interpretations. No
stock-based employee compensation is reflected in net income, as all options
granted had an exercise price equal to the market value of the underlying common
stock on the grant date.
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - $3,860
2001 - $4,202
2002 - $4,353
2003 - $4,653
2004 - $5,010]
NET INCOME
($000)
RESULTS OF OPERATION - SUMMARY
Net income for the Company for the year 2004 was $5,010,000 compared to
$4,653,000 for the year 2003. This represents an increase of $357,000 or 7.7%
over the prior year. Basic and diluted earnings per share for 2004 were $1.89
and $1.85 respectively, increasing from $1.79 and $1.75, respectively, in 2003.
The return on average assets (ROAA) for the year ended December 31, 2004 was
1.27%, with a return on average equity (ROAE) of 11.39%.
The increase in earnings was principally attributable to an increase in net
interest income and a lower level of provision for loan losses. Net interest
income, on a fully taxable equivalent basis (fte), totaled $14,653,000 in 2004,
compared to $13,945,000 in 2003, an increase of $708,000 or 5.1%. The Company
was able to decrease its provision for loan losses to $455,000 for the year
ending December 31, 2004 from $660,000 for the prior year. The decrease was due
to a lower level of net charge-offs in 2004, $274,000, declining from $539,000
in 2003. Also, non-performing loans decreased from .06% of total loans to .03%
as of December 31, 2004.
15
Loans receivable increased $21.1 million to total $254.8 million as of
December 31, 2004. The growth was principally in commercial and residential real
estate loans. This growth in loans was funded by a $12.0 million growth in
deposits, and a $7.9 million decrease in the securities available for sale
portfolio.
Other income for 2004 was $3,546,000, an increase of $53,000 over 2003. The
Company had a lower level of gains on sales of securities and loans in 2004,
$525,000 compared to $884,000 in 2003. This was offset by a $276,000 increase in
service charges and fees and $51,000 increase in income from fiduciary
activities. Other income, excluding gains on sales of securities, represented
17.4% of total revenues in 2004, improving from 16.7% in 2003. Other expenses
totaled $10,090,000 in 2004 compared to $9,808,000 in 2003, an increase of
$282,000 or 2.9%. The increase was primarily due to costs related to a new
branch opened in July 2004 and an increase in employee benefits plan costs.
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - $1.54
2001 - $1.65
2002 - $1.68
2003 - $1.75
2004 - $1.85]
DILUTED EARNINGS
PER SHARE
Net income for the Company for the year 2003 was $4,653,000 compared to
$4,353,000 for the year 2002. This represents an increase of $300,000 or 6.9%
over the prior year. Basic and diluted earnings per share for 2003 were $1.79
and $1.75 respectively, increasing from $1.70 and $1.68, respectively, in 2002.
The return on average assets (ROAA) for the year ended December 31, 2003 was
1.22%, with a return on average equity (ROAE) of 11.24%.
The increase in earnings was principally attributable to growth in other
income and a lower level of operating expenses, offsetting a decline in net
interest income. Net interest income, on a fully taxable equivalent basis (fte),
totaled $13,945,000 in 2003, compared to $14,479,000 in 2002. The decline in net
interest income was due to a decrease in earning asset yields as a result of an
increase in cash flows in the investment portfolio and refinancings in the loan
portfolio with the proceeds reinvested at lower yields. This was partially
offset by a $21.4 million increase in average earning assets.
Loans receivable increased $15.7 million to total $233.7 million as of
December 31, 2003. The growth was principally in commercial and residential real
estate loans. This growth in loans was funded by a $14.8 million growth in
deposits. Credit quality remained strong with lower a level of non-performing
assets and net charge-offs for the year ended December 31, 2003 as compared to a
prior year.
Other income for 2003 was $3,493,000, an increase of $489,000 or 16.3% over
2002. The increase was due in part to an increase in gains on sales of
securities which totaled $692,000 in 2003, compared to $427,000 in 2002. The
gains were principally in equity holdings of other financial institutions,
corporate bonds and mortgage-backed securities. Other income, excluding gains on
the sales of securities, represented 16.7% of total revenues in 2003, improving
from 15.1% in 2002. Other expenses totaled $9,808,000 in 2003 compared to
$10,349,000 in 2002, a decrease of $541,000 or 5.2%. The decrease in expenses
was principally due to a lower level of losses on lease residuals, $50,000 in
2003 compared to $870,000 in 2002. The decrease was due to the significantly
lower number of vehicles in the leasing portfolio.
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - $327
2001 - $346
2002 - $367
2003 - $387
2004 - $412]
TOTAL ASSETS
(IN MILLIONS)
FINANCIAL CONDITION
TOTAL ASSETS
Total assets at December 31, 2004, were $411.6 million compared to
$387.5 million at year-end 2003, an increase of $24.1 million or 6.2%.
LOANS RECEIVABLE
Loans receivable represent the most significant percentage of the Company's
assets at 61.9% of total assets. As of December 31, 2004, total loans receivable
were $254.8 million compared to $233.7 million at year-end 2003, an increase of
$21.1 million, or 9.0%. Loan growth in commercial and residential real estate
was partially offset by a net run-off in indirect automobile financing, which is
included in consumer loans to individuals.
16
Residential real estate, which includes home equity lending, totaled $90.6
million as of December 31, 2004, compared to $77.5 million as of year-end 2003.
This increase of $13.1 million is net of prepayments, refinancing activity and
sales of mortgage loans into the secondary market. In the relatively low
interest rate environment of 2004, fixed rate mortgage products were preferred
by customers and accounted for the majority of the activity. The Company sells a
portion of its long-term fixed rate residential loan production for interest
rate risk management, with $4.1 million of 30 year fixed rate loans sold into
the secondary market during 2004 at a gain of $67,000, included in other income.
The Company holds the majority of its fifteen and twenty year fixed rate
residential mortgage production in its portfolio. The Company had significant
growth in home equity lending in 2004, as a result of a promotional campaign.
Home equity outstandings included in residential real estate increased $13.2
million to $36.8 million as of December 31, 2004.
The Company's indirect lending portfolio (included in consumer loans to
individuals) declined $8.2 million to $20.2 million as of December 31, 2004. A
portion of the net decrease may be attributable to the significant financing
incentives offered by the automakers throughout 2004, and increased competition
from other banks. In addition, the Company is focusing its efforts on increasing
direct and real estate lending through its branch network and, as a result,
anticipates a decrease in indirect financing again in 2005.
During the third quarter of 2004, the Company liquidated its final leased
vehicles. Losses on lease residuals (included in other expense) totaled $90,000
in 2004. The Company anticipates no further leasing activity.
Commercial loans consist principally of loans made to small businesses
within the Company's market and are usually secured by real estate or other
assets of the borrower. Commercial and commercial real estate loans totaled
$131.4 million as of December 31 2004, increasing from $113.3 million as of
December 31, 2003, an increase of $18.1 million or 16.0%. The majority of the
increase was in loans secured by real estate with adjustable rates based on a
spread to the prime rate. The growth in commercial lending was centered in the
Pike and Monroe County market areas.
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - 0.22%
2001 - 0.21%
2002 - 0.07%
2003 - 0.04%
2004 - 0.02%]
NPAS TO ASSETS
NON-PERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES
Non-performing assets consist of non-performing loans and real estate
acquired through foreclosure, which is held for sale. Loans are placed on
non-accrual status when management believes that a borrower's financial
condition is such that collection of interest is doubtful. Commercial and real
estate related loans are generally placed on non-accrual when interest is 90
days delinquent. When loans are placed on non-accrual, accrued interest income
is reversed from current earnings.
As of December 31, 2004, non-performing loans totaled $67,000 and
represented .03% of total loans receivable compared to $143,000 and .06% as of
year-end 2003. Total non-performing assets, which includes foreclosed real
estate totaled $67,000 and represented .02% of total assets, declining from
$143,000 and .04% as of December 31, 2003. As of December 31, 2004 and 2003, the
Company had no foreclosed real estate. The non-performing loans as of December
31, 2004 consist principally of loans secured by residential real estate. The
Company does not anticipate any significant losses related to these loans.
The allowance for loan losses totaled $3,448,000 as of December 31, 2004
and represented 1.35% of total loans receivable compared to $3,267,000 and 1.40%
of total loans as of year-end 2003. Net charge-offs for 2004 were $274,000,
consisting principally of losses on the sale of repossessed automobiles,
compared to net charge-offs of $539,000 in 2003. In 2004, the Company sold a
block of charged-off automobile loans and leases for a recovery of $39,000. The
provision for loan losses for 2004 was $455,000, compared to $660,000 in 2003.
17
The Company's loan review process assesses the adequacy of the allowance
for loan losses on a quarterly basis. The process includes a review of the risks
inherent in the loan portfolio. It includes an analysis of impaired loans and an
historical review of losses. Other factors considered in the analysis include;
concentration of credit in specific industries in the commercial portfolio; the
local and regional economic condition; trends in delinquencies, large dollar
exposures and growth in the portfolio. As of December 31, 2004, the Company
considered its concentration of credit risk profile to be moderate. The local
economy was stable in 2004, with no significant change in the unemployment rate
in its primary market area of Wayne, Pike and Monroe Counties. The Company has
modestly increased its number of large commercial credits and has had double
digit growth in real estate related loans. As a result of its analysis, after
applying these factors, management considers the allowance as of December 31,
2004, adequate. 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.
The following table sets forth information with respect to the Company's
allowance for loan losses at the dates indicated:
YEAR-ENDED DECEMBER 31,
--------------------------------------------------------
(IN THOUSANDS)
2004 2003 2002 2001 2000
--------------------------------------------------------
Allowance balance at beginning of period $ 3,267 $ 3,146 $ 3,216 $ 3,300 $ 3,344
Charge-Offs:
Commercial and all other (19) (121) (34) (12) --
Real Estate (10) -- (122) (11) (9)
Consumer (342) (478) (608) (711) (589)
Lease Financing (11) (36) (30) (152) (170)
--------------------------------------------------------
Total (382) (635) (794) (886) (768)
--------------------------------------------------------
Recoveries:
Commercial and all other 13 5 -- 8 54
Real Estate 8 24 13 1 73
Consumer 78 64 72 85 88
Lease Financing 9 3 9 13 29
--------------------------------------------------------
Total 108 96 94 107 244
--------------------------------------------------------
Provision expense 455 660 630 695 480
--------------------------------------------------------
Allowance balance at end of period $ 3,448 $ 3,267 $ 3,146 $ 3,216 $ 3,300
========================================================
Allowance for loan losses as a percent
of total loans outstanding 1.35% 1.40% 1.44% 1.50% 1.52%
Net loans charged off as a percent of
average loans outstanding .11% .24% .33% .36% .25%
Allowance coverage
of non-performing loans 51.5x 22.8x 14.2x 4.7x 4.8x
18
The following table sets forth information regarding non-performing
assets. The Bank had no troubled debt restructurings as defined in FAS No. 114.
As of December 31, 2004, the Company has no impaired or collateral dependent
loans.
AS OF DECEMBER 31,
------------------------------------
(IN THOUSANDS)
2004 2003 2002 2001 2000
------------------------------------
Non-accrual loans:
Commercial and all other $ -- $ -- $ -- $ 64 $ 64
Real estate 32 125 213 597 518
Consumer 8 -- 3 11 --
------------------------------------
Total 40 125 216 672 582
Accruing loans which are contractually
past due 90 days or more 27 18 5 11 98
------------------------------------
Total non-performing loans 67 143 221 683 680
Foreclosed real estate -- -- 21 54 27
------------------------------------
Total non-performing assets $ 67 $143 $242 $737 $707
====================================
Non-performing loans to total loans .03% .06% .10% .32% .31%
Non-performing loans to total assets .02% .04% .06% .20% .21%
Non-performing assets to total assets .02% .04% .07% .21% .22%
SECURITIES
The securities portfolio consists principally of issues of United States
Government agencies, including mortgage-backed securities; municipal
obligations, and corporate debt. In accordance with FAS#115 "Accounting for
Certain Investments in Debt and Equity Securities" the Company classifies its
investments into two categories: held to maturity (HTM) and available for sale
(AFS). The Company does not have a trading account. Securities classified as HTM
are those in which the Company has the ability and the intent to hold the
security until contractual maturity. As of December 31, 2004, the HTM portfolio
totaled $5.7 million and consisted entirely of municipal obligations. Securities
classified as AFS are eligible to be sold due to liquidity needs or interest
rate risk management. These securities are adjusted to and carried at their fair
market value with any unrealized gains or losses recorded as an adjustment to
capital and reported in the equity section of the balance sheet as accumulated
other comprehensive income. As of December 31, 2004, $116.9 million in
securities were so classified and carried at their fair market value, with
unrealized appreciation, net of tax, of $333,000, included in Accumulated other
comprehensive income in stockholders' equity.
As of December 31, 2004, the average life of the portfolio was 2.6 years
compared to 2.1 years as of the prior year-end. The Company has maintained a
relatively short average life in the portfolio in order to generate cash flow to
fund loan growth. Total purchases for the year were $43.3 million with
securities called, maturities and cash flow of $37.8 million and sales of $11.7
million. The purchases were funded principally by cash flow from the portfolio.
The Company had overnight federal funds sold of $13.1 million as of December 31,
2004 and no such balance as of December 31, 2003. As of December 31, the
carrying value of the Company's securities portfolio (HTM and AFS) totaled
$122.7 million with the mix as follows:
19
2004 2003
------------------------------------------
(DOLLARS IN THOUSANDS)
CARRYING % OF CARRYING % OF
VALUE PORTFOLIO VALUE PORTFOLIO
------------------------------------------
US Treasury Securities $ 2,014 1.6% $ 2,065 1.6%
US Government agencies 47,151 38.5% 47,632 36.5%
States & political subdivisions 24,256 19.8% 24,678 18.9%
Corporate obligations 15,308 12.5% 13,665 10.5%
Mortgage-backed securities 32,060 26.1% 40,508 31.0%
Equity securities 1,868 1.5% 2,023 1.5%
------------------------------------------
Total $122,657 100.0% $130,571 100.0%
==========================================
The portfolio had $13.2 million of floating rate instruments, principally
adjustable rate mortgage backed securities as of December 31, 2004. The
portfolio contained no structured notes, step-up bonds and no off-balance sheet
derivatives were in use. The U.S. Government agency portfolio consists
principally of Federal Home Loan Bank callable notes with final maturities of
generally less than five years. The mortgage backed securities are pass-through
bonds with Federal National Mortgage Association (FNMA), Federal Home Loan
Mortgage Corp (Freddie Mac), and Guaranteed National Mortgage Association
(GNMA). During 2004, the Company reduced its exposure to mortgage-backed
securities issued by FNMA and Freddie Mac.
DEPOSITS
The Company, through the eleven branches of the Bank, provides a full range
of deposit products to its retail and business customers. These products include
interest-bearing and non-interest bearing transaction accounts, statement
savings and money market accounts. Time deposits consist of certificates of
deposit (CD) with terms of up to five years and include Individual Retirement
Accounts. The Bank participates in the Jumbo CD ($100,000 and over) markets with
local municipalities and school districts, which are typically awarded on a
competitive bid basis.
Total deposits as of December 31, 2004, were $318.6 million increasing from
$306.7 million as of year-end 2003, an increase of $11.9 million or 3.9%. The
increase was principally in core transaction accounts. The Company's money
market deposit accounts increased $4.6 million, or 10%, to $51.1 million. In
addition, savings deposit products increased $4.2 million, or 7.5%, to $60.1
million.
Time deposits over $100,000, which consist principally of school district
and other public funds, with maturities generally less than one year, were $33.3
million as of December 31, 2004, compared to $29.4 million at year-end 2003. The
increase was principally due to a higher level of jumbo CDs with local school
districts. These deposits are subject to competitive bid and the Company bases
its bid on current interest rates, loan demand, investment portfolio structure
and relative cost of other funding sources.
As of December 31, 2004, non-interest bearing demand deposits totaled $44.4
million, increasing $4.9 million or 12.5% from the prior year-end. This growth
is partially attributable to an increase in commercial deposits, related to the
increase in the commercial loan portfolio. In addition, a portion of the growth
is due to the Bank's "Simply Free" retail checking product. The Company also has
$11.9 million of cash management accounts included in short-term borrowings.
These balances represent commercial customers' funds invested in over-night
securities. The Company considers these accounts as a source of core funding.
The Company believes a portion of its deposit growth over the prior three
years may be due in part to the relatively weak stock market performance since
March 2000 and a low interest rate environment which offered limited
opportunities to earn higher yields. Bank deposit growth did slow in 2004, as
the stock market became more attractive to investors and competition for
deposits increased among banks. However, the Company
20
believes it can continue to increase its core deposits by establishing new
commercial loan relationships, and by seeking new branch locations in high
growth areas.
BORROWINGS
Short-term borrowings totaled $23.0 million as of December 31, 2004
compared to $12.9 million as of the prior year-end. The increase of $11.1
million was principally due to $8 million of short-term advances from the FHLB.
Long-term borrowings were $23 million as of December 31, 2004 and 2003.
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 December 31, 2004, the level of net interest income at
risk in a 200 basis points change in interest rates was within the Company's
policy limits. The Company's policy allows for a decline of no more than 8% of
net interest income.
Imbalance in repricing opportunities at a given point in time reflect
interest-sensitivity gaps measured as the difference between rate-sensitive
assets and rate-sensitive liabilities. These are static gap measurements that do
not take into account any future activity, and as such are principally used as
early indications of potential interest rate exposures over specific intervals.
At December 31, 2004, the Bank had a positive 90 day interest sensitivity
gap of $32.5 million or 7.9% of total assets. A positive gap means that
rate-sensitive assets are greater than rate-sensitive liabilities at the time
interval. This would indicate that in a rising rate environment, the yield on
interest-earning assets would increase faster than the cost of interest-bearing
liabilities in the 90 day time frame. The repricing intervals are managed by
ALCO strategies, including adjusting the average life of the investment
portfolio, pricing of deposit liabilities to attract longer term time deposits,
loan pricing to encourage variable rate products and evaluation of loan sales of
long term fixed rate mortgages.
The Company analyzes and measures the time periods in which rate sensitive
assets (RSA) and rate sensitive liabilities (RSL) will mature or reprice in
accordance with their contractual terms and assumptions. Management believes
that the assumptions used are reasonable. The interest rate sensitivity of
assets and liabilities could vary substantially if differing assumptions were
used or if actual experience differs from the assumptions used in the analysis.
For example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in differing degrees to changes in
market interest rates. The interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates. Interest
rates may change at different rates changing the shape of the yield curve. In
2004, short-term interest rates increased to a greater extent than long term
rates. Further, in the event of a significant change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed. Finally, the ability of borrowers to service their
adjustable-rate debt may decrease in the event of an interest rate increase. The
operating results of the Company are not subject to foreign currency exchange or
commodity price risk.
21
The following table displays interest-sensitivity as of December 31, 2004 (in
thousands):
3 MONTHS 3-12 GREATER THAN
OR LESS MONTHS 1-3 YEARS 3 YEARS TOTAL
---------------------------------------------------------------
Federal funds sold and interest
bearing deposits $ 13,178 $ -- $ -- $ -- $ 13,178
Securities 9,687 18,507 71,898 22,565 122,657
Loans receivable 93,054 42,717 58,803 60,183 254,757
---------------------------------------------------------------
Total Rate Sensitive Assets (RSA) $ 115,919 $ 61,224 $ 130,701 $ 82,748 $ 390,592
===============================================================
Non-maturity interest bearing deposits $ 26,640 $ 34,272 $ 91,613 $ -- $ 152,525
Time deposits 29,492 46,103 36,363 9,802 121,760
Borrowings 27,287 12,581 6,114 -- 45,982
---------------------------------------------------------------
Total Rate Sensitive Liabilities (RSL) $ 83,419 $ 92,956 $ 134,090 $ 9,802 $ 320,267
===============================================================
Interest sensitivity gap $ 32,500 $ (31,732) $ (3,389) $ 72,946 $ 70,325
Cumulative gap 32,500 768 (2,621) 70,325
RSA/RSL-Cumulative 139.0% 100.4% 99.2% 122.0%
As of December 31, 2003
Interest sensitivity gap $ 30,202 $ (10,656) $ (21,015) $ 62,826 $ 61,357
Cumulative gap 30,202 19,546 (1,469) 61,357
RSA/RSL-Cumulative 141.0% 111.9% 99.5% 120.2%
Securities and loans receivable are included in the period in which
interest rates are next scheduled to adjust or in which they are due. Prepayment
speeds are based on historical experience and management judgment.
Non-maturity deposits are generally subject to immediate withdrawal.
However, based on retention experience in various interest rate environments,
management considers deposits to have longer effective maturities.
LIQUIDITY
Liquidity can be viewed as the ability to fund customers' borrowing needs
and their deposit withdrawal requests while supporting asset growth. The
Company's primary sources of liquidity include deposit generation, asset
maturities, and cash flow from payments on loans and securities.
As of December 31, 2004, the Company had cash and cash equivalents of $20.7
million in the form of cash, due from banks, federal funds sold and short-term
deposits with other institutions. In addition, the Company had total securities
available for sale of $116.9 million, which could be used for liquidity needs.
This totals $137.6 million and represents 33.4% of total assets compared to
$134.0 million and 34.6% of total assets as of December 31, 2003. The Company
also monitors other liquidity measures, all of which were within the Company's
policy guidelines as of December 31, 2004. Based upon these measures, the
Company believes its liquidity position is adequate.
The Company maintains established lines of credit with the Federal Home
Loan Bank of Pittsburgh (FHLB), the Atlantic Central Bankers Bank (ACBB) and
other correspondent banks, which support liquidity needs. The approximate
borrowing capacity from FHLB was $142.3 million. As of year-end 2004, the
Company had $23 million in long-term borrowings and $8 million of short-term
borrowings from the FHLB.
The Company's financial statements do not reflect various commitments that
are made in the normal course of business, which may involve some liquidity
risk. These commitments consist mainly of unfunded loans and letters of credit
made under the same standards as on-balance sheet instruments. Unused
commitments, as of
22
December 31, 2004 totaled $48,150,000. This consisted of $15,748,000 in
commercial real estate, construction and land developments loans, $9,140,000 in
home equity lines of credit, $1,791,000 in standby letters of credit and the
remainder in other unused commitments. Because these instruments have fixed
maturity dates and because many of them will expire without being drawn upon,
they do not represent any significant liquidity risk.
Management believes that any amounts actually drawn upon can be funded in
the normal course of operations. The Company has no investment in or financial
relationship with any unconsolidated entities that are reasonably likely to have
a material effect on liquidity or the availability of capital resources.
The following table represents the aggregate on and off balance sheet
contractual obligations to make future payments.
CONTRACTUAL OBLIGATIONS
DECEMBER 31, 2004
----------------------------------------------------
LESS THAN OVER
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
----------------------------------------------------
(in thousands)
Time deposits $121,670 $75,595 $36,278 $ 9,802 $ --
Long term debt 23,000 5,000 5,000 10,000 3,000
Operating leases 2,215 187 268 168 1,592
----------------------------------------------------
$146,885 $80,782 $41,541 $19,970 $4,592
----------------------------------------------------
RESULTS OF OPERATION
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - $13,424
2001 - $14,014
2002 - $14,479
2003 - $13,945
2004 - $14,653]
NET INTEREST INCOME
(FTE) (000)
NET INTEREST INCOME
Net interest income is the difference between income earned on loans and
securities and interest paid on deposits and borrowings. For the year ended
December 31, 2004, net interest income on a fully taxable equivalent basis (fte)
totaled $14,653,000, an increase of $708,000 or 5.1%, compared to $13,945,000 in
2003. The resulting fte net interest spread and net interest margin for 2004
were 3.60% and 3.91%, respectively, increasing from 3.51% and 3.86%,
respectively, in 2003.
Interest income (fte) for the year ended December 31, 2004 totaled
$19,647,000 compared to $19,968,000 in 2003. The yield (fte) on earning assets
for 2004 was 5.25% declining from 5.53% in 2003. The decrease in yield is due in
part to the cumulative effect of lower rate assets that have been put on the
balance sheet over the last three years. This has been partially offset by the
recent increase in short-term interest rates with the Federal Funds rate
increasing from 1.00% on January 1, 2004 to 2.25% as of December 31, 2004, and
the prime rate increasing from 4.00% to 5.25% over the same time period. The
decrease in the earning asset yield was also partially offset by growth in
average earning assets of $13.6 million. In addition, the mix of earning assets
improved, with loans representing 65.6% of average earning assets compared to
62.5% in 2003.
Interest income (fte) earned on loans totaled $14,912,000 for 2004, an
increase of $333,000 over the $14,579,000 earned in 2003. An increase in average
volume of $20.1 million to $245.8 million for 2004 offset a 39 basis point
decline in yield to 6.07%.
Securities available for sale averaged $118.3 million with fte net interest
income of $4,159,000 and a yield of 3.52% compared to $120.5 million, $4,711,000
and 3.91%, respectively in 2003. Total cash flow from maturities, calls and
principal reductions on mortgage-backed securities totaled $37.8 million in 2004
compared to $72.9 million in 2003. In addition, there was $11.7 million in
proceeds from sales of securities compared to $22.5 million in 2003. These
amounts were generally re-invested in short-term callable US Government agency
securities, municipal obligations and corporate debt. Proceeds were also used to
fund loan growth.
23
Interest expense for the year ended December 31, 2004 totaled $4,994,000,
declining from $6,023,000 in 2003. The average cost of interest-bearing
liabilities declined 37 basis points to 1.65% in 2004 from 2.02% in 2003. The
Company was able to reduce its cost of interest-bearing deposits to 1.33% in
2004 from 1.75% in 2003, with decreases in each category. The cost of deposits
was also favorably impacted by a change in deposit mix, with a higher percentage
of lower-costing transaction and savings accounts in 2004. Average transaction
accounts (including non-interest bearing demand deposits) and savings accounts
to total average deposits was 62.3% in 2004 compared to 58.0% in 2003.
For 2004, Federal Funds sold averaged $4.6 million at a yield of 1.46%
compared to $8.4 million at a yield of 1.12% in 2003. The decrease in Federal
Funds sold was used to fund loan growth.
For the year ended December 31, 2003, net interest income on a fully
taxable basis (fte) was $13,945,000, a decrease of $534,000 or 3.7%, compared to
$14,479,000 in 2002. The resulting fte net interest spread and net interest
margin for 2003 were 3.51% and 3.86%, respectively, compared to 3.82% and 4.26%,
respectively, in 2002.
Interest income (fte) for the year ended December 31, 2003 totaled
$19,968,000 compared to $22,092,000 in 2002. The decrease was principally due to
lower interest rates in 2003, with an average prime rate of 4.12% and Federal
Funds target rate of 1.12%, compared to 4.67% and 1.67%, respectively, on
average, for 2002. As a result of the lower interest rates, the yield on earning
assets declined 98 basis points, to 5.53% in 2003.
The earning asset yield was also unfavorably impacted by increased cash
flows and maturities in the investment portfolio, which were reinvested at lower
yields. The reinvestment purchases were also relatively short-term instruments
with average lives of less than three years. Loan yields were also unfavorably
impacted by increased refinancing activity and cash flows. This was partially
offset by an improvement in the earning asset mix with an increase in the
securities available for sale portfolio of $16.9 million funded in part by a
reduction in Federal Funds sold of $7.2 million.
Interest income earned on loans totaled $14,579,000 with a yield of 6.46%
in 2003, decreasing from $15,651,000 with a yield of 7.32% in 2002. The decline
in the yield was due in part to the lower interest rate environment with an
average prime rate of 4.12% in 2003 compared to 4.67% in 2002. Loans averaged
$225.7 million in 2003, compared to $213.8 million in 2002.
Securities available for sale averaged $120.5 million in 2003 with an fte
interest income of $4,711,000 and a yield of 3.91% compared to $103.6 million,
$5,634,000 and 5.44%, respectively, in 2002. During 2003, cash flows on
mortgage-backed securities increased as a result of mortgage refinancing
activity in the continued low interest rate environment. Total cash flow from
maturities and principal reductions on mortgage-backed securities were $72.9
million in 2003 compared to $46.3 million in 2002. In addition, there was $22.5
million in proceeds from sales compared to $6.5 million. These amounts were
generally reinvested in lower coupon mortgage-backed securities, callable US
Government agency securities and short-term tax-exempt municipal obligations.
The yields on the reinvestments were typically 125 basis points less than the
cash flow yield. The Company reinvested in short-term securities in anticipation
of an increase in rates in late 2004.
Interest expense for the year-ended December 31, 2003 totaled $6,023,000,
declining from $7,613,000 in 2002. The average cost of interest-bearing
liabilities in 2003 was 2.02%, a decrease of 67 basis points from 2.69% in 2002.
The Company was able to reduce its cost of interest bearing deposits to 1.75%
from 2.45% in 2002.
For 2003, Federal Funds sold averaged $8.4 million at a yield of 1.12%
compared to $15.6 million and 1.66% in 2002. The decrease was used to fund
securities available for sale, typically at yields of 150 basis points higher
than the federal funds rate.
24
The net interest margin for 2003 was also unfavorably impacted by a
decrease in the loan to deposit ratio, which averaged 74.0% in 2003 compared to
75.1% in 2002.
OTHER INCOME
Other income totaled $3,546,000 for the year-ended December 31, 2004
compared to $3,493,000 in 2003. Service charges and fees were $2,122,000 in 2004
compared to $1,846,000 in 2003, an increase of $276,000 or 15%. The increase was
principally due to a higher level of overdraft (nsf) fees as a result of the
Overdraft Manager Service introduced in July 2004. Overdraft fees increased
$293,000, to $892,000 for 2004.
Income from fiduciary activities totaled $301,000 in 2004, increasing from
$250,000 in 2003. In 2004, there was a higher level of estate fees collected.
Also, the market value of trust accounts was higher, at $83.4 million as of
December 31, 2004 compared to $74.0 million as of December 31, 2003. Commissions
on sales of annuities and mutual funds totaled $154,000 in 2004 increasing from
$112,000 in 2003, principally due to an increase in volume sold.
Earnings on the cash surrender value (CSV) of Bank-owned Life Insurance
(BOLI, included in other assets) was $316,000 in 2004 compared to $271,000 in
2003. The increase was due to the full effect in 2004 of the purchase of $2.55
million in BOLI during the third quarter of 2003. The proceeds were used to fund
employee benefit plans.
The Company had a lower level of net realized gains on sales of securities
in 2004, $458,000, declining from $692,000 in 2003. Total securities sold in
2004 were $11.7 million compared to $22.5 million.
Total gains on sales of mortgage loans, included in Other, were $67,000 in
2004, declining from $192,000 in 2003. The Company sold a lower level of fixed
rate loans in 2004, $4.1 million, compared to $7.1 million in 2003. The loans
sold were principally 30 year fixed rate mortgages with coupons above the
current market rate and the sales were for interest rate management, to reduce
the Company's exposure in long-term fixed rate assets.
Other income totaled $3,493,000 in 2003, an increase of $489,000 or 16.3%
over the $3,004,000 in 2002. Other income represented 16.7% of total revenues
increasing from 15.1% in 2002.
Service charges and fees were $1,846,000 in 2003 compared to $1,788,000 in
2002, an increase of $58,000. The increase is due in part to loan documentation
fees, which increased $48,000 to $286,000 due to volume, and debit card
activity, which generated $180,000 in revenues, increasing from $166,000 in
2002. These items were partially offset by a $23,000 decrease in retail checking
fees as a result of more customers opting for the Bank's "Simply Free"
non-interest bearing checking account. In addition, fees related to
non-sufficient funds (nsf) in checking accounts increased $28,000 to $599,000
due to a lower percentage of fees waived in 2003.
Income from fiduciary activities was $250,000 in 2003 compared to $236,000
in 2002. The increase was principally due to higher market value of trust
accounts in 2003 which was $74.0 million as of December 31, 2003, compared to
$60.1 million at the end of 2002. In 2003, the Company sold $7.1 million of
residential mortgages into the secondary market at a gain of $192,000 compared
to $5.4 million of loans sold, at a gain of $82,000 in 2002. The loans sold were
principally 30-year mortgages with coupons above the current market rate, and
the sales were done for interest rate management, to reduce the Company's
exposure in long term fixed rate assets.
The Company had net gains on sales of securities of $692,000 compared to
$427,000 in 2002. The Company sold selected equity holdings of other financial
institutions, which appeared attractively priced,
25
corporate bonds and fast paying underperforming mortgage-backed securities. The
proceeds of the sales, which were $22.5 million, were reinvested in available
for sale securities.
Earnings on the CSV of BOLI, were $271,000 in 2003, increasing from
$203,000 in 2002. The increase was principally due to the purchase of an
additional $2.55 million in BOLI, during the third quarter of 2003, the proceeds
of which were used to fund employee benefit plans.
The Company's merchant processing net revenue decreased in 2003 to
$61,000 from $88,000 in 2002. The decrease is due in part to a reduction in
margin received by the bank from Visa and MasterCard.
Other Income (dollars in thousands)
For the year-ended December 31 2004 2003 2002
----------------------------
Service charges on deposit accounts $ 375 $ 409 $ 415
ATM Fees 219 202 187
NSF Fees 892 599 571
Merchant card processing 35 61 88
Loan related service fees 324 286 254
Visa Check Card 213 180 166
Fiduciary activities 301 250 236
Mutual funds & annuities 154 112 136
Gain on sales of mortgage loans 67 192 82
CSV on life insurance 316 271 203
Other income 192 239 239
----------------------------
3,088 2,801 2,577
Net realized gains on sales of securities 458 692 427
----------------------------
Total $3,546 $3,493 $3,004
============================
OTHER EXPENSES
Other expenses totaled $10,090,000 in 2004, an increase of $282,000 or
2.9%, over the $9,808,000 for 2003. Salaries and employee benefits, which
represented 50.9% of total other expenses, were $5,133,000 in 2004, an increase
of $217,000, or 4.4%, over $4,916,000 in 2003. The increase was principally due
to increasing costs related to the Company's Employee Stock Ownership Plan,
which increased $102,000 due to appreciation in Company stock price and health
insurance premiums which increased $51,000.
Furniture and equipment costs declined to $542,000 from $602,000 in 2003.
The decrease was partially due to a lower level of depreciation expense,
$324,000 in 2004 compared to $387,000 in 2003. This was the result of equipment
which was fully depreciated in 2003. Data processing related expenses increased
$49,000 to $598,000 in 2004. The increase was due in part to contractual rate
with the Company's primary data processing provider, Fiserv, and new products
and services. Professional fees and services totaled $323,000 in 2004 compared
to $277,000 in 2003. The increase was principally due to consulting services
related to profitability analysis and loan processing. Losses on lease residuals
totaled $90,000 in 2004 compared to $50,000. The final leased vehicles were
disposed of in 2004 and the Company does not anticipate any lease expense in
2005.
Other expenses totaled $9,808,000 in 2003, a decrease of $541,000 or 5.2%
from $10,349,000 in 2002. Salaries and employee benefit costs, which represented
50.1% of total other expense, were $4,916,000, for 2003, an increase of $69,000
or 1.4%. The increase was principally due to increasing costs of retirement
plans and health insurance.
Losses on lease residuals were $50,000 in 2003, decreasing significantly
from $870,000 in 2002. The decrease was principally due to the lower number of
cars liquidated in 2003 compared to 2002.
26
These losses were partially offset by lease termination fee income, included in
other income, of $16,000 in 2003 and $36,000 in 2002.
Furniture and equipment expense for 2003 totaled $602,000, increasing from
$517,000. The increase was due in part to a full year of maintenance costs on
the item processing system installed in 2002. Professional fees were $277,000 in
2003 compared to $178,000 in 2002. The increase was due in part to $45,000 of
legal expenses related to the resolution of a problem credit and for general
corporate matters. Also consulting expense, included in professional fees,
increased $28,000 due to a project related to loan processing and investment
banking fees.
INCOME TAXES
Income tax expense for the year 2004 was $2,003,000 for an effective tax
rate of 28.6% compared to an expense of $1,694,000 and an effective tax rate of
26.7% in 2003. The increase in effective tax rate is due in part to the
expiration of low-income housing tax credit of $58,000 in 2003 with no such
credit available in 2004.
Income tax expense for the year 2003 was $1,694,000 for an effective
tax rate of 26.6%, compared to an expense of $1,623,000 and an effective rate of
27.2% in 2002. The decrease in the effective tax rate is principally due to
higher levels of interest income on municipal securities, and the cash surrender
value of life insurance, which is not subject to Federal Income Tax.
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2000 - $11.99
2001 - $13.37
2002 - $15.09
2003 - $15.96
2004 - $16.95]
BOOK VALUE
PER SHARE
CAPITAL AND DIVIDENDS
Total stockholders' equity as of December 31, 2004, was $45.7 million,
compared to $42.8 million as of year-end 2003. The increase was principally due
to retention of earnings of $3,180,000 after cash dividends declared of
$1,830,000. This was partially offset by a $1,098,000 decrease in accumulated
other comprehensive income due to market value changes in the Company's AFS
securities portfolio principally as a result of changing interest rates. As of
December 31, 2004 the Company had a leverage capital ratio of 10.52%, Tier 1
risk-based capital of 15.53% and total risk-based capital of 17.06% compared to
10.52%, 15.53% and 17.06%, respectively, in 2003. The average equity to average
asset ratio for 2004, 2003 and 2002 was 11.15%, 10.86% and 10.45% respectively.
The Company's stock is traded on the Nasdaq market under the symbol,
NWFL. As of December 31, 2004, there were approximately 1,300 shareholders based
on transfer agent mailings.
The following table sets forth the price range and cash dividends
declared per share regarding common stock for the period indicated:
CLOSING PRICE RANGE
------------------------ CASH DIVIDEND
HIGH LOW PAID PER SHARE
--------------------------------------------
Year 2004
First Quarter $ 30.50 $ 26.15 $ .17
Second Quarter 32.00 26.87 .17
Third Quarter 31.00 27.55 .17
Fourth Quarter 35.35 29.37 .18
Year 2003
First Quarter $ 20.83 $ 19.39 $ .16
Second Quarter 24.20 19.84 .16
Third Quarter 29.70 23.47 .16
Fourth Quarter 27.59 24.88 .17
The book value of the common stock was $16.95 as of December 31, 2004
compared to $15.96 as of December 31, 2003. As of year-end 2004, the stock price
was $35.35, compared to $26.15 as of December 31, 2003.
27
NORWOOD FINANCIAL CORP
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
(Dollars in thousands, except per share amounts)
2004
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------------------------------------------
Interest income $4,940 $4,782 $4,595 $4,689
Interest expense 1,299 1,224 1,215 1,256
----------------------------------------------
Net interest income 3,641 3,558 3,380 3,433
Provision for loan losses 65 100 165 125
Other income 829 820 678 761
Net realized gains on sales of securities 145 51 84 178
Other expense 2,542 2,509 2,444 2,595
----------------------------------------------
Income before income taxes 2,008 1,820 1,533 1,652
Income tax expense 645 500 406 452
----------------------------------------------
NET INCOME $1,363 $1,320 $1,127 $1,200
==============================================
Basic earnings per share $ 0.51 $ 0.50 $ 0.43 $ 0.46
==============================================
Diluted earnings per share $ 0.50 $ 0.49 $ 0.42 $ 0.45
==============================================
2003
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------------------------------------------
Interest income $4,844 $4,760 $4,816 $4,925
Interest expense 1,347 1,461 1,568 1,647
----------------------------------------------
Net interest income 3,497 3,299 3,248 3,278
Provision for loan losses 165 165 165 165
Other income 648 729 679 745
Net realized gains on sales of securities 150 156 243 143
Other expense 2,450 2,417 2,475 2,466
----------------------------------------------
Income before income taxes 1,680 1,602 1,530 1,535
Income tax expense 453 408 408 425
----------------------------------------------
NET INCOME $1,227 $1,194 $1,122 $1,110
==============================================
Basic earnings per share $ 0.47 $ 0.46 $ 0.43 $ 0.43
==============================================
Diluted earnings per share $ 0.46 $ 0.45 $ 0.42 $ 0.42
==============================================
28
NORWOOD FINANCIAL CORP CONSOLIDATED AVERAGE
BALANCE SHEETS WITH RESULTANT INTEREST AND RATES
(Tax-Equivalent Basis, dollars in thousands)
Year Ended December 31 2004 2003
---------------------------------------------------------------------
AVERAGE AVE AVERAGE AVE
BALANCE(2) INTEREST(1) RATE BALANCE(2) INTEREST(1) RATE
---------------------------------------------------------------------
ASSETS
Interest Earning Assets:
Federal funds sold $ 4,468 $ 68 1.46% $ 8,369 $ 94 1.12%
Interest bearing deposits with banks 120 2 1.67 154 1 0.65
Securities held to maturity 5,732 506 8.83 6,165 583 9.47
Securities available for sale
Taxable 100,180 3,127 3.12 103,506 3,677 3.55
Tax-exempt 18,080 1,032 5.71 17,025 1,034 6.07
------------------- ------------------
Total securities available
for sale 118,260 4,159 3.52 120,531 4,711 3.91
Loans receivable (3,4) 245,783 14,912 6.07 225,680 14,579 6.46
------------------- ------------------
Total interest earning assets 374,543 19,647 5.25 360,890 19,968 5.53
Non-interest earning assets:
Cash and due from banks 8,542 9,364
Allowance for loan losses (3,376) (3,273)
Other assets 14,846 13,982
-------- --------
Total non-interest earning
assets 20,012 20,073
-------- --------
TOTAL ASSETS $394,555 $380,963
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liablities:
Interest-bearing demand
and money market $ 89,851 549 0.61 $ 82,596 532 0.64
Savings 58,243 273 0.47 55,055 428 0.78
Time 118,512 2,733 2.31 127,995 3,678 2.87
------------------- ------------------
Total interest-bearing
deposits 266,606 3,555 1.33 265,646 4,638 1.75
Short-term borrowings 12,965 151 1.16 9,081 99 1.09
Long term debt 23,000 1,288 5.60 23,000 1,286 5.59
------------------- ------------------
Total interest bearing
liabilities 302,571 4,994 1.65 297,727 6,023 2.02
------- -------
Non-interest bearing liabilities
Non-interest bearing demand deposits 47,399 39,119
Other liabilities 596 2,729
-------- --------
Total non-interest bearing
liabilities 47,995 41,848
-------- --------
Stockholders' equity 43,989 41,388
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $394,555 $380,963
======== ========
Net interest income
(tax-equivalent basis) 14,653 3.60% 13,945 3.51%
==== ====
Tax-equivalent basis adjustment (641) (623)
------- -------
Net Interest Income $14,012 $13,322
======= =======
Net Interest margin(tax-equivalent basis) 3.91% 3.86%
==== ====
Year Ended December 31 2002
----------------------------------
AVERAGE AVE
BALANCE(2) INTEREST(1) RATE
----------------------------------
ASSETS
Interest Earning Assets:
Federal funds sold $ 15,573 $ 258 1.66%
Interest bearing deposits with banks 346 5 1.45
Securities held to maturity 6,212 545 8.77
Securities available for sale
Taxable 89,956 4,623 5.14
Tax-exempt 13,616 1,010 7.42
------------------
Total securities available
for sale 103,572 5,633 5.44
Loans receivable (3,4) 213,814 15,651 7.32
------------------
Total interest earning assets 339,517 22,092 6.51
Non-interest earning assets:
Cash and due from banks 8,452
Allowance for loan losses (3,228)
Other assets 14,093
--------
Total non-interest earning
assets 19,317
--------
TOTAL ASSETS $358,834
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liablities:
Interest-bearing demand
and money market $ 74,696 730 0.98
Savings 48,361 648 1.34
Time 127,571 4,761 3.73
------------------
Total interest-bearing
deposits 250,628 6,139 2.45
Short-term borrowings 9,550 176 1.84
Long term debt 23,230 1,298 5.59
------------------
Total interest bearing
liabilities 283,408 7,613 2.69
-------
Non-interest bearing liabilities
Non-interest bearing demand deposits 33,966
Other liabilities 3,949
--------
Total non-interest bearing
liabilities 37,915
--------
Stockholders' equity 37,511
--------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $358,834
========
Net interest income
(tax-equivalent basis) 14,479 3.82%
====
Tax-equivalent basis adjustment (528)
-------
Net Interest Income $13,951
=======
Net Interest margin(tax-equivalent basis) 4.26%
====
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. Loan balances include non-accrual loans and are net of unearned income.
4. Loan yields include the effect of amortization of deferred fees net of
costs.
29
RATE/VOLUME ANALYSIS
The following table shows fully taxable equivalent effect of changes in
volumes and rates on interest income and interest expense.
INCREASE/(DECREASE)
-------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2004 COMPARED TO 2003 2003 COMPARED TO 2002
VARIANCE DUE TO VARIANCE DUE TO
-------------------------------------------------------------------------
VOLUME RATE NET VOLUME RATE NET
------------------------------------ ---------------------------------
INTEREST EARNING ASSETS:
- --------------------------------------------------------------------------------------------------------------------------
Federal funds sold $ (49) $ 23 $ (26) $ (96) $ (68) $ (164)
Interest bearing deposits with banks -- 1 1 (2) (2) (4)
Securities held to maturity (39) (38) (77) (5) 43 38
Securities available for sale
Taxable (115) (435) (550) 626 (1,572) (946)
Tax-exempt 62 (64) (2) 227 (203) 24
-------------------------------------------------------------------------
Total securities available for sale (53) (490) (552) 853 (1,775) (922)
Loans receivable 1,252 (919) 333 836 (1,908) (1,072)
-------------------------------------------------------------------------
Total interest earning assets 1,111 (1,432) (321) 1,586 (3,710) (2,124)
INTEREST BEARING LIABLITIES:
- --------------------------------------------------------------------------------------------------------------------------
Interest-bearing demand and money market 45 (28) 17 71 (269) (198)
Savings 24 (179) (155) 80 (300) (220)
Time (258) (687) (945) 16 (1,099) (1,083)
-------------------------------------------------------------------------
Total interest- bearing deposits (189) (894) (1,083) 167 (1,668) (1,501)
Short-term borrowings 45 7 52 (8) (69) (77)
Long term debt -- 2 2 (13) 1 (12)
-------------------------------------------------------------------------
Total interest bearing liabilities (144) (885) (1,029) 146 (1,736) (1,590)
-------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $1,255 $ (547) $ 708 $ 1,550 $(1,974) $ (534)
=========================================================================
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.
30
BEARD MILLER
COMPANY LLP
- --------------------------------------------
Certified Public Accountants and Consultants
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Norwood Financial Corp.
Honesdale, Pennsylvania
We have audited the accompanying consolidated balance sheets of Norwood
Financial Corp. and its subsidiary as of December 31, 2004 and 2003, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Norwood
Financial Corp. and its subsidiary as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Beard Miller Company LLP
Reading, Pennsylvania
January 21, 2005
31
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
2004 2003
----------------------
(In Thousands)
ASSETS
Cash and due from banks $ 7,488 $ 9,110
Interest bearing deposits with banks 118 64
Federal funds sold 13,060 --
----------------------
Cash and Cash Equivalents 20,666 9,174
Securities available for sale 116,933 124,823
Securities held to maturity, fair value 2004 $5,878; 2003 $5,975 5,724 5,748
Loans receivable, net of allowance for loan losses 2004 $3,448 2003 $3,267 251,309 230,466
Investment in FHLB stock, at cost 2,225 2,002
Bank premises and equipment, net 5,489 5,596
Accrued interest receivable 1,641 1,783
Other assets 7,639 7,891
----------------------
TOTAL ASSETS $ 411,626 $ 387,483
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing demand $ 44,450 $ 39,517
Interest-bearing demand 41,336 40,926
Money market deposit accounts 51,125 46,481
Savings 60,064 55,895
Time 121,670 123,850
----------------------
Total Deposits 318,645 306,669
Short-term borrowings 22,982 12,859
Long-term debt 23,000 23,000
Accrued interest payable 1,200 1,309
Other liabilities 114 815
----------------------
TOTAL LIABILITIES 365,941 344,652
----------------------
STOCKHOLDERS' EQUITY
Common stock, par value $.10 per share; authorized 10,000,000 shares;
issued 2,705,715 shares 270 270
Surplus 5,336 4,933
Retained earnings 40,222 37,042
Treasury stock, at cost 2004 8,913 shares; 2003 21,318 shares (149) (295)
Accumulated other comprehensive income 333 1,431
Unearned Employee Stock Ownership Plan (ESOP) shares (327) (550)
----------------------
Total Stockholders' Equity 45,685 42,831
----------------------
Total Liabilities and Stockholders' Equity $ 411,626 $ 387,483
======================
See notes to consolidated financial statements
32
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
---------------------------
2004 2003 2002
---------------------------
(In Thousands, Except per Share Data)
Interest Income
Loans receivable, including fees $14,794 $14,506 $15,651
Securities:
Taxable 3,127 3,677 4,623
Tax exempt 1,015 1,067 1,027
Other 70 95 263
---------------------------
Total Interest Income 19,006 19,345 21,564
---------------------------
Interest Expense
Deposits 3,555 4,638 6,139
Short-term borrowings 151 99 176
Long-term debt 1,288 1,286 1,298
---------------------------
Total Interest Expense 4,994 6,023 7,613
---------------------------
Net Interest Income 14,012 13,322 13,951
Provision for Loan Losses 455 660 630
---------------------------
Net Interest Income after Provision
for Loan Losses 13,557 12,662 13,321
---------------------------
Other Income
Service charges and fees 2,122 1,846 1,788
Income from fiduciary activities 301 250 236
Net realized gains on sales of securities 458 692 427
Earnings on life insurance policies 316 271 203
Other 349 434 350
---------------------------
Total Other Income 3,546 3,493 3,004
---------------------------
Other Expenses
Salaries and employee benefits 5,133 4,916 4,847
Occupancy 813 799 759
Furniture and equipment 542 602 517
Data processing related operations 598 549 556
Losses on lease residuals 90 50 870
Advertising 156 170 168
Professional fees 323 277 178
Postage and telephone 471 465 425
Taxes, other than income 276 256 222
Amortization of intangible assets 52 83 178
Other 1,636 1,641 1,629
---------------------------
Total Other Expenses 10,090 9,808 10,349
---------------------------
Income before Income Taxes 7,013 6,347 5,976
Income Tax Expense 2,003 1,694 1,623
---------------------------
Net Income $ 5,010 $ 4,653 $ 4,353
===========================
Earnings per Share
Basic $ 1.89 $ 1.79 $ 1.70
===========================
Diluted $ 1.85 $ 1.75 $ 1.68
===========================
See notes to consolidated financial statements
33
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
-------------------------------------------------------------------------------------------------
ACCUMULATED
NUMBER OF OTHER UNEARNED
SHARES COMMON RETAINED TREASURY COMPREHENSIVE ESOP
ISSUED STOCK SURPLUS EARNINGS STOCK INCOME SHARES TOTAL
-------------------------------------------------------------------------------------------------
(Dollars in Thousands)
BALANCE - DECEMBER 31, 2001 1,803,824 $180 $4,687 $31,265 $(1,066) $1,002 $(952) $35,116
--------
Comprehensive income:
Net income - - - 4,353 - - - 4,353
Change in unrealized gains on
securities available for sale,
net of reclassification
adjustment and tax effects - - - - - 1,489 - 1,489
--------
Total Comprehensive Income 5,842
--------
Cash dividends declared,
$.60 per share - - - (1,536) - - - (1,536)
Stock options exercised - - (78) - 434 - - 356
Tax benefit of stock
options exercised - - 5 - - - - 5
Acquisition of treasury stock - - - - (8) - - (8)
Release of earned ESOP
shares, net - - 148 - - - 202 350
-------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 1,803,824 180 4,762 34,082 (640) 2,491 (750) 40,125
--------
Comprehensive income:
Net income - - - 4,653 - - - 4,653
Change in unrealized gains on
securities available for sale,
net of reclassification
adjustment and tax effects - - - - - (1,060) - (1,060)
--------
Total Comprehensive Income 3,593
--------
Cash dividends declared,
$.65 per share - - - (1,693) - - - (1,693)
Three-for-two stock split
in the form of a
50% stock dividend 901,891 90 (91) - - - - (1)
Stock options exercised - - (24) - 358 - - 334
Tax benefit of stock
options exercised - - 20 - - - - 20
Acquisition of treasury stock - - - - (46) - - (46)
Release of treasury stock
for ESOP - - 30 - 33 - - 63
Release of earned ESOP
shares, net - - 236 - - - 200 436
-------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2003 2,705,715 270 4,933 37,042 (295) 1,431 (550) 42,831
--------
Comprehensive income:
Net income - - - 5,010 - - - 5,010
Change in unrealized gains on
securities available for sale,
net of reclassification
adjustment and tax effects - - - - - (1,098) - (1,098)
--------
Total Comprehensive Income 3,912
--------
Cash dividends declared,
$.69 per share - - - (1,830) - - - (1,830)
Stock options exercised - - (21) - 227 - - 206
Tax benefit of stock
options exercised - - 22 - - - 22
Acquisition of treasury stock - - - - (118) - - (118)
Release of treasury stock
for ESOP - - 40 - 37 - - 77
Release of earned ESOP
shares, net - - 362 - - - 223 585
-------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2004 2,705,715 $270 $5,336 $40,222 $ (149) $ 333 $ (327) $45,685
================================================================================================
See notes to consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------
2004 2003 2002
-----------------------------------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,010 $ 4,653 $ 4,353
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses 455 660 630
Depreciation 544 611 617
Amortization of intangible assets 52 83 178
Deferred income taxes (81) (249) (1,159)
Net amortization of securities premiums and discounts 540 500 233
Net realized gains on sales of securities (458) (692) (427)
Net increase in investment in life insurance (283) (247) (183)
Gain on sale of bank premises and equipment and
foreclosed real estate (12) (20) (49)
Gain on sale of mortgage loans (67) (192) (82)
Mortgage loans originated for sale (4,101) (7,060) (5,409)
Proceeds from sale of mortgage loans 4,168 7,252 5,491
Release of ESOP shares 585 436 350
Decrease in accrued interest receivable and other assets 906 1,335 1,188
Decrease in accrued interest payable and other liabilities (200) (600) (530)
-----------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,058 6,470 5,201
-----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 11,687 22,544 6,455
Proceeds from maturities and principal reductions on
mortgage-backed securities 37,779 72,879 46,336
Purchases (43,331) (106,842) (69,393)
Securities held to maturity, proceeds from maturities 35 494 30
Increase in investment in FHLB stock (223) (365) (237)
Net increase in loans (21,579) (16,912) (5,660)
Purchase of life insurance -- (2,550) --
Purchase of bank premises and equipment (445) (221) (572)
Proceeds from sales of premises and equipment and foreclosed
real estate 42 84 590
-----------------------------------
NET CASH USED IN INVESTING ACTIVITIES (16,035) (30,889) (22,451)
-----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 11,976 14,817 16,929
Net increase in short-term borrowings 10,123 3,843 2,375
Repayments of long-term debt -- -- (2,000)
Stock options exercised 206 334 356
ESOP purchase of shares from treasury stock 77 63 --
Acquisition of treasury stock (118) (46) (8)
Cash dividends paid (1,795) (1,662) (1,494)
-----------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 20,469 17,349 16,158
-----------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 11,492 (7,070) (1,092)
CASH AND CASH EQUIVALENTS - BEGINNING 9,174 16,244 17,336
-----------------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 20,666 $ 9,174 $ 16,244
===================================
See notes to consolidated financial statements.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
Norwood Financial Corp. (Company) is a one bank holding company. Wayne Bank
(Bank) is a wholly-owned subsidiary of the Company. The Bank is a
state-chartered bank located in Honesdale, Pennsylvania. The Company derives
substantially all of its income from the bank related services which include
interest earnings on commercial mortgages, residential real estate, commercial
and consumer loans, as well as interest earnings on investment securities and
deposit services to its customers. The Company is subject to regulation and
supervision by the Federal Reserve Board while the Bank is subject to regulation
and supervision by the Federal Deposit Insurance Corporation and the
Pennsylvania Department of Banking.
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, the Bank, and the Bank's wholly-owned
subsidiaries, WCB Realty Corp., Norwood Investment Corp. and WTRO Properties.
All intercompany accounts and transactions have been eliminated in
consolidation.
Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for loan
losses and the valuation of deferred tax assets.
Significant Group Concentrations of Credit Risk
Most of the Company's activities are with customers located within
northeastern Pennsylvania. Note 3 discusses the types of securities that the
Company invests in. Note 4 discusses the types of lending that the Company
engages in. The Company does not have any significant concentrations to any one
industry or customer.
Concentrations of Credit Risk
The Bank operates primarily in Wayne, Pike and Monroe Counties,
Pennsylvania and, accordingly, 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. These customers are also the primary
depositors of the Bank. The Bank is limited in extending credit by legal lending
limits to any single borrower or group of borrowers.
Securities
Securities classified as available for sale are those securities that the
Company intends to hold for an indefinite period of time but not necessarily to
maturity. Any decision to sell a security classified as available for sale would
be based on various factors, including significant movement in interest rates,
changes in maturity mix of the Company's assets and liabilities, liquidity
needs, regulatory capital considerations and other similar factors. Securities
available for sale are carried at fair value. Unrealized gains and losses are
reported in other comprehensive income, net of the related deferred tax effect.
Realized gains or losses, determined on the basis of the cost of the specific
securities sold, are included in earnings. Premiums and discounts are recognized
in interest income using a method which approximates the interest method over
the term of the security.
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.
36
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Management determines the appropriate classification of debt securities at
the time of purchase and re-evaluates such designation as of each 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, management 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 and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Federal law requires a member institution of the Federal Home Loan Bank
system to hold stock of its district Federal Home Loan Bank according to a
predetermined formula. This restricted stock is carried at cost.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at their outstanding
unpaid principal balances, net of an allowance for loan losses and any deferred
fees. Interest income is accrued on the unpaid principal balance. Loan
origination fees are deferred and recognized as an adjustment of the yield
(interest income) of the related loans. The Company is generally amortizing
these amounts over the contractual life of the loan.
The Company has a portfolio of direct financing leases. These direct
financing leases are carried at the Company's net investment, which includes the
sum of aggregate rentals receivable and the estimated residual value of the
leased automobiles less unearned income. Unearned income is amortized over the
leases' terms.
The accrual of interest is generally discontinued when the contractual
payment of principal or interest has become 90 days past due or management has
serious doubts about further collectibility of principal or interest, even
though the loan is currently performing. A loan may remain on accrual status if
it is in the process of collection and is either guaranteed or well secured.
When a loan is placed on nonaccrual status, unpaid interest credited to income
in the current year is reversed and unpaid interest accrued in prior years is
charged against the allowance for loan losses. Interest received on nonaccrual
loans generally is either applied against principal or reported as interest
income, according to management's judgment as to the collectibility of
principal. Generally, loans are restored to accrual status when the obligation
is brought current, has performed in accordance with the contractual terms for a
reasonable period of time and the ultimate collectibility of the total
contractual principal and interest is no longer in doubt.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan
losses charged against income. Loans deemed to be uncollectible are charged
against the allowance for loan losses, and subsequent recoveries, if any, are
credited to the allowance.
The allowance for loan losses is maintained at a level considered adequate
to provide for losses that can be reasonably anticipated. Management's periodic
evaluation of the adequacy of the allowance is based on the Company's past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of any
underlying collateral, composition of the loan portfolio, current economic
conditions and other relevant factors. This evaluation is inherently subjective
as it requires material estimates that may be susceptible to significant
revision as more information becomes available.
37
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component is maintained to cover uncertainties that
could affect management's estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and construction
loans by either 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 real estate loans for impairment
disclosures, unless such loans are the subject of a restructuring agreement.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation expense is calculated principally on the straight-line method over
the respective assets estimated useful lives as follows:
Years
-----
Buildings and improvements 10 - 40
Furniture and equipment 3 - 10
Transfers of Financial Assets
Transfers of financial assets, including loan and loan participation sales,
are accounted for as sales, when control over the assets has been surrendered.
Control over transferred assets is deemed to be surrendered when (1) the assets
have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge
or exchange the transferred assets and (3) the Company does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure
are to be sold and are initially recorded at fair value less cost to sell at the
date of foreclosure establishing a new cost basis. After foreclosure, valuations
are periodically performed by management and the real estate is carried at the
lower of its carrying amount or fair value less cost to sell. Revenue and
expenses from operations and changes in the valuation allowance are included in
other expenses. Foreclosed real estate is included in other assets.
38
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Bank Owned Life Insurance
The Company invests in bank owned life insurance ("BOLI") as a source of
funding for employee benefit expenses. BOLI involves the purchasing of life
insurance by the Bank on a chosen group of employees. The Company is the owner
and beneficiary of the policies. This life insurance investment is carried at
the cash surrender value of the underlying policies and is included in other
assets in the amount of $6,959,000 and $6,676,000 at December 31, 2004 and 2003,
respectively. Income from the increase in cash surrender value of the policies
is included in other income on the income statement.
Intangible Assets
Intangible assets represent goodwill arising from acquisitions. Goodwill
represents the excess cost of an acquisition over the fair value of the net
assets acquired. On January 1, 2002, the Company adopted SFAS 142, "Goodwill and
Other Intangible Assets," and SFAS 147, "Accounting for Certain Acquisitions of
Banking and Thrift Institutions." At December 31, 2004 and 2003, the Company had
intangible assets of $325,000 and $377,000, net of accumulated amortization of
$455,000 and $403,000, which are included in other assets. These intangible
assets will continue to be amortized on a straight-line basis over fifteen years
under the provisions of SFAS 142 and SFAS 147. Amortization expense related to
intangible assets was $52,000, $83,000 and $178,000 for the years ended December
31, 2004, 2003 and 2002, respectively.
Income Taxes
Deferred income tax assets and liabilities are determined based on the
differences between financial statement carrying amounts and the tax basis of
existing assets and liabilities. These differences are measured at the enacted
tax rates that will be in effect when these differences reverse. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion of the deferred tax assets will not
be realized. As changes in tax laws or rates are enacted, deferred tax assets
and liabilities are adjusted through the provision for income taxes. The Company
and its subsidiary file a consolidated federal income tax return.
Advertising Costs
The Company follows the policy of charging the costs of advertising to
expense as incurred.
Earnings per Share
On April 8, 2003, the Board of Directors declared a three-for-two stock
split in the form of a 50% stock dividend on common stock outstanding, payable
June 16, 2003 to shareholders of record on May 30, 2003. The stock split
resulted in the issuance of 901,891 additional common shares. All per share data
has been adjusted for the effect of the stock split.
Basic earnings per share represents income available to common stockholders
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
Potential common shares that may be issued by the Company relate solely to
outstanding stock options and are determined using the treasury stock method.
Stock Option Plans
The Company accounts for its stock option plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise
39
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
price equal to the market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, "Accounting for Stock-Based Compensation," to stock-based
employee compensation.
YEARS ENDED DECEMBER 31,
-----------------------------------
2004 2003 2002
-----------------------------------
(In Thousands, Except per Share Data)
Net income, as reported $ 5,010 $ 4,653 $ 4,353
Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related taxes (143) (50) (74)
-----------------------------------
Pro forma net income $ 4,867 $ 4,603 $ 4,279
===================================
Earnings per share (basic):
As reported $ 1.89 $ 1.79 $ 1.70
Pro forma $ 1.84 $ 1.77 $ 1.67
Earnings per share (assuming dilution):
As reported $ 1.85 $ 1.75 $ 1.68
Pro forma $ 1.80 $ 1.74 $ 1.65
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
YEARS ENDED DECEMBER 31,
----------------------------
2004 2003 2002
----------------------------
Dividend yield 2.61% 2.68% 3.13%
Expected life 7 years 8 years 8 years
Expected volatility 34.66% 27.97% 11.81%
Risk-free interest rate 3.80% 3.97% 3.81%
Weighted average fair value of options granted $ 9.97 $ 6.97 $ 2.44
Cash Flow Information
For the purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, interest-bearing deposits with banks and
federal funds sold.
Cash payments for interest for the years ended December 31, 2004, 2003 and
2002 were $5,103,000, $6,368,000 and $8,285,000, respectively. Cash payments for
income taxes for the years ended December 31, 2004, 2003 and 2002 were
$1,941,000, $1,802,000 and $3,117,000, respectively. Non-cash investing
activities for 2004, 2003 and 2002 included foreclosed mortgage loans
transferred to foreclosed real estate and repossession of other assets of
$281,000, $610,000 and $1,183,000, respectively.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to extend
credit, letters of credit and commitments to sell loans. Such financial
instruments are recorded in the balance sheets when they become receivable or
payable.
40
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Trust Assets
Assets held by the Company in a fiduciary capacity for customers are not
included in the financial statements since such items are not assets of the
Company. Trust income is reported on the accrual method.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses,
gains and losses be included in net income. Although certain changes in assets
and liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
The components of other comprehensive income and related tax effects are as
follows:
YEARS ENDED DECEMBER 31,
-----------------------------
2004 2003 2002
-----------------------------
(In Thousands)
Unrealized holding gains (losses) on available for sale securities $(1,204) $ (901) $ 2,690
Reclassification adjustment for gains realized in income 458 692 427
-----------------------------
Net Unrealized Gains (Losses) (1,662) (1,593) 2,263
Income tax (benefit) (564) (533) 774
-----------------------------
Net of Tax Amount $(1,098) $(1,060) $ 1,489
=============================
Segment Reporting
The Company acts as an independent community financial service provider and
offers traditional banking and related financial services to individual,
business and government customers. Through its branch and automated teller
machine network, the Company offers a full array of commercial and retail
financial services, including the taking of time, savings and demand deposits;
the making of commercial, consumer and mortgage loans; and the providing of safe
deposit services. The Company also performs personal, corporate, pension and
fiduciary services through its Trust Department.
Management does not separately allocate expenses, including the cost of
funding loan demand, between the commercial, retail, mortgage banking and trust
operations of the Company. As such, discrete information is not available and
segment reporting would not be meaningful.
Reclassifications
Certain items in the 2003 and 2002 financial statements have been
reclassified to conform to the 2004 financial statement presentation format.
These reclassifications had no effect on net income.
New Accounting Standards
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) revised
Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. Statement No. 123(R) will require compensation costs
related to share-based
41
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
payment transactions to be recognized in the financial statements (with limited
exceptions). The amount of compensation cost will be measured based on the
grant-date fair value of the equity or liability instruments issued.
Compensation cost will be recognized over the period that an employee provides
service in exchange for the award. This statement is effective as of the
beginning of the first interim or annual reporting period that begins after June
15, 2005. The Company is currently evaluating the impact from this standard on
its results of operations and financial position.
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurements of loan commitments recognized at fair value
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 did not have a material effect on our consolidated
financial statements.
In December 2003, the Accounting Standards Executive Committee issued
Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer." SOP 03-3 addresses accounting for
differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer, including business combinations, if those differences
are attributable, at least in part, to credit quality. SOP 03-3 is effective for
loans or debt securities acquired in fiscal years beginning after December 15,
2004. The Company intends to adopt the provisions of SOP 03-3 effective January
1, 2005, and does not expect the initial implementation to have a material
effect on the Company's consolidated financial statements.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities were as follows:
DECEMBER 31, 2004
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------
(In Thousands)
AVAILABLE FOR SALE:
U.S. Treasuries $ 2,030 $ -- $ (16) $ 2,014
U.S. Government agencies 47,764 6 (619) 47,151
States and political subdivisions 18,377 234 (79) 18,532
Corporate obligations 15,428 55 (175) 15,308
Mortgage-backed securities 32,269 82 (291) 32,060
---------------------------------------------
115,868 377 (1,180) 115,065
Equity securities 539 1,329 -- 1,868
---------------------------------------------
$116,407 $1,706 $(1,180) $116,933
=============================================
HELD TO MATURITY:
States and political subdivisions $ 5,724 $ 154 $ -- $ 5,878
=============================================
42
NOTE 3 - SECURITIES (CONTINUED)
DECEMBER 31, 2003
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------
(In Thousands)
AVAILABLE FOR SALE:
U.S. Treasuries $ 2,051 $ 14 $ -- $ 2,065
U.S. Government agencies 47,791 157 (316) 47,632
States and political subdivisions 18,578 382 (30) 18,930
Corporate obligations 13,374 291 -- 13,665
Mortgage-backed securities 40,413 359 (264) 40,508
---------------------------------------------
122,207 1,203 (610) 122,800
Equity securities 428 1,595 -- 2,023
---------------------------------------------
$122,635 $2,798 $(610) $124,823
=============================================
HELD TO MATURITY:
States and political subdivisions $ 5,748 $ 227 $ -- $ 5,975
=============================================
The following table shows 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, at December 31, 2004:
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
---------------------------------------------------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------
(In Thousands)
U. S. Treasuries $ 2,014 $ (16) $ -- $ -- $ 2,014 $ (16)
U.S. Government agencies 36,349 (421) 6,796 (198) 43,145 (619)
States and political subdivisions 5,342 (69) 373 (10) 5,715 (79)
Corporate obligations 13,247 (175) -- -- 13,247 (175)
Mortgage-backed securities 18,540 (124) 6,496 (167) 25,036 (291)
---------------------------------------------------------------------
$ 75,492 $ (805) $ 13,665 $ (375) $ 89,157 $ (1,180)
=====================================================================
The Company has 86 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. Management believes that
the unrealized losses represent temporary impairment of the securities, as the
Company has the intent and ability to hold these investments until maturity or
market price recovery.
The amortized cost and fair value of securities as of December 31, 2004 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.
43
NOTE 3 - SECURITIES (CONTINUED)
AVAILABLE FOR SALE HELD TO MATURITY
------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------------------------------------
(In Thousands)
Due in one year or less $ 2,925 $ 2,911 $ -- $ --
Due after one year through five years 68,658 67,902 -- --
Due after five years through ten years 6,127 6,172 162 179
Due after ten years 5,889 6,020 5,562 5,699
------------------------------------------
83,599 83,005 5,724 5,878
Mortgage-backed securities 32,269 32,060 -- --
------------------------------------------
$115,868 $115,065 $5,724 $ 5,878
==========================================
Gross realized gains and gross realized losses on sales of securities
available for sale were $475,000 and $17,000, respectively, in 2004, $723,000
and $31,000, respectively, in 2003, and $432,000 and $5,000, respectively, in
2002.
Securities with a carrying value of $45,424,000 and $34,775,000 at December
31, 2004 and 2003, respectively, were pledged to secure public deposits, U.S.
Treasury demand notes, securities sold under agreements to repurchase and for
other purposes as required or permitted by law.
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
The components of loans receivable at December 31 were as follows:
2004 2003
---------------------
(In Thousands)
Real estate:
Residential $ 90,606 $ 77,459
Commercial 111,164 96,276
Construction 4,890 5,904
Commercial, financial and agricultural 20,263 17,022
Consumer loans to individuals 28,193 37,219
Lease financing, net of unearned income -- 316
---------------------
255,116 234,196
Unearned income and deferred fees (359) (463)
Allowance for loan losses (3,448) (3,267)
---------------------
$251,309 $230,466
=====================
The Bank's net investment in direct financing leases at December 31
consists of:
2004 2003
-------------------
(In Thousands)
Minimum lease payments receivable $-- $ 24
Estimated unguaranteed residual values -- 297
Unearned income -- (5)
-------------------
$-- $ 316
===================
44
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table presents changes in the allowance for loan losses:
YEARS ENDED DECEMBER 31,
---------------------------------
2004 2003 2002
---------------------------------
(In Thousands)
Balance, beginning $ 3,267 $ 3,146 $ 3,216
Provision for loan losses 455 660 630
Recoveries 108 96 94
Loans charged off (382) (635) (794)
---------------------------------
Balance, ending $ 3,448 $ 3,267 $ 3,146
=================================
The recorded investment in impaired loans, not requiring an allowance for
loan losses was $-0- and $263,000 at December 31, 2004 and 2003, respectively.
The recorded investment in impaired loans requiring an allowance for loan losses
was $-0- at December 31, 2004 and 2003. For the years ended December 31, 2004,
2003 and 2002, the average recorded investment in these impaired loans was $-0-,
$337,000 and $262,000 and the interest income recognized on these impaired loans
was $-0-, $30,000 and $23,000, respectively.
Loans on which the accrual of interest has been discontinued amounted to
$40,000 and $125,000 at December 31, 2004 and 2003, respectively. Loan balances
past due 90 days or more and still accruing interest, but which management
expects will eventually be paid in full, amounted to $27,000 and $18,000 at
December 31, 2004 and 2003, respectively.
NOTE 5 - PREMISES AND EQUIPMENT
Components of premises and equipment at December 31 are as follows:
2004 2003
------------------------
(In Thousands)
Land and improvements $ 925 $ 925
Buildings and improvements 6,897 6,844
Furniture and equipment 3,977 3,650
------------------------
11,799 11,419
Accumulated depreciation (6,310) (5,823)
------------------------
$ 5,489 $ 5,596
========================
Certain facilities are leased under various operating leases. Rental
expense for these leases was $147,000, $109,000 and $109,000 for the years ended
December 31, 2004, 2003 and 2002. Future minimum rental commitments under
noncancellable leases as of December 31, 2004 were as follows(in thousands):
2005 $ 187
2006 149
2007 119
2008 89
2009 79
Thereafter 1,592
------
$2,215
======
45
NOTE 6 - DEPOSITS
Aggregate time deposits in denominations of $100,000 or more were
$33,283,000 and $29,372,000 at December 31, 2004 and 2003, respectively.
At December 31, 2004, the scheduled maturities of time deposits are as follows
(in thousands):
2005 $ 75,595
2006 30,895
2007 5,378
2008 6,648
2009 3,154
--------
$121,670
========
NOTE 7 - BORROWINGS
Short-term borrowings at December 31 consist of the following:
2004 2003
-------------------
(In Thousands)
Securities sold under agreements to repurchase $13,982 $11,806
Short-term FHLB advances 8,000 420
U.S. Treasury demand notes 1,000 633
-------------------
$22,982 $12,859
===================
The outstanding balances and related information of short-term borrowings are
summarized as follows:
Years Ended December 31,
-------------------------
2004 2003
-------------------------
(Dollars in Thousands)
Average balance during the year $ 12,965 $ 9,081
Average interest rate during the year 1.17% 1.09%
Maximum month-end balance during the year $ 22,982 $ 12,859
Weighted average interest rate at the end of the year 1.83% 0.99%
Securities sold under agreements to repurchase generally mature within one
day to one year from the transaction date. Securities with an amortized cost and
fair value of $15,757,000 and $15,495,000 at December 31, 2004 and $12,793,000
and $12,712,000 at December 31, 2003 were pledged as collateral for these
agreements. The securities underlying the agreements were under the Company's
control.
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 2005. There were no borrowings under this line at December 31, 2004
and $420,000 at December 31, 2003. The Company has a line of credit commitment
available from Atlantic Central Bankers Bank for $7,000,000. There were no
borrowings under this line of credit at December 31, 2004 and 2003. The Company
also has two $4,000,000 short-term advances from the FHLB outstanding as of
December 31, 2004 at interest rates of 2.51% and 2.30%.
46
NOTE 7 - BORROWINGS (CONTINUED)
Long-term debt consisted of the following at December 31, 2004 and 2003:
2004 2003
--------------------
(In Thousands)
Notes with the Federal Home Loan Bank (FHLB):
Convertible note due April 2005 at 6.13% $ 5,000 $ 5,000
Convertible note due December 2006 at 6.19% 5,000 5,000
Convertible note due April 2009 at 4.83% 5,000 5,000
Convertible note due April 2009 at 5.07% 5,000 5,000
Convertible note due January 2011 at 5.24% 3,000 3,000
--------------------
$23,000 $23,000
====================
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 11 to 16 basis points. If the notes are converted, the option allows the
Bank to put the funds back to the FHLB at no charge.
Contractual maturities of long-term debt at December 31, 2004 (in thousands):
2005 $ 5,000
2006 5,000
2007 --
2008 --
2009 10,000
Thereafter 3,000
-------
$23,000
=======
The Bank's maximum borrowing capacity with the Federal Home Loan Bank was
$142,340,000 of which $31,000,000 was outstanding at December 31, 2004. Advances
from the Federal Home Loan Bank are secured by qualifying assets of the Bank.
NOTE 8 - EMPLOYEE BENEFIT PLANS
The Company has a defined contributory profit-sharing plan which includes
provisions of a 401(k) plan. The plan permits employees to make pre-tax
contributions up to 15% of the employee's compensation. The amount of
contributions to the plan, including matching contributions, is at the
discretion of the Board of Directors. All employees over the age of 21 are
eligible to participate in the plan after one year of employment. Employee
contributions are vested at all times, and any Company contributions are fully
vested after five years. The Company's contributions are expensed as the cost is
incurred, funded currently, and amounted to $185,000, $192,000 and $170,000 for
the years ended December 31, 2004, 2003 and 2002, respectively.
The Company has a non-qualified supplemental executive retirement plan for
the benefit of certain executive officers. At December 31, 2004 and 2003, other
liabilities include approximately $580,000 and $450,000 accrued under the Plan.
Compensation expense includes approximately $130,000, $124,000 and $110,000
relating to the supplemental executive retirement plan for 2004, 2003 and 2002,
respectively. To fund the benefits under this plan, the Company is the owner of
single premium life insurance policies on participants in the non-qualified
retirement plan. At December 31, 2004 and 2003, the cash value of these policies
was $6,959,000 and $6,676,000, respectively.
47
NOTE 8 - EMPLOYEE BENEFIT PLANS (CONTINUED)
The Company has a leveraged employee stock ownership plan ("ESOP") for the
benefit of employees who meet the eligibility requirements which include having
completed one year of service with the Company and having attained age
twenty-one. The ESOP Trust purchased shares of the Company's common stock with
proceeds from a loan from the Company. The Bank makes cash contributions to the
ESOP on an annual basis sufficient to enable the ESOP to make the required loan
payments. The loan bears interest at the prime rate adjusted annually. Interest
is payable annually and principal payable in equal annual installments over ten
years. The loan is secured by the shares of the stock purchased.
As the debt is repaid, shares are released from collateral and allocated to
qualified employees based on the proportion of debt service paid in the year.
The Company accounts for its leveraged ESOP in accordance with Statement of
Position 93-6. Accordingly, the shares pledged as collateral are reported as
unallocated ESOP shares in the consolidated balance sheets. As shares are
released from collateral, the Company reports compensation expense equal to the
current market price of the shares, and the shares become outstanding for
earnings per share computations. Dividends on allocated ESOP shares are recorded
as a reduction of retained earnings and dividends on unallocated ESOP shares are
recorded as a reduction of debt. Dividends recorded as a reduction of debt were
$34,000 and $44,000 for the years ended December 31, 2004 and 2003,
respectively. The total employer contribution was $185,000 and $184,000 for the
years ended December 31, 2004 and 2003, respectively.
Compensation expense for the ESOP was $530,000, $428,000 and $348,000 for
the years ended December 31, 2004, 2003 and 2002, respectively.
The status of the ESOP shares at December 31 are as follows:
2004 2003
---------------------------
Allocated shares 132,934 114,083
Shares released from allocation 17,066 15,203
Unreleased shares 31,818 52,532
---------------------------
Total ESOP shares 181,818 181,818
===========================
Fair value of unreleased shares $1,125,000 $1,374,000
===========================
NOTE 9 - INCOME TAXES
The components of the provision for federal income taxes are as
follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
-----------------------------------------
(In Thousands)
Current $ 2,084 $ 1,943 $ 2,782
Deferred (81) (249) (1,159)
-----------------------------------------
$ 2,003 $ 1,694 $ 1,623
=========================================
48
NOTE 9 - INCOME TAXES (CONTINUED)
Income tax expense of the Company is less than the amounts computed by
applying statutory federal income tax rates to income before income taxes
because of the following:
PERCENTAGE OF INCOME
BEFORE INCOME TAXES
------------------------
YEARS ENDED DECEMBER 31,
------------------------
2004 2003 2002
------------------------
Tax at statutory rates 34.0% 34.0% 34.0%
Tax exempt interest income, net of interest
expense disallowance (5.6) (6.0) (5.8)
Low-income housing tax credit -- (0.9) (1.0)
Earnings on life insurance (1.4) (1.4) (1.1)
Other 1.6 1.0 1.1
------------------------
28.6% 26.7% 27.2%
========================
The income tax provision includes $156,000, $235,000 and $145,000 of income
taxes relating to realized securities gains for the years ended December 31,
2004, 2003 and 2002, respectively.
The net deferred tax asset included in other assets in the accompanying
balance sheets includes the following amounts of deferred tax assets and
liabilities:
2004 2003
-----------------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $ 983 $ 900
Deferred compensation 204 166
Intangible assets 146 172
Other 1 --
-----------------
Total Deferred Tax Assets 1,334 1,238
-----------------
Deferred tax liabilities:
Net unrealized gain on securities 193 757
Premises and equipment 253 234
Lease financing -- 73
Deferred loan fees 197 128
-----------------
Total Deferred Tax Liabilities 643 1,192
-----------------
Net Deferred Tax Asset $ 691 $ 46
=================
NOTE 10 - TRANSACTIONS WITH EXECUTIVE OFFICERS AND DIRECTORS
Certain directors and executive officers of the Company, their families and
their affiliates are customers of the Bank. Any transactions with such parties,
including loans and commitments, were in the ordinary course of business at
normal terms, including interest rates and collateralization, prevailing at the
time and did not represent more than normal risks. At December 31, 2004 and 2003
such loans amounted to $2,483,000 and $1,545,000, respectively. During 2004, new
loans to such related parties totaled $1,321,000 and repayments and other
reductions aggregated $383,000.
49
NOTE 11 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY
The Company and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative measures
of the Company's assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk-weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets, and of Tier 1 capital to average assets.
Management believes, as of December 31, 2004, that the Company and the Bank meet
all capital adequacy requirements to which they are subject.
As of December 31, 2004, the most recent notification from the regulators
has categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios are presented in the table:
To be Well
Capitalized under
For Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
--------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------
(Dollars in Thousands)
As of December 31, 2004:
Total capital (to risk-weighted
assets) $47,234 16.81% $=>22,473 =>8.00% $=>28,092 =>10.00%
Tier 1 capital (to risk-weighted
assets) 43,331 15.42 =>11,237 =>4.00 =>16,855 =>6.00
Tier 1 capital (to average assets) 43,331 10.65 =>16,278 =>4.00 =>20,348 =>5.00
As of December 31, 2003:
Total capital (to risk-weighted
assets) $43,839 16.97% $=>20,668 =>8.00% $=>25,835 =>10.00%
Tier 1 capital (to risk-weighted
assets) 40,028 15.49 =>10,334 =>4.00 =>15,501 =>6.00
Tier 1 capital (to average assets) 40,028 10.24 =>15,629 =>4.00 =>19,536 =>5.00
The Company's ratios do not differ significantly from the Bank's ratios
presented above.
The Bank is required to maintain average cash reserve balances in vault
cash or with the Federal Reserve Bank. The amount of these restricted cash
reserve balances at December 31, 2004 and 2003 was approximately $306,000 and
$4,386,000, respectively.
Under Pennsylvania banking law, the Bank is subject to certain restrictions
on the amount of dividends that it may declare without prior regulatory
approval. At December 31, 2004, $37,587,000 of retained earnings were available
for dividends without prior regulatory approval, subject to the regulatory
capital requirements discussed above. Under Federal Reserve regulations, the
Bank is limited as to the amount it may lend affiliates, including the Company,
unless such loans are collateralized by specific obligations.
50
NOTE 12 - STOCK OPTION PLANS
The Company adopted a Stock Option Plan for the officers and employees of
the Company in 1995. An aggregate of 750,000 shares of authorized but unissued
common stock of the Company were reserved for future issuance under the Plan. In
1999, the Company adopted the Directors Stock Compensation Plan with an
aggregate of 26,400 shares reserved for issuance under the Plan. The stock
options typically have expiration terms of ten years subject to certain
extensions and early terminations and vest over periods ranging from six months
to one year from the date of grant. The per share exercise price of a stock
option shall be, at a minimum, equal to the fair value of a share of common
stock on the date the option is granted.
A summary of the Company's stock option activity and related information
for the years ended December 31 follows:
2004 2003 2002
--------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------------------------------------------------------------------
Outstanding, beginning of year 141,607 $ 16.85 145,830 $ 14.92 155,385 $ 13.40
Granted 19,500 31.50 21,644 25.15 22,500 20.00
Exercised (14,860) 13.80 (25,867) 12.90 (32,055) 11.12
Forfeited (3,393) 16.97 -- N/A -- N/A
--------------------------------------------------------------------
Outstanding, end of year 142,854 $ 19.16 141,607 $ 16.85 145,830 $ 14.92
====================================================================
Exercisable, at end of year 123,354 $ 17.21
====================
Exercise prices for options outstanding as of December 31, 2004 ranged from
$10.88 to $31.50 per share. The weighted average remaining contractual life is
6.5 years.
NOTE 13 - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share:
YEARS ENDED DECEMBER 31,
-------------------------------------
2004 2003 2002
-------------------------------------
(In Thousands, Except per Share Data)
Numerator, net income $5,010 $4,653 $4,353
==================================
Denominator:
Denominator for basic earnings per share,
weighted average shares 2,647 2,605 2,556
Effect of dilutive securities, employee stock options 56 47 41
----------------------------------
Denominator for diluted earnings per share, adjusted weighted
average shares and assumed conversions 2,703 2,652 2,597
==================================
Basic earnings per common share $ 1.89 $ 1.79 $ 1.70
==================================
Diluted earnings per common share $ 1.85 $ 1.75 $ 1.68
==================================
51
NOTE 14 - OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
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:
DECEMBER 31,
---------------------
2004 2003
---------------------
(In Thousands)
Commitments to grant loans $15,748 $12,197
Unfunded commitments under lines of credit 30,611 26,269
Standby letters of credit 1,791 2,128
---------------------
$48,150 $40,594
=====================
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. The Bank evaluates each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the customer and generally consists of real
estate.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The majority of these
standby letters of credit expire within the next twelve months. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending other loan commitments. The Bank requires collateral supporting
these letters of credit when deemed necessary. Management believes that the
proceeds obtained through a liquidation of such collateral would be sufficient
to cover the maximum potential amount of future payments required under the
corresponding guarantees. The current amount of the liability as of December 31,
2004 for guarantees under standby letters of credit issued is not material. .
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Management uses its best judgment in estimating the fair value of the
Company's financial instruments; however, there are inherent weaknesses in any
estimation technique. Therefore, for substantially all financial instruments,
the fair value estimates herein are not necessarily indicative of the amounts
the Company could have realized in a sales transaction on the dates indicated.
The estimated fair value amounts have been measured as of their respective year
ends and have not been re-evaluated or updated for purposes of these
consolidated financial statements subsequent to those respective dates. As such,
the estimated fair values of these financial instruments subsequent to the
respective reporting dates may be different than the amounts reported at each
year end.
52
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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 December 31, 2004 and 2003:
o For cash and due from banks, interest-bearing deposits with banks and
federal funds sold, the carrying amount is a reasonable estimate of fair
value.
o For securities, fair value equals quoted market price, if available. If a
quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.
o The fair value of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining maturities.
Disclosure of the fair value of leases receivable is not required and has
not been included in the following table.
o The fair value of the investment in FHLB stock is the carrying amount.
o The fair value of accrued interest receivable and accrued interest payable
is the carrying amount.
o The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits for similar remaining maturities.
o The fair value of short-term borrowings approximate their carrying amount.
o The fair value of long-term debt is estimated using discounted cash flow
analyses based upon the Company's current borrowing rates for similar types
of borrowing arrangements.
o The fair value of commitments to extend credit and for outstanding letters
of credit is estimated using the fees currently charged to enter into
similar agreements.
53
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Company's financial instruments are as
follows:
DECEMBER 31, 2004 DECEMBER 31, 2003
-----------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-----------------------------------------
(In Thousands)
Financial assets:
Cash and due from banks, interest-bearing
deposits with banks and federal
funds sold $ 20,666 $ 20,666 $ 9,174 $ 9,174
Securities 122,657 122,811 130,571 130,798
Loans receivable, net 251,309 253,369 230,150 236,335
Investment in FHLB stock 2,225 2,225 2,002 2,002
Accrued interest receivable 1,641 1,641 1,783 1,783
Financial liabilities:
Deposits 318,645 318,454 306,669 307,339
Short-term borrowings 22,982 22,982 12,859 12,859
Long-term debt 23,000 24,030 23,000 24,960
Accrued interest payable 1,200 1,200 1,309 1,309
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding
letters of credit -- -- -- --
54
NOTE 16 - NORWOOD FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
BALANCE SHEETS DECEMBER 31,
-----------------
2004 2003
-----------------
Assets (In Thousands)
Cash on deposit in bank subsidiary $ 1,668 $ 1,118
Securities available for sale 744 605
Investment in bank subsidiary 43,792 41,648
Other assets 68 10
-----------------
$46,272 $43,381
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 587 $ 550
Stockholders' equity 45,685 42,831
-----------------
$46,272 $43,381
=================
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------
2004 2003 2002
-----------------------------
Income: (In Thousands)
Dividends from bank subsidiary $ 1,830 $ 1,693 $ 1,536
Interest income from bank subsidiary 19 29 42
Other interest income 22 16 15
-----------------------------
1,871 1,738 1,593
Expenses 147 187 144
-----------------------------
1,724 1,551 1,449
Income tax expense (benefit) (36) (49) (31)
-----------------------------
1,760 1,600 1,480
Equity in undistributed earnings of subsidiary 3,250 3,053 2,873
-----------------------------
Net Income $ 5,010 $ 4,653 $ 4,353
=============================
Statements of CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------
2004 2003 2002
-----------------------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,010 $ 4,653 $ 4,353
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (3,250) (3,053) (2,873)
Release of ESOP shares 585 436 350
Other, net (40) (56) (28)
-----------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,305 1,980 1,802
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in bank subsidiary -- (1,000) --
Purchase of securities available for sale (125) (95) (55)
-----------------------------
NET CASH USED IN INVESTING ACTIVITIES (125) (1,095) (55)
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised 206 334 356
ESOP purchase of shares from treasury stock 77 63 --
Acquisition of treasury stock (118) (46) (8)
Cash dividends paid (1,795) (1,662) (1,494)
-----------------------------
NET CASH USED IN FINANCING ACTIVITIES (1,630) (1,311) (1,146)
-----------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 550 (426) 601
CASH AND CASH EQUIVALENTS - BEGINNING 1,118 1,544 943
-----------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 1,668 $ 1,118 $ 1,544
=============================
55
INVESTOR INFORMATION
STOCK LISTING
Norwood Financial Corp stock is traded on the Nasdaq Market under the
symbol NWFL. The following firms are known to make a market in the Company's
stock:
FERRIS BAKER WATTS F.J. MORRISSEY & Co, INC.
Baltimore, MD West Conshohocken, PA
410-659-4616 800-842-8928
LEGG MASON WOOD WALKER, INC. JANNEY MONTGOMERY SCOTT, LLC
Scranton, PA 18507 Scranton, PA 18503
570-346-9300 800-638-4417
RYAN BECK & CO. BOENNING & SCATTERGOOD, INC.
Livingston, NJ West Conshohoken, PA
800-395-7926 800-496-1170
TRANSFER AGENT
Illinois Stock Transfer Company, 209 West Jackson Blvd., Suite 903,
Chicago, IL 60606. Stockholders who may have questions regarding their stock
ownership should contact the Transfer Agent at 312-427-2953
DIVIDEND CALENDAR
Dividends on Norwood Financial Corp common stock, if approved by the Board
of Directors are customarily paid on or about February 1, May 1, August 1 and
November 1.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
The Plan, open to all shareholders, provides the opportunity to have
dividends automatically reinvested into Norwood stock. Participants in the Plan
may also elect to make cash contributions to purchase additional shares of
common stock. Shareholders do not incur brokerage commissions for the
transactions. Please contact the transfer agent or Lewis J. Critelli for
additional information.
SEC REPORTS AND ADDITIONAL INFORMATION
A copy of the Company's report on Form 10-K for its fiscal year ended
December 31, 2004 including financial statements and schedules thereto, required
to be filed with the Securities and Exchange Commission may be obtained upon
written request of any stockholder, investor or analyst by contacting Lewis J.
Critelli, Executive Vice President and Chief Financial Officer, Norwood
Financial Corp, 717 Main Street, PO Box 269, Honesdale, PA 18431, 570-253-1455
56
DIRECTORY OF OFFICERS
NORWOOD FINANCIAL CORP
Russell L. Ridd Chairman of the Board Kelly J. Lalley Assistant VIce President &
Assistant Secretary
William W. Davis, Jr. President & Chief Executive Jennifer M. Witowic Assistant Vice President
Officer Manager
Lewis J. Critelli Executive Vice President & Laurie J. Bishop Assistant Community Office Manager
Chief Financial Officer
Edward C. Kasper Senior Vice President Sandra Cella Community Office Manager
John H. Sanders Senior Vice President Denise Finagan Assistant Community Office Manager
Joseph A. Kneller Senior Vice President Lorraine M. Gallik Commercial Loan Administration Manager
John E. Marshall Secretary Renee Gilbert Community Office Manager
Marianne Glamann Assistant Community Office Manager
WAYNE BANK
Russell L. Ridd Chairman of the Board Gary D. Henry Consumer Lending Officer
William W. Davis, Jr. President & Chief Executive Annette A. Jurkowski Trust Operations Manager
Officer
Lewis J. Critelli Executive Vice President & Thomas Kowalski Resource Recovery Manager
Chief Financial Officer
Edward C. Kasper Senior Vice President & Jill Melody Assistant Community Office Manager
Senior Loan Officer/
Corporate Bank
John H. Sanders Senior Vice President/Retail William E. Murray Mortgage Originator
Bank
Joseph A. Kneller Senior Vice President Sarah J. Rapp Human Resources Officer
Wayne D. Wilcha Senior Vice President & Diane L. Richter Assistant Community Office Manager
Trust Officer
John E. Marshall Secretary Toni M. Stenger Assistant Community Office Manager
Robert J. Behrens, Jr. Vice President Doreen A. Swingle Residential Mortgage Lending Officer
John F. Carmody Vice President Nancy M. Worobey Community Office Manager
Carolyn K. Gwozdziewycz Vice President Renee Wyant Community Office Manager
Nancy A. Hart Vice President, Controller &
Assistant Secretary NORWOOD INVESTMENT CORP
William J. Henigan, Jr. Vice President William W. Davis, Jr. President & Chief Executive Officer
William R. Kerstetter Vice President Lewis J. Critelli Executive Vice President
Mary Alice Petzinger Vice President Scott C. Rickard Investment Representative,
Invest Financial Corporation
Barabara A. Ridd Vice President
Eli T. Tomlinson Vice President MONROE COUNTY ASSOCIATE BOARD
James D. Dyson Assistant Vice President Michael J. Baxter James H. Ott
JoAnn Fuller Assistant Vice President Sara Cramer Ron Sarajian
Karen R. Gasper Internal Auditor & Andrew Forte Ray Price
Assistant Vice President
Ralph A. Matergia, Esq. Marvin Papillon
Raymond C. Hebden Assistant Vice President
Randy R. Motts Robert L. Weseloh, CPA
Katherine A. Horan Assistant Vice President
Norma J. Kuta Assistant Vice President
NORWOOD
FINANCIAL CORP
VISIT US AT:
WWW.WAYNEBANK.COM