[GRAPHIC OMITTED]
MAIN STREET HONESDALE, 1912
Wayne County Fair Parade proceeds down Main Street in Honesdale, 1912. Fair
President W.J. Ferguson rides on the first carriage with Amos Ward, Marshall.
Note the ox-drawn cart and muddy street.
- --------------------------------------------------------------------------------
A HERITAGE OF HARD WORK, DILIGENCE AND ACHIEVEMENT
[GRAPHIC OMITTED]
NORWOOD FINANCIAL CORP. o 2006 ANNUAL REPORT
[GRAPHIC OMITTED]
MAIN STREET - CIRCA 1942
Color postcard depicting Honesdale in the 1930s-40s. Note Wayne Bank, the
yellow-pillared building on the right.
- -------------------------------------------------------------------------------
SUMMARY OF SELECTED FINANCIAL DATA
(dollars in thousands, except per share data)
For the years ended December 31, 2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------
Net interest income $ 16,183 $ 15,263 $ 14,012 $ 13,322 $ 13,951
Provision for loan losses 220 350 455 660 630
Other income 3,517 3,506 3,088 2,801 2,577
Net realized gains on sales of securities 66 42 458 692 427
Other expense 10,957 10,623 10,090 9,808 10,349
Income before income taxes 8,589 7,838 7,013 6,347 5,976
Income tax expense 2,679 2,341 2,003 1,694 1,623
Net Income $ 5,910 $ 5,497 $ 5,010 $ 4,653 $ 4,353
Net income per share-Basic $ 2.11 $ 1.96* $ 1.80* $ 1.70* $ 1.62*
Net income per share-Diluted $ 2.07 $ 1.92* $ 1.77* $ 1.67* $ 1.60*
Cash dividends declared 0.85 0.71* 0.66* 0.62* 0.57*
Dividend pay-out ratio 40.28% 36.41% 36.51% 36.31% 35.29%
Return on average assets 1.33% 1.31% 1.27% 1.22% 1.21%
Return on average equity 11.85% 11.72% 11.39% 11.24% 11.60%
BALANCES AS OF YEAR END
Total assets $454,356 $433,556 $411,626 $387,483 $367,468
Loans receivable 315,567 290,890 254,757 233,733 217,970
Allowance for loan losses 3,828 3,669 3,448 3,267 3,146
Total deposits 358,103 340,603 318,645 306,669 291,852
Shareholders' equity 52,231 48,108 45,685 42,831 40,125
Trust assets under management 96,879 86,972 83,397 73,991 60,102
Book value per share $ 18.67 $ 17.07* $ 16.14* $ 15.20* $ 14.37*
Tier 1 Capital to risk-adjusted assets 15.67% 15.29% 15.91% 15.58% 15.06%
Total Capital to risk-adjusted assets 16.99% 16.63% 17.34% 17.09% 16.57%
Allowance for loan losses to total loans 1.21% 1.26% 1.35% 1.40% 1.44%
Non-performing assets to total assets 0.09% 0.08% 0.02% 0.04% 0.07%
* References to share and per-share amounts reflect the 5% stock dividend
distributed to shareholders on May 26, 2006.
NORWOOD
FINANCIAL CORP
2006 ANNUAL REPORT TABLE OF CONTENTS
A LETTER TO OUR SHAREHOLDERS 2-7
YOUR BOARD OF DIRECTORS 4-5
WAYNE BANK BRANCH LOCATIONS 8
FINANCIAL REPORT INDEX 9
[GRAPHIC OMITTED]
Portrait of the Honesdale Semi-Pro Baseball Club. Note Christy Mathewson second
from the left. Mathewson was one of the first five players ever elected to the
Baseball Hall of Fame.
[GRAPHIC OMITTED]
A Letter to our Shareholders
We hope you enjoy the photographs throughout this year's Annual Report,
reflecting various eras in our community's history. We feel they reflect the
ongoing sense of community and strong work ethic our local people have
demonstrated generation after generation and into the present time. These values
are important to Wayne Bank and to our community, and we are proud to offer
examples from our work this year that demonstrate the Bank's dedication to
building community through initiative and dedicated labor.
- --------------------------------------------------------------------------------
WE ARE PLEASED TO REPORT that your Company had a very strong financial
performance in 2006. Our earnings for the year ended December 31, 2006 totaled
$5,910,000 which is an increase of $413,000, or 7.5%, over the $5,497,000 earned
in 2005. Earnings per share on a fully diluted basis were $2.07 compared to
$1.92 in 2005. The return on average assets for the year was 1.33% with a return
on average equity of 11.85%. Both of these measures of performance improved over
the prior year.
As a result of this excellent performance, the Board of Directors approved
two increases to dividends declared for our shareholders during 2006. Cash
dividends declared per share totaled $.85 in 2006, an increase of $.14 or 19.7%
over the $.71 per share declared in 2005. In addition, the Company also
distributed a 5% stock dividend in May 2006.
Total assets as of December 31, 2006 were $454.4 million with loans
receivable of $315.6 million, deposits of $358.1 million and shareholders'
equity of $52.2 million. Total assets have increased $20.8 million from December
31, 2005.
We had steady loan activity throughout 2006. Loans receivable increased
$24.7 million, or 8.5% from the prior year. We had balanced growth during the
year with the commercial loan portfolio increased $12.6 million and residential
mortgages, including home equity financing, growing $13.1 million. The majority
of our loan growth was funded with a $17.5 million increase in deposits.
Credit quality ratios were consistently strong during the year.
Non-performing loans totaled $409,000 and represented .13% of loans as of
December 31, 2006 compared to $353,000 and .12% as of year ended 2005. Our net
charge-offs decreased by over 50%, and totaled $61,000 in 2006
NET INCOME
- ----------
($ in thousands) for the year ended December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $4,353
2003 - $4,653
2004 - $5,010
2005 - $5,497
2006 - $5,910]
NORWOOD FINANCIAL CORP 2 2006 ANNUAL REPORT
compared to $129,000 in 2005. As a result of the lower level of charge-offs, our
provision expense in 2006 was $220,000 compared to $350,000 in 2005. The
allowance for loan losses totaled $3,828,000 and 1.21% as of December 31, 2006
compared to $3,669,000 and 1.26% as of year end 2005.
The Company faced a challenging interest rate environment during 2006, in
which short term interest rates, which effect CD rates, were higher than long
term rates, which impacts loan pricing. For the year, net interest income (fully
taxable equivalent) totaled $16,708,000, an increase of $819,000 over the
$15,889,000 earned in 2005. Our net interest margin, (fte) for the year was
3.96% decreasing only 3 basis points from 3.99% in the prior year. The slight
decrease in net interest margin was principally due to an increase in deposit
costs, most evident in the CD portfolio, which was partially offset by loan
volume and higher yields on loans and investments.
For the year, other income totaled $3,583,000 compared to $3,548,000 in
2005. The increase was principally due to $147,000 in gains on sales of mortgage
loans and servicing rights in 2006 increasing from $64,000 in similar gains in
2005. Other expenses totaled $10,957,000 in 2006, an increase of $334,000 or
3.1% over the prior year. The increase was principally due to rising salary and
employee benefit costs. We strongly encourage you to read Management's
Discussion and Analysis and the Audited Financial Statements and Footnotes for
more details on our performance.
DILUTED EARNINGS PER SHARE
--------------------------
For the year ended December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $1.60
2003 - $1.67
2004 - $1.77
2005 - $1.92
2006 - $2.07]
Wayne Bank takes pride in seeing businesses, in particular locally owned
businesses, flourish in all the communities we serve. In accord with our slogan,
"Helping the Community Grow," we have helped to finance start-up businesses as
well as the expansion of existing businesses. The Bank played a major role in
the significant commercial growth experienced in our market area during 2006.
Wayne Bank also launched a Free Business Checking account in December of 2006
and began to offer small business owners loans at the
[GRAPHIC OMMITTED]
Do Your Part - Circa 1944
The bank lobby circa 1944 - evident are the various war bond signs and the
flags of our allies, along with the scale which still resides in the lobby
today. Above right is our original bond wallet as issued by Wayne Bank.
NORWOOD FINANCIAL CORP 3 2006 ANNUAL REPORT
[GRAPHIC OMITTED]
Picture - The Board of Directors
- --------------------------------------------------------------------------------
branch level for those who were looking for loans of $50,000 or less. We are
able to offer "Same Day Approval" on these loans due to the fact that Wayne Bank
is locally owned--many of the inconveniences that go with large financial
institutions are not a dilemma with Wayne Bank. We pride ourselves on giving our
customers exceptional service with quick decision-making and rapid-fire
processing.
Throughout its long history, Wayne Bank has helped thousands of individuals
and families enjoy the benefits of homeownership. That tradition continues into
the 21st century. In 2006 we generated almost $50 million in loans for new home
construction, purchases and refurbishing. New, more flexible Residential
Mortgage and Home Equity Lending Programs were also introduced to meet the needs
of our communities. The Bank actively supports the local home building
industry--our officers are active in area realtors' and builders' associations.
BOOK VALUE PER SHARE
--------------------
as of year end December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $14.37
2003 - $15.20
2004 - $16.14
2005 - $17.07
2006 - $18.67]
The Wealth Management and Trust Services Division staff believes that "slow
and steady wins the race." This philosophy of controlled growth allows us to
provide the level of services our clients deserve and expect. The department
ended the year with a record dollar value of assets under management, increasing
almost $10 million dollars from the previous year. This resulted in a record
high level of total revenue.
Many of the Bank's key business objectives are centered upon the effective
deployment of information technology. Technology investments made in recent
years have led to improvements in productivity that influenced the Bank's
ability to control costs and stay competitive during 2006. For example, a modern
wire transfer system introduced during the third quarter reduces handling by 70%
while enhancing accuracy for all wires and adding cost savings for foreign
interchange transactions.
Direct Link, our Internet banking service, now includes bill payment
capability, expanded access to account information and the addition of Direct
Protect authentication to enhance online security. New telecommunications,
security and customer service devices have been introduced throughout our
community office network. Our transaction processing unit continues its work to
align the bank with paper reduction strategies such as the Federal Reserve's
Check 21 program, converting checks to digital form for interbank exchange and
archives. Great strides have been made in converting internal file systems to
digitized format and providing Direct Link users with detailed transaction
histories for their loans.
NORWOOD FINANCIAL CORP 4 2006 ANNUAL REPORT
[GRAPHIC OMITTED]
The Norwood Financial Corp. Board of Directors (left to right) William W.
Davis, Jr., Russell Ridd, Daniel J. O'Neill, John E. Marshall, Richard L.
Snyder, Susan Gumble-Cottell, Dr. Kenneth A. Phillips, Ralph A. Matergia, Esq.
and Gary P. Rickard, in the newly renovated lobby of the main branch in
Honesdale, PA.
- --------------------------------------------------------------------------------
TOTAL DEPOSITS
--------------
($ in millions) as of year end December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $291.9
2003 - $306.7
2004 - $318.6
2005 - $340.6
2006 - $358.1]
- --------------------------------------------------------------------------------
Wayne Bank employs over 120 people throughout Wayne, Pike and Monroe
Counties. Year after year, we steadfastly achieve the results we desire due to
the combined efforts of our Board of Directors, officers and employees. It is
always a pleasure to recognize the achievements of our staff. In 2006 the
following Wayne Bank employees were promoted to Vice President: Ray Hebden,
JoAnn Fuller and Jennifer Witowic. In addition, Teresa Melucci was promoted to
Branch Manager in our Stroudsburg location, Renee Gilbert was promoted to Branch
Manager in our Tannersville location and Sandy Mruczkewycz was hired as Branch
Manager of the Lords Valley location. Lastly, Jeff Shrader was hired and
appointed to Vice President, Regional Manager of the Monroe County Branches.
Notably, we had 16 staff members who have achieved between 5 and 30 years of
service, a remarkable feat when so many people are transient these days.
TIMERBERING - CIRCA 1895
[GRAPHIC OMITTED]
Men at work at Dyberry Sawmill. At left, a formal portrait of Horace C.
Hand, Cashier of Wayne County Savings Bank from its inception in 1871 to January
1898, a service of 27 years. Mr. Hand was elected President of the Bank in 1898.
NORWOOD FINANCIAL CORP 5 2006 ANNUAL REPORT
[GRAPHIC OMITTED]
Senior Management 2006
Senior Management at the Bank's entrance in Honsedale, PA.
Front row, from left to right are: Wayne D. Wilcha, William W. Davis, Jr.,
and Lewis J. Critelli. Back row, from left to right are: Edward C. Kasper,
Joseph A. Kneller and John H. Sanders.
- --------------------------------------------------------------------------------
TOTAL LOANS
-----------
($ in millions) as of December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $218.0
2003 - $233.7
2004 - $254.8
2005 - $290.9
2006 - $315.6
- --------------------------------------------------------------------------------
In 2006, we were extremely pleased to have Susan Gumble-Cottell join the
Board of Directors of Wayne Bank and Norwood Financial Corp. Sue's experience
includes ten years as President and CEO of Gumble Brothers, Inc., a building
materials company located in Paupack. She is a welcome addition to our board,
bringing a variety of business knowledge from both Florida and the Lake Region
of the Poconos in addition to her real estate background and experience as a
local business owner.
Wayne Bank is proud to have served its community since 1871. Our community
is supported by many nonprofit organizations to which our Directors, officers
and employees give their time and energy. We have taken a leadership role in
working with the Wayne County YMCA. Wayne Memorial Hospital, Wayne County
Builders Association, the Wayne County Chamber of Commerce, Wayne County
Historical Society, the Wayne County Community Foundation, the Greater Honesdale
Partnership, the Pike County Chamber of Commerce, the Pike County United Way,
Pocono Builders Association, Pocono Mountain Chamber of Commerce, the Pocono
Mountain Association of Realtors, the Dorflinger-Suydan Wildlife Sanctuary, and
the Villaume Foundation, to name just a few.
Although Norwood Financial Corp. is headquartered in Honesdale, with 6
branches located within Wayne County, we have grown steadily and have 3 branches
in Pike County as well as 3 branches in Monroe County. Our newest Monroe County
branch, in Tannersville, opened in December of 2006. According to the 2000
Census, "Monroe [44.9%]. Pike [65.6%], and Wayne [19.5%] counties have the
highest population growth rates in the Commonwealth" of Pennsylvania. Our branch
expansion serves that population growth.
NET INTEREST INCOME
-------------------
(Fully taxable equivalent, $ in thousands) for the year ended December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $14,479
2003 - $13,945
2004 - $14,653
2005 - $15,889
2006 - $16,708
- --------------------------------------------------------------------------------
NORWOOD FINANCIAL CORP 6 2006 ANNUAL REPORT
NET CHARGE-OFFS
---------------
($ in thousands) for the year ended December 31
[BAR GRAPH WITH FOLLOWING DATA POINTS:
2002 - $700
2003 - $539
2004 - $274
2005 - $129
2006 - $ 61
- --------------------------------------------------------------------------------
We also remodeled the Honesdale Community Branch lobby to create a very
stately look with better functionality for the privacy of customers. (The
photograph on pages 4 & 5 features the new decor). Two plasma television screens
were installed in the lobby to advertise our services and a coin sorter machine
was also added as an amenity for our customers.
As you can see, Norwood Financial had a very notable 2006 with strong
financial results, a new branch opening and new product launches. Our consistent
performance has been noticed by the investment community. We were pleased that
Wayne Bank was one of only forty companies awarded "Honor Roll" status by Keefe
Bruyette & Woods, a prominent investment banking firm. Keefe Bruyette & Woods
includes in its "Honor Roll" those banking institutions that have continually
reported increases in earnings per share over the last decade, regardless of the
economic environment. The report also highlighted that Norwood's compound annual
growth rate in stock price for the period 2000 to 2005 exceeded 23%.
We are always looking for new ways to improve customer service, help our
communities prosper, and enhance your shareholder value. In closing, we are
proud of our accomplishments and look forward to new challenges and rewards in
2007.
/s/ William W. Davis, Jr.
William W. Davis, Jr., President and Chief Executive Officer
/s/ Russell L. Ridd
Russell L. Ridd, Chairman of the Board
[GRAPHIC OMITTED]
4th of July - 1925
A group of children celebrating on a front porch
NORWOOD FINANCIAL CORP 7 2006 ANNUAL REPORT
717 Main Street
P.O. Box 269
Honesdale, PA 18431
[GRAPHIC OMITTED - MAP]
717 Main Street
Honesdale, PA 18431
245 Willow Avenue
Honesdale, PA 18431
Belmont & Water Streets
Waymart, PA 18472
Route 6
Hawley, PA 18428
111 West Harford Street
Milford, PA 18337
Weis Market, Route 590
Hamlin, PA 18427
Richardson Avenue
Shohola, PA 18458
Route 370 & Lake Como Road
Lakewood, PA 18439
Stroud Mall - ROute 611
Stroudsburg, PA 18360
Route 739
Lords Valley Shopping Plaza
Lords Valley, PA 18428
Route 209
5165 Milford Road
Marshalls Creek, PA 18335
Route 611
Tannersville, PA 18327
NORWOOD FINANCIAL CORP 8 2006 ANNUAL REPORT
NORWOOD
--------------
FINANCIAL CORP
2006
CONSOLIDATED FINANCIAL REPORT
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS 11-28
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 29
CONSOLIDATED BALANCE SHEETS 30
CONSOLIDATED STATEMENTS OF INCOME 31
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 32
CONSOLIDATED STATEMENTS OF CASH FLOWS 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 34-55
INVESTOR INFORMATION 56
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, 2006 and 2005 and for
the years ended December 31, 2006, 2005, and 2004. All share and per share
amounts have been adjusted to reflect the effect of the 5% stock dividend
distributed to shareholders on May 26, 2006. 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, demand for real estate and general
economic conditions. The Company undertakes no obligation to publicly release
the results of any revisions to those forward-looking statements which may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES
Note 2 to the Company's consolidated financial statements (incorporated by
reference in Item 8 of the Form 10-K) lists significant accounting policies used
in the development and presentation of its financial statements. This discussion
and analysis, the significant accounting policies, and other financial statement
disclosures identify and address key variables and other qualitative and
quantitative factors that are necessary for an understanding and evaluation of
the Company and its results of operations.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowance for loan losses,
accounting for stock options, the valuation of deferred tax assets and the
determination of other-than-temporary impairment losses on securities. Please
refer to the discussion of the allowance for loan losses calculation under
"Non-performing Assets and Allowance for Loan Losses" in the "Financial
Condition" section.
For periods ending prior to January 1, 2006, the Company accounted for
stock option plans under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. Under APB Opinion No. 25, no stock-based employee compensation
was reflected in net income, as all options granted had an exercise price equal
to the market value of the underlying common stock on the grant date. The
Company adopted SFAS No. 123 (R), "Share-Based Payment" as of January 1, 2006,
which requires that transactions be recognized as compensation cost in the
income statement based on their fair values on the measurement date, which, for
the Company is the grant date. The Norwood Financial Corp.
NORWOOD FINANCIAL CORP 11 2006 ANNUAL REPORT
2006 Stock Option Plan was approved on April 25, 2006 and the Company granted
47,700 options during 2006. For the year ended December 31, 2006 salaries and
employee benefit expense includes $136,000 related to the adoption of Statement
No. 123 (R). See Notes 2 and 12 for additional discussion of this
pronouncement's impact on the Company's consolidated financial statements.
The deferred income taxes reflect temporary differences in the recognition
of the revenue and expenses for tax reporting and financial statement purposes,
principally because certain items are recognized in different periods for
financial reporting and tax return purposes. Although realization is not
assured, the Company believes it is more likely than not that all deferred tax
assets will be realized.
In estimating other-than-temporary impairment losses on securities, the
Company considers 1) the length of time and extent to which the fair value has
been less than cost 2) the financial condition of the issuer and 3) the intent
and ability of the Company to hold the security to allow for a recovery to fair
value. The Company believes that the unrealized losses, at December 31, 2006 and
2005 represent temporary impairment of the securities.
RESULTS OF OPERATIONS - SUMMARY
Net income for the Company for the year ended December 31, 2006 totaled
$5,910,000 an increase of $413,000 or 7.5% over the $5,497,000 earned for 2005.
Basic and diluted earnings per share for 2006 were $2.11 and $2.07 respectively,
increasing from $1.96 and $1.92, respectively in 2005. The return on average
assets (ROA) for the year ended December 31, 2006 was 1.33% improving from 1.31%
for 2005. Return on average equity also showed improvement at 11.85% in 2006
compared to 11.72% in 2005.
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 $16,708,000 in 2006,
compared to $15,889,000 in 2005, an increase of $819,000, or 5.2%.
Net interest income was favorably impacted by a $27.5 million, or 10.0%,
increase in average loans receivable for 2006 compared to average loans
receivable in 2005. The Company reduced its provision for loan losses to
$220,000 for the year ended December 31, 2006 from $350,000 for 2005. The
decrease was principally due to a lower level of net charge-offs, $61,000 in
2006 declining from $129,000 in 2005.
Loans receivable increased $24.7 million, to total $315.6 million as of
December 31, 2006. The Company had balanced growth throughout the year with the
commercial loan portfolio, including commercial real estate, increasing $12.7
million and loans secured by residential real estate growing $13.1 million. The
majority of the loan growth was funded with a $17.5 million increase in
deposits, principally short-term time deposits.
Other income for 2006 totaled $3,583,000 compared to $3,548,000 for 2005.
The increase was principally due to $147,000 of gains on sales of mortgage loans
and servicing rights in 2006 compared to $64,000 in similar gains in 2005. Other
expenses totaled $10,957,000, an increase of $334,000 or 3.1% over 2005. The
increase was primarily due to rising salary and employee benefit costs. The
resulting efficiency ratio for 2006 was 54.0% improving from 54.7% in 2005.
NORWOOD FINANCIAL CORP 12 2006 ANNUAL REPORT
The following table sets forth changes in net income (in thousands):
Net income for 2005 $ 5,497
Net interest income 920
Provision for loan losses 130
Gains on sales of mortgage loans 83
All other income (48)
Salaries and employee benefits (245)
Professional fees 104
All other expenses (193)
Income tax expense (338)
--------
Net income for 2006 $ 5,910
========
Net income for the Company for the year 2005 totaled $5,497,000 compared to
$5,010,000 earned in 2004. This represents an increase of $487,000, or 9.7%,
over the prior year. Basic and diluted earnings per share for 2005 were $1.96
and $1.92 respectively, increasing from $1.80 and $1.77, respectively, in 2004.
The return on average assets (ROA) for the year ended December 31, 2005 was
1.31% improving from 1.27% for 2004. Likewise, return on average equity (ROE)
for 2005 was 11.72%, increasing from 11.39% in 2004.
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 $15,889,000 in 2005,
compared to $14,653,000 in 2004, an increase of $1,236,000, or 8.4%.
The primary driver for the increase in net interest income was an increase
in average loans receivable of $28.3 million, or 11.5%, for the year 2005
compared to the average loans receivable for 2004. The Company reduced its
provision for loan losses to $350,000 for the year ended December 31, 2005 from
$455,000 for 2004. The decrease was due in part to a lower level of net
charge-offs in 2005, $129,000 compared to $274,000 in 2004.
Loans receivable increased $36.1 million to total $290.9 million as of
December 31, 2005. The growth was principally related to loans secured by real
estate, both commercial, and to a lesser extent, residential. The loan growth
was funded by a $22.0 million growth in deposits, and a $13 million decrease in
Federal Funds sold.
Other income for 2005 was $3,548,000 compared to $3,546,000 in 2004. The
Company had a significantly lower level of net realized gains on sales of
securities, $42,000 in 2005 compared to $458,000 in 2004. This was principally
offset by $385,000 increase in service charges and fees. Other income, excluding
gains on sales of securities represented 18.1% of total revenues in 2005,
improving from 17.4% in 2004. Other expenses totaled $10,623,000 in 2005
compared to $10,090,000 in 2004, an increase of $533,000 or 5.3%. The increase
was principally due to higher professional fees and costs related to employee
benefit plans.
NORWOOD FINANCIAL CORP 13 2006 ANNUAL REPORT
The following table sets forth changes in net income for the year ended
December 31, 2005 compared to the year ended December 31, 2004:
(in thousands)
Net income for 2004 $ 5,010
Net interest income 1,251
Provision for loan losses 105
Net realized gains on sales of securities (416)
All other income 418
Salaries and employee benefits (277)
Professional fees (121)
All other expenses (135)
Income tax expense (338)
-------
Net income for 2005 $ 5,497
=======
FINANCIAL CONDITION
TOTAL ASSETS
Total assets as of December 31, 2006, were $454.4 million compared to
$433.6 million as of year-end 2005, an increase of $21 million or 4.8%.
LOANS RECEIVABLE
As of December 31, 2006, total loans receivable were $315.6 million
compared to $290.9 million as of year-end 2005, an increase of $24.7 million, or
8.5%. 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. Loans receivable represented 69.5% of the Company's total
assets as of December 31, 2006 compared to 67.1% at year end 2005.
Residential real estate loans, which includes home equity lending, totaled
$113.8 million as of December 31, 2006, compared to $100.7 million as of
year-end 2005. The 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 2006, fixed rate mortgage products
were preferred by the Bank's customers and accounted for the majority of the
activity. The Company does not originate any non-traditional mortgage products
such as interest-only loans or option adjustable rate mortgages. The Company
sells a portion of its long-term fixed rate residential loan production for
interest rate risk management, with $2.1 million of 30 year fixed rate loans
sold into the secondary market during 2006. The Company holds the majority of
its fifteen and twenty year fixed rate residential mortgage production in its
portfolio. The Company also had growth in home equity lending in 2006 through
its branch system. Total outstandings increased $6.3 million to $49.5 million as
of December 31, 2006.
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
$172.9 million as of December 31, 2006, increasing from $160.3 million as of
December 31, 2005, an increase of $12.6 million or 7.9%. Loans secured by
commercial real estate increased $5.4 million. The terms for commercial real
estate loans are typically 15 years, with adjustable rates based on a spread to
the
NORWOOD FINANCIAL CORP 14 2006 ANNUAL REPORT
prime rate. The majority of the Company's commercial real estate portfolio
is owner occupied and includes the personal guarantees of the principals. The
growth in commercial lending was centered in the Pike and Monroe County market
areas. Commercial loans consisting principally of lines of credit and term loans
secured by equipment or other assets increased $7.3 million.
The Company's indirect lending portfolio (included in consumer loans to
individuals) declined $2.9 million to $14.0 million as of December 31, 2006. The
Company has de-emphasized this product line due to credit losses and increased
pricing competition.
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, 2006, non-performing loans totaled $409,000 and
represented .13% of total loans receivable compared to $353,000 and .12% as of
year-end 2005. The balance is principally attributable to two credits to one
borrower. The loans are secured by real estate and the Company is actively
pursuing a resolution. Total non-performing assets, which includes foreclosed
real estate totaled $409,000 and represented .09% of total assets, compared to
$353,000 and .08% as of December 31, 2005. As of December 31, 2006 and 2005, the
Company had no foreclosed real estate.
The allowance for loan losses totaled $3,828,000 as of December 31, 2006
and represented 1.21% of total loans receivable compared to $3,669,000 and 1.26%
of total loans as of year-end 2005. Net charge-offs for 2006 were $61,000,
consisting principally of losses on the sale of repossessed automobiles,
compared to net charge-offs of $129,000 in 2005. The provision for loan losses
for 2006 was $220,000, compared to $350,000 in 2005.
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 a
historical review of losses. Other factors considered in the analysis include;
concentrations of credit in specific industries in the commercial portfolio; the
local and regional economic condition; trends in delinquencies, internal risk
rating classifications, and large dollar loans of over $2 million and growth in
the portfolio. As of December 31, 2006, the Company considered its concentration
of credit risk profile to be acceptable. The local economy was stable in 2006,
with a slight decrease 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 had double digit growth in commercial and real
estate related loans. As a result of its analysis, after applying these factors,
management considers the allowance as of December 31, 2006 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.
NORWOOD FINANCIAL CORP 15 2006 ANNUAL REPORT
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)
2006 2005 2004 2003 2002
-------------------------------------------------------
Allowance balance at beginning of period $ 3,669 $ 3,448 $ 3,267 $ 3,146 $ 3,216
Charge-offs:
Commercial and all other -- (4) (19) (121) (34)
Real Estate -- (6) (10) -- (122)
Consumer (150) (200) (342) (478) (608)
Lease Financing -- -- (11) (36) (30)
-------------------------------------------------------
Total (150) (210) (382) (635) (794)
-------------------------------------------------------
Recoveries:
Commercial and all other 18 12 13 5 --
Real Estate 2 18 8 24 13
Consumer 65 46 78 64 72
Lease Financing 4 5 9 3 9
-------------------------------------------------------
Total 89 81 108 96 94
-------------------------------------------------------
Provision expense 220 350 455 660 630
-------------------------------------------------------
Allowance balance at end of period $ 3,828 $ 3,669 $ 3,448 $ 3,267 $ 3,146
=======================================================
Allowance for loan losses as a percent
of total loans outstanding 1.21% 1.26% 1.35% 1.40% 1.44%
Net loans charged off as a percent of
average loans outstanding .02% .05% .11% .24% .33%
Allowance coverage of non-performing loans 9.4x 10.4x 51.5x 22.8x 14.2x
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, 2006, the Company had $290,000 impaired and collateral dependent
loans compared to $310,000 at year-end 2005.
As of December 31,
-------------------------------------
(in thousands)
2006 2005 2004 2003 2002
-------------------------------------
Non-accrual loans:
Commercial and all other $ -- $ -- $ -- $ -- $ --
Real estate 392 330 32 125 213
Consumer 17 11 8 -- 3
-------------------------------------
Total 409 341 40 125 216
Accruing loans which are contractually
past due 90 days or more -- 12 27 18 5
-------------------------------------
Total non-performing loans 409 353 67 143 221
Foreclosed real estate -- -- -- -- 21
-------------------------------------
Total non-performing assets $ 409 $ 353 $ 67 $ 143 $ 242
=====================================
Non-performing loans to total loans .13% .12% .03% .06% .10%
Non-performing loans to total assets .09% .08% .02% .04% .06%
Non-performing assets to total assets .09% .08% .02% .04% .07%
NORWOOD FINANCIAL CORP 16 2006 ANNUAL REPORT
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 SFAS No. 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, 2006, the HTM portfolio
totaled $954,000 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 other
comprehensive income (loss), net of deferred income taxes. As of December 31,
2006, $112.9 million in securities were so classified and carried at their fair
market value, with unrealized depreciation; net of tax, of $44,000, included in
Accumulated other comprehensive loss in stockholders' equity.
As of December 31, 2006, the average life of the portfolio was 2.1 years.
The Company has maintained a relatively short average life in the portfolio in
order to generate cash flows to support loan growth. Purchases for the year
totaled $32.3 million with securities called, maturities and principal
reductions of $36.0 million and proceeds from sales of $96,000. The purchases
were funded principally by cash flow from the portfolio. As of December 31, the
carrying value of the Company's securities portfolio (HTM and AFS) totaled
$113.9 million with the mix as follows:
2006 2005
-----------------------------------------------------------------
(dollars in thousands)
Carrying Carrying
Value % of portfolio Value % of portfolio
-----------------------------------------------------------------
US Treasury Securities $ -- --% $ 1,989 1.7%
US Government agencies 47,581 41.9 51,996 44.3
States and political subdivisions 17,419 15.3 21,175 18.1
Corporate obligations 8,439 7.4 10,450 8.9
Mortgage-backed securities 38,652 33.8 29,954 25.5
Equity securities 1,775 1.6 1,702 1.5
------------------------------------------------------------
Total $ 113,866 100.0% $ 117,266 100.0%
============================================================
The portfolio had $17.7 million of floating rate instruments, principally
adjustable rate mortgage backed securities as of December 31, 2006 compared to
$11.4 million at year end 2005. 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 callable notes with final
maturities of generally less than five years. The mortgage backed securities are
pass-through bonds with the Federal National Mortgage Association (FNMA),
Federal Home Loan Mortgage Corp (Freddie Mac), and Guaranteed National Mortgage
Association (GNMA). During 2006, the Company increased its holdings of
mortgage-backed securities with the expectation that the bonds will provide
regular cash flow.
DEPOSITS
The Company, through the twelve 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 (CDs) 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.
NORWOOD FINANCIAL CORP 17 2006 ANNUAL REPORT
Total deposits as of December 31, 2006, totaled $358.1 million increasing
from $340.6 million as of year-end 2005, an increase of $17.5 million or 5.1%.
The increase was principally in time deposits as the Bank offered competitive
rates on short-term CDs. The Company's money market deposit and savings deposit
products decreased $10.3 million reflecting depositors' preference for
short-term time deposits in 2006 to take advantage of higher short-term interest
rates.
Time deposits over $100,000, which consist principally of school district
and other public funds, with maturities generally less than one year, were $56.7
million as of December 31, 2006, compared to $48.9 million at year-end 2005. 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 the relative cost of other funding sources. The Company also had short-term
time deposits of $9.1 million from commercial customers as of December 31, 2006.
As of December 31, 2006, non-interest bearing demand deposits totaled $53.9
million, increasing $3.0 million or 5.8% 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. Interest-bearing
demand accounts totaled $36.6 million as of December 31, 2006 compared to $40.7
million at year end 2005. The decrease is principally due to certain municipal
accounts converting to cash management accounts. Cash management accounts
included in short-term borrowings, totaled $20.7 million at year end 2006
compared to $12.5 million. These balances represent commercial and municipal
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 have been due in part to the relatively low interest rate environment
which offered limited opportunities to earn higher yields. Bank deposit growth
in core deposits did slow in 2006, as the stock market became more attractive to
investors, competition for deposits increased among banks, and customers took
advantage of higher time deposit rates. However, the Company 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.
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
should 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, 2006, the level of net interest income at
risk in a 200 basis points increase or decrease was within the Company's policy
limits, of a decline less 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, 2006, the Bank had a positive 90 day interest sensitivity
gap of $24.0 million or 5.3% of total assets. A positive gap indicates that the
balance sheet has more rate-sensitive assets (RSA) than
NORWOOD FINANCIAL CORP 18 2006 ANNUAL REPORT
rate-sensitive liabilities (RSL) 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 level of RSA and RSL for an interval is managed by ALCO strategies,
including adjusting the average life of the investment portfolio through
purchase and sales, 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 RSA and 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. This was evident in 2006 as the Federal Funds rate
increased 100 basis points, while the two to ten year treasury bond yields
increased about 40 basis points. As a result the yield curve was inverted for
most of 2006 as short-term rates were higher 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. We do not believe that the
operating results of the Company are subject to foreign currency exchange or
commodity price risk.
The following table displays interest-sensitivity as of December 31, 2006
(in thousands):
3 Months 3-12 Greater than
or Less Months 1-3 Years 3 Years Total
---------------------------------------------------------------------
Interest-bearing deposits $ 67 $ -- $ -- $ -- $ 67
Securities 19,348 32,837 34,324 27,357 113,866
Loans Receivable 95,019 48,739 70,478 101,331 315,567
---------------------------------------------------------------------
Total Rate Sensitive Assets (RSA) $ 114,434 $ 81,576 $ 104,802 $ 128,688 $ 429,500
=====================================================================
Non-maturity interest bearing deposits $ 20,583 $ 22,435 $ 59,406 $ 29,368 $ 131,792
Time Deposits 55,976 86,304 22,024 8,151 172,455
Other 13,913 7,264 14,559 -- 35,736
---------------------------------------------------------------------
Total Rate Sensitive Liabilities (RSL) $ 90,472 $ 116,003 $ 95,989 $ 37,519 $ 339,983
=====================================================================
Interest Sensitivity Gap $ 23,962 $ (34,427) $ 8,813 $ 91,169 $ 89,517
Cumulative Gap 23,962 (10,465) (1,652) 89,517
RSA/RSL-Cumulative 126.5% 94.9% 99.5% 126.3%
As of December 31, 2005
Interest Sensitivity Gap $ 24,402 $ (5,676) $ 1,642 $ 56,582 $ 76,950
Cumulative Gap 24,402 18,726 20,368 76,950
RSA/RSL-Cumulative 126.5% 110.7% 107.1% 123.2%
LIQUIDITY
Liquidity is 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.
NORWOOD FINANCIAL CORP 19 2006 ANNUAL REPORT
As of December 31, 2006, the Company had cash and cash equivalents of $9.5
million in the form of cash, due from banks, and short-term deposits with other
institutions. In addition, the Company had total securities available for sale
of $112.9 million, which could be used for liquidity needs. This totals $122.4
million and represents 26.9% of total assets compared to $125.6 million and 29%
of total assets as of December 31, 2005. The change was principally due to the
lower level of securities available for sale as of December 31, 2006. The
Company used the proceeds from the investment portfolio to fund loan growth. The
Company also monitors other liquidity measures, all of which were within the
Company's policy guidelines as of December 31, 2006. 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 total available
under all the lines was $46 million, with $-0- outstanding at December 31, 2006.
The maximum borrowing capacity from FHLB was $216.9 million. As of year-end
2006, the Company had $13 million in term borrowings from the FHLB, decreasing
from $23 million in similar borrowings from the FHLB as of December 31, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
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 December 31, 2006 totaled $54.0 million. They consisted of
$18.3 million in commercial real estate, construction and land developments
loans, $10.6 million in home equity lines of credit, $7.2 million in standby
letters of credit and $17.9 million in other unused commitments principally
commercial lines of credit. 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.
CONTRACTUAL OBLIGATIONS
The following table represents the aggregate on and off balance sheet
contractual obligations to make future payments (in thousands):
(In thousands) December 31, 2006
------------------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years Over 5 years
------------------------------------------------------------------------
Time deposits $ 172,455 $ 142,281 $ 22,024 $ 8,150 $ --
Long-term debt 13,000 -- 10,000 3,000 --
Operating leases 4,011 271 472 467 2,801
----------------------------------------------------------------------
$ 189,466 $ 142,552 $ 32,496 $ 11,617 $ 2,801
======================================================================
RESULTS OF OPERATIONS
NET INTEREST INCOME
The following analysis should be read in conjunction with the "Consolidated
Average Balance Sheets with Resultant Interest and Rates" and "Rate/Volume
Analysis" tables.
Net interest income is the most significant source of revenue for the
Company and represented 81.9% of total revenue for the year ended December 31,
2006. Net interest income on a fully taxable equivalent basis (fte)
NORWOOD FINANCIAL CORP 20 2006 ANNUAL REPORT
totaled $16,708,000, for the year ended December 31, 2006 compared to
$15,889,000 for 2005, an increase of $819,000, or 5.2%. The resulting fte net
interest spread and fte net interest margin were 3.36% and 3.96%, respectively
in 2006 compared to 3.58% and 3.99% respectively in 2005.
Interest income (fte) for the year ended December 31, 2006 totaled
$26,474,000 an increase of $4,080,000 over $22,394,000 in 2005. The fte yield on
average earning assets for 2006 was 6.27% increasing from 5.62% in 2005. The
increase in interest income was principally due to higher yields on loans and
investments, growth in average earning assets and a higher percentage of loans
on the balance sheet. The prime rate of interest and other short-term interest
rates reflected a steady increase from June 2004 to June 2006. During that
period the prime rate increased from 4.00% to 8.25%. This has improved the yield
on the Company's floating rate loans, principally commercial real estate and
commercial lines of credit, which are tied to the prime rate. As of December 31,
2006, $78.8 million of loans were immediately repricable. Average earning assets
for 2006 totaled $422.0 million, an increase of $23.9 million over the average
for 2005. The mix of earning assets also improved with higher yield loans
representing 71.2% of average earning assets in 2006 compared to 68.8% in 2005.
Interest income (fte) earned on loans totaled $21,600,000 for the year
ended December 31, 2006 with a resulting fte yield of 7.16% compared to
$17,727,000 with a fte yield of 6.47% in 2005. Rising short-term interest rates
and an increase in average volume of $27.4 million, or 10.0%, were responsible
for the improvement in income and yield.
The securities available for sale portfolio averaged $116.6 million during
2006, with fte interest income of $4,637,000 and a fte yield of 3.98% compared
to $116.6 million with fte interest income of $4,139,000 and a fte yield of
3.55% in 2005. The increase in yield was due to re-investment of cash flows from
the portfolio into higher yielding instruments, due to the increase in
short-term interest rates.
Interest expense for the year ended December 31, 2006 totaled $9,766,000,
an increase of $3,261,000 over $6,505,000 in 2005. The increase was principally
due to higher short term interest rates and a more expensive mix of
interest-bearing liabilities in 2006. The Company incurred higher costs for time
deposits, in 2006 at 3.96% compared to 2.82% in 2005. The cost of time deposits
was influenced by competitive pressures, and higher short-term rates. The
Company expects the cost of short-term deposits to increase again in 2007.
Higher interest rates also impacted the cost of money market accounts and
short-term borrowings. The mix of average interest-bearing liabilities was also
more expensive in 2006, with average time deposits and short-term borrowings
representing 49.3% of the total compared to 45.4% on average in 2005.
Net interest income represented 81.8% of total revenue for the year ended
December 31, 2005. Net interest income (fte) totaled $15,889,000 for 2005, an
increase of $1,236,000, or 8.4%, over the amount earned in the year-ended
December 31, 2004. The resulting fte net interest spread and net interest margin
for 2005 were 3.58% and 3.99%, respectively, compared to 3.60% and 3.91%,
respectively, in 2004.
Interest income (fte) for the year ended December 31, 2005 totaled
$22,394,000 compared to $19,647,000 in 2004. The yield (fte) on average earning
assets for 2005 was 5.62% increasing from 5.25% in 2004. The increase in
interest income was principally due to growth in average earning assets, a
higher percentage of loans on the balance sheet, and an increase in the prime
rate. Average earning assets increased $23.6 million or 6.3%. The mix of earning
assets improved with loans representing 68.8% of average earning assets during
2005 compared to 65.6% during 2004. Prime rate and short-term interest rates
reflected a steady increase from June 2004 through December 2005. During that
period, the prime rate increased from 4.00% to 7.25%. This improved the yield on
the Company's floating rate loans, principally commercial real estate, tied to
prime rate. As of December 31, 2005, $79.6 million of loans were immediately
repricable.
NORWOOD FINANCIAL CORP 21 2006 ANNUAL REPORT
Interest income earned on loans during 2005 totaled $17,727,000 with a
yield of 6.47%, increasing from $14,912,000 and a yield of 6.07% during 2004. An
increase in average volume of $28.3 million, or 11.5% and increasing interest
rates were responsible for the improvement in income and yield.
The securities available for sale portfolio averaged $116.6 million during
2005, with interest income of $4,139,000 and a yield of 3.55%. This represented
very little change from 2004, which had an average balance of $118.3 million,
interest income of $4,159,000 and a yield of 3.52%. Total cash flow from sales,
maturities, calls and principal reductions on mortgage-backed securities totaled
$17.9 million in 2005 declining from $49.5 million in 2004. Proceeds in 2005
were generally reinvested in short-term callable U. S. Government agency
instruments and mortgage-backed securities. The Company has kept the portfolio
relatively short due to a flattening treasury yield curve in 2005.
Interest expense for the year-ended December 31, 2005 totaled $6,505,000
compared to $4,994,000 in 2004. The average cost of interest-bearing liabilities
increased 39 basis points to 2.04% for 2005 from 1.65% in 2004. The increase was
due to rising short-term interest rates. This impacted the Company's cost of
time deposits which increased 51 basis points to 2.82%.
OTHER INCOME
Other income totaled $3,583,000 for the year-ended December 31, 2006
compared to $3,548,000 in 2005. Service charges and fees decreased $52,000 to
$2,455,000. The decrease was partially due to $26,000 decline in service charges
on deposit accounts reflecting growth in the Bank's no fee retail checking
products. Loan related services decreased $79,000 due in part to a lower level
of letter of credit fees and no-fee loan promotions conducted in 2006.
Income from fiduciary activities totaled $355,000 in 2006 increasing
$12,000 from 2005. The increase was principally due to $9.9 million growth in
assets under management which totaled $96.9 million as of December 31, 2006.
Gains on sales of mortgage loans and servicing rights, included in Other,
totaled $147,000 in 2006 compared to $64,000 in 2005. The increase was due to
the gain on sale of $13.7 million of mortgage servicing rights on loans
previously sold in the secondary market to FNMA. The Company does not expect
similar gains on the sale of servicing rights in 2007.
Other income totaled $3,548,000 for the year ended December 31, 2005
compared to $3,546,000 in 2004.
Service charges and fees increased $385,000 to $2,507,000 for 2005. The
increase was principally due to a higher level of overdraft (nsf) fees which
increased $373,000. Service charges on deposit accounts decreased $53,000 to
$322,000 reflecting growth in the Bank's no-fee retail checking product.
Income from fiduciary activities totaled $343,000 in 2005, increasing
$42,000 from 2004. The increase was partially due to a $10,000 growth in estate
fees. In addition, the market value of assets under management increased $3.6
million to $87.0 million.
The Company had a lower level of net realized gains on sales of securities
in 2005 at $42,000 declining from $458,000 in 2004. Total securities sold in
2005 totaled $6.1 million compared to $11.7 million in 2004. The decrease in
gains is due in part to the increase in interest rates in 2005, which adversely
impacts the value of securities.
Total gains on sales of mortgage loans, included in Other were $64,000
on sales of $6.7 million in 2005, compared to $67,000 on sales of $4.1 million
in 2004. The loans sold were principally 30 year fixed rate residential
mortgages. The sales were for interest rate risk management to reduce the
Company's exposure in long-term fixed rate assets.
NORWOOD FINANCIAL CORP 22 2006 ANNUAL REPORT
Other Income (dollars in thousands)
For the year-ended December 31
2006 2005 2004
------------------------
Service charges on deposit accounts $ 296 $ 322 $ 375
ATM Fees 224 215 219
NSF Fees 1,260 1,265 892
Safe Deposit Box Rental 55 56 57
Loan related service fees 271 350 324
Debit Card 282 253 213
Fiduciary activities 355 343 301
Mutual funds & annuities 131 150 154
Gain on sales of mortgage loans and servicing assets 147 64 67
CSV on life insurance 309 296 316
Other income 187 192 170
------------------------
3,517 3,506 3,088
Net realized gains on sales of securities 66 42 458
------------------------
Total $3,583 $3,548 $3,546
========================
OTHER EXPENSES
Other expenses for the year ended December 31, 2006 totaled $10,957,000, an
increase of $334,000 or 3.15% over $10,623,000 in 2005.
Salaries and employee benefits expense, which represented 51.6% of total
expense, increased $245,000 or 4.5% to $5,655,000 in 2006. The cost of health
insurance premiums paid by the Company for its employees increased $105,000 in
2006. The Company incurred $136,000 of expense related to stock options granted
in 2006 as a result of adopting FASB Statement No. 123 (R) "Share Based
Payment". The Company had expense of $444,000 related to its employee stock
ownership plan (ESOP) in 2006 compared to $588,000 in 2005. The ESOP had a ten
year life and was fully funded as of September 30, 2006.
Furniture and equipment expense decreased $96,000 to $479,000 in 2006
principally due to lower maintenance expense. Data processing related operations
totaled $700,000 in 2006 compared to $625,000 in 2005. The increase was due to
enhancement to the Bank's on-line banking product and implementation of software
related to image based check processing. Advertising expense increased $65,000
to $224,000 in 2006 reflecting increased use of radio advertising. Professional
fees decreased $104,000 due to a lower level of corporate legal fees and
accounting services.
Other expenses for the year ended December 31, 2005 totaled $10,623,000, an
increase of $533,000, or 5.3%, over the $10,090,000 in 2004. Salaries and
employee benefits, which represented 50.9% of total other expense, increased
$277,000, or 5.4% to $5,410,000 in 2005. The increase was principally due to
increasing costs related to the Company's Employee Stock Ownership Plan (ESOP),
which increased $57,000 due to appreciation in the Company's stock price and
health insurance premiums which increased $59,000.
Occupancy costs increased $115,000 to $928,000 for 2005. This was
principally due to the full year effect of the Marshalls Creek Office which
opened in August 2004 and increases in real estate taxes. Data processing
related expenses totaled $625,000 in 2005 compared to $598,000 in 2004. The
increase reflects costs associated with enhancing the Bank's on-line banking
service. The Company disposed of its final leased vehicles in
NORWOOD FINANCIAL CORP 22 2006 ANNUAL REPORT
2004, therefore, there was no loss on lease residuals in 2005, compared to
$90,000 in 2004. Professional fees totaled $444,000 in 2005 increasing from
$323,000 in 2004. This includes an increase of $76,000 to $238,000 for
accounting services reflecting expenses associated with the internal control
documentation required by Sarbanes-Oxley.
INCOME TAXES
Income tax expense for the year ended December 31, 2006 totaled $2,679,000
for an effective tax rate of 31.2% compared to an expense of $2,341,000 and an
effective tax rate of 29.9% for 2005. The higher effective tax rate was
principally due to a lower level of tax exempt interest income and the tax
effect of compensation expense related to stock options.
Income tax expense for the year ended December 31, 2005 totaled $2,341,000
for an effective tax rate of 29.9% compared to an expense of $2,003,000 an
effective tax rate of 28.6% in 2004. The increase in the effective tax rate was
principally due to a lower level of tax exempt interest income in 2005.
CAPITAL AND DIVIDENDS
Total stockholders' equity as of December 31, 2006, was $52.2 million,
compared to $48.1 million as of year-end 2005. The increase was principally due
to retention of earnings of $3,542,000 after cash dividends declared of
$2,368,000. Accumulated other comprehensive income increased $728,000 due to
market value changes in the Company's AFS securities portfolio principally as a
result of changing interest rates. As of December 31, 2006 the Company had a
leverage capital ratio of 11.43%, Tier 1 risk-based capital of 15.67% and total
risk-based capital of 16.99% compared to, 11.05%, 15.29% and 16.63%,
respectively, at year end 2005.
The Company's stock is traded on the Nasdaq Global market under the symbol,
NWFL. As of December 31, 2006, there were approximately 1,400 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 declared per share
---------------------------------------------
Year 2005
- ---------
First Quarter $ 34.18 $ 24.24 $ .1714
Second Quarter 32.47 28.57 .1714
Third Quarter 31.43 29.32 .1714
Fourth Quarter 31.74 29.33 .20
Year 2006
- ---------
First Quarter $ 31.16 $ 29.59 $ .20
Second Quarter 33.75 30.24 .21
Third Quarter 32.00 31.07 .21
Fourth Quarter 31.68 30.22 .23
The book value of the common stock was $18.67 as of December 31, 2006
compared to $17.07 as of December 31, 2005. As of year-end 2006, the stock price
was $31.50, compared to $31.71 as of December 31, 2005.
NORWOOD FINANCIAL CORP 24 2006 ANNUAL REPORT
STOCK PERFORMANCE GRAPH
Set forth below is a stock performance graph comparing the cumulative total
shareholder return on the Common Stock with (a) the cumulative total stockholder
return on stocks included in the Nasdaq Stock Market index and (b) the
cumulative total stockholder return on stocks included in the Nasdaq Bank index,
as prepared for Nasdaq by the Center for Research in Securities Prices ("CRSP")
at the University of Chicago. All three investment comparisons assume the
investment of $100 at the market close on December 31, 2001 and the reinvestment
of dividends paid. The graph provides comparison at December 31, 2001 and each
fiscal year through December 31, 2006.
[Line graph appears here showing 5-year cumulative total return on $100
invested in the Common Stock compared to cumulative total returns on $100
invested in the Nasdaq Bank Index and Nasdaq Index, respectively. Line graph
starts at December 31, 2001 and shows the cumulative total returns at December
31, 2002, 2003, 2004, 2005 and 2006. Plot points are shown below]
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
- ----------------------------------------------------------------------------------------------------------------------------
Norwood Financial Corp. 100.0 117.8 161.2 220.8 206.0 217.0
- ----------------------------------------------------------------------------------------------------------------------------
Nasdaq Stock Market (US Companies) 100.0 69.1 103.4 112.5 114.9 126.2
- ----------------------------------------------------------------------------------------------------------------------------
Nasdaq Bank Stocks 100.0 102.4 131.7 150.7 147.2 165.2
- ----------------------------------------------------------------------------------------------------------------------------
There can be no assurance that the Company's future stock performance will
be the same or similar to the historical performance shown in the above graph.
The Company neither makes nor endorses any predictions as to stock performance.
NORWOOD FINANCIAL CORP 25 2006 ANNUAL REPORT
NORWOOD FINANCIAL CORP.
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
(Dollars in thousands, except per share amounts)
2006
December 31 September 30 June 30 March 31
-------------------------------------------------
Interest income $6,956 $6,647 $6,350 $5,996
Interest expense 2,830 2,545 2,321 2,070
------------------------------------------------
Net interest income 4,126 4,102 4,029 3,926
Provision for loan losses 50 45 55 70
Other income 862 849 989 817
Net realized gains on sales of securities -- 45 14 7
Other expense 2,620 2,730 2,841 2,766
------------------------------------------------
Income before income taxes 2,318 2,221 2,136 1,914
Income tax expense 739 699 660 581
------------------------------------------------
NET INCOME $1,579 $1,522 $1,476 $1,333
================================================
Basic earnings per share $ 0.56 $ 0.54 $ 0.53 $ 0.48
================================================
Diluted earnings per share $ 0.55 $ 0.53 $ 0.52 $ 0.47
================================================
2005
December 31 September 30 June 30 March 31
-------------------------------------------------
Interest income $ 5,904 $5,578 $5,313 $4,973
Interest expense 1,941 1,644 1,517 1,403
------------------------------------------------
Net interest income 3,963 3,934 3,796 3,570
Provision for loan losses 70 90 90 100
Other income 896 905 862 843
Net realized gain (loss) on sales
of securities (41) 3 3 77
Other expense 2,668 2,627 2,677 2,651
------------------------------------------------
Income before income taxes 2,080 2,125 1,894 1,739
Income tax expense 638 643 564 496
------------------------------------------------
NET INCOME $ 1,442 $1,482 $1,330 $1,243
================================================
Basic earnings per share $ 0.52 $ 0.53 $ 0.47 $ 0.44
================================================
Diluted earnings per share $ 0.51 $ 0.52 $ 0.46 $ 0.43
================================================
NORWOOD FINANCIAL CORP 26 2006 ANNUAL REPORT
NORWOOD FINANCIAL CORP. CONSOLIDATED AVERAGE BALANCE SHEETS WITH RESULTANT
INTEREST AND RATES
(Tax-Equivalent Basis, dollars in thousands)
Year Ended December 31 2006 2005
---------------------------------------------------------------------
Average Ave Average Ave
Balance(2) Interest(1) Rate Balance(2) Interest(1) Rate
---------------------------------------------------------------------
ASSETS
Interest Earning Assets:
Federal funds sold $ 2,778 $ 142 5.11% $ 3,730 $ 129 3.46%
Interest bearing deposits with banks 98 5 5.10 123 3 2.44
Securities held to maturity 981 90 9.17 3,608 396 10.98
Securities available for sale
Taxable 99,571 3,712 3.73 98,038 3,116 3.18
Tax-exempt 17,070 925 5.42 18,602 1,023 5.50
------------------- -------------------
Total securities available
for sale 116,641 4,637 3.73 116,640 4,139 3.55
Loans receivable (3,4) 301,533 21,600 7.16 274,053 17,727 6.47
------------------- -------------------
Total interest earning assets 422,031 26,474 6.27 398,154 22,394 5.62
Non-interest earning assets:
Cash and due from banks 8,857 8,569
Allowance for loan losses (3,785) (3,597)
Other assets 16,976 16,049
-------- --------
Total non-interest earning
assets 22,048 21,021
-------- --------
TOTAL ASSETS $444,079 $419,175
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-Bearing Liabilities:
Interest-bearing demand
and money market $ 96,882 $ 1,688 1.74 $ 93,747 969 1.03
Savings 49,937 232 0.46 57,128 268 0.47
Time 146,344 5,798 3.96 128,704 3,634 2.82
------------------- -------------------
Total interest-bearing
deposits 293,163 7,718 2.63 279,579 4,871 1.74
Short-term borrowings 19,284 823 4.27 15,783 416 2.64
Long term debt 23,419 1,225 5.23 23,000 1,218 5.30
------------------- -------------------
Total interest bearing
liabilities 335,866 9,766 2.91 318,362 6,505 2.04
------- -------
Non-interest bearing liabilities
Non-interest bearing demand deposits 54,798 52,109
Other liabilities 3,526 1,804
-------- --------
Total non-interest bearing
liabilities 58,324 53,913
-------- --------
Stockholders' equity 49,889 46,900
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $444,079 $419,175
======== ========
Net interest income
(tax-equivalent basis) 16,708 3.36% 15,889 3.58%
==== ====
Tax-equivalent basis adjustment (525) (626)
------- -------
Net Interest Income $16,183 $15,263
======= =======
Net Interest margin(tax-equivalent basis) 3.96% 3.99%
==== ====
Year Ended December 31 2004
---------------------------------
Average Ave
Balance(2) Interest(1) Rate
---------------------------------
ASSETS
Interest Earning Assets:
Federal funds sold $ 4,648 $ 68 1.46%
Interest bearing deposits with banks 120 2 1.67
Securities held to maturity 5,732 506 8.83
Securities available for sale
Taxable 100,180 3,127 3.12
Tax-exempt 18,080 1,032 5.71
-------------------
Total securities available
for sale 118,260 4,159 3.52
Loans receivable (3,4) 245,783 14,912 6.07
-------------------
Total interest earning assets 374,543 19,647 5.25
Non-interest earning assets:
Cash and due from banks 8,542
Allowance for loan losses (3,376)
Other assets 14,846
--------
Total non-interest earning
assets 20,012
--------
TOTAL ASSETS $394,555
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-Bearing Liabilities:
Interest-bearing demand
and money market $ 89,851 549 0.61
Savings 58,243 273 0.47
Time 118,512 2,733 2.31
-------------------
Total interest-bearing
deposits 266,606 3,555 1.33
Short-term borrowings 12,965 151 1.16
Long term debt 23,000 1,288 5.60
-------------------
Total interest bearing
liabilities 302,571 4,994 1.65
-------
Non-interest bearing liabilities
Non-interest bearing demand deposits 47,399
Other liabilities 596
--------
Total non-interest bearing
liabilities 47,995
--------
Stockholders' equity 43,989
--------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $394,555
========
Net interest income
(tax-equivalent basis) 14,653 3.60%
====
Tax-equivalent basis adjustment (641)
-------
Net Interest Income $14,012
=======
Net Interest margin(tax-equivalent basis) 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. 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.
NORWOOD FINANCIAL CORP 27 2006 ANNUAL REPORT
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)
-------------------------------------------------------------------------
(dollars in thousands) 2006 COMPARED TO 2005 2005 COMPARED TO 2004
-------------------------------------------------------------------------
VARIANCE DUE TO VARIANCE DUE TO
-------------------------------------------------------------------------
VOLUME RATE NET VOLUME RATE NET
------------------------------------ ---------------------------------
INTEREST EARNING ASSETS:
- --------------------------------------------------------------------------------------------------------------------------
Federal funds sold $ (38) $ 51 $ 13 $ (16) $ 77 $ 61
Interest bearing deposits with banks (1) 3 2 -- 1 1
Securities held to maturity (250) (56) (306) (215) 105 (110)
Securities available for sale
Taxable 49 547 596 (68) 57 (11)
Tax-exempt (83) (15) (98) 29 (38) (9)
-------------------------------------------------------------------------
Total securities available for sale (34) 532 498 (39) 19 (20)
Loans receivable 1,870 2,003 3,873 1,787 1,028 2,815
-------------------------------------------------------------------------
Total interest earning assets 1,547 2,533 4,080 1,517 1,230 2,747
-------------------------------------------------------------------------
INTEREST BEARING LIABILITIES:
- --------------------------------------------------------------------------------------------------------------------------
Interest-bearing demand and money market 33 686 719 25 395 420
Savings (33) (3) (36) (5) -- (5)
Time 549 1,615 2,164 250 651 901
-------------------------------------------------------------------------
Total interest-bearing deposits 549 2,298 2,847 270 1,046 1,316
Short-term borrowings 107 300 407 39 276 265
Long term debt 22 (15) 7 -- (70) (70)
-------------------------------------------------------------------------
Total interest bearing liabilities 678 2,583 3,261 309 1,202 1,511
-------------------------------------------------------------------------
Net interest income (tax-equivalent basis) $ 869 $ (50) $ 819 $1,208 $ 28 $ 1,236
=========================================================================
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.
NORWOOD FINANCIAL CORP 28 2006 ANNUAL REPORT
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, 2006 and 2005, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2006. 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 the 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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
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, 2006 and 2005, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the
Company changed its method of accounting for share-based payments in 2006.
/s/ Beard Miller Company LLP
Beard Miller Company LLP
Reading, Pennsylvania
February 26, 2007
NORWOOD FINANCIAL CORP 29 2006 ANNUAL REPORT
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
2006 2005
----------------------
(IN THOUSANDS,
EXCEPT SHARE DATA)
ASSETS
Cash and due from banks $ 9,450 $ 9,746
Interest bearing deposits with banks 67 70
----------------------
Cash and Cash Equivalents 9,517 9,816
Securities available for sale 112,912 115,814
Securities held to maturity, fair value 2006 $971; 2005 $1,480 954 1,452
Loans receivable, net of allowance for loan losses 2006 $3,828; 2005 $3,669 311,739 287,221
Investment in FHLB stock, at cost 1,687 1,620
Bank premises and equipment, net 6,020 5,393
Bank owned life insurance 7,479 7,213
Accrued interest receivable 2,129 1,812
Other assets 1,919 3,215
----------------------
TOTAL ASSETS $ 454,356 $ 433,556
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing demand $ 53,856 $ 50,891
Interest-bearing demand 36,600 40,738
Money market deposit accounts 50,048 52,194
Savings 45,144 53,311
Time 172,455 143,469
----------------------
TOTAL DEPOSITS 358,103 340,603
Short-term borrowings 22,736 18,564
Long-term debt 13,000 23,000
Accrued interest payable 2,894 1,691
Other liabilities 5,392 1,590
----------------------
TOTAL LIABILITIES 402,125 385,448
----------------------
STOCKHOLDERS' EQUITY
Common stock, par value $.10 per share; authorized 10,000,000 shares;
issued 2006: 2,840,872 2005: 2,705,715 shares 284 270
Surplus 10,149 5,648
Retained earnings 43,125 43,722
Treasury stock, at cost 2006 43,721 shares; 2005 21,189 shares (1,283) (633)
Accumulated other comprehensive loss (44) (772)
Unearned Employee Stock Ownership Plan (ESOP) shares -- (127)
----------------------
TOTAL STOCKHOLDERS' EQUITY 52,231 48,108
----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 454,356 $ 433,556
======================
See notes to consolidated financial statements
NORWOOD FINANCIAL CORP 30 2006 ANNUAL REPORT
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
------------------------------------
2006 2005 2004
------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME
Loans receivable, including fees $21,422 $17,583 $14,794
Securities:
Taxable 3,712 3,116 3,127
Tax exempt 668 937 1,015
Other 147 132 70
------------------------------------
TOTAL INTEREST INCOME 25,949 21,768 19,006
------------------------------------
INTEREST EXPENSE
Deposits 7,718 4,871 3,555
Short-term borrowings 823 416 151
Long-term debt 1,225 1,218 1,288
------------------------------------
TOTAL INTEREST EXPENSE 9,766 6,505 4,994
------------------------------------
NET INTEREST INCOME 16,183 15,263 14,012
PROVISION FOR LOAN LOSSES 220 350 455
------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 15,963 14,913 13,557
------------------------------------
OTHER INCOME
Service charges and fees 2,455 2,507 2,122
Income from fiduciary activities 355 343 301
Net realized gains on sales of securities 66 42 458
Earnings on life insurance policies 309 296 316
Other 398 360 349
------------------------------------
TOTAL OTHER INCOME 3,583 3,548 3,546
------------------------------------
OTHER EXPENSES
Salaries and employee benefits 5,655 5,410 5,133
Occupancy 968 928 813
Furniture and equipment 479 575 542
Data processing related operations 700 625 598
Losses on lease residuals -- -- 90
Advertising 224 159 156
Professional fees 340 444 323
Postage and telephone 471 470 471
Taxes, other than income 354 334 276
Amortization of intangible assets 52 52 52
Other 1,714 1,626 1,636
------------------------------------
TOTAL OTHER EXPENSES 10,957 10,623 10,090
------------------------------------
INCOME BEFORE INCOME TAXES 8,589 7,838 7,013
INCOME TAX EXPENSE 2,679 2,341 2,003
------------------------------------
NET INCOME $ 5,910 $ 5,497 $ 5,010
====================================
EARNINGS PER SHARE
Basic $ 2.11 $ 1.96 $ 1.80
====================================
Diluted $ 2.07 $ 1.92 $ 1.77
====================================
See notes to consolidated financial statements.
NORWOOD FINANCIAL CORP 31 2006 ANNUAL REPORT
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
-------------------------------------------------------------------------------------------------
ACCUMULATED
NUMBER OF OTHER UNEARNED
SHARES COMMON RETAINED TREASURY COMPREHENSIVE ESOP
ISSUED STOCK SURPLUS EARNINGS STOCK INCOME (LOSS) SHARES TOTAL
-------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
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,
$.66 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
--------
Comprehensive income:
Net income - - - 5,497 - - - 5,497
Change in unrealized gains
on securities available for sale,
net of reclassification
adjustment and tax effects - - - - - (1,105) - (1,105)
--------
Total Comprehensive Income 4,392
--------
Cash dividends declared,
$.71 per share - - - (1,997) - - - (1,997)
Stock options exercised - - (78) - 228 - - 150
Tax benefit of stock
options exercised - - 18 - - - - 18
Acquisition of treasury stock - - - - (819) - - (819)
Release of treasury stock
for ESOP - - 7 - 107 - - 114
Release of earned ESOP
shares, net - - 365 - - - 200 565
-------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2005 2,705,715 270 5,648 43,722 (633) (772) (127) 48,108
Comprehensive income:
Net income - - - 5,910 - - - 5,910
Change in unrealized gains (losses)
on securities available for sale,
net of reclassification
adjustment and tax effects - - - - - 728 - 728
--------
Total Comprehensive Income 6,638
--------
Cash dividends declared,
$.85 per share - - - (2,368) - - - (2,368)
5% stock dividend at $30.59
per share 135,157 14 4,121 (4,139) - - - (4)
Acquisition of treasury stock - - - - (890) - - (890)
Stock options exercised - - (68) - 128 - - 60
Tax benefit of stock
options exercised - - 10 - - - - 10
Release of treasury stock
for ESOP - - 8 - 112 - - 120
Compensation expense related
to stock options - - 136 - - - - 136
Release of earned ESOP
shares, net - - 294 - - - 127 421
-------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2006 2,840,872 $284 $10,149 $43,125 $(1,283) $ (44) $ - $52,231
================================================================================================
See notes to consolidated financial statements.
NORWOOD FINANCIAL CORP 32 2006 ANNUAL REPORT
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------------
2006 2005 2004
--------------------------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,910 $ 5,497 $ 5,010
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 220 350 455
Depreciation 503 535 544
Amortization of intangible assets 52 52 52
Deferred income taxes (108) (37) (81)
Net amortization of securities premiums and discounts 301 431 540
Net realized gains on sales of securities (66) (42) (458)
Net increase in investment in life insurance (266) (254) (283)
Gain on sale of bank premises and equipment and
foreclosed real estate (12) (5) (12)
Gain on sale of mortgage loans and servicing rights (147) (64) (67)
Mortgage loans originated for sale (2,065) (6,650) (4,101)
Proceeds from sale of mortgage loans 2,212 6,714 4,168
Tax benefit of stock options exercised -- 18 22
Release of ESOP shares 421 565 585
Compensation expense related to stock options 136 -- --
Decrease (increase) in accrued interest receivable and
other assets 1,137 (1,725) 884
Increase (decrease) in accrued interest payable and other Liabilities 4,543 1,575 (200)
--------------------------------
Net Cash Provided by Operating Activities 12,771 6,960 7,058
--------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 96 6,073 11,687
Proceeds from maturities and principal reductions on
mortgage-backed securities 35,962 11,799 37,779
Purchases (32,291) (18,878) (43,331)
Securities held to maturity, proceeds from maturities 505 4,330 35
(Increase) decrease in investment in FHLB stock (67) 605 (223)
Net increase in loans (24,892) (36,374) (21,579)
Purchase of bank premises and equipment (1,130) (446) (445)
Proceeds from sales of premises and equipment and foreclosed real estate 64 12 42
--------------------------------
Net Cash Used in Investing Activities (21,753) (32,879) (16,035)
--------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 17,500 21,958 11,976
Net increase (decrease) in short-term borrowings 4,172 (4,418) 10,123
Proceeds from long-term debt -- 5,000 --
Repayments of long-term debt (10,000) (5,000) --
Stock options exercised 60 150 206
Tax benefit of stock options exercised 10 -- --
ESOP purchase of shares from treasury stock 120 114 77
Acquisition of treasury stock (890) (819) (118)
Cash dividends paid (2,289) (1,916) (1,795)
--------------------------------
Net Cash Provided by Financing Activities 8,683 15,069 20,469
--------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (299) (10,850) 11,492
CASH AND CASH EQUIVALENTS - BEGINNING 9,816 20,666 9,174
--------------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 9,517 $ 9,816 $ 20,666
================================
See notes to consolidated financial statements
NORWOOD FINANCIAL CORP 33 2006 ANNUAL REPORT
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 mortgages,
commercial and consumer loans, as well as interest earnings on investment
securities and fees from 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 SIGNIFICANT 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, the valuation of deferred tax assets, and the determination of
other-than-temporary impairment on securities.
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 in
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.
Management determines the appropriate classification of debt securities at
the time of purchase and re-evaluates such designation as of each balance sheet
date.
NORWOOD FINANCIAL CORP 34 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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.
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.
NORWOOD FINANCIAL CORP 35 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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. Income from the increase in
cash surrender value of the policies is included in other income on the
consolidated statement of income.
NORWOOD FINANCIAL CORP 36 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, 2006 and 2005, the Company had
intangible assets of $221,000 and $273,000, which is net of accumulated
amortization of $559,000 and $507,000, 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 for each of the years ended
December 31, 2006, 2005 and 2004.
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 11, 2006, the Company declared a 5% stock dividend on common stock
outstanding payable May 26, 2006 to shareholders of record on May 12, 2006. The
stock dividend resulted in the issuance of 135,157 additional common shares. All
share amounts and per share data have been adjusted for the effect of the stock
dividend
Basic earnings per share represents income available to common stockholders
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
Potential common shares that may be issued by the Company relate solely to
outstanding stock options and are determined using the treasury stock method.
STOCK OPTION PLANS
In December 2004, the Financial Acounting Standards Board (FASB) issued
Statement No. 123 (R), "Share-Based Payment." Statement No. 123 (R) replaces
Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123
(R) requires the fair value of share-based payment transactions to be recognized
as compensation costs in the financial statements over the period that an
employee provides service in exchange for the award. The fair value of the
share-based payments is estimated using the Black-Scholes option-pricing model.
The Company adopted Statement No. 123 (R) effective January 1, 2006, using the
modified-prospective transition method. Under the modified prospective method,
companies are required to record compensation cost for new and modified awards
over the related vesting period of such awards and record compensation cost
prospectively for the unvested portion, at the date of adoption, of previously
issued and outstanding awards over the remaining vesting period of such awards.
No change to prior periods presented is permitted under the modified prospective
method. The Company did not issue any stock options in 2005. All outstanding
options as of December 31, 2005 were fully vested.
NORWOOD FINANCIAL CORP 37 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
For the years ended December 31, 2005 and 2004, the Company accounted 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 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,
----------------------------------
2005 2004
----------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA)
Net income, as reported $ 5,497 $ 5,010
Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related taxes (194) (143)
----------------------------------
Pro forma net income $ 5,303 $ 4,867
----------------------------------
Earnings per share (basic):
As reported $ 1.96 $ 1.80
Pro forma $ 1.89 $ 1.75
----------------------------------
Earnings per share (assuming dilution):
As reported $ 1.92 $ 1.77
Pro forma $ 1.85 $ 1.71
==================================
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, 2006, 2005 and
2004 were $8,563,000, $6,014,000, and $5,103,000, respectively. Cash payments
for income taxes for the years ended December 31, 2006, 2005 and 2004 were
$2,677,000, $2,449,000, and $1,941,000, respectively. Non-cash investing
activities for 2006, 2005 and 2004 included foreclosed mortgage loans
transferred to foreclosed real estate and repossession of other assets of
$154,000, $112,000, and $281,000, 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 consolidated balance sheets when they become
receivable or payable.
NORWOOD FINANCIAL CORP 38 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT 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 accepted in the United States of America
require that recognized revenue, expenses, gains and losses be included in net
income. Although certain changes in assets and liabilities, such as unrealized
gains and losses on available for sale securities, are reported as a separate
component of the equity section of the consolidated 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,
----------------------------
2006 2005 2004
----------------------------
(IN THOUSANDS)
Unrealized holding gains/ (losses) on available for sale securities $ 1,173 $(1,636) $(1,204)
Reclassification adjustment for gains realized in income 66 42 458
----------------------------
Net Unrealized Gains/( Losses) 1,107 (1,678) (1,662)
Income tax expense (benefit) 379 (573) (564)
----------------------------
Net of Tax Amount $ 728 $(1,105) $(1,098)
============================
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.
NEW ACCOUNTING STANDARDS
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments". SFAS No. 155 amends FASB Statement No. 133 and
FASB Statement No. 140, and improves the financial reporting of certain hybrid
financial instruments by requiring more consistent accounting that eliminates
exemptions and provides a means to simplify the accounting for these
instruments. Specifically, SFAS No. 155 allows financial instruments that have
embedded derivatives to be accounted for as a whole (eliminating the need to
bifurcate the derivative from its host) if the holder elects to account for the
whole instrument on a fair value basis. SFAS No. 155 is effective for all
financial instruments acquired or issued after the beginning of an entity's
first fiscal year that begins after September 15, 2006. The Company is required
to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year
2007. Management does not believe the adoption of SFAS No. 155 will have a
material impact on the Company's consolidated financial position and results of
operations.
NORWOOD FINANCIAL CORP 39 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - An Amendment of FASB Statement No. 140" ("SFAS 156"). SFAS
156 requires that all separately recognized servicing assets and servicing
liabilities be initially measured at fair value, if practicable. The statement
permits, but does not require, the subsequent measurement of servicing assets
and servicing liabilities at fair value. SFAS 156 is effective as of the
beginning of an entity's first fiscal year that begins after September 15, 2006,
which for the Company will be as of the beginning of fiscal 2007. The Company
does not believe that the adoption of SFAS 156 will have a significant effect on
its consolidated financial statements.
In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4,
"Classification of Options and Similar Instruments Issued as Employee
Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent
Event." This position amends SFAS 123R to incorporate that a cash settlement
feature that can be exercised only upon the occurrence of a contingent event
that is outside the employee's control does not meet certain conditions in SFAS
123R until it becomes probable that the event will occur. The guidance in this
FASB Staff Position shall be applied upon initial adoption of Statement 123R.
The Company is currently evaluating the impact that the adoption of SFAS 123R
will have on its consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" (FIN 48), which clarifies the
accounting for uncertainty in tax positions. This Interpretation requires that
companies recognize in their financial statements the impact of a tax position,
if that position is more likely than not of being sustained on audit, based on
the technical merits of the position. The provisions of FIN 48 are effective for
fiscal years beginning after December 15, 2006, with the cumulative effect of
the change in accounting principle recorded as an adjustment to opening retained
earnings. We are currently evaluating the impact of adopting FIN 48 on our
consolidated financial statements.
In September 2006, the FASB issued FASB Statement No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
FASB Statement No. 157 applies to other accounting pronouncements that require
or permit fair value measurements. The new guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and for
interim periods within those fiscal years. We are currently evaluating the
potential impact, if any, of the adoption of FASB Statement No. 157 on our
consolidated financial position, results of operations and cash flows.
On September 13, 2006, the Securities and Exchange Commission "SEC" issued
Staff Accounting Bulletin No. 108 ("SAB 108"). SAB 108 provides interpretive
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a potential current year
misstatement. Prior to SAB 108, Companies might evaluate the materiality of
financial-statement misstatements using either the income statement or balance
sheet approach, with the income statement approach focusing on new misstatements
added in the current year, and the balance sheet approach focusing on the
cumulative amount of misstatement present in a company's balance sheet.
Misstatements that would be material under one approach could be viewed as
immaterial under another approach, and not be corrected. SAB 108 now requires
that companies view financial statements misstatements as material if they are
material according to either the income statement or balance sheet approach. The
Company has analyzed SAB 108 and determined that upon adoption it will have no
impact on the reported results of operations or financial condition.
NORWOOD FINANCIAL CORP 40 2006 ANNUAL REPORT
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In September 2006, the FASB's Emerging Issues Task Force (EIFT) issued EITF
Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit
Aspects of Endorsement Split Dollar Life Insurance Arrangements" ("EITF 06-4).
EITF 06-4 requires the recognition of a liability related to the postretirement
benefits covered by an endorsement split-dollar life insurance arrangement. The
consensus highlights that the employer (who is also the policyholder) has a
liability for the benefit it is providing to its employee. As such, if the
policyholder has agreed to maintain the insurance policy in force for the
employee's benefit during his or her retirement, then the liability recognized
during the employee's active service period should be based on the future cost
of insurance to be incurred during the employee's retirement. Alternatively, if
the policy holder has agreed to provide the employee with a death benefit, then
the liability for the future death benefit should be recognized by following the
guidance in SFAS No. 106 or Accounting Principals Board (APB) Opinion No. 12, as
appropriate. For transition, an entity can choose to apply the guidance using
either of the following approaches: (a) a change in accounting principle through
retrospective application to all periods presented or (b) a change in accounting
principle through a cumulative-effect adjustment to the balance in retained
earnings at the beginning of the year of adoption. The disclosures are required
in fiscal years beginning after December 15, 2007, with early adoption
permitted. The Company does not believe that the implementation of this guidance
will have a material impact on the Company's consolidated financial statements.
In October 2006, the FASB issued FASB Staff Position No. 123(R)-5,
"Amendment of FASB Staff Position FAS 123(R)-1" ("FSP 123(R)-5"). FSP 123(R)-5
amends FSP 123(R)-1 for equity instruments that were originally issued as
employee compensation and then modified, with such modification made solely to
reflect an equity restructuring that occurs when the holders are no longer
employees. The Company does not expect the adoption of FSP 123(R)-5 to have a
material impact on its financial condition, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS No. 159 is
effective for our Company January 1, 2008. The Company is evaluating the impact
that the adoption of SFAS No. 159 will have on our consolidated financial
statements.
NORWOOD FINANCIAL CORP 41 2006 ANNUAL REPORT
NOTE 3 - SECURITIES
The amortized cost and fair value of securities were as follows:
DECEMBER 31, 2006
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------
(IN THOUSANDS)
AVAILABLE FOR SALE:
U.S. Government agencies $ 48,117 $ 10 $ (546) $ 47,581
States and political subdivisions 16,572 73 (180) 16,465
Corporate obligations 8,552 -- (113) 8,439
Mortgage-backed securities 39,123 98 (569) 38,652
---------------------------------------------
112,364 181 (1,408) 111,137
Equity securities 593 1,182 -- 1,775
---------------------------------------------
$112,957 $1,363 $ (1,408) $ 112,912
=============================================
HELD TO MATURITY:
States and political subdivisions $ 954 $ 17 $ -- $ 971
=============================================
DECEMBER 31, 2005
---------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------------
(IN THOUSANDS)
AVAILABLE FOR SALE:
U.S. Treasuries $ 2,008 $ - $ (19) $ 1,989
U.S. Government agencies 53,180 - (1,184) 51,996
States and political subdivisions 19,810 141 (228) 19,723
Corporate obligations 10,708 2 (260) 10,450
Mortgage-backed securities 30,675 17 (738) 29,954
---------------------------------------------
116,381 160 (2,429) 114,112
Equity securities 586 1,118 (2) 1,702
---------------------------------------------
$116,967 $1,278 $ (2,431) $115,814
=============================================
HELD TO MATURITY:
States and political subdivisions $ 1,452 $ 28 $ - $ 1,480
=============================================
The following tables show the Company's investments' gross unrealized
losses and fair value, aggregated by length of time that individual securities
have been in a continuous unrealized loss position:
DECEMBER 31, 2006
----------------------------------------------------------------------
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. Government agencies $ 9,966 $ (32) $ 34,605 $ (514) $ 44,571 $ (546)
States and political subdivisions 3,104 (8) 8,064 (172) 11,168 (180)
Corporate obligations -- -- 7,440 (113) 7,440 (113)
Mortgage-backed securities 4,952 (35) 21,419 (534) 26,371 (569)
----------------------------------------------------------------------
$ 18,022 $ (75) $ 71,528 $ (1,333) $ 89,550 $ (1,408)
======================================================================
NORWOOD FINANCIAL CORP 42 2006 ANNUAL REPORT
DECEMBER 31, 2005
----------------------------------------------------------------------
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 $ - $ - $ 1,989 $ (19) $ 1,989 $ (19)
U.S. Government agencies 11,378 (122) 40,618 (1,062) 51,996 (1,184)
States and political subdivisions 6,014 (78) 4,797 (150) 10,811 (228)
Corporate obligations - - 9,452 (260) 9,452 (260)
Mortgage-backed securities 14,675 (225) 14,380 (513) 29,055 (738)
Equity securities 34 (2) - - 34 (2)
----------------------------------------------------------------------
$ 32,101 $ (427) $ 71,236 $(2,004) $103,337 $(2,431)
======================================================================
At December 31, 2006, the Company had 20 securities in the less than twelve
month category and 92 securities in the twelve months or more category. In
management's opinion, the unrealized losses reflect changes in interest rates
subsequent to the acquisition of specific securities. 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 debt securities as of December 31,
2006 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.
AVAILABLE FOR SALE HELD TO MATURITY
-----------------------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-----------------------------------------
(IN THOUSANDS)
Due in one year or less $ 32,157 $ 31,835 $ -- $ --
Due after one year through five years 30,106 29,632 -- --
Due after five years through ten years 8,883 8,923 414 429
Due after ten years 2,095 2,095 540 542
-----------------------------------------
73,241 72,485 954 971
Mortgage-backed securities 39,123 38,652 -- --
-----------------------------------------
$112,364 $111,137 $ 954 $ 971
=========================================
Gross realized gains and gross realized losses on sales of securities
available for sale were $66,000 and $-0-, respectively, in 2006, $107,000 and
$65,000, respectively, in 2005, and $475,000 and $17,000, respectively, in 2004.
Securities with a carrying value of $50,677,000 and $41,959,000 at December
31, 2006 and 2005, 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.
NORWOOD FINANCIAL CORP 43 2006 ANNUAL REPORT
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
The components of loans receivable at December 31 were as follows:
2006 2005
----------------------
(IN THOUSANDS)
Real estate:
Residential $ 113,783 $ 100,705
Commercial 138,881 133,495
Construction 7,714 5,944
Commercial, financial and agricultural 34,019 26,755
Consumer loans to individuals 21,520 24,353
----------------------
315,917 291,252
Unearned income and deferred fees (350) (362)
Allowance for loan losses (3,828) (3,669)
----------------------
$ 311,739 $ 287,221
======================
The following table presents changes in the allowance for loan losses:
YEARS ENDED DECEMBER 31,
---------------------------------
2006 2005 2004
---------------------------------
(IN THOUSANDS)
Balance, beginning $ 3,669 $ 3,448 $ 3,267
Provision for loan losses 220 350 455
Recoveries 89 81 108
Loans charged off (150) (210) (382)
---------------------------------
Balance, ending $ 3,828 $ 3,669 $ 3,448
=================================
The recorded investment in impaired loans, not requiring an allowance for
loan losses was $290,000 and $310,000 at December 31, 2006 and 2005,
respectively. The recorded investment in impaired loans requiring an allowance
for loan losses was $-0- at December 31, 2006 and 2005. For the years ended
December 31, 2006, 2005 and 2004, the average recorded investment in these
impaired loans was $286,000, $316,000, and $-0-, and the interest income
recognized on these impaired loans was $1,000, $11,000, and $-0-, respectively.
Loans on which the accrual of interest has been discontinued amounted to
$409,000 and $341,000 at December 31, 2006 and 2005, 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 $-0- and $12,000 at
December 31, 2006 and 2005, respectively.
NOTE 5 - PREMISES AND EQUIPMENT
Components of premises and equipment at December 31 are as follows:
2006 2005
--------------------------
(In Thousands)
Land and improvements $ 925 $ 925
Buildings and improvements 7,766 7,318
Furniture and equipment 4,638 3,956
--------------------------
13,329 12,199
Accumulated depreciation (7,309) (6,806)
--------------------------
$ 6,020 $ 5,393
==========================
NORWOOD FINANCIAL CORP 44 2006 ANNUAL REPORT
NOTE 5 - PREMISES AND EQUIPMENT (CONTINUED)
Certain facilities are leased under various operating leases. Rental
expense for these leases was $222,000, $203,000, and $147,000, for the years
ended December 31, 2006, 2005 and 2004. Future minimum rental commitments under
noncancellable leases as of December 31, 2006 were as follows (in thousands):
2007 $ 271
2008 241
2009 231
2010 228
2011 239
Thereafter 2,801
------
$4,011
======
NOTE 6 - DEPOSITS
Aggregate time deposits in denominations of $100,000 or more were
$56,736,000 and $48,857,000 at December 31, 2006 and 2005, respectively.
At December 31, 2006, the scheduled maturities of time deposits are as
follows (in thousands):
2007 $142,281
2008 17,713
2009 4,311
2010 3,897
2011 4,253
--------
$172,455
========
NOTE 7 - BORROWINGS
Short-term borrowings at December 31 consist of the following:
2006 2005
-------------------
(IN THOUSANDS)
Securities sold under agreements to repurchase $21,736 $12,464
Federal funds purchased -- 5,100
U.S. Treasury demand notes 1,000 1,000
-------------------
$22,736 $18,564
===================
The outstanding balances and related information of short-term borrowings
are summarized as follows:
YEARS ENDED DECEMBER 31,
-----------------------
2006 2005
-----------------------
(DOLLARS IN THOUSANDS)
Average balance during the year $22,209 $15,059
Average interest rate during the year 4.39% 2.76%
Maximum month-end balance during the year $29,677 $24,956
Weighted average interest rate at the end of the year 4.20% 3.76%
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 $24,535,000 and $24,270,000 at December 31, 2006 and $14,768,000
and $14,396,000 at December 31, 2005 were pledged as collateral for these
agreements. The securities underlying the agreements were under the Company's
control.
NORWOOD FINANCIAL CORP 45 2006 ANNUAL REPORT
NOTE 7 - BORROWINGS (CONTINUED)
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 2011. There were no borrowings under this line at December 31, 2006
and 2005. The Company has a line of credit commitment available from PNC for
$12,000,000, Atlantic Central Bankers Bank for $7,000,000 and Wachovia Bank for
$2,000,000. There were no borrowings under these lines of credit at December 31,
2006 and 2005. The Company had a line of credit commitment available from the
Bank of Lancaster County for $5,000,000 at December 31, 2006 and for $8,000,000
at December 31, 2005. There was $-0- outstanding under this line of credit at
December 31, 2006 and $5,100,000 at December 31, 2005.
Long-term debt consisted of the following at December 31, 2006 and 2005:
2006 2005
-------------------
(IN THOUSANDS)
Notes with the Federal Home Loan Bank (FHLB):
Convertible note due December 2006 at 6.19% $ -- $ 5,000
Fixed rate note due April 2008 at 4.17% 5,000 5,000
Convertible note due April 2009 at 5.53% and 4.83% 5,000 5,000
Convertible note due April 2009 at 5.07% -- 5,000
Convertible note due January 2011 at 5.24% 3,000 3,000
-------------------
$13,000 $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, 2006 are as
follows (in thousands):
2007 $ --
2008 5,000
2009 5,000
2010 --
2011 3,000
Thereafter --
-------
$13,000
=======
The Bank's maximum borrowing capacity with the Federal Home Loan Bank was
$216,869,000 of which $13,000,000 was outstanding at December 31, 2006. 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 between 2% and 10% 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 $181,000, $207,000, and $185,000 for
the years ended December 31, 2006, 2005 and 2004, respectively.
NORWOOD FINANCIAL CORP 46 2006 ANNUAL REPORT
NOTE 8 - EMPLOYEE BENEFIT PLANS (CONTINUED)
The Company has a non-qualified supplemental executive retirement plan for
the benefit of certain executive officers. At December 31, 2006 and 2005, other
liabilities include approximately $858,000 and $720,000 accrued under the Plan.
Compensation expense includes approximately $138,000, $140,000, and $130,000,
relating to the supplemental executive retirement plan for 2006, 2005 and 2004,
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, 2006 and 2005, the cash value of these policies
was $7,479,000 and $7,213,000, respectively.
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
$12,000 and $23,000 for the years ended December 31, 2006 and 2005,
respectively. The total employer contribution was $143,000 and $193,000 for the
years ended December 31, 2006 and 2005, respectively.
Compensation expense for the ESOP was $444,000, $588,000, and $530,000 for
the years ended December 31, 2006, 2005, and 2004, respectively.
The status of the ESOP shares at December 31 are as follows:
2006 2005
-------------------------
Allocated shares 162,690 151,125
Shares released from allocation 28,219 25,466
Unreleased shares -- 14,318
-------------------------
TOTAL ESOP SHARES 190,909 190,909
-------------------------
Fair value of unreleased shares $ -- $440,000
=========================
NOTE 9 - INCOME TAXES
The components of the provision for federal income taxes are as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------
2006 2005 2004
-----------------------------------------
(IN THOUSANDS)
Current $ 2,787 $ 2,378 $ 2,084
Deferred (108) (37) (81)
-----------------------------------------
$ 2,679 $ 2,341 $ 2,003
=========================================
NORWOOD FINANCIAL CORP 47 2006 ANNUAL REPORT
NOTE 9 - INCOME TAXES (CONTINUED)
Deferred income taxes reflect temporary differences in the recognition of
revenue and expenses for tax reporting and financial statement purposes,
principally because certain items, such as, the allowance for loan losses and
loan fees are recognized in different periods for financial reporting and tax
return purposes. A valuation allowance has not been established for deferred tax
assets. Realization of the deferred tax assets is dependent on generating
sufficient taxable income. Although realization is not assured, management
believes it is more likely than not that all of the deferred tax asset will be
realized. Deferred tax assets are recorded in other assets.
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,
----------------------------------------
2006 2005 2004
----------------------------------------
Tax at statutory rates 34.0% 34.0% 34.0%
Tax exempt interest income, net of interest expense disallowance (3.6) (4.7) (5.6)
Increase in fair market value of ESOP 1.2 1.6 1.7
Incentive stock options compensation expense 0.5 - -
Earnings on life insurance (1.0) (1.1) (1.4)
Other 0.1 0.1 (0.1)
----------------------------------------
31.2% 29.9% 28.6%
========================================
The income tax provision includes $22,000, $14,000, and $156,000, of income
taxes relating to realized securities gains for the years ended December 31,
2006, 2005, and 2004, respectively.
The net deferred tax asset included in other assets in the accompanying
consolidated balance sheets includes the following amounts of deferred tax
assets and liabilities:
2006 2005
-----------------
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses $1,142 $1,070
Deferred compensation 292 252
Intangible assets 94 120
Net unrealized losses on securities 1 380
Other 21 4
-----------------
Total Deferred Tax Assets 1,550 1,826
-----------------
Deferred tax liabilities:
Premises and equipment 215 254
Deferred loan fees 305 271
-----------------
Total Deferred Tax Liabilities 520 525
-----------------
Net Deferred Tax Asset $1,030 $1,301
=================
NORWOOD FINANCIAL CORP 48 2006 ANNUAL REPORT
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, 2006 and 2005
such loans amounted to $5,959,000 and $3,130,000, respectively. During 2006, new
loans to such related parties totaled $3,360,000 and repayments and other
reductions aggregated $531,000.
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, 2006, that the Company and the Bank meet
all capital adequacy requirements to which they are subject.
As of December 31, 2006, 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, 2006:
Total capital (to risk-weighted
assets) $55,017 16.73% $=>26,308 =>8.00% $=>32,885 =>10.00%
Tier 1 capital (to risk-weighted
assets) 50,800 15.45 =>13,153 =>4.00 =>19,728 =>6.00
Tier 1 capital (to average assets) 50,800 11.15 =>18,224 =>4.00 =>22,780 =>5.00
AS OF DECEMBER 31, 2005:
Total capital (to risk-weighted
assets) $51,033 16.41% $=>24,879 =>8.00% $=>31,098 =>10.00%
Tier 1 capital (to risk-weighted
assets) 46,986 15.11 =>12,438 =>4.00 =>18,658 =>6.00
Tier 1 capital (to average assets) 46,986 10.84 =>17,338 =>4.00 =>21,673 =>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, 2006 and 2005 was approximately $253,000 and
$308,000, respectively.
NORWOOD FINANCIAL CORP 49 2006 ANNUAL REPORT
NOTE 11 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY (CONTINUED)
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, 2006, $44,816,000 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.
NOTE 12 - STOCK OPTION PLANS
The Company's shareholders approved the Norwood Financial Corp 2006 Stock
Option Plan at the Annual Meeting on April 26, 2006. An aggregate of 250,000
shares of authorized but unissued Common Stock of the Company were reserved for
future issuance under the Plan. This includes up to 40,000 shares for awards to
outside directors. The options granted under this plan have an exercise price
equal to the fair market value of the common stock on the grant date and vest
over a twelve month period. Under this plan, the Company granted 47,700 options
in 2006, which included 7,675 options granted to outside directors. 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. There were no options granted under either plan in 2005, as
both plans have expired.
As of December 31, 2006, there was approximately $251,000 of total
unrecognized compensation cost related to nonvested options under the plan. For
the year ended December 31, 2006, salaries and employee benefits expense
includes $136,000 related to the adoption of Statement No. 123 (R). Net income
for 2006 was reduced by approximately $129,000.
A summary of the Company's stock option activity and related information
for the years ended December 31 follows:
2006 2005 2004
---------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE INTRINSIC EXERCISE EXERCISE
OPTIONS PRICE VALUE OPTIONS PRICE OPTIONS PRICE
---------------------------------------------------------------------------------
Outstanding, beginning of year 140,295 $ 18.45 149,997 $ 18.25 148,687 $ 16.05
Granted 47,700 30.91 -- -- 20,475 30.00
Exercised (4,351) 13.05 (9,701) 15.44 (15,603) 13.14
Forfeited -- -- -- -- (3,562) 16.16
---------------------------------------------------------------------------------
Outstanding, end of year 183,645 $ 21.81 $1,780,000 140,296 $ 18.45 149,997 $ 18.25
=================================================================================
Exercisable, at end of year 135,945 $ 18.62 $1,751,000
==================================
NORWOOD FINANCIAL CORP 50 2006 ANNUAL REPORT
NOTE 12 - STOCK OPTION PLANS (CONTINUED)
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,
----------------------------
2006 2005 2004
----------------------------
Dividend yield 2.70% --% 2.61%
Expected life 7 years -- 7 years
Expected volatility 25.12% --% 34.66%
Risk-free interest rate 4.85% --% 3.80%
Weighted average fair value of options granted $8.11 $-- $9.50
The expected volatility is based on historical volatility. The risk-free
interest rates for periods within the contractual life of the awards are based
on the U.S. Treasury yield curve in effect at the time of the grant. The
expected life is based on historical exercise experience. The dividend yield
assumption is based on the Company's history and expectation of dividend
payouts.
Proceeds from stock option exercises totaled $60,000 in 2006. Shares issued
in connection with stock options exercises are issued from available treasury
shares. If no treasury shares are available, new shares are issued from
available authorized shares. During 2006, all the shares issued in connection
with stock option exercises, 4,351 shares in total, were issued from available
treasury shares.
As of December 31, 2006, outstanding stock options consist of the
following:
Options Exercise Remaining Options Exercise
Outstanding Price Life, Years Exercisable Price
--------------------------------------------------------------------
13,695 $10.88 1.0 13,695 $10.88
18,900 15.24 2.0 18,900 15.24
16,537 14.12 3.0 16,537 14.12
9,450 10.36 4.0 9,450 10.36
18,113 16.98 5.0 18,113 16.98
18,113 19.05 6.0 18,113 19.05
20,662 23.95 7.0 20,662 23.95
20,475 30.00 8.0 20,475 30.00
25,200 30.38 9.3 -- --
22,500 31.50 10.0 -- --
------- -------
Outstanding, end of year 183,645 $21.81 6.0 135,945 $18.62
======= =======
NORWOOD FINANCIAL CORP 51 2006 ANNUAL REPORT
NOTE 13 - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share:
YEARS ENDED DECEMBER 31,
-------------------------------------
2006 2005 2004
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator, net income $5,910 $5,497 $5,010
=====================================
Denominator:
Denominator for basic earnings per share, weighted
average shares 2,795 2,800 2,779
Effect of dilutive securities, employee stock options 55 59 59
-------------------------------------
Denominator for diluted earnings per share, adjusted weighted average
shares and assumed conversions 2,850 2,859 2,838
=====================================
Basic earnings per common share $ 2.11 $ 1.96 $ 1.80
=====================================
Diluted earnings per common share $ 2.07 $ 1.92 $ 1.77
=====================================
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 consolidated
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,
---------------------
2006 2005
---------------------
(IN THOUSANDS)
Commitments to grant loans $12,611 $16,078
Unfunded commitments under lines of credit 34,152 29,969
Standby letters of credit 7,215 6,791
---------------------
$53,978 $52,838
=====================
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. The Bank evaluates each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the customer and generally consists of real
estate.
NORWOOD FINANCIAL CORP 52 2006 ANNUAL REPORT
NOTE 14 - OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS (CONTINUED)
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,
2006 and 2005 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.
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, 2006 and 2005:
o For cash and due from banks and interest-bearing deposits with banks 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.
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 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.
NORWOOD FINANCIAL CORP 53 2006 ANNUAL REPORT
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, 2006 DECEMBER 31, 2005
-----------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-----------------------------------------
(IN THOUSANDS)
Financial assets:
Cash and due from banks and interest-bearing
deposits with banks $ 9,517 $ 9,517 $ 9,816 $ 9,816
Securities 113,866 113,883 117,266 117,294
Loans receivable, net 311,739 305,779 287,221 282,623
Investment in FHLB stock 1,687 1,687 1,620 1,620
Accrued interest receivable 2,129 2,129 1,812 1,812
Financial liabilities:
Deposits 358,103 357,691 340,603 340,124
Short-term borrowings 22,736 22,736 18,564 18,564
Long-term debt 13,000 12,974 23,000 23,194
Accrued interest payable 2,894 2,894 1,691 1,691
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding
letters of credit -- -- -- --
NORWOOD FINANCIAL CORP 54 2006 ANNUAL REPORT
NOTE 16 - NORWOOD FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
BALANCE SHEETS
DECEMBER 31,
--------------------
2006 2005
--------------------
(IN THOUSANDS)
ASSETS
Cash on deposit in bank subsidiary $ 552 $ 989
Securities available for sale 808 753
Investment in bank subsidiary 50,781 46,316
Other assets 731 700
--------------------
$52,872 $48,758
====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 641 $ 650
Stockholders' equity 52,231 48,108
--------------------
$52,872 $48,758
====================
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------
2006 2005 2004
-----------------------------
(IN THOUSANDS)
Income:
Dividends from bank subsidiary $ 2,369 $ 1,997 $ 1,830
Interest income from bank subsidiary 5 16 19
Other interest income 28 26 22
Net realized gain on sales of securities 15 -- --
-----------------------------
2,417 2,039 1,871
Expenses 175 198 147
-----------------------------
2,242 1,841 1,724
Income tax expense (benefit) (43) (53) (36)
-----------------------------
2,285 1,894 1,760
Equity in undistributed earnings of subsidiary 3,625 3,603 3,250
-----------------------------
Net Income $ 5,910 $ 5,497 $ 5,010
=============================
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------
2006 2005 2004
------------------------------
(IN THOUSANDS)
Cash Flows from Operating Activities
Net income $ 5,910 $ 5,497 $ 5,010
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (3,625) (3,603) (3,250)
Release of ESOP shares 421 565 585
Other, net (131) (615) (40)
------------------------------
Net Cash Provided by Operating Activities 2,575 1,844 2,305
------------------------------
Cash Flows from Investing Activities
Proceeds from sale of securities 30 -- --
Purchase of securities available for sale (43) (52) (125)
------------------------------
Net Cash Used in Investing Activities (13) (52) (125)
------------------------------
Cash Flows from Financing Activities
Stock options exercised 60 150 206
ESOP purchase of shares from treasury stock 120 114 77
Acquisition of treasury stock (890) (819) (118)
Cash dividends paid (2,289) (1,916) (1,795)
------------------------------
Net Cash Used in Financing Activities (2,999) (2,471) (1,630)
------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (437) (679) 550
------------------------------
Cash and Cash Equivalents - Beginning 989 1,668 1,118
------------------------------
Cash and Cash Equivalents - Ending $ 552 $ 989 $ 1,668
==============================
NORWOOD FINANCIAL CORP 55 2006 ANNUAL REPORT
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, 2006 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.
NORWOOD FINANCIAL CORP 56 2006 ANNUAL REPORT
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Main Street Parade - 1899
Lower Main Street during a Flag Day Parade, 1899. Note Wayne County Savings
Bank across the street.
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DIRECTORY OF OFFICERS
NORWOOD FINANCIAL CORP.
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Russell L. Ridd Chairman of the Board Kelly J. Lalley Assistant Vice President & Assistant
Secretary
William W. Davis, Jr. President & Chief Executive Laurie J. Bishop Assistant Community Office Manager
Officer
Lewis J. Critelli Executive Vice President & Renee M. Gilbert Community Office Manager
Chief Financial Officer
Edward C. Kasper Senior Vice President Marianne M. Glamann Community Office Manager
John H. Sanders Senior Vice President Teresa Melucci Community Office Manager
Joseph A. Kneller Senior Vice President Sandra Mruczkewycz Community Office Manager
John E. Marshall Secretary Sandra Halas Wealth Management Invetment Manager
WAYNE BANK Gary D. Henry Consumer Lending Officer
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Russell L. Ridd Chairman of the Board Annette A. Jurkowski Wealth Management Operations Manager
William W. Davis, Jr. President & Chief Executive Thomas Kowalski Resource Recovery Manager
Officer
Lewis J. Critelli Executive Vice President & Jill Melody Assistant Community Office Manager
Chief Financial Officer
Linda M. Moran Marketing Officer
Edward C. Kasper Senior Vice President & William E. Murray Mortgage Originator
Senior Loan Officer/
Corporate Bank Sarah J. Rapp Human Resources Officer
Diane L. Richter Assistant Community Office Manager
John H. Sanders Senior Vice President/Retail
Bank Toni M. Stenger Assistant Community Office Manager
Joseph A. Kneller Senior Vice President Doreen A. Swingle Residential Mortgage Lending Officer
Wayne D. Wilcha Senior Vice President & Karen Vashlishan Compliance Officer
Trust Officer
John E. Marshall Secretary Karen Verbeke Community Office Manager
Robert J. Behrens, Jr. Vice President Nancy M. Worobey Community Office Manager
John F. Carmody Vice President
JoAnn Fuller Vice President
Carolyn K. Gwozdziewycz Vice President NORWOOD INVESTMENT CORP
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Nancy A. Hart Vice President, Controller & William W. Davis, Jr. President & Chief Executive Officer
Assistant Secretary
Lewis J. Critelli Executive Vice President
Raymond C. Hebden Vice President
Scott C. Rickard Investment Representative,
William J. Henigan, Jr. Vice President Invest Financial Corp.
William R. Kerstetter Vice President Amy E. Kasper Investment Representative,
Invest Financial Corp.
Mary Alice Petzinger Vice President
MONROE COUNTY ASSOCIATE BOARD
Barabara A. Ridd Vice President & Assistant -----------------------------
Secretary Michael J. Baxter James H. Ott
Jeffrey R. Shrader Vice President
Sara Cramer Ron Sarajian
Eli T. Tomlinson Vice President
Andrew Forte Ray Price
Jennifer M. Witowic Vice President
Ralph A. Matergia, Esq. Marvin Papillon
Karen R. Gasper Internal Auditor &
Assistant Vice President Randy R. Motts
Norma J. Kuta Assistant Vice President
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We would like to thank Gloria McCullough and the Wayne County Historical
Society for providing these photographs and their provenance. Wayne Bank very
much appreciates this kindness and generosity.
visit us: www.waynebank.com