SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number 0-28366
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Norwood Financial Corp.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2828306
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(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
717 Main Street, Honesdale, Pennsylvania 18431
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570)253-1455
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N/A
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Former name, former address and former fiscal year, if changed since last
report.
Indicate by check (x) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
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Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
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Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding as of November 10, 2005
- --------------------------------------- 2,686,689
common stock, par value $0.10 per share ---------
NORWOOD FINANCIAL CORP.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
INDEX
Page
Number
PART I - CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD
FINANCIAL CORP.
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer
Purchases of Equity Securities 28
Item 3. Defaults upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5 Other Information 28
Item 6 Exhibits 28
Signatures 29
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
NORWOOD FINANCIAL CORP.
Consolidated Balance Sheets
(dollars in thousands, except per share data)
September 30, December 31,
2005 2004
--------- ---------
Unaudited
---------
ASSETS
Cash and due from banks $ 9,755 $ 7,488
Interest bearing deposits with banks 132 118
Federal funds sold 2,295 13,060
--------- ---------
Cash and cash equivalents 12,182 20,666
Securities available for sale 113,162 116,933
Securities held to maturity, fair value 2005
$2,902, 2004: $5,878 2,860 5,724
Loans receivable (net of unearned income) 282,264 254,757
Less: Allowance for loan losses 3,643 3,448
--------- ---------
Net loans receivable 278,621 251,309
Investment in FHLB Stock 1,711 2,225
Bank premises and equipment, net 5,454 5,489
Accrued interest receivable 1,888 1,641
Other assets 9,733 7,639
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TOTAL ASSETS $ 425,611 $ 411,626
========= =========
LIABILITIES
Deposits:
Non-interest bearing demand $ 58,061 $ 44,450
Interest bearing 282,370 274,195
--------- ---------
Total deposits 340,431 318,645
Short-term borrowings 11,515 22,982
Long-term debt 23,000 23,000
Accrued interest payable 1,369 1,200
Other liabilities 1,849 114
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TOTAL LIABILITIES 378,164 365,941
STOCKHOLDERS' EQUITY
Common stock, $.10 par value, authorized
10,000,000 shares issued 2,705,715 shares 270 270
Surplus 5,545 5,336
Retained earnings 42,840 40,222
Treasury stock at cost: 2005: 16,026 shares, 2004: 8,913 shares (468) (149)
Unearned ESOP shares (199) (327)
Accumulated other comprehensive income (loss) (541) 333
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TOTAL STOCKHOLDERS' EQUITY 47,447 45,685
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 425,611 $ 411,626
========= =========
See accompanying notes to the consolidated financial statements
3
NORWOOD FINANCIAL CORP. Consolidated Statements of Income (unaudited)
(dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2005 2004 2005 2004
------- ------- ------- -------
INTEREST INCOME
Loans receivable, including fees $ 4,527 $ 3,770 $12,735 $10,886
Securities 993 1,004 3,054 3,155
Other 58 8 75 25
------- ------- ------- -------
Total interest income 5,578 4,782 15,864 14,066
INTEREST EXPENSE
Deposits 1,262 858 3,351 2,628
Short-term borrowings 83 46 294 103
Long-term debt 299 320 919 964
------- ------- ------- -------
Total interest expense 1,644 1,224 4,564 3,695
------- ------- ------- -------
NET INTEREST INCOME 3,934 3,558 11,300 10,371
PROVISION FOR LOAN LOSSES 90 100 280 390
------- ------- ------- -------
NET INTEREST INCOME AFTER
PROVSION FOR LOAN LOSSES 3,844 3,458 11,020 9,981
------- ------- ------- -------
OTHER INCOME
Service charges and fees 648 575 1,830 1,489
Income from fiduciary activities 78 83 254 238
Net realized gains on sales of securities 3 51 83 313
Gain on sale of loans 8 1 63 63
Other 171 161 463 469
------- ------- ------- -------
Total other income 908 871 2,693 2,572
------- ------- ------- -------
OTHER EXPENSES
Salaries and employee benefits 1,360 1,276 4,081 3,840
Occupancy, furniture & equipment, net 356 335 1,105 1,025
Data processing related 161 149 474 451
Losses on lease residuals -- -- -- 90
Taxes, other than income 19 2 226 185
Professional fees 102 77 350 233
Other 629 670 1,719 1,724
------- ------- ------- -------
Total other expenses 2,627 2,509 7,955 7,548
------- ------- ------- -------
INCOME BEFORE INCOME TAXES 2,125 1,820 5,758 5,005
INCOME TAX EXPENSE 643 500 1,703 1,358
------- ------- ------- -------
NET INCOME $ 1,482 $ 1,320 $ 4,055 $ 3,647
======= ======= ======= =======
BASIC EARNINGS PER SHARE $ 0.56 $ 0.50 $ 1.52 $ 1.38
======= ======= ======= =======
DILUTED EARNINGS PER SHARE $ 0.54 $ 0.49 $ 1.49 $ 1.35
======= ======= ======= =======
Cash dividends per share $ 0.18 $ 0.17 $ 0.54 $ 0.51
======= ======= ======= =======
See accompanying notes to the consolidated financial statements.
4
NORWOOD FINANCIAL CORP
Consolidated statements of changes in stockholders' equity (unaudited)
(dollars in thousands)
Accumulated
Number of Unearned Other
shares Common Retained Treasury ESOP Comprehensive
issued Stock Surplus Earnings Stock Shares Income(Loss) Total
------ ----- ------- -------- ----- ------ ------------ -----
Balance December 31, 2003 2,705,715 $270 $4,933 $37,042 ($295) ($550) $1,431 $42,831
Comprehensive Income:
Net Income 3,647 3,647
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax
effects (827) (827)
-------
Total comprehensive income 2,820
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Cash dividends declared, $.51 per share (1,351) (1,351)
Stock options exercised (20) 186 166
Tax benefit of stock options exercised 14 14
Acquisition of treasury stock (95) (95)
Release of earned ESOP shares 253 150 403
--------- ---- ------ ------- ----- ----- ---- -------
Balance, September 30, 2004 2,705,715 $270 $5,180 $39,338 ($204) ($400) $604 $44,788
========= ==== ====== ======= ===== ===== ==== =======
Accumulated
Number of Unearned Other
shares Common Retained Treasury ESOP Comprehensive
issued Stock Surplus Earnings Stock Shares Income(Loss) Total
------ ----- ------- -------- ----- ------ ------------ -----
Balance December 31, 2004 2,705,715 $270 $5,336 $40,222 ($149) ($327) $333 $45,685
Comprehensive Income:
Net Income 4,055 4,055
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax
effects (874) (874)
-------
Total comprehensive income 3,181
Cash dividends declared $.54 per share (1,437) (1,437)
Stock options exercised (78) 229 151
Tax benefit of stock options exercised 18 18
Release of treasury stock 22 22
Acquisition of treasury stock (570) (570)
Release of earned ESOP shares 269 128 397
--------- ---- ------ ------- ----- ----- ----- -------
Balance, September 30, 2005 2,705,715 $270 $5,545 $42,840 ($468) ($199) ($541) $47,447
========= ==== ====== ======= ===== ===== ===== =======
See accompanying notes to the Consolidated Financial Statements
5
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cashflows (Unaudited)
(dollars in thousands)
Nine Months Ended
-----------------
September
-----------------
2005 2004
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CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 4,055 $ 3,647
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 280 390
Depreciation 387 407
Amortization of intangible assets 39 39
Deferred income taxes (430) (221)
Net amortization of securities premiums and discounts 327 404
Net realized gain on sales of securities (83) (313)
Earnings on life insurance policy (190) (236)
Net gain (loss) on sale of bank premises and equipment and foreclosed real estate (5) (12)
Net gain on sale of mortgage loans (63) (63)
Mortgage loans originated for sale (6,508) (3,966)
Proceeds from sale of mortgage loans 6,571 4,029
Release of ESOP shares 419 403
Tax benefit of stock options exercised 18 14
Decrease (increase) in accrued interest receivable and other assets (241) 644
Increase in accrued interest payable and other liabilities 919 162
-------- --------
Net cash provided by operating activities 5,495 5,328
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CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 5,097 11,537
Proceeds from maturities and principal reductions on mortgage-backed securities 9,386 31,501
Purchases (12,342) (30,666)
Securities held to maturity proceeds 2,920 35
Increase/decrease in investment in FHLB stock 514 (181)
Net increase in loans (27,668) (23,684)
Purchase of bank premises and equipment, net of sales (359) (423)
Proceeds from sale of bank equipment and foreclosed real estate 12 44
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Net cash used in investing activities (22,440) (11,837)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 21,786 11,276
Net decrease in short term borrowings (11,467) (1,665)
Repayments of long-term debt (5,000) --
Proceeds from long-term debt 5,000 --
Stock options exercised 151 166
Acquisition of treasury stock (570) (95)
Cash dividends paid and cash paid in lieu of fractional shares (1,439) (1,346)
-------- --------
Net cash provided by financing activities 8,461 8,336
-------- --------
Increase (decrease) in cash and cash equivalents (8,484) 1,827
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 20,666 9,174
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 12,182 $ 11,001
======== ========
See accompanying notes to the unaudited consolidated financial statements
6
Notes to Unaudited Consolidated Financial Statements
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1. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of Norwood
Financial Corp. (Company) and its wholly-owned subsidiary, Wayne Bank (Bank) and
the Bank's wholly-owned subsidiaries, WCB Realty Corp., Norwood Investment Corp.
and WTRO Properties. All significant intercompany transactions have been
eliminated in consolidation.
2. Estimates
---------
The financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and revenues and expenses for the period. Actual results could differ from those
estimates. The financial statements reflect, in the opinion of management, all
normal, recurring adjustments necessary to present fairly the financial position
of the Company. The operating results for the three and nine month periods ended
September 30, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005 or any other future interim
period.
These statements should be read in conjunction with the consolidated
financial statements and related notes which are incorporated by reference in
the Company's Annual Report on Form 10-K for the year-ended December 31, 2004.
3. Earnings Per Share
------------------
Basic earnings per share represents income available to common
stockholders divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the Company relate
solely to outstanding stock options and are determined using the treasury stock
method.
The following table sets forth the computations of basic and diluted
earnings per share:
(in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2005 2004 2005 2004
------ ------ ------ ------
Basic EPS weighted average shares outstanding 2,667 2,650 2,668 2,644
Dilutive effect of stock options 54 53 57 55
------ ------ ------ ------
Diluted EPS weighted average shares outstanding 2,721 2,703 2,725 2,699
====== ====== ====== ======
7
4. Stock Option Plans
------------------
The Company accounts for stock option plans under the recognition and
measurement principles of APB opinion No. 25, "Accounting For Stock Issued to
Employees", and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of the 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.
Three Months Nine Months
(In thousands, except for per share data) Ended September 30 Ended September 30
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net income as reported $ 1,482 $ 1,320 $ 4,055 $ 3,647
Total stock based employee compensation determined under
fair value based method for all awards, net of taxes (49) (36) (147) (108)
--------- --------- --------- ---------
Pro forma net income $ 1,433 $ 1,284 $ 3,908 $ 3,539
========= ========= ========= =========
Earnings per share (basic)
As Reported $ .56 $ .50 $ 1.52 $ 1.38
Pro forma .54 .49 1.46 1.34
Earnings per share (assuming dilution)
As Reported .54 .49 1.49 1.35
Pro forma .53 .48 1.43 1.31
During the nine months ended September 30, 2005, there were 9,239 stock options
exercised at an average exercise price of $16.21 per share.
5. Cash Flow Information
---------------------
For the purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, interest-bearing deposits with
banks and federal funds sold.
Cash payments for interest for the periods ended September 30, 2005 and
2004 were $4,395,000 and $3,868,000 respectively. Cash payments for income taxes
in 2005 were $1,746,000 compared to $1,381,000 in 2004. Non-cash investing
activity for 2005 and 2004 included repossession of other assets of $76,000 and
$259,000, respectively.
6. 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.
8
(in thousands) Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2005 2004 2005 2004
------- ------- ------- -------
Unrealized holding gains/(losses)
on available for sale securities $ (664) $ 1,514 $(1,248) $ (940)
Reclassification adjustment for gains
realized in income (3) (51) (83) (313)
------- ------- ------- -------
Net unrealized gains/(losses) $ (667) 1,463 (1,331) (1,253)
Income tax (benefit) (229) 497 (457) (426)
------- ------- ------- -------
Other comprehensive income (loss) $ (438) $ 966 $ (874) $ (827)
======= ======= ======= =======
7. Off Balance Sheet Financial Instruments and Guarantees
------------------------------------------------------
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the Bank's financial instrument commitments is as follows:
(in thousands) September 30
---------------------
2005 2004
------- -------
Commitments to grant loans $16,015 $14,815
Unfunded commitments under lines of credit 34,844 30,538
Standby letters of credit 1,773 1,358
------- -------
$52,632 $46,711
======= =======
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.
The Bank does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Generally, all letters
of credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Bank, generally, holds
collateral and/or personal guarantees supporting these commitments. Management
believes that the proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the potential amount of
future payment required under the corresponding guarantees. The current amount
of the liability as of September 30, 2005 for guarantees under standby letters
of credit issued is not material.
9
Recent Accounting Standards
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FAS 123(R)
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 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.
On April 14, 2005, the Securities and Exchange Commission ("SEC") adopted a new
rule that amends the compliance dates for Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123R"). Under the new rule, the Company is required to adopt
SFAS No. 123R in the first annual period beginning after June 15, 2005. The
Company has not yet determined the method of adoption or the effect of adopting
SFAS No. 123R, and it has not determined whether the adoption will result in
amounts that are similar to the current pro forma disclosures under SFAS No.
123.
SOP 03-3
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 for debt securities acquired in fiscal years beginning after December 15,
2004. The Company adopted the provisions of SOP 03-3 on January 1, 2005.
SAB 107
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No. 107"),
"Share-Based Payment", providing guidance on option valuation methods, the
accounting for income tax effects of share-based payment arrangements upon
adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the
adoption. The Company will provide SAB No. 107 required disclosures upon
adoption of SFAS No. 123(R) on January 1, 2006.
10
FIN 47
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an interpretation of SFAS No. 143,"
("FIN 47"). This Interpretation provides clarification with respect to the
timing of liability recognition for legal obligations associated with the
retirement of tangible long-lived assets when the timing and/or method of
settlement of the obligation are conditional on a future event. FIN 47 is
effective for all fiscal years ending after December 15, 2005 (December 31,
2005, for calendar-year companies). Retrospective application for interim
financial information is permitted but is not required. Early adoption of this
Interpretation is encouraged. We do not expect the adoption of FIN 47 to
materially impact our condensed consolidated financial statements.
SFAS 154
In May 2005, FASB issued SFAS 154, "Accounting Changes and Error
Corrections". The Statement requires retroactive application of a voluntary
change in accounting principle to prior period financial statements unless it is
impracticable. SFAS 154 also requires that a change in method of depreciation,
amortization, or depletion for long lived, non-financial assets be accounted for
as a change in accounting estimate that is affected by a change in accounting
principle. SFAS 154 replaces APB Opinion 20, "Accounting Changes", and SFAS 3,
"Reporting Accounting Changes in Interim Financial Statements". SFAS 154 will be
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Management currently believes that adoption
of the provisions of SFAS 154 will not have a material impact on the Company's
condensed consolidated financial statements.
EITF 03-1
In January 2003, the FASB's Emerging Issues Task Force (EITF) issued
EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investors" ("EITF 03-1"), and in March 2004, the EITF
issued an update. EITF 03-1 addresses the meaning of other-than-temporary
impairment and its application to certain debt and equity securities. EITF 03-1
aids in the determination of impairment of an investment and gives guidance as
to the measurement of impairment loss and the recognition and disclosures of
other-than-temporary investments. EITF 03-1 also provides a model to determine
other-than-temporary impairment using evidence-based judgment about the recovery
of the fair value up to the cost of the investment by considering the severity
and duration of the impairment in relation to the forecasted recovery of the
fair value. In July 2005, FASB adopted the recommendation of its staff to
nullify key parts of EITF 03-1. The staff's recommendations were to nullify the
guidance on the determination of whether an investment is impaired as set forth
in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the
meaning of other-than-temporary impairment. Instead, the staff recommends
entities recognize other-than-temporary impairments by applying existing
accounting literature such as paragraph 16 of SFAS 115.
11
FASB Exposure Draft - Interpretation of FAS 109
In July 2005, the FASB issued a proposed interpretation of FAS 109,
"Accounting for Income Taxes", to clarify certain aspects of accounting for
uncertain tax positions, including issues related to the recognition and
measurement of those tax positions. If adopted as proposed, the interpretation
would be effective in the fourth quarter of 2005, and any adjustments required
to be recorded as a result of adopting the interpretation would be reflected as
a cumulative effect from a change in accounting principle. We are currently in
the process of determining the impact of adoption of the interpretation as
proposed on our financial position or results of operations.
EITF 05-6
In June 2005, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 05-6, "Determining the Amortization Period for Leasehold
Improvements Purchased after Lease Inception or Acquired in a Business
Combination" ("EITF 05-6"). This guidance requires that leasehold improvements
acquired in a business combination or purchased subsequent to the inception of a
lease be amortized over the shorter of the useful life of the assets or a term
that includes required lease periods and renewals that are reasonably assured at
the date of the business combination or purchase. This guidance is applicable
only to leasehold improvements that are purchased or acquired in reporting
periods beginning after June 29, 2005. The Company has evaluated the provisions
of EITF 05-6 and we do not believe it will have a material impact on the
Company's financial condition or results of operations.
FSP FAS 13-1
In October 2005, the FASB issued FASB Staff Position FAS 13-1 ("FSP
FAS 13-1"), which requires companies to expense rental costs associated with
ground or building operating leases that are incurred during a construction
period. As a result, companies that are currently capitalizing these rental
costs are required to expense them beginning in its first reporting period
beginning after December 15, 2005. FSP FAS 13-1 is effective for our Company as
of the first quarter of fiscal 2006. We evaluated the provisions of FSP FAS 13-1
and do not believe that its adoption will have a material impact on our
Company's financial condition or results of operations.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
- --------------------------
The Private Securities Litigation Reform Act of 1995 contains safe
harbor provisions regarding forward-looking statements. When used in this
discussion, the words "believes, "anticipates," "contemplates," "expects," and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. Those risks and
uncertainties include changes in interest rates, risks associated with the
effect of opening a new branch, the ability to control costs and expenses,
additional regulatory and compliance costs, and general economic conditions.
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 loans losses and accounting for
stock options. Please refer to the discussion of the allowance for loan losses
calculation under "Allowance for Loan Losses and Non-performing Assets" and in
the "Changes in Financial Condition" section below. 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. The Company currently has no
intentions of adopting the expense recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation."
Changes in Financial Condition
- ------------------------------
General
- -------
Total assets as of September 30, 2005 were $425.6 million compared to
$411.6 million as of December 31, 2004. The increase was principally due to loan
growth of $27.5 million funded in part by $21.8 million of deposit growth and
cash flow from the securities available for sale portfolio. Proceeds from a
$10.8 million decrease in Federal Funds Sold were used to pay-down $11.4 million
of short-term borrowings.
13
Securities
- ----------
The fair value of securities available for sale as of September 30,
2005 was $113.2 million declining from $116.9 million as of December 31, 2004.
The decrease was principally due to the cash flow received from mortgage-backed
securities of $9.4 million and proceeds from sales of $5.1 million. This was
partially offset by purchases of $12.3 million. In addition, the
held-to-maturity portfolio, which consists of municipal bonds, declined $2.9
million as a result of call features on certain securities. The Company used
cash from the securities portfolios to help fund loan growth.
The Company has securities in an unrealized loss position. In
management's opinion the unrealized losses reflect changes in interest rates
subsequent to the acquisition of specific securities. The Company's
available-for-sale portfolio has an average repricing term of 2.1 years.
Interest rates in the 2-3 year section of the Treasury yield have increased over
150 basis points since September 30, 2004, impacting the fair value of the
portfolio. Management believes that the unrealized losses represent temporary
impairment of securities, as the Company has the intent and ability to hold
these investments until maturity or market price recovery.
Loans Receivable
- ----------------
Total loans receivable were $282.3 million as of September 30, 2005, an
increase of $27.5 million or 10.8% compared to $254.8 million as of December 31,
2004.
Commercial real estate activity remains strong, with the portfolio
increasing $17.0 million, or 15.3%. The growth was principally in the Monroe
County Market Area. Other commercial loans increased $7.4 million principally
due to equipment financing and usage on lines of credit.
The Company's indirect lending portfolio (included in consumer loans to
individuals) declined $2.6 million to $17.5 million as of September 30, 2005.
The balance includes $8.1 million of automobiles loans.
The Company sold $6.5 million of 30 year fixed rate residential
mortgages at a gain of $63,000 (included in other income) for the nine months
ended September 30, 2005. The Company holds in its portfolio its 15 year
originations. During 2005, the Company has emphasized home equity lending
through its branch system. As a result, home equity loans and lines increased
$5.2 million, to $42.1 million.
14
Set forth below is selected data relating to the composition of the loan
portfolio at the dates indicated:
Types of loans
- --------------
(dollars in thousands) September 30, 2005 December 31, 2004
- ---------------------- ------------------ -----------------
$ % $ %
--- --- --- ---
Real Estate-Residential $ 97,787 34.6 $ 90,606 35.5
Commercial 128,141 45.3 111,164 43.6
Construction 4,008 1.4 4,890 1.9
Commercial, financial and agricultural 27,669 9.8 20,263 7.9
Consumer loans to individuals 25,020 8.9 28,193 11.1
-------- ----- -------- -----
Total loans 282,625 100.0% 255,116 100.0%
-------- --------
Less:
Deferred Fees 361 359
-------- --------
282,264 254,757
Allowance for loan losses 3,643 3,448
-------- --------
Net loans receivable $278,621 $251,309
======== ========
Allowance for Loan Losses and Non-performing Assets
- ---------------------------------------------------
Following is a summary of changes in the allowance for loan losses for
the periods indicated:
Three Months Nine Months
Ended September 30 Ended September 30
-------------------- --------------------
(dollars in thousands) 2005 2004 2005 2004
------ ------- ------ ------
Balance, beginning $3,600 $3,362 $3,448 $3,267
Provision for loan losses 90 100 280 390
Charge-offs (66) (116) (143) (325)
Recoveries 19 72 58 86
------ ------- ------ ------
Net charge-offs (47) (44) (85) (239)
------ ------- ------ ------
Balance, ending $3,643 $ 3,418 $3,643 $3,418
====== ======= ====== ======
Allowance to total loans 1.29% 1.33% 1.29% 1.33%
Net charge-offs to average loans
(annualized) .07% .07% .04% .13%
The allowance for loan losses totaled $3,643,000 as of September 30,
2005 and represented 1.29% of total loans compared to $3,448,000 and 1.35% as of
December 31, 2004. Net charge-offs for the nine months ended September 30, 2005
totaled $85,000 declining from $239,000 for the similar period in 2004. The
decrease was principally due to a lower level of repossessed automobiles as the
Company has lowered its exposure to indirect automobile lending. As a result of
the lower net charge-offs, the provision for loan losses was reduced for the
nine months ended September 30, 2005 to $280,000 compared to $390,000 for the
similar period in 2004. However, the allowance for loan losses did increase
$195,000 when compared to December 31, 2004
The Company's loan review process assesses the adequacy of the
allowance for loan losses on a quarterly basis. The process includes an analysis
of the risks inherent in the loan portfolio. It includes an analysis of impaired
loans and a historical review of credit losses by loan type. Other factors
considered include: concentration of credit in specific industries; economic and
industry conditions; trends in delinquencies, large dollar exposures and loan
growth. Management considers the allowance adequate at September 30, 2005 based
on the Company's criteria. However, there can be no assurance that the allowance
for loan losses will be adequate to cover significant losses, if any, that might
be incurred in the future.
15
As of September 30, 2005, non-performing loans totaled $107,000,
which is .04% of total loans compared to $67,000, or .03% of total loans at
December 31, 2004. The following table sets forth information regarding
non-performing loans and foreclosed real estate at the date indicated:
(dollars in thousands) September 30, 2005 December 31, 2004
------------------ -----------------
Loans accounted for on a non accrual basis:
Commercial and all other $ - $ -
Real Estate 81 32
Consumer 12 8
----- -----
Total 93 40
Accruing loans which are contractually
past due 90 days or more 14 27
----- -----
Total non-performing loans 107 67
Foreclosed real estate - -
----- -----
Total non-performing assets $ 107 $ 67
===== =====
Allowance for loans losses
coverage of non-performing loans 34.0x 51.5x
Non-performing loans to total loans .04% .03%
Non-performing assets to total assets .03% .02%
Deposits
- --------
Total deposits as of September 30, 2005 were $340.4 million,
increasing $21.8 million from $318.6 million as of December 31, 2004. The
deposit growth was used to fund loan activity. Non-interest bearing demand
accounts increased $13.6 million, 30.1%, reflecting an increase in commercial
accounts and the seasonality of certain corporate and municipal accounts.
Savings accounts decreased $5.6 million, reflecting a movement of funds to
higher yielding money market accounts and short-term CDs. Time deposits less
than $100,000 increased $4.4 million as a result of increases in CDs with
maturities less than one year. Time deposits greater than $100,000 include
short-term CDs from local school districts. The Company expects to bid on
additional school district funds during the fourth quarter.
The following table sets forth deposit balances as of the dates
indicated.
(dollars in thousands) September 30, 2005 December 31, 2004
------------------- -----------------
Non-interest bearing demand $ 58,061 $ 44,450
Interest bearing demand 46,577 41,336
Money Market 55,592 51,125
Savings 54,426 60,064
Time deposits <$100,000 92,826 88,387
Time deposits >$100,000 32,949 33,283
-------- --------
Total $340,431 $318,645
======== ========
16
Short-term Borrowings
- ---------------------
Short-term borrowings as of September 30, 2005 were $11.5 million
compared to $23.0 million as of December 31, 2004. The decrease was due to the
pay-off of short-term borrowings from the Federal Home loan Bank.
Off Balance Sheet Arrangements
- ------------------------------
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the contractual amount of the Company's financial
instrument commitments is as follows:
September 30, December 31,
2005 2004
---- ----
(In thousands)
Commitments to grant loans $16,015 $15,748
Unfunded commitments under lines of credit 34,844 30,611
Standby letters of credit 1,773 1,791
------- -------
$52,632 $48,150
======= =======
Stockholders' Equity and Capital Ratios
- ---------------------------------------
As of September 30, 2005, total stockholders' equity totaled $47.4
million, a net increase of $1,762,000 from December 31, 2004. The net change in
stockholders' equity was primarily due to $4,055,000 in net income which was
partially offset by $1,437,000 of dividends declared. In addition, accumulated
other comprehensive income decreased $874,000 due to a decrease in fair value of
securities in the available for sale portfolio. This decrease in fair value is
the result of a change in interest rates, which may impact the fair value of the
securities. Because of interest rate volatility, the Company's accumulated other
comprehensive income could materially fluctuate for each interim and year-end
period. The Company has also repurchased 18,000 shares for the nine months ended
September 30, 2005, at a cost of $570,000. These purchases are part of an
open-market stock repurchase program for up to 134,000 shares, as announced on
June 15,2005.
17
A comparison of the Company's regulatory capital ratios is as follows:
September 30, 2005 December 31, 2004
------------------ -----------------
Tier 1 Capital
(To average assets) 11.10% 11.11%
(To risk-weighted assets) 15.39% 15.91%
Total Capital
(To risk-weighted assets) 16.74% 17.34%
The minimum capital requirements imposed by the FDIC on the Bank for
leverage, Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Company
has similar capital requirements imposed by the Board of Governors of the
Federal Reserve System (FRB). The Bank is also subject to more stringent
Pennsylvania Department of Banking (PDB) guidelines. The Bank's capital ratios
do not differ significantly from the Company's ratios. Although not adopted in
regulation form, the PDB utilizes capital standards requiring a minimum of 6.5%
leverage capital and 10% total capital. The Company and the Bank were in
compliance in FRB, FDIC and PDB capital requirements as of September 30, 2005
and December 31, 2004.
Liquidity
- ---------
As of September 30, 2005, the Company had cash and cash equivalents
of $12.2 million in the form of cash, due from banks, federal funds sold and
short-term deposits with other institutions declining from $20.7 million as of
December 31, 2004. The decrease was due to a reduction of federal funds with the
proceeds used to pay down short-term borrowings. In addition, the Company had
total securities available for sale of $113.1 million which could be used for
liquidity needs. This totals $125.3 million and represents 29.4% of total assets
compared to $137.6 million and 33.4% of total assets as of December 31, 2004.
The Company also monitors other liquidity measures, all of which were within the
Company's policy guidelines as of September 30, 2005 and December 31, 2004.
Based upon these measures, the Company believes its liquidity is adequate.
The Company maintains established lines of credit with the Federal
Home Loan Bank of Pittsburgh (FHLB), the Atlantic Central Bankers Bank (ACBB)
and other correspondent banks, which are available to support liquidity needs.
The approximate borrowing capacity from the FHLB was $145.6 million, of which
$23 million of borrowings was outstanding as of September 30, 2005 and $31
million as of December 31, 2004.
18
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Three Months Ended September 30,
----------------------------------------------------------------------------
2005 2004
--------------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- --------
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 6,546 $ 56 3.42% $ 2,526 $ 8 1.29%
Interest bearing deposits with banks 180 2 4.44 87 - -
Securities held-to-maturity 3,090 102 13.20 5,718 126 8.81
Securities available for sale:
Taxable 95,534 757 3.17 98,389 791 3.22
Tax-exempt 18,559 255 5.50 18,398 205 4.46
-------- ------ -------- ------
Total securities available for sale (1) 114,093 1,012 3.55 116,787 996 3.41
Loans receivable (4) (5) 279,060 4,565 6.54 253,123 3,807 6.02
-------- ------ -------- ------
Total interest earning assets 402,969 5,737 5.69 378,241 4,937 5.22
Non-interest earning assets:
Cash and due from banks 8,990 8,273
Allowance for loan losses (3,631) (3,403)
Other assets 16,279 14,963
-------- --------
Total non-interest earning assets 21,638 19,833
-------- --------
Total Assets $424,607 $398,074
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $ 99,857 278 1.11% $ 91,246 137 0.60%
Savings 56,699 67 0.47 59,502 70 0.47
Time 126,681 917 2.90 114,368 651 2.28
-------- ------ -------- ------
Total interest bearing deposits 283,237 1,262 1.78 265,116 858 1.29
Short-term borrowings 11,639 83 2.85 14,155 46 1.30
Other borrowings 23,000 299 5.20 23,000 320 5.57
-------- ------ -------- ------
Total interest bearing liabilities 317,876 1,644 2.07 302,271 1,224 1.62
Non-interest bearing liabilities:
Demand deposits 56,543 50,851
Other liabilities 2,883 1,240
-------- --------
Total non-interest bearing liabilities 59,426 52,091
Stockholders' equity 47,305 43,712
-------- --------
Total Liabilities and Stockholders' Equity $424,607 $398,074
======== ========
Net interest income (tax equivalent basis) 4,093 3.62% 3,713 3.60%
===== =====
Tax-equivalent basis adjustment (159) (155)
------ ------
Net interest income $3,934 $3,558
====== ======
Net interest margin (tax equivalent basis) 4.06% 3.93%
===== =====
(1) Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
(2) Average balances have been calculated based on daily balances.
(3) Annualized
(4) Loan balances include non-accrual loans and are net of unearned income.
(5) Loan yields include the effect of amortization of deferred fees, net of
costs.
19
Rate/Volume Analysis. The following table shows the fully taxable
equivalent effect of changes in volumes and rates on interest income and
interest expense.
Increase/(Decrease)
-------------------
Three months ended September 30, 2005 Compared to
---------------------------- --------------------
Three months ended September 30, 2004
---------------------------- --------
Variance due to
---------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest earning assets:
Federal funds sold ......................... $ 23 $ 25 $ 48
Interest bearing deposits with banks ....... - 2 2
Securities held to maturity ................ (252) 228 (24)
Securities available for sale:
Taxable .................................. (23) (11) (34)
Tax-exempt securities .................... 2 48 50
----- ----- -----
Total securities ....................... (21) 37 16
Loans receivable ........................... 409 349 758
----- ----- -----
Total interest earning assets .............. 159 641 800
Interest bearing liabilities:
Interest-bearing demand and money market.. 14 127 141
Savings .................................. (5) 2 (3)
Time ..................................... 75 191 266
----- ----- -----
Total interest bearing deposits ....... 84 320 404
Short-term borrowings ...................... (51) 88 37
Other borrowings ........................... - (21) (21)
----- ----- -----
Total interest bearing liabilities ......... 33 387 420
----- ----- -----
Net interest income (tax-equivalent basis).. $ 126 $ 254 $ 380
===== ===== =====
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.
Comparison of Operating Results for Three Months Ended September 30, 2005 and
- --------------------------------------------------------------------------------
September 30, 2004.
- -------------------
General
- -------
For the three months ended September 30, 2005, net income totaled
$1,482,000 which represents an increase of $162,000, or 12.3%, over $1,320,000
earned in the similar period of 2004. Earnings per share for the current period
were $.56 basic and $.54 on a diluted basis, compared to $.50 basic and $.49 on
a diluted basis for the three months ended September 30, 2004. The resulting
annualized return on average assets and return on average equity for the three
months ended September 30, 2005, were 1.38% and 12.43%, respectively compared to
1.32% and 12.01%, respectively for the similar period in 2004.
20
The following table sets forth the effect on net income:
Three months ended
----------------------------------------
September 30, 2005 to September 30, 2004
----------------------------------------
(dollars in thousands)
Net income for the three months ended September 30, 2004 $1,320
------
Net interest income 376
Provision for loan losses 10
Net realized gains on sales of securities (48)
Gains on sale of loans 7
All other income 78
Salaries and employee benefits (84)
All other expenses (34)
Income tax effect (143)
------
Net income for the three months ended September 30, 2005 $1,482
======
Net Interest Income
- -------------------
Net interest income on a fully taxable equivalent basis (fte) for the
three months ended September 30, 2005 totaled $4,093,000, an increase of
$380,000, or 10.2%, over the similar period in 2004. The fte net interest spread
and net interest margin were 3.62% and 4.06%, respectively, increasing from
3.60% and 3.93%, respectively, for the three months ended September 30, 2004.
Interest income (fte) totaled $5,737,000 with an average yield of
5.69%, increasing from $4,937,000 and 5.22% for the 2004 period. The increase
was principally due to growth in the loan portfolio. Average loans increased
$25.9 million and represented 69.3% of average earning assets compared to 66.9%
of average earning assets for the similar period in 2004. The average yield
(fte) on loans also increased, and was 6.54% for the three months ended
September 30, 2005 compared to 6.02% for the similar period in 2004. This
principally is the result of the increase in the prime interest rate, which was
6.75% as of September 30, 2005 compared to 4.75% as of September 30, 2004. The
increase in prime rate increases the rate on the Company's floating rate
commercial loan portfolio and on home equity lines of credit.
Interest expense for the three months ended September 30, 2005
totaled $1,644,000 at an average cost of 2.07% increasing from $1,224,000 and an
average cost of 1.62% for the similar period in 2004. The increase was
principally due to the increase in the short-term interest with the Federal
Funds rate at 3.75% as of September 30, 2005 compared to 1.75% as of September
30, 2004. As a result the Company increased rates paid on money market accounts
and time deposits. The cost of time deposits increased to an average 2.90% in
the current period from an average rate paid of 2.28% in the similar period of
2004. The Company expects the cost of time deposits to continue to increase as
lower rate instruments are repricing at the current higher rates. The cost of
short-term borrowings, which are principally repurchase agreements, increased
with an average rate paid of 2.85% for the 2005 period compared to 1.30% for the
similar period in 2004.
Other Income
- ------------
Other income totaled $908,000 for the three months ended September
30, 2005 compared to $871,000 for the similar period in 2004. Net realized gains
on the sales of securities were $3,000 for the 2005 period declining from
$51,000 for the similar period in 2004. This was offset by $73,000 increase in
service charges and fees. The increase was principally due to additional
overdraft fees resulting from the higher volume of overdrafts in 2005 related to
the Bank's overdraft manager program.
21
Other Expenses
- --------------
Other expenses for the three months ended September 30, 2005, totaled
$2,627,000, an increase of $118,000, or 4.7%, over the similar period in 2004.
Salaries and employee benefits increased $84,000, or 6.6%,
principally due to increases in expense related to the Company's Employee Stock
Ownership Plan (ESOP) due to an increase in the company's stock price and to an
increase in health insurance costs. The Bank made a $100,000 charitable
contribution (included in Other) in the third quarter of 2005. The contribution
qualifies for the PA Education Improvement Tax Credit. As a result, a $90,000
tax credit was recorded against the PA Shares Tax Liability (Included in Taxes,
Other than income). The Company made a similar contribution in 2004.
Professional fees increased $25,000 principally due to costs associated with the
Sarbanes-Oxley internal control documentation project.
Income Tax Expense
- ------------------
Income tax expense totaled $643,000 for an effective tax rate of
30.2% for the three months ended September 30, 2005, compared to $500,000 and
27.5% for the similar period in 2004. The effective rate is lower than the
statutory rate due to tax-exempt interest income on certain investments and
loans. The rate is higher in 2005 partially due to a higher level of
non-deductible ESOP expense.
22
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Nine Months Ended September 30,
----------------------------------------------------------------------------
2005 2004
--------------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ------- ------- -------- --------
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 3,053 $ 72 3.14% $ 3,147 $ 24 1.02%
Interest bearing deposits with banks 126 3 3.17 110 1 1.21
Securities held-to-maturity 4,174 353 11.28 5,735 379 8.81
Securities available for sale:
Taxable 98,498 2,315 3.13 101,177 2,387 3.15
Tax-exempt 18,601 767 5.50 18,174 786 5.77
-------- --- -------- ---
Total securities available for sale (1) 117,099 3,082 3.51 119,351 3,173 3.54
Loans receivable (4) (5) 269,761 12,841 6.35 242,151 10,976 6.04
-------- ------ -------- ------
Total interest-earning assets 394,213 16,351 5.53 370,494 14,553 5.24
Non-interest earning assets:
Cash and due from banks 8,397 8,515
Allowance for loan losses (3,569) (3,346)
Other assets 15,807 14,893
-------- --------
Total non-interest earning assets 20,635 20,062
-------- --------
Total Assets $414,848 $390,556
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $ 92,965 654 0.94% $ 88,405 395 0.60%
Savings 58,313 205 0.47 57,742 202 0.47
Time 124,992 2,492 2.66 117,920 2,031 2.30
-------- ------- -------- -------
Total interest bearing deposits 276,270 3,351 1.62 264,067 2,628 1.33
Short-term borrowings 15,415 294 2.54 12,677 103 1.08
Long-term debt 23,000 919 5.33 23,000 964 5.59
-------- ------- -------- -------
Total interest bearing liabilities 314,685 4,564 1.93 299,744 3,695 1.64
Non-interest bearing liabilities:
Demand deposits 51,315 45,594
Other liabilities 2,243 1,656
-------- --------
Total non-interest bearing liabilities 53,558 47,250
Stockholders' equity 46,604 43,562
-------- --------
Total Liabilities and Stockholders' Equity $414,847 $390,556
======== ========
Net interest income (tax equivalent basis) 11,787 3.60% 10,858 3.59%
==== ====
Tax-equivalent basis adjustment (487) (487)
------- -------
Net interest income $11,300 $10,371
======= =======
Net interest margin (tax equivalent basis) 3.99% 3.91%
==== ====
(1) Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
(2) Average balances have been calculated based on daily balances.
(3) Annualized
(4) Loan balances include non-accrual loans and are net of unearned income.
(5) Loan yields include the effect of amortization of deferred fees, net of
costs.
23
Rate/Volume analysis. The following table shows the fully taxable
equivalent effect of changes in volumes and rates on interest income and
expense.
Increase/(Decrease)
-------------------
Nine months ended September 30, 2005 Compared to
------------------------------------------------
Nine months ended September 30, 2004
------------------------------------
Variance due to
---------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest earning assets:
Federal funds sold ......................... $ (1) $ 49 $ 48
Interest bearing deposits with banks ....... - 2 2
Securities held to maturity ................ (152) 126 (26)
Securities available for sale:
Taxable .................................. (63) (9) (72)
Tax-exempt securities .................... 26 (45) (19)
------- ------- -------
Total securities available for sale .... (37) (54) (91)
Loans receivable ........................... 1,295 570 1,865
------- ------- -------
Total interest earning assets .......... 1,105 693 1,798
Interest bearing liabilities:
Interest-bearing demand and money market.. 21 238 259
Savings .................................. 2 1 3
Time ..................................... 127 334 461
------- ------- -------
Total interest bearing deposits ....... 150 573 723
Short-term borrowings ...................... 26 165 191
Other borrowings ........................... - (45) (45)
------- ------- -------
Total interest bearing liabilities .... 176 693 869
------- ------- -------
Net interest income (tax-equivalent basis).. $ 929 $ - $ 929
======= ======= =======
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.
Comparison of Operating Results for The Nine Months Ended September 30, 2005 to
- --------------------------------------------------------------------------------
September 30, 2004
- ------------------
General
- -------
For the nine months ended September 30, 2005, net income totaled
$4,055,000, which represents an increase of $408,000, or 11.2% when compared to
$3,647,000 earned in the similar period of 2004. Basic and diluted earnings per
share were $1.52 and $1.49, respectively, in 2005 compared to $1.38 and $1.35,
respectively, in 2004. The resulting annualized return on average assets for the
nine months ended September 30, 2005 was 1.31%, with a return on average equity
of 11.63% compared to 1.24% and 11.18%, respectively, for the similar period in
2004.
24
The following table sets forth changes in net income:
(in thousands)
Nine months ended
-----------------
September 30, 2005 to September 30, 2004
----------------------------------------
Net income for the nine months ended September 30, 2004 $3,647
------
Net interest income 929
Provision for loan losses 110
Net realized gains on sales of securities (230)
All other income 351
Salaries and employee benefits (241)
Losses on lease residuals 90
All other expenses (256)
Income tax effect (345)
------
Net income for the nine months ended September 30, 2005 $4,055
======
Net Interest Income
- -------------------
Net interest income on a fully taxable equivalent basis (fte) totaled
$11,787,000 for the nine months ended September 30, 2005, an increase of
$929,000 or 8.6%, over $10,858,000 for the similar period in 2004. The fte net
interest spread and net interest margin for the period in 2005 were 3.60% and
3.99%, respectively, compared to 3.59% and 3.91%, respectively, for the similar
period in 2004.
Interest income (fte) totaled $16,351,000 with an average yield of
5.53% for the nine months ended September 30, 2005 compared to $14,553,000 and
5.24% for the similar period in 2004. The increase is principally due to the
growth in average loans. For the 2005 period, average loans totaled $269.8
million and represented 68.4% of average earning assets compared to $242.2
million and 65.3% of average earning assets for the similar period in 2004.
Interest income was also favorably impacted by the increase in the Prime
Interest Rate which was 6.75% as of September 30, 2005, increasing from 4.75% as
of September 30, 2004.
Interest expense for the nine months ended September 30, 2005 totaled
$4,564,000 with an average rate paid of 1.93% compared to $3,695,000 and an
average rate paid of 1.64% for the similar period in 2004. The increase is due
in part to rising short-term interest rates which caused increases in rates paid
on money market accounts, time deposits and short-term borrowings. The average
rate paid on time deposits for the 2005 period was 2.66% increasing from 2.30%
in the 2004 period. The Company expects the cost of time deposits to continue to
increase as lower cost instruments reach maturity and are replaced at higher
rates.
Other Income
- ------------
Other income totaled $2,693,000 for the nine months ended September
30, 2005, an increase of $121,000 over the $2,572,000 earned in the similar
period of 2004. Net realized gains on sales of securities totaled $83,000 in the
2005 period, decreasing $230,000 from $313,000 in gains for the 2004 period. The
decline is principally due to a lower level of securities sold in 2005. This was
offset by a $341,000 increase in service charges and fees. The increase was
principally due to fees on overdrafts, with more volume in the 2005 period
related to the Bank's Overdraft Manager Service.
25
Other Expenses
- --------------
Other expense totaled $7,955,000 for the nine months ended September
30, 2005, an increase of $407,000, or 5.4%, over the $7,548,000 for the similar
period in 2004. Salaries and employee benefits increased $241,000, 6.3%, due in
part to increased costs related to the Bank's Employee Stock Ownership Plan and
incentive compensation. Professional fees increased $117,000 due to costs
related to internal control documentation required by Sarbanes-Oxley, consulting
fees for a profitability analysis and legal fees related to strategic analysis.
The Company had $90,000 in losses on lease residuals in the 2004 period, with no
expense in the 2005 period. The Company anticipates no additional expenses
related to leasing as the final vehicles were liquidated in 2004.
Income Tax Expense
- ------------------
Income tax expense totaled $1,703,000 for an effective tax rate of
29.6% for the nine months ended September 30, 2005 compared to $1,358,000 and
27.1% for the similar period in 2004. The increase in the effective tax rate was
due in part to a higher level of non-deductible ESOP expense.
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Market Risk
-----------
Interest rate sensitivity and the repricing characteristics to assets
and liabilities are managed by the Asset and Liability Management Committee
(ALCO). The principal objective of ALCO is to maximize net interest income
within acceptable levels of risk, which are established by policy. Interest rate
risk is monitored and managed by using financial modeling techniques to measure
the impact of changes in interest rates.
Net interest income, which is the primary source of the Company's
earnings, is impacted by changes in interest rates and the relationship of
different interest rates. To manage the impact of the rate changes, the balance
sheet must be structured so that repricing opportunities exist for both assets
and liabilities at approximately the same time intervals. The Company uses net
interest simulation to assist in interest rate risk management. The process
includes simulating various interest rate environments and their impact on net
interest income. As of September 30, 2005, 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
reflects interest-sensitivity gaps measured as the difference between
rate-sensitive assets and rate-sensitive liabilities. These are static gap
measurements that do not take into account any future activity, and as such are
principally used as early indications of potential interest rate exposures over
specific intervals.
As of September 30, 2005, the Bank had a positive 90 day interest
sensitivity gap of $42.3 million or 9.9% of total assets, increasing from $32.5
million, 7.9% of total assets as of December 31, 2004. 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.
26
September 30, 2005
- ------------------
Rate Sensitivity Table
- ----------------------
3 Months 3-12 Months 1 to 3 Years 3 Years Total
-------- ----------- ------------ ------- -----
Federal funds sold and interest bearing deposits $ 2,427 $ - $ - $ - $ 2,427
Securities 8,834 28,678 62,174 16,336 116,022
Loan Receivable 106,416 44,121 56,164 75,563 282,264
-------- ------- -------- ------- --------
Total Rate Sensitive Assets 117,677 72,799 $118,338 $91,899 $400,713
Non-maturity interest-bearing deposits 24,864 26,094 69,500 36,137 156,595
Time Deposits 30,162 44,454 43,761 7,398 125,775
Other 20,394 3,483 9,638 - 33,515
-------- ------- -------- ------- --------
Total Rate Sensitive Liabilities 75,420 74,031 122,899 43,535 315,885
Interest Sensitivity Gap $ 42,257 $(1,232) $ (4,561) $48,364 $ 84,828
Cumulative gap $ 42,257 $41,025 $ 36,464 $84,828
RSA/RSL-Cumulative 156.0% 127.5% 113.4% 126.9%
December 31,2004
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%
Item 4: Controls and Procedures
The Company's management evaluated, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, the effectiveness
of the Company's disclosure controls and procedures, as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer concluded that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
There were no changes in the Company's internal control over
financial reporting that occurred during the Company's last fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
27
Part II. Other Information
Item 1. Legal Proceedings
Not applicable
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer
Purchases of Equity Securities
Issuer Purchases of
Equity Securities
-----------------
Maximum number
of shares (or
Total number of approximate
shares purchased dollar value) that
as part of may yet
Total number Average price publicly be purchased
of shares paid per announced plans under the plans
purchased share or programs (1) or programs
--------- ----- --------------- -----------
July 1 - July 31, 2005 - - - -
August 1-August 31, 2005 5,000 $32.05 5,000 119,000
September 1-September 30, 2005 - - - -
----- ------ ----- -------
Total 5,000 $32.05 5,000 119,000
===== ====== ===== =======
(1) On June 15, 2005, the Company announced an open market stock repurchase
plan for up to 5% of shares outstanding
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None applicable
Item 5. Other Information
None
Item 6. The following exhibits are either filed or incorporated by reference
3(i) Articles of Incorporation of Norwood Financial Corp.*
3(ii) Bylaws of Norwood Financial Corp.*
4.0 Specimen Stock Certificate of Norwood Financial Corp.*
10.1 Amended Employment Agreement with William W. Davis, Jr.***
10.2 Amended Employment Agreement with Lewis J. Critelli ***
10.3 Form of Change-In-Control Severance Agreement with seven key
employees of the Bank*
10.4 Consulting Agreement with Russell L. Ridd**
10.5 Wayne Bank Stock Option Plan*
10.6 Salary Continuation Agreement between the Bank and William W.
Davis, Jr.***
10.7 Salary Continuation Agreement between the Bank and Lewis J.
Critelli***
10.8 Salary Continuation Agreement between the Bank and Edward C.
Kasper***
10.9 1999 Directors Stock Compensation Plan***
10.10Salary Continuation Agreement between the Bank and Joseph A.
Kneller****
10.11Salary Continuation Agreement between the Bank and John H.
Sanders****
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
32 Section 1350 Certification
- ---------------------------
* Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10 Registration Statement initially filed with
the Commission on April 29, 1996.
** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 31,
1997.
*** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 20,
2000.
**** Incorporated herein by reference to the identically numbered exhibit
to the Registrant's Form 10-K filed with the Commission on March 22,
2004.
28
Signatures
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORWOOD FINANCIAL CORP.
Date: November 10, 2005 By: /s/William W. Davis, Jr.
---------------------------------------
William W. Davis, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 10, 2005 By: /s/Lewis J. Critelli
---------------------------------------
Lewis J. Critelli
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
29