2007
NORWOOD
FINANCIAL CORP
ANNUAL REPORT
TO SHAREHOLDERS
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NORWOOD
FINANCIAL CORP
SUMMARY OF SELECTED FINANCIAL DATA
(dollars in thousands, except per share data)
For the years ended December 31, 2007 2006 2005 2004 2003
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Net interest income $ 17,272 $ 16,183 $ 15,263 $ 14,012 $ 13,322
Provision for loan losses 315 220 350 455 660
Other income 3,507 3,517 3,506 3,088 2,801
Net realized gains on sales of securities 17 66 42 458 692
Other expense 11,341 10,957 10,623 10,090 9,808
Income before income taxes 9,140 8,589 7,838 7,013 6,347
Income tax expense 2,629 2,679 2,341 2,003 1,694
NET INCOME $ 6,511 $ 5,910 $ 5,497 $ 5,010 $ 4,653
Net income per share-Basic $ 2.34 $ 2.11 $ 1.96 $ 1.80 $ 1.70
Net income per share-Diluted 2.30 2.07 1.92 1.77 1.67
Cash dividends declared 0.94 0.85 0.71 0.66 0.62
Dividend pay-out ratio 40.17% 40.28% 36.41% 36.51% 36.31%
Return on average assets 1.39% 1.33% 1.31% 1.27% 1.22%
Return on average equity 12.10% 11.85% 11.72% 11.39% 11.24%
BALANCES AT YEAR-END
Total assets $480,610 $454,356 $433,556 $411,626 $387,483
Loans receivable 331,296 315,567 290,890 254,757 233,733
Allowance for loan losses 4,081 3,828 3,669 3,448 3,267
Total deposits 370,000 358,103 340,603 318,645 306,669
Shareholders' equity 55,819 52,231 48,108 45,685 42,831
Trust assets under management 101,714 96,879 86,972 83,397 73,991
Book value per share $ 20.27 $ 18.67 $ 17.07 $ 16.14 $ 15.20
Tier 1 Capital to risk-adjusted assets 16.26% 15.67% 15.29% 15.91% 15.58%
Total Capital to risk-adjusted assets 17.60% 16.99% 16.63% 17.34% 17.09%
Allowance for loan losses to total loans 1.23% 1.21% 1.26% 1.35% 1.40%
Non-performing assets to total assets 0.03% 0.09% 0.08% 0.02% 0.04%
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NORWOOD
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FINANCIAL CORP
PRESIDENT'S LETTER
PAGES 2-7
BOARD OF DIRECTORS
PAGES 6-7
BRANCH LOCATIONS
PAGE 8
FINANCIAL REPORT INDEX
PAGE 9
2007
NORWOOD
FINANCIAL CORP
ANNUAL REPORT
TO SHAREHOLDERS
MOVING FORWARD WITH CONFIDENCE,
WHILE ALWAYS BEING GUIDED BY OUR PAST,
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It is truly a pleasure to report to million, deposits of $370.0 with full collection of principal,
you that your Company had a million and shareholders' equity interest and fees. We would also
very strong financial performance of $55.8 million. Total assets like to note that Norwood never
in 2007. We had record earnings increased $26.3 million from participated in the Subprime
for the year ended December 31, December 31, 2006. mortgage market. The Company
2007 of $6,511,000 which had net charge-offs of $62,000
represented an increase of Loans receivable increased $15.7 for the year-ended December
$601,000, or 10.2% over the million, or 5.0% from the prior 31, 2007 representing only .02%
$5,910,000 earned in 2006. year. The increase in loans was of average loans. Though loan
Earnings per share on a fully centered in residential mortgage quality indicators remain strong,
diluted basis were $2.30 for the activity, including home equity we felt it was prudent to increase
current year compared to $2.07 lending and to a lesser extent, in the provision for loan losses to
in 2006. The Company declared the commercial real estate loan $315,000 for the year ended
cash dividends totaling $.94 per portfolio. The majority of the loan December 31, 2007, from
share in 2007, an increase of $.09 growth was funded with an $11.9 $220,000 for the similar period
per share, or 10.6%, over the $.85 million increase in deposits, in 2006, as we do recognize the
per share declared in 2006. This principally in money market stress on the local and national
marks the sixteenth consecutive accounts and non-interest bearing economy. The allowance for loan
year of increased cash dividends checking accounts. losses increased $253,000 from
for our shareholders. The return December 31, 2006 to $4,081,000
on average assets for the year was Non-performing loans totaled and represented 1.23% of total
1.39% with a return on average $163,000 and represented .05% loans as of December 31, 2007.
equity of 12.10%. Both of these of total loans as of December 31,
peformed measures improved 2007 compared to $409,000, or For the year, net interest income
over the prior year. .13%, as of December 31, 2006. (fully taxable equivalent) totaled
Our improvement over the prior $17,811,000 with a net interest
Total assets as of December 31, year was the result of resolving margin (fte) of 3.98% compared
2007 were $480.6 million with our largest non-performing loan to $16,708,000, and a net
loans receivable of $331.3 during the third quarter of 2007 interest margin (fte) of 3.96% in
[PICTURE OMITTED]
WILLIAM W. DAVIS, JR.
President and Chief Executive Officer
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2006. The slight increase in net due to costs associated with the NET INCOME ($000)
interest margin for the year was Tannersville Office which opened [Bar graph with following data points]
principally due to an increase in in December 2006. $4,653 $5,010 $5,497 $5,910 $6,511
the yield on the investment 2003 2004 2005 2006 2007
securities portfolio and an WE STRONGLY ENCOURAGE
increased amount of loans on the YOU TO READ THE
balance sheet. These increases FINANCIAL SECTION OF
were partially offset by an increase THIS ANNUAL REPORT FOR
in the cost of deposits, principally A MORE DETAILED ANALYSIS
higher costing time deposits OF OUR RESULTS.
For the year, other income Wayne Bank's primary market TOTAL DEPOSITS * LOANS o (IN MILLIONS)
totaled $3,524,000 compared to area consists of three of the fastest [Bar graph with following data points]
$3,583,000 in the prior year. The growing counties in Pennsylvania * $306.7 $318.6 $340.6 $358.1 $370.0
decrease was principally due to a - Wayne, Pike and Monroe. o $233.7 $254.8 $290.9 $315.6 $331.3
lower level of gains on the sales This tri-county region serves as a 2003 2004 2005 2006 2007
of mortgage loans which totaled haven for people in neighboring
$23,000 in 2007 and $147,000 states as the area provides great
in the prior year, which included relief from larger congested areas
$110,000 gain on the sale of such as Philadelphia and New
mortgage servicing rights. This York. They travel to the region
decrease was partially offset by a to take advantage of the natural
$68,000 increase in Wealth beauty of the mountains, pristine NET INTEREST INCOME (FTE %$ IN 000)
Management/Trust revenues. lakes and waterfalls and wooded [Bar graph with following data points]
areas. The amenities are many $13,945 $14,653 $15,589 $16,708 $17,811
For the year, other expenses with ski resorts, craft shops, art 2003 2004 2005 2006 2007
totaled $11,341,000, an increase galleries, golf courses, museums,
of $384,000 or 3.5% over the prior an indoor water park, resorts,
year. The increase was principally and most recently the advent of a
casino in Monroe County. With services allow the Bank to meet Checking account to cultivate
tourism being high on the list of all of our customers needs. more business relationships. To
major industries, it is no wonder strengthen our business
that many of these visitors decide relationships even more, Wayne
to purchase a home in the area. Bank will introduce a new product
We have worked diligently to DILUTED EARNINGS (PER SHARE) branded "Business Link" in 2008.
position Wayne Bank as the first [Bar graph with following data points] The service is Remote Deposit
choice in banking for those new $1.67 $1.77 $1.92 $2.07 $2.30 Capture that allows a business to
to the region. Wayne Bank offers 03 04 05 06 07 virtually deposit their checks via
land loans, a terrific construction the Internet without having to
mortgage program, tiered loan go to the bank, again saving time.
rates, Jumbo loans for the more We believe this service will retain
expensive homes and home equity our current business accounts and
products to suit the needs of the help us expand Wayne Bank's
growing populace. Wayne Bank footprint without the additional
did not enter into the Subprime investment in branch locations.
lending arena, which generated The Internet has become more
significant loan volume for some popular with our customers and Technology is top-of-mind at
financial institutions, but was Wayne Bank's team works to Wayne Bank as we look to ways
based on weak underwriting. make our services more conve- to streamline processes within
Our mortgage lending programs. nient, accessible and user-friendly. our organization that add
are built on solid credit Along those lines, we are efficiencies. We recently converted
fundamentals that are best for constantly updating and to a digital image filing system
both the customer and the Bank. adding more information to which enables us to respond timely
Wayne Bank's website to the needs of our customers
We also play a significant role in (waynebank.com) and now feature who request copies of documents,
the commercial development of a short, online loan application. transaction histories or other
our market area. The Bank is These services are in addition information. Additionally, Wayne
involved in many of the major to Direct Link, Free Internet Bank is in the planning stage of
projects throughout Wayne, Banking with Free Bill Pay that is implementing a branch capture
Pike and Monroe Counties. available for both businesses and device, so that our branch network
We provide commercial financing consumers alike. The Bank will will be able to make their check
to a wide range of businesses which continue to improve our website's deposits virtually to our corporate
support the regional economy; capabilities to keep up with the headquarters eliminating the need
including the hotel industry, retail demands of our customers for for couriers and increasing our
shopping areas, local resorts, this marketing channel. Many deposit cut-off times to provide
summer camps, building customers are using Direct Link, better customer service.
contractors, and residential Wayne Bank's Internet banking
property owner associations. service to handle some or all of Wayne Bank's success is due to
their banking transactions and we the talent and dedication of our
The Wealth Management and expect this trend to continue. employees as they focus, each and
Trust Services Division provides everyday, to serve our customers
our clients with a level of service An ongoing focus is to grow our in a positive, effective and efficient
second to none. Our investment small business customer base, and manner. During the past year, we
management products, trust to that end we launched a very recognized the achievements and
administration and executor attractive FREE Business accordingly promoted a number
[PICTURE OMITTED]
SENIOR MANAGEMENT TEAM
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EDWARD C. KASPER / WAYNE D. WILCHA / WILLIAM W. DAVIS, JR. / JOSEPH A. KNELLER / LEWIS J. CRITELLI / JOHN H. SANDERS
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of employees to Vice President. the Shohola Community Office in Monroe county. He is also
Those recipients include Linda Manager was named the Teller extremely involved with tourism
Moran, Karyn Vashlishan and Training Officer. and hospitality trade associations
Kelley Lalley. In addition, Sandy in the Pocono region.
Halas was promoted to Assistant In 2007, we were extremely pleased
Vice President, as well as the new to have Andrew Forte join the Since its founding in 1871, Wayne
appointments of Gary Sipe, Vice Board of Directors of Wayne Bank Bank has been a leader in
President, Wealth Management and Norwood Financial Corp. community involvement. We
Investment Officer; Neicy Ramos, Andy has strong financial are a notable presence in the
Business Development Officer management background, is a communities we serve and that is
in Monroe County and Wendy CPA and is pursuing his doctorate due in part to the volunteerism
Davis, Assistant Community at pace University. He currently and support our reemployees
Officer Manager in Shohola. In is President of Forte, Inc. which contribute to the local area. The
addition, Karen Verbeke formerly operates the Stroudsmoor Inn Senior Management team leads
[PICTURES OMITTED]
NORWOOD FINANCIAL 2007 BOARD OF DIRECTORS
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(FROM LEFT TO RIGHT) WILLIAM W. DAVIS, JR. / JOHN E. MARSHALL / GARY P. RICKARD / DANIEL J. O'NEILL
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the way by serving as Directors Sanctuary and the Dorflinger- nonprofit organizations through
or board members for many Suydam Wildlife Sanctuary are volunteering and financial support
organizations such as the Wayne notable in our support as they such as the American Cancer
County YMCA, Wayne County provide natural history, Society's Relay for Life, The
Memorial Hospital, Wayne conservation, culture and American Red Cross and the
County Builders Association, education to the area through United Way, just to mention a few.
the Wayne County Chamber of their programs. In addition, We are proud to support the local
Commerce, the Wayne County Wayne Bank supports the Pike area and are committed to making
Historical Society, the Greater County Chamber of Commerce, our community a better place to
Honesdale Partnership and the Pocono Builders Association and live and work.
Wayne Economic Development the Pocono Mountain Chamber
Corporation. Conservation of Commerce. Additionally, We marked another milestone in
groups such as Lacawac employees support many 2007, as Russell L. Ridd retired as
[PICTURES OMITTED]
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DR. KENNETH A. PHILLIPS / RALPH A. MATERGIA, ESQ. / ANDREW A. FORTE / SUSAN GUMBLE-COTTELL / RICHARD L. SNYDER
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our Chairman of the Board. Russell At the Annual Reorganizational needs. We truly appreciate your
had a 44 year career with the Bank. Meeting in April, John E. support and confidence and look
He joined the Bank in 1963, was Marshall was appointed forward to hearing any of your
appointed President and Director Chairman of the Board of comments and suggestions!
in 1980 and Chairman in 1993. Directors of Norwood and Wayne
During Russell's career, the Bank Bank. John brings many years of Sincerely yours,
grew from $10 million in assets experience to the position having
to $460 million. The Board served as a Director since 1983.
passed a resolution designating /s/ William W. Davis, Jr.
Russell, Director Emeritus of We look forward to another year William W. Davis, Jr.
Norwood Financial Corp and of innovation and achievement President & Chief Executive Officer
Wayne Bank. We sincerely wish in 2008. Please think of Wayne
Russell well in his retirement. Bank first, for all you financial
[MAP OMITTED]
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BRANCH LOCATIONS AND SERVICE AREA COVERED
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Administrative Office: Route 6 East Route 611 & Stroud Mall
717 Main Street Hawley, PA 18428 Stroudsburg, PA 18360
P.O. Box 269
Honesdale, PA 18431 111 West Harford Street 637 Route 739
Milford, PA 18337 Lords Valley Shopping Plaza
Community Offices: Lords Valley, PA 18428
717 Main Street Weis Market, Route 590
Honesdale, PA 18431 Hamlin, PA 18427 Route 209, 5165 Milford Road
Marshalls Creek, PA 18335
245 Willow Avenue 107 Richardson Avenue
Honesdale, PA 18431 Shohola, PA 18458 Route 611, Fountain Springs East II
Tannersville, PA 18372
Belmont & Water Streets Route 370 & Lake Como Road
Waymart, PA 18472 Lakewood, PA 18439 Online at: waynebank.com
NORWOOD
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FINANCIAL CORP
2007
CONSOLIDATED FINANCIAL REPORT
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MANAGEMENT'S DISCUSSION & ANALYSIS 10-27
MANAGEMENT'S REPORT ON CONTROL OVER FINANCIAL REPORTING 28
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 29
CONSOLIDATED BALANCE SHEETS 31
CONSOLIDATED STATEMENTS OF INCOME 32
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 33
CONSOLIDATED STATEMENTS OF CASH FLOWS 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 35-55
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, 2007 and 2006 and for
the years ended December 31, 2007, 2006, and 2005. 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,
using the modified prospective transition method. Under this method companies
are required to record compensation expense, based on the fair value of options
over the vesting period. See Note 2 for additional discussion of this
pronouncement's impact on the Company's consolidated financial statements.
10
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, 2007 and
2006 represent temporary impairment of the securities.
RESULTS OF OPERATION - SUMMARY
Net income for the Company for the year ended December 31, 2007 totaled
$6,511,000, an increase of $601,000 or 10.2% over the $5,910,000 earned in 2006.
Basic and diluted earnings per share were $2.34 and $2.30 respectively
increasing from $2.11 and $2.07, respectively in 2006. The return on average
assets (ROA) for the year ended December 31, 2007 was 1.39% improving from 1.33%
for 2006. Return on average equity (ROE) increased to 12.10% for the current
year from 11.85% in 2006.
The increase in earnings was principally attributable to an increase in
net interest income which totaled $17,811,000 on a fully taxable equivalent
(fte) basis in 2007 compared to $16,708,000 (fte) in 2006. This represents an
increase of $1,103,000, or 6.6%. Net interest income was favorably impacted by a
$21.9 million, or 7.3% increase in average loans receivable for 2007 compared to
average loans receivable in 2006. The yield on the securities portfolio
increased 76 basis points which also favorably impacted net interest income.
These two items were partially offset by a 59 basis point increase in the cost
of interest bearing deposits, principally short-term time deposits.
Loans receivable increased $15.7 million to total $331.3 million as of
December 31, 2007. The increase in loans was centered in residential mortgage
activity and to a lesser extent, in the commercial real estate portfolio. The
majority of the loan growth was funded with an $11.9 million increase in
deposits, principally in money market accounts and non-interest bearing
checking.
The Company's loan quality metrics remained strong with non-performing
loans decreasing to .05% of total loans at December 31, 2007 from .13% as of the
prior year end. Net charge-offs were only $62,000 for the year, or .02% of
average loans. Loan loss provision expense increased to $315,000 in 2007, from
$220,000 in 2006 as the Company recognizes a general slow down in the local
economy.
Other income for 2007 totaled $3,524,000 compared to $3,583,000 in
2006. The decrease was principally due to a lower level of gains on the sales of
mortgage loans which totaled $23,000 in 2007 and $147,000 in the prior year,
which included $110,000 gain on the sale of a portfolio of mortgage servicing
rights. Other expenses totaled $11,341,000 in 2007, an increase of $384,000 or
3.5% over the prior year. The increase was principally due to costs associated
with the Tannersville Office which opened in December 2006.
11
The following table sets forth changes in net income (in thousands):
Net income for 2006 $ 5,910
Net interest income 1,089
Provision for loan losses (95)
Gain on sale of mortgage loans (124)
Other income 65
Salaries and employee benefits (170)
Occupancy (119)
Other expense (95)
Income tax expense 50
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Net income for 2007 $ 6,511
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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 $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 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.
12
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
Other income (48)
Salaries and employee benefits (245)
Professional fees 104
All other expenses (193)
Income tax expense (338)
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Net income for 2006 $5,910
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FINANCIAL CONDITION
Total Assets
Total assets as of December 31, 2007, were $480.6 million compared to
$454.4 million as of year-end 2006, an increase of $26.2 million or 5.8%.
Loans Receivable
As of December 31, 2007, loans receivable totaled $331.3 million
compared to $315.6 million as of
year-end 2006, an increase of $15.7 million, or 5.0%. Loan growth in residential
and commercial real estate was partially offset by lower commercial term loans
and lines of credit and a net run-off in indirect automobile financing, which is
included in consumer loans to individuals.
Residential real estate, which includes home equity lending, totaled
$129.9 million as of December 31, 2007, compared to $113.8 million as of
year-end 2006. The increase of $16.1 million is net of prepayments, refinancing
activity and sales of mortgage loans into the secondary market. 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 and has no sub-prime mortgage exposure. The Company evaluates sales of
its long-term fixed rate residential loan production for interest rate risk
management, with $1.1 million of 30 year fixed rate loans sold into the
secondary market during 2007. The Company held in portfolio the majority of
fixed rate residential mortgage production in 2007. The Company also had growth
in home equity lending in 2007 through its branch system. Total outstandings
increased $3.0 million to $52.6 million as of December 31, 2007.
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 real estate loans totaled $133.6 million as
of December 31, 2007, increasing from $127.6 million as of December 31, 2006, an
increase of $6.0 million or 4.7%. The terms for commercial real estate are
typically 15 to 20 years, with adjustable rates based on a spread to the 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 real estate lending was
13
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 decreased $4.9 million to $29.2 million as of December 31, 2007. The
decrease was principally due to pay-offs in equipment loans and lower usage on
lines of credit.
The Company's indirect lending portfolio (included in consumer loans to
individuals) declined $2.4 million to $11.6 million as of December 31, 2007. The
Company has de-emphasized indirect automobile lending due to increased pricing
competition offered by automotive industry finance companies.
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, 2007, non-performing loans totaled $163,000 and
represented .05% of total loans receivable compared to $409,000 and .13% as of
year-end 2006. The Company resolved its largest non-performing loan during 2007
with full collection of principal, interest and fees. Total non-performing
assets, which includes foreclosed real estate totaled $163,000 and represented
..03% of total assets, compared to $409,000 and .09% as of December 31, 2006. As
of December 31, 2007 and 2006, the Company had no foreclosed real estate.
The allowance for loan losses totaled $4,081,000 as of December 31,
2007 and represented 1.23% of total loans receivable compared to $3,828,000 and
1.21% of total loans as of year-end 2006. Net charge-offs for 2007 were $62,000,
consisting principally of losses on the sale of repossessed automobiles and a
loss on one residential mortgage, compared to net charge-offs of $61,000 in
2006. The provision for loan losses for 2007 was $315,000, compared to $220,000
in 2006.
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 conditions; trends in
delinquencies, internal risk rating classification, large dollar loans of over
$2 million and growth in the portfolio. As of December 31, 2007, the Company
considered its concentration of credit risk profile to be acceptable. The local,
regional and national economy weakened in 2007 as energy prices increased and
the real estate market slowed. Local unemployment rates showed a modest
increase. The Company has modestly increased its number of large commercial
credits and saw a slow down in growth in commercial real estate related loans.
As a result of its analysis, after applying these factors, management considers
the allowance as of December 31, 2007, 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.
14
The following table sets forth information with respect to the
Company's allowance for loan losses at the dates indicated:
Year-ended December 31,
-------------------------------------------------------
(dollars in thousands)
2007 2006 2005 2004 2003
-------------------------------------------------------
Allowance balance at beginning of year $ 3,828 $ 3,669 $ 3,448 $ 3,267 $ 3,146
Charge-offs:
Commercial and all other - - (4) (19) (121)
Real Estate (4) - (6) (10) -
Consumer (117) (150) (200) (342) (478)
Lease Financing - - - (11) (36)
------- ------- ------- ------- -------
Total (121) (150) (210) (382) (635)
Recoveries:
Commercial and all other - 18 12 13 5
Real Estate 2 2 18 8 24
Consumer 54 65 46 78 64
Lease Financing 3 4 5 9 3
------- ------- ------- ------- -------
Total 59 89 81 108 96
Provision expense 315 220 350 455 660
------- ------- ------- ------- -------
Allowance balance at end of year $ 4,081 $ 3,828 $ 3,669 $ 3,448 $ 3,267
======= ======= ======= ======= =======
Allowance for loan losses as a percent
of total loans outstanding 1.23% 1.21% 1.26% 1.35% 1.40%
Net loans charged off as a percent of
average loans outstanding .02% .02% .05% .11% .24%
Allowance coverage of non-performing loans 25.0x 9.4x 10.4x 51.5x 22.8x
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, 2007, the Company had $3,208,000 impaired and collateral
dependent loans compared to $290,000 at year-end 2006. This increase is due to
two related credits with no required allowance.
December 31,
-------------------------------------------------------
(dollars in thousands)
2007 2006 2005 2004 2003
-------------------------------------------------------
Non-accrual loans:
Commercial and all other $ - $ - $ - $ - $ -
Real estate 109 392 330 32 125
Consumer 2 17 11 8 -
------- ------- ------- ------- -------
Total 111 409 341 40 125
Accruing loans which are contractually
past due 90 days or more 52 - 12 27 18
------- ------- ------- ------- -------
Total non-performing loans 163 409 353 67 143
------- ------- ------- ------- -------
Foreclosed real estate - - - - -
Total non-performing assets $ 163 $ 409 $ 353 $ 67 $ 143
=======================================================
Non-performing loans to total loans .05% .13% .12% .03% .06%
Non-performing loans to total assets .03% .09% .08% .02% .04%
Non-performing assets to total assets .03% .09% .08% .02% .04%
15
SECURITIES
The securities portfolio consists principally of issues of United
States Government agencies, including mortgage-backed securities, municipal
obligations, and corporate debt. In accordance with FAS 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, 2007, the HTM portfolio
totaled $705,000 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, net of deferred income taxes,
recorded as an adjustment to capital and reported in the equity section of the
balance sheet as accumulated other comprehensive income (loss). As of December
31, 2007, $124.0 million in securities were classified as AFS and carried at
their fair market value, with unrealized appreciation, net of tax, of
$1,054,000, included in accumulated other comprehensive income in stockholders'
equity.
As of December 31, 2007, the average life of the portfolio was 2.2
years. The Company has maintained a relatively short average life in the
portfolio in order to generate cash flow to support loan growth. Purchases for
the year totaled $62.0 million with securities called, maturities and cash flow
of $52.4 million and proceeds from sales of $74,000. 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 $124.7 million
with the mix as follows:
2007 2006
--------------------------------------------------
(dollars in thousands)
Carrying Carrying
Value % of portfolio Value % of portfolio
--------------------------------------------------
US Government agencies $ 41,508 33.4% $ 47,581 41.9%
States & political subdivisions 22,622 18.1 17,419 15.3
Corporate obligations 4,994 4.0 8,439 7.4
Mortgage-backed securities 54,082 43.3 38,652 33.8
Equity securities 1,486 1.2 1,775 1.6
-------- ----- -------- -----
Total $124,692 100.0% $113,866 100.0%
======== ===== ======== =====
The portfolio had $19.1 million of floating rate instruments,
principally adjustable rate mortgage backed securities as of December 31, 2007
compared to $17.7 million at year end 2006. 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 2007, the Company increased its holdings of
mortgage-backed securities with the expectation that these bonds will provide
regular cash flow, provide liquidity and support loan growth.
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.
16
Total deposits as of December 31, 2007, totaled $370.0 million
increasing from $358.1 million as of year-end 2006, an increase of $11.9 million
or 3.3%. The increase was principally due to growth in money market and
non-interest bearing demand accounts, $7.9 million and $6.2 million
respectively, as compared to December 31, 2006. This was partially offset by a
decline in savings and interest-bearing demand accounts of $2.2 million and $4.2
million respectively, as compared to December 31, 2006.
Time deposits over $100,000, which consist principally of school
district and other public funds, with maturities generally less than one year,
totaled $62.3 million as of December 31, 2007, compared to $56.7 million at
year-end 2006. 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.
As of December 31, 2007, non-interest bearing demand deposits totaled
$60.1 million, increasing $6.2 million or 11.5% from the prior year-end. This
growth is partially attributable to an increase in commercial deposits, as a
result of the Bank's promotion of a free-business checking account in 2007.
Interest bearing demand accounts totaled $32.4 million as of December 31, 2007
compared to $36.6 million at year end 2006. The decrease is principally due to
certain municipal accounts converting to cash management accounts. Cash
management accounts included in short-term borrowings, totaled $24.0 million at
year end 2007 compared to $20.7 million as of December 31, 2006. These balances
represent commercial and municipal customers' funds invested in overnight
securities. The Company considers these accounts as a source of core funding.
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, 2007, 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, 2007, the Bank had a positive 90 day interest
sensitivity gap of $6.0 million or 1.3% of total assets. A positive gap
indicates that the balance sheet has more rate-sensitive assets (RSA) than
rate-sensitive liabilities at the time interval. This would indicate that in a
rising rate environment, the yield on interest-earning assets would increase
faster than the cost of interest-bearing liabilities in the 90
17
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. During 2007, short-term interests declined more
than long-term interests. For example, the Federal Funds rate declined 100 basis
points while the 10 year treasury rate dropped 60 basis points. This created a
positive shaped yield curve as of December 31, 2007. 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. 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. It
should be noted that the operating results of the Company are not subject to
foreign currency exchange or commodity price risk.
The following table displays interest-sensitivity as of December 31,
2007 (dollars in thousands):
December 31, 2007
Rate Sensitivity Table 3 Months 3-12 Months
or Less Months 1-3 Years 3 Years Total
----------------------------------------------------------------
Federal Funds Sold and
interest bearing deposits $ 50 $ - $ - $ - $ 50
Securities 20,487 26,455 40,609 37,141 124,692
Loans Receivable 90,225 47,769 84,664 108,638 331,296
----------------------------------------------------------------
Total Rate Sensitive Assets (RSA) $ 110,762 $ 74,224 $ 125,273 $ 145,779 $ 456,038
================================================================
Non-maturity interest bearing deposits $ 21,046 $ 23,353 $ 61,873 $ 27,086 $ 133,358
Time Deposits 73,576 71,406 20,280 11,319 176,581
Other 10,144 13,434 26,108 - 49,686
----------------------------------------------------------------
Total Rate Sensitive Liabilities (RSL) $ 104,766 $ 108,193 $ 108,261 $ 38,405 $ 359,625
================================================================
Interest Sensitivity Gap $ 5,996 $ (33,969) $ 17,012 $ 107,374 $ 96,413
Cumulative gap 5,996 (27,973) (10,961) 96,413
RSA/RSL-cumulative 105.7% 86.9% 96.6% 126.8%
December 31, 2006
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%
18
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.
As of December 31, 2007, the Company had cash and cash equivalents of
$9.1 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 $124.0 million, which could be used for liquidity needs. This totals
$133.1 million and represents 27.7% of total assets compared to $122.4 million
and 26.9% of total assets as of December 31, 2006. The change was principally
due to a higher level of securities available for sale as of December 31, 2007.
The Company also monitors other liquidity measures, all of which were within the
Company's policy guidelines as of December 31, 2007. 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 $41 million, with $800,000 outstanding at December 31,
2007. The maximum borrowing capacity from FHLB was $240.2 million. As of
December 31, 2007, the Company had $23 million in term borrowings from the FHLB,
increasing from $13 million in similar borrowings from the FHLB as of December
31, 2006. The growth of $10 million was used to fund an increase in earning
assets in 2007.
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, 2007 totaled $47.3 million. They consisted of
$16.1 million in commercial real estate, construction and land developments
loans, $10.9 million in home equity lines of credit, $2.3 million in standby
letters of credit and $18.0 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 of on and off balance
sheet contractual obligations to make future payments (in thousands):
` December 31, 2007
----------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years Over 5 years
----------------------------------------------------------------
Time deposits $176,581 $144,982 $ 20,280 $ 11,319 $ -
Long-term debt 23,000 5,000 - 8,000 10,000
Operating leases 3,813 279 494 487 2,553
----------------------------------------------------------------
$203,394 $150,261 $ 20,774 $ 19,806 $ 12,553
================================================================
19
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 83.0% of total revenue for the year ended December 31,
2007. Net interest income (fte) totaled $17,811,000 for the year ended December
31, 2007 compared to $16,708,000 for 2006, an increase of $1,103,000, or 6.6%.
The resulting fte net interest spread and net interest margin were 3.27% and
3.98% respectively in 2007 compared to 3.36% and 3.96% respectively, in 2006.
Interest income (fte) for the year ended December 31, 2007 totaled
$29,794,000, an increase of $3,320,000 over $26,474,000 earned in 2006. The fte
yield on average earning assets for 2007 was 6.66%, increasing 39 basis points,
from 6.27% in 2006. The increase in interest income was principally due to
higher yields on the securities available for sale portfolio and loan portfolio
and a higher percentage of loans on the balance sheet. The prime interest rate
was flat at 8.25% from January to mid-September 2007 and decreased to 7.25% by
December 31, 2007. This decline in short-term rates impacts the Company's
floating rate loans, principally commercial real estate, commercial and home
equity lines of credit which are tied to the prime rate. As of December 31,
2007, $69.1 million of loans were immediately repriceable. Average earning
assets for 2007 totaled $447.4 million, an increase of $25.4 million over the
average for 2006. The mix of earning assets also improved with higher yielding
loans representing 72.3% of average earning assets compared to 71.2% during
2006.
Interest income (fte) earned on loans totaled $23,876,000 for the year
ended December 31, 2007 with a resulting fte yield of 7.38% compared to
$21,600,000 with a yield (fte) of 7.16% in 2006. The increase was due to growth
in average volume of loans of $21.9 million and a higher average prime interest
rate in 2007 than average in 2006.
The securities available for sale portfolio averaged $118.7 million
during 2007 with interest income (fte) of $5,623,000 and yield (fte) of 4.74%
compared to $116.6 million with interest income (fte) of $4,637,000 and yield
(fte) of 3.98% in 2006. The increase in yield was due to the reinvestment of
cash flow and maturities from the portfolio into higher yielding instruments.
Interest expense for the year ended December 31, 2007 totaled
$11,983,000 with cost of interest-bearing liabilities of 3.39% compared to
interest expense of $9,766,000 at an average cost of 2.91% for 2006. The
increase was principally due to a more expensive mix of interest-bearing
liabilities with a higher percentage of average time deposits in 2007, 50.7%
compared to 43.6% on average in 2006. In addition, the cost of time deposits
increased on average to 4.57% in 2007 as compared to 3.96% in 2006. The increase
was principally due to higher average short-term rates in 2007 and a competitive
market for these deposits.
Net interest income represented 81.9% of total revenue for the year
ended December 31, 2006 and totaled $16,708,000. This represents an increase of
$819,000, or 5.2% over the $15,889,000 earned in 2005. 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
20
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 an 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. 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.
OTHER INCOME
Other income totaled $3,524,000 for the year ended December 31, 2007
compared to $3,583,000 in 2006. Service charges and fees increased $54,000 to
$2,509,000 in 2007. The increase was due to an $87,000 increase in overdraft
(NSF) fees to $1,347,000 partially offset by a $39,000 decrease in business
account analysis fees as the bank now offers a free business checking account
with no analysis fees. Income from fiduciary activities totaled $423,000 in 2007
increasing $68,000 from 2006. The increase was due to new business and a higher
level of estate fees. Assets under management increased $4.8 million to $101.7
million. Gains on sales of mortgage loans and servicing rights totaled $23,000
for the 2007 period compared to $147,000 in 2006. The decrease was due to the
gain in 2006 on the sale of $13.7 million of mortgage servicing rights on loans
previously sold in the secondary market.
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 a $26,000 decline in service
charges on deposit accounts reflecting growth in the Bank's free retail checking
products. Loan related services decreased $79,000 due in part to 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.
21
Other Income (dollars in thousands)
For the year-ended December 31
2007 2006 2005
------------------------------------
Service charges on deposit accounts $ 226 $ 296 $ 322
ATM Fees 241 224 215
NSF Fees 1,347 1,260 1,265
Safe Deposit Box Rental 55 55 56
Loan related service fees 236 271 350
Debit Card 328 282 253
Fiduciary activities 423 355 343
Commissions on mutual funds & annuities 120 131 150
Gain on sales of mortgage loans 23 147 64
Earnings on bank-owned life insurance 333 309 296
Other income 175 187 192
------------------------------------
3,507 3,517 3,506
Net realized gains on sales of securities 17 66 42
------------------------------------
Total $3,524 $3,583 $3,548
====================================
OTHER EXPENSES
Other expenses for the year ended December 31, 2007 totaled
$11,341,000, an increase of $384,000, or 3.50% over the $10,957,000 in 2006.
Salaries and employee benefits expense which represented 51.4% of total
other expenses, increased $170,000 or 3.0% to $5,825,000 in 2007. The Company
incurred $251,000 of expense related to stock options in 2007, compared to
$136,000 in 2006 with the increase related to the timing of grants awarded in
2006. The Company had expense of $444,000 related to its Employee Stock
Ownership Plan (ESOP) in 2006 with no similar expense in 2007 as the plan had a
ten year life and was fully allocated as of September 30, 2006. This decrease in
expense was partially offset by higher 401k Plan expense of $220,000 and
incentives of $62,000.
Occupancy expenses increased $119,000 to $1,087,000 in 2007 with
$71,000 of the increase related to the Tannersville branch which opened in
December 2006. Furniture and equipment expense increased $74,000 to $553,000 due
to maintenance expense on imaging equipment and $31,000 of costs associated with
Tannersville. The efficiency ratio, which is total other expenses as a
percentage of net interest income (fte) plus other income, for the year ended
December 31, 2007 was 53.2% improving from 54.0% for 2006.
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.
22
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 lower level of corporate legal fees and
accounting services.
INCOME TAXES
Income tax expense for the year ended December 31, 2007 totaled
$2,629,000 for an effective tax rate of 28.8% compared to an expense of
$2,679,000 and an effective tax rate of 31.2% in 2006. The decrease in the
effective tax rate is partially due to a higher level of tax-exempt income in
2007.
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.
CAPITAL AND DIVIDENDS
Total stockholders' equity as of December 31, 2007, was $55.8 million,
compared to $52.2 million as of year-end 2006. The increase was principally due
to retention of earnings of $3,905,000 after cash dividends declared of
$2,606,000. Accumulated other comprehensive income increased $1,098,000 due to
an increase in the fair value of securities in the Company's portfolio
principally as a result of a change in interest rates. As of December 31, 2007
the Company had a leverage capital ratio of 11.38%, Tier 1 risk-based capital of
16.26% and total risk-based capital of 17.60% compared to, 11.43%, 15.67% and
16.99%, respectively, in 2006.
The Company's stock is traded on The Nasdaq Global Market under the
symbol, NWFL. As of December 31, 2007, there were approximately 1,500 recorded
beneficial shareholders based on transfer agent mailings.
The following table sets forth the price range and cash dividends
declared per share regarding the common stock for the periods indicated:
Closing Price Range
----------------------------- Cash dividends
High Low declared per share
-----------------------------------------------------
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
Year 2007
- ---------
First Quarter $ 33.75 $ 30.55 $ .23
Second Quarter 33.35 31.48 .23
Third Quarter 32.75 30.05 .23
Fourth Quarter 32.50 29.90 .25
The book value per share of the common stock was $20.27 as of December
31, 2007 compared to $18.67 as of December 31, 2007. As of year-end 2007, the
stock price was $31.25, compared to $31.50 as of December 31, 2006.
23
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, 2002 and the
reinvestment of dividends paid. The graph provides comparison at December 31,
2002 and each fiscal year through December 31, 2007.
[STOCK PERFORMANCE GRAPH OMITTED]
- -----------------------------------------------------------------------------------------------
Legend
12/2002 12/2003 12/2004 12/2005 12/2006 12/2007
Norwood Finanical Corp 100.0 136.9 187.4 174.9 184.2 193.0
Nasdaq Stock Market (US Companies) 100.0 149.5 162.7 166.2 182.6 198.0
Nasdaq Bank Stocks 100.0 128.6 147.2 143.8 161.4 127.9
SIC 6020-6029,6710-6719 US & Foreign
- -----------------------------------------------------------------------------------------------
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.
24
NORWOOD FINANCIAL CORP.
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
(Dollars in thousands, except per share amounts)
2007
December 31 September 30 June 30 March 31
-------------------------------------------------
Interest income $7,473 $7,457 $7,246 $7,079
Interest expense 3,070 2,965 2,960 2,988
-------------------------------------------------
Net interest income 4,403 4,492 4,286 4,091
Provision for loan losses 120 90 55 50
Other income 858 913 842 894
Net realized gains on sales of securities 2 - 15 -
Other expense 2,846 2,787 2,847 2,861
-------------------------------------------------
Income before income taxes 2,297 2,528 2,241 2,074
Income tax expense 625 722 671 611
-------------------------------------------------
NET INCOME $1,672 $1,806 $1,570 $1,463
=================================================
Basic earnings per share $ 0.61 $ 0.65 $ 0.56 $ 0.52
=================================================
Diluted earnings per share $ 0.60 $ 0.64 $ 0.55 $ 0.51
=================================================
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
=================================================
25
NORWOOD FINANCIAL CORP.
CONSOLIDATED AVERAGE BALANCE SHEETS
WITH RESULTANT INTEREST AND RATES
(Tax-Equivalent Basis, dollars in thousands)
Year Ended December 31 2007 2006 2005
----------------------------------------------------------------------------------------------
Average Ave Average Ave Average Ave
Balance(2) Interest (1) Rate Balance(2) Interest (1) Rate Balance(2) Interest (1) Rate
----------------------------------------------------------------------------------------------
ASSETS
Interest Earning Assets:
Federal funds sold $ 3,895 $ 195 5.01% $ 2,778 $ 142 5.11% $ 3,730 $ 129 3.46%
Interest bearing deposits
with banks 483 26 5.38 98 5 5.10 123 3 2.44
Securities held to maturity 830 74 8.92 981 90 9.17 3,608 396 10.98
Securities available for sale
Taxable 99,399 4,571 4.60 99,571 3,712 3.73 98,038 3,116 3.18
Tax-exempt 19,320 1,052 5.45 17,070 925 5.42 18,602 1,023 5.50
------------------- ------------------- -------------------
Total securities
available for sale 118,719 5,623 4.74 116,641 4,637 3.98 116,640 4,139 3.55
Loans receivable (3,4) 323,444 23,876 7.38 301,533 21,600 7.16 274,053 17,727 6.47
------------------- ------------------- -------------------
Total interest
earning assets 447,371 29,794 6.66 422,031 26,474 6.27 398,154 22,394 5.62
Non-interest earning assets:
Cash and due from banks 8,128 8,857 8,569
Allowance for loan losses (3,925) (3,785) (3,597)
Other assets 17,318 16,976 16,049
-------- -------- --------
Total non-interest
earning assets 21,521 22,048 21,021
-------- -------- --------
TOTAL ASSETS $468,892 $444,079 $419,175
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Liablities:
Interest-bearing demand
and money market $ 90,392 1,852 2.05 $ 96,882 1,688 1.74 $ 93,747 $ 969 1.03
Savings 45,858 215 0.47 49,937 232 0.46 57,128 268 0.47
Time 172,986 7,900 4.57 146,344 5,798 3.96 128,704 3,634 2.82
------------------- ------------------- -------------------
Total interest-bearing
deposits 309,236 9,967 3.22 293,163 7,718 2.63 279,579 4,871 1.74
Short-term borrowings 22,443 932 4.15 19,284 823 4.27 15,783 416 2.64
Long-term debt 22,315 1,084 4.86 23,419 1,225 5.23 23,000 1,218 5.30
------------------- ------------------- -------------------
Total interest bearing
liabilities 353,994 11,983 3.39 335,866 9,766 2.91 318,362 6,505 2.04
------- ------- -------
Non-interest bearing liabilities:
Non-interest bearing
demand deposits 56,523 54,798 52,109
Other liabilities 4,545 3,526 1,804
-------- -------- --------
Total non-interest
bearing liabilities 61,068 58,324 53,913
-------- -------- --------
Stockholders' equity 53,830 49,889 46,900
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $468,892 $444,079 $419,175
======== ======== ========
Net interest income
(tax-equivalent basis) 17,811 3.27% 16,708 3.36% 15,889 3.58%
Tax-equivalent basis adjustment (539) ==== (525) ==== (626) ====
------- ------- -------
Net Interest Income $17,272 $16,183 $15,263
======= ======= =======
Net Interest margin
(tax-equivalent basis) 3.98% 3.96% 3.99%
==== ==== ====
1. Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
2. Average balances have been calculated based on daily balances.
3. 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.
26
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) 2007 compared to 2006 2006 compared to 2005
---------------------------------------------------------------
Variance due to Variance due to
---------------------------------------------------------------
Volume Rate Net Volume Rate Net
---------------------------------------------------------------
INTEREST EARNING ASSETS:
- --------------------------------------------------------------------------------------------------------
Federal funds sold $ 56 $ (3) $ 53 $ (38) $ 51 $ 13
Interest bearing deposits
with banks 21 - 21 (1) 3 2
Securities held to maturity (14) (2) (16) (250) (56) (306)
Securities available for sale
Taxable (6) 865 859 49 547 596
Tax-exempt 122 5 127 (83) (15) (98)
---------------------------------------------------------------
Total securities available
for sale 116 870 986 (34) 532 498
Loans receivable 1,603 673 2,276 1,870 2,003 3,873
---------------------------------------------------------------
Total interest earning assets 1,783 1,537 3,320 1,547 2,533 4,080
---------------------------------------------------------------
INTEREST BEARING LIABILITIES:
- --------------------------------------------------------------------------------------------------------
Interest-bearing demand
and money market (119) 283 164 33 686 719
Savings (19) 2 (17) (33) (3) (36)
Time 1,143 959 2,102 549 1,615 2,164
---------------------------------------------------------------
Total interest-bearing deposits 1,006 1,243 2,249 549 2,298 2,847
Short-term borrowings 132 (23) 109 107 300 407
Long-term debt (56) (85) (141) 22 (15) 7
---------------------------------------------------------------
Total interest bearing liabilities 1,081 1,136 2,217 678 2,583 3,261
---------------------------------------------------------------
Net interest income
(tax-equivalent basis) $ 701 $ 401 $ 1,103 $ 869 $ (50) $ 819
===============================================================
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.
27
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
TO THE SHAREHOLDERS OF NORWOOD FINANCIAL CORP.
Management of Norwood Financial Corp. and its subsidiary (Norwood) is
responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934. Norwood's internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of the consolidated financial
statements for external purposes in accordance with accounting principles
generally accepted in the United States of America.
Norwood's internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of Norwood; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that
our receipts and expenditures are being made only in accordance with
authorizations of Norwood's management and directors; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of Norwood's assets that could have a material effect on the
consolidated financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Norwood's internal control
over financial reporting as of December 31, 2007. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in "Internal Control - Integrated
Framework." Based on our assessment and those criteria, management determined
that Norwood maintained effective internal control over financial reporting as
of December 31, 2007.
Norwood's independent registered certified public accounting firm has
audited the effectiveness of Norwood's internal control over financial
reporting. Their report appears on page 30.
28
[LOGO] bmc
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Norwood Financial Corp.
Honesdale, Pennsylvania
We have audited the accompanying consolidated balance sheets of Norwood
Financial Corp. and its subsidiary as of December 31, 2007 and 2006, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the years in the three-year period ended December 31, 2007. Norwood
Financial Corp. and its subsidiary's management is responsible for these
consolidated financial statements. 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
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, 2007 and 2006, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2007 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.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Norwood Financial Corp. and its
subsidiary's internal control over financial reporting as of December 31, 2007,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO),
and our report dated March 11, 2008 expressed an unqualified opinion.
/s/Beard Miller Company LLP
Beard Miller Company LLP
Lancaster, Pennsylvania
March 11, 2008
29
[LOGO] bmc
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Norwood Financial Corp.
Honesdale, Pennsylvania
We have audited Norwood Financial Corp. and its subsidiary's internal
control over financial reporting as of December 31, 2007, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Norwood Financial
Corp. and its subsidiary's Management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting included in the
accompanying Management's Report On Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on the company's internal control
over financial reporting based on our audit.
We conducted our audit 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
effective internal control over financial reporting was maintained in all
material respects. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audit also included performing such other procedures as
we considered necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, Norwood Financial Corp. and its subsidiary maintained,
in all material respects, effective internal control over financial reporting as
of December 31, 2007, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets and the related statements of income, stockholders' equity and cash flows
of Norwood Financial Corp. and its subsidiary, and our report dated March 11,
2008 expressed an unqualified opinion.
/s/Beard Miller Company, LLP
Beard Miller Company, LLP
Lancaster, Pennsylvania
March 11, 2008
30
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------
2007 2006
----------------------
(In Thousands,
Except Share Data)
ASSETS
Cash and due from banks $ 9,014 $ 9,450
Interest bearing deposits with banks 50 67
----------------------
Cash and Cash Equivalents 9,064 9,517
Securities available for sale 123,987 112,912
Securities held to maturity, fair value 2007 $721; 2006 $971 705 954
Loans receivable, net of allowance for loan losses 2007 $4,081; 2006 $3,828 327,215 311,739
Investment in FHLB stock, at cost 2,072 1,687
Bank premises and equipment, net 5,742 6,020
Bank owned life insurance 7,767 7,479
Accrued interest receivable 2,343 2,129
Other assets 1,715 1,919
----------------------
Total Assets $ 480,610 $ 454,356
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing demand $ 60,061 $ 53,856
Interest-bearing demand 32,426 36,600
Money market deposit accounts 57,970 50,048
Savings 42,962 45,144
Time 176,581 172,455
----------------------
Total Deposits 370,000 358,103
Short-term borrowings 26,686 22,736
Long-term debt 23,000 13,000
Accrued interest payable 3,198 2,894
Other liabilities 1,907 5,392
----------------------
Total Liabilities 424,791 402,125
----------------------
STOCKHOLDERS' EQUITY
Common stock, par value $.10 per share; authorized 10,000,000 shares;
issued 2,840,872 shares 284 284
Surplus 10,159 10,149
Retained earnings 47,030 43,125
Treasury stock, at cost 2007 87,256 shares; 2006 43,721 shares (2,708) (1,283)
Accumulated other comprehensive income (loss) 1,054 (44)
----------------------
Total Stockholders' Equity 55,819 52,231
----------------------
Total Liabilities and Stockholders' Equity $ 480,610 $ 454,356
======================
See notes to consolidated financial statements.
31
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
---------------------------
2007 2006 2005
---------------------------
(In Thousands, Except per Share Data)
INTEREST INCOME
Loans receivable, including fees $23,720 $21,422 $17,583
Securities:
Taxable 4,571 3,712 3,116
Tax-exempt 743 668 937
Other 221 147 132
---------------------------
Total Interest Income 29,255 25,949 21,768
---------------------------
INTEREST EXPENSE
Deposits 9,967 7,718 4,871
Short-term borrowings 932 823 416
Long-term debt 1,084 1,225 1,218
---------------------------
Total Interest Expense 11,983 9,766 6,505
---------------------------
Net Interest Income 17,272 16,183 15,263
PROVISION FOR LOAN LOSSES 315 220 350
---------------------------
Net Interest Income after Provision for Loan Losses 16,957 15,963 14,913
---------------------------
OTHER INCOME
Service charges and fees 2,509 2,455 2,507
Income from fiduciary activities 423 355 343
Net realized gains on sales of securities 17 66 42
Earnings on life insurance policies 333 309 296
Other 242 398 360
---------------------------
Total Other Income 3,524 3,583 3,548
---------------------------
OTHER EXPENSES
Salaries and employee benefits 5,825 5,655 5,410
Occupancy 1,087 968 928
Furniture and equipment 553 479 575
Data processing related operations 690 700 625
Advertising 235 224 159
Professional fees 349 340 444
Postage and telephone 491 471 470
Taxes, other than income 414 354 334
Amortization of intangible assets 52 52 52
Other 1,645 1,714 1,626
---------------------------
Total Other Expenses 11,341 10,957 10,623
---------------------------
Income before Income Taxes 9,140 8,589 7,838
INCOME TAX EXPENSE 2,629 2,679 2,341
---------------------------
Net Income $ 6,511 $ 5,910 $ 5,497
===========================
EARNINGS PER SHARE
Basic $ 2.34 $ 2.11 $ 1.96
===========================
Diluted $ 2.30 $ 2.07 $ 1.92
===========================
See notes to consolidated financial statements.
32
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2007, 2006 and 2005
----------------------------------------------------------------------------------
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, 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 (losses) on
securities available for sale,
net of reclassification
adjustment and tax effects - - - - - (1,105) - (1,105)
-------
Total Comprehensive Income 4,392
-------
Cash dividends declared, $0.71 per share - - - (1,997) - - - (1,997)
Stock options exercised (9,239 shs) - - (78) - 228 - - 150
Tax benefit of stock options exercised - - 18 - - - - 18
Acquisition of treasury stock (25,201 shs) - - - - (819) - - (819)
Sale of treasury stock for ESOP (3,686 shs) - - 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, $0.85 per share - - - (2,368) - - - (2,368)
5% stock dividend at $30.59 per share 135,157 14 4,121 (4,139) - - - (4)
Treasury stock effect of 5% stock dividend
(1,933 shs) - - - - - - - -
Acquisition of treasury stock (28,746 shs) -- - - - (890) - - (890)
Stock options exercised (4,331 shs) - - (68) - 128 - - 60
Tax benefit of stock options exercised - - 10 - - - - 10
Sale of treasury stock for ESOP (3,816 shs) - - 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
Comprehensive income: - - - - - - - -
Net income - - - 6,511 - - - 6,511
Change in unrealized gains (losses) on
securities available for sale,
net of reclassification
adjustment and tax effects - - - - - 1,098 - 1,098
-------
Total Comprehensive Income - - - - - - - 7,609
-------
Cash dividends declared, $0.94 per share - - - (2,606) - - - (2,606)
Acquisition of treasury stock (72,875 shs) - - - - (2,313) - - (2,313)
Stock options exercised (24,720 shs) - - (404) - 745 - - 341
Tax benefit of stock options exercised - - 162 - - - - 162
Sale of treasury stock for ESOP (4,620 shs) - - 1 - 143 - - 144
Compensation expense related to stock
options - - 251 - - - - 251
-----------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2007 2,840,872 $ 284 $10,159 $47,030 $(2,708) $ 1,054 $ - $55,819
==================================================================================
See notes to consolidated financial statements.
33
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------------------
2007 2006 2005
------------------------------------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,511 $ 5,910 $ 5,497
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 315 220 350
Depreciation 566 503 535
Amortization of intangible assets 52 52 52
Deferred income taxes (151) (108) (37)
Net amortization (accretion)?of securities premiums and discounts 113 301 431
Net realized gains on sales of securities (17) (66)
Net increase in investment in life insurance (288) (266) (254)
Gain on sale of bank premises and equipment and
foreclosed real estate (1) (12) (5)
Gain on sale of mortgage loans (23) (147) (64)
Mortgage loans originated for sale (794) (2,065) (6,650)
Proceeds from sale of mortgage loans 817 2,212 6,714
Tax benefit of stock options exercised - - 18
Release of ESOP shares - 421 565
Compensation expense related to stock options 251 136 -
Decrease (increase) in accrued interest receivable and
other assets (414) 1,137 (1,725)
Increase (decrease) in accrued interest payable and other liabilities (3,228) 4,543 1,575
------------------------------------
Net Cash Provided by Operating Activities 3,709 12,771 6,960
------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 74 96 6,073
Proceeds from maturities and principal reductions on
mortgage-backed securities 52,408 35,962 11,799
Purchases (62,005) (32,291) (18,878)
Securities held to maturity, proceeds from maturities 250 505 4,330
(Increase) decrease in investment in FHLB stock (385) (67) 605
Net increase in loans (15,839) (24,892) (36,374)
Purchase of bank premises and equipment (288) (1,130) (446)
Proceeds from sales of premises and equipment and foreclosed real estate 1 64 12
------------------------------------
Net Cash Used in Investing Activities (25,784) (21,753) (32,879)
------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 11,897 17,500 21,958
Net increase (decrease) in short-term borrowings 3,950 4,172 (4,418)
Proceeds from long-term debt 15,000 - 5,000
Repayments of long-term debt (5,000) (10,000) (5,000)
Stock options exercised 341 60 150
Tax benefit of stock options exercised 162 10 -
Purchase of ESOP shares from treasury stock 144 120 114
Acquisition of treasury stock (2,313) (890) (819)
Cash dividends paid (2,559) (2,289) (1,916)
------------------------------------
Net Cash Provided by Financing Activities 21,622 8,683 15,069
------------------------------------
Net Decrease in Cash and Cash Equivalents (453) (299) (10,850)
CASH AND CASH EQUIVALENTS - BEGINNING 9,517 9,816 20,666
------------------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 9,064 $ 9,517 $ 9,816
====================================
See notes to consolidated financial statements.
34
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 and 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,
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.
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.
35
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
36
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 income
statement.
Intangible Assets
Intangible assets represent goodwill arising from acquisitions.
Goodwill represents the excess cost of an acquisition over the fair value of the
net assets acquired. On January 1, 2002, the Company adopted SFAS 142, "Goodwill
and Other Intangible Assets," and SFAS 147, "Accounting for Certain Acquisitions
of Banking and Thrift Institutions." At December 31, 2007 and 2006, the Company
had intangible assets of $169,000 and $221,000, which is net of accumulated
amortization of $611,000 and $559,000, 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, 2007, 2006 and 2005. The amortization expense will be $52,000 for
each of the years ended December 31, 2008, 2009 and 2010 and $13,000 for the
year ended December 31, 2011.
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.
37
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
For the year ended December 31, 2005, 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.
Year Ended December 31,
------------------------------
2005
------------------------------
(Thousands, Except per Share Data)
Net income, as reported $ 5,497
Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related taxes (194)
-------
Pro forma net income $ 5,303
=======
Earnings per share (basic):
As reported $ 1.96
Pro forma $ 1.89
Earnings per share (assuming dilution):
As reported $ 1.92
Pro forma $ 1.85
38
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, all of which mature within 90 days.
Cash payments for interest for the years ended December 31, 2007, 2006
and 2005 were $11,679,000, $8,563,000, and $6,014,000, respectively. Cash
payments for income taxes for the years ended December 31, 2007, 2006 and 2005
were $2,845,000, $2,677,000, and $2,449,000, respectively. Non-cash investing
activities for 2007, 2006 and 2005 included foreclosed mortgage loans
transferred to foreclosed real estate and repossession of other assets of
$48,000, $154,000, and $112,000, respectively.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to extend
credit, letters of credit and commitments to sell loans. Such financial
instruments are recorded in the balance sheets when they become receivable or
payable.
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 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,
------------------------------
2007 2006 2005
------------------------------
(In Thousands)
Unrealized holding gains/(losses) on available for sale securities $ 1,665 $ 1,173 $ (1,636)
Reclassification adjustment for gains realized in income 17 66 42
------------------------------
Net Unrealized Gains/(Losses) 1,648 1,107 (1,678)
Income tax expense (benefit) 550 379 (573)
------------------------------
Net of Tax Amount $ 1,098 $ 728 $ (1,105)
==============================
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, among 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.
39
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
New Accounting Standards
In September 2006, the FASB's Emerging Issues Task Force (EITF) 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 policyholder 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 Principles
Board (APB) Opinion No. 12, as appropriate. For transition, an entity can choose
to apply the guidance using either 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 EITF is effective for fiscal years beginning after December 15, 2007, with
early adoption permitted. The Company has chosen approach (b) and is expected to
record a cumulative effect adjustment as of January 1, 2008 to the balance of
retained earnings of $520,000, with $90,000 of Net Periodic Postretirement
Benefit expense for the year ended December 31, 2008.
On September 7, 2006, the Task Force reached a conclusion on EITF Issue
No. 06-5, "Accounting for Purchases of Life Insurance - Determining the Amount
that Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4,
Accounting for Purchases of Life Insurance" (EITF 06-5"). The Scope of EITF 06-5
consists of six separate issues relating to accounting for life insurance
policies purchased by entities protecting against the loss of key persons. The
six issues are clarifications of previously issued guidance on FASB Technical
Bulletin No. 85-4 EITF 06-5 is effective for fiscal years beginning after
December 15, 2006. The adoption of EITF 06-5 did not have a material impact on
the Company's 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 157 applies to all 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.
In December 2007, the FASB issued proposed FASB Staff Position (FSP)
157-b, "Effective Date of FASB Statement No. 157," that would permit a one-year
deferral in applying the measurement provisions of Statement No. 157 to
non-financial assets and non-financial liabilities (non-financial items) that
are not recognized or disclosed at fair value in an entity's financial
statements on a recurring basis (at least annually). Therefore, if the change in
fair value of a non-financial item is not required to be recognized or disclosed
in the financial statements on an annual basis or more frequently, the effective
date of application of Statement 157 to that item is deferred until fiscal years
beginning after November 15, 2008 and interim periods within those fiscal years.
This deferral does not apply, however, to an entity that applies Statement 157
in interim or annual financial statements before proposed FSP 157-b is
finalized. The Company is currently evaluating the impact, if any, that the
adoption of FSP 157-b will have on the Company's consolidated financial
statements.
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.
40
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FASB Statement No. 141 (R) "Business Combinations" was issued in
December of 2007. This Statement establishes principles and requirements for how
the acquirer of a business recognizes and measures in its financial statements
the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree. The Statement also provides guidance
for recognizing and measuring the goodwill acquired in the business combination
and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. The guidance will become effective as of the beginning of a
company's fiscal year beginning after December 15, 2008. This new pronouncement
will impact the Company's accounting for business combinations beginning January
1, 2009.
FASB Statement No. 160 "Noncontrolling Interests in Consolidated
Financial Statements--an amendment of ARB No. 51" was issued in December of
2007. This Statement establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The guidance will become effective as of the beginning of a
company's fiscal year beginning after December 15, 2008. The Company believes
that this new pronouncement will have an immaterial impact on the Company's
consolidated financial statements in future periods.
Staff Accounting Bulletin No. 110 (SAB 110) amends and replaces
Question 6 of Section D.2 of Topic 14, "Share-Based Payment," of the Staff
Accounting Bulletin series. Question 6 of Section D.2 of Topic 14 expresses the
views of the staff regarding the use of the "simplified" method in developing an
estimate of expected term of "plain vanilla" share options and allows usage of
the "simplified" method for share option grants prior to December 31, 2007. SAB
110 allows public companies which do not have historically sufficient experience
to provide a reasonable estimate to continue use of the "simplified" method for
estimating the expected term of "plain vanilla" share option grants after
December 31, 2007. SAB 110 is effective January 1, 2008.
Staff Accounting Bulletin No. 109 (SAB 109), "Written Loan Commitments
Recorded at Fair Value Through Earnings" expresses the views of the staff
regarding written loan commitments that are accounted for at fair value through
earnings under generally accepted accounting principles. To make the staff's
views consistent with current authoritative accounting guidance, the SAB revises
and rescinds portions of SAB No. 105, "Application of Accounting Principles to
Loan Commitments." Specifically, the SAB revises the SEC staff's views on
incorporating expected net future cash flows related to loan servicing
activities in the fair value measurement of a written loan commitment.
The SAB retains the staff's views on incorporating expected net future cash
flows related to internally-developed intangible assets in the fair value
measurement of a written loan commitment. The staff expects registrants to apply
the views in Question 1 of SAB 109 on a prospective basis to derivative loan
commitments issued or modified in fiscal quarters beginning after December 15,
2007. The Company does not expect SAB 109 to have a material impact on its
consolidated financial statements.
In June 2007, the Emerging Issues Task Force (EITF) reached a consensus
on Issue No. 06-11, "Accounting for Income Tax Benefits of Dividends on
Share-Based Payment Awards" ("EITF 06-11"). EITF 06-11 states that an entity
should recognize a realized tax benefit associated with dividends on nonvested
equity shares, nonvested equity share units and outstanding equity share options
charged to retained earnings as an increase in additional paid in capital.
The amount recognized in additional paid in capital should be included in the
pool of excess tax benefits available to absorb potential future tax
deficiencies on share-based payment awards. EITF 06-11 should be applied
prospectively to income tax benefits of dividends on equity-classified
share-based payment awards that are declared in fiscal years beginning after
December 15, 2007. The Company expects that EITF 06-11 will not have an impact
on its consolidated financial statements.
Effective January 1, 2007, the Company adopted Financial Accounting
Standards Board (FASB) Statement 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. The adoption of SFAS 156 did not have a significant
effect on the consolidated financial statements.
41
NOTE 3 - SECURITIES
The amortized cost and fair value of securities were as follows:
December 31, 2007
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------
(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies $ 41,110 $ 435 $ (37) $ 41,508
States and political subdivisions 21,765 196 (44) 21,917
Corporate obligations 5,078 - (84) 4,994
Mortgage-backed securities 53,846 458 (222) 54,082
------------------------------------------------
121,799 1,089 (387) 122,501
Equity securities 585 941 (40) 1,486
------------------------------------------------
$ 122,384 $ 2,030 $ (427) $ 123,987
================================================
HELD TO MATURITY:
States and political subdivisions $ 705 $ 16 $ - $ 721
================================================
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
================================================
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, 2007
--------------------------------------------------------------------
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 $ - $ - $ 9,461 $ (37) $ 9,461 $ (37)
States and political subdivisions 344 (1) 5,401 (43) 5,745 (44)
Corporate obligations 3,006 (67) 1,988 (17) 4,994 (84)
Mortgage-backed securities 8,095 (19) 10,854 (203) 18,949 (222)
Equity securities 178 (40) - - 178 (40)
--------------------------------------------------------------------
$ 11,623 $ (127) $ 27,704 $ (300) $ 39,327 $ (427)
====================================================================
42
NOTE 3 - SECURITIES (CONTINUED)
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)
====================================================================
The Company has 12 securities in the less than twelve month category
and 46 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,
2007 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 $ 9,125 $ 9,104 $ - $ -
Due after one year through five years 28,497 28,533 - -
Due after five years through ten years 21,560 21,925 705 721
Due after ten years 8,771 8,857 - -
--------------------------------------
67,953 68,419 705 721
Mortgage-backed securities 53,846 54,082 - -
--------------------------------------
$121,799 $122,501 $ 705 $ 721
======================================
Gross realized gains and gross realized losses on sales of securities
available for sale were $40,000 and $23,000, respectively, in 2007, $66,000 and
$-0-, respectively, in 2006, $107,000 and $65,000, respectively, in 2005.
Securities with a carrying value of $56,398,000 and $50,677,000 at
December 31, 2007 and 2006, 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.
41
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
The components of loans receivable at December 31 were as follows:
2007 2006
-------------------
(In Thousands)
Real estate:
Residential $129,888 $113,783
Commercial 133,593 127,640
Construction 20,404 18,955
Commercial, financial and agricultural 29,159 34,019
Consumer loans to individuals 18,526 21,520
-------------------
331,570 315,917
Unearned income and deferred fees (274) (350)
Allowance for loan losses (4,081) (3,828)
-------------------
$327,215 $311,739
===================
The following table presents changes in the allowance for loan losses:
Years Ended December 31,
-------------------------
2007 2006 2005
-------------------------
(In Thousands)
Balance, beginning $3,828 $3,669 $3,448
Provision for loan losses 315 220 350
Recoveries 59 89 81
Loans charged off (121) (150) (210)
-------------------------
Balance, ending $4,081 $3,828 $3,669
=========================
The recorded investment in impaired loans, not requiring an allowance
for loan losses was $3,208,000 and $290,000 at December 31, 2007 and 2006,
respectively. The recorded investment in impaired loans requiring an allowance
for loan losses was $-0- at December 31, 2007 and 2006. For the years ended
December 31, 2007, 2006 and 2005, the average recorded investment in these
impaired loans was $3,127,000, $286,000, and $316,000, and the interest income
recognized on these impaired loans was $290,000, $1,000, and $11,000,
respectively.
Loans on which the accrual of interest has been discontinued amounted
to $111,000 and $409,000 at December 31, 2007 and 2006, 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 $52,000 and $-0-
at December 31, 2007 and 2006, respectively.
NOTE 5 - PREMISES AND EQUIPMENT
Components of premises and equipment at December 31 are as follows:
2007 2006
-----------------------
(In Thousands)
Land and improvements $ 925 $ 925
Buildings and improvements 7,875 7,766
Furniture and equipment 4,798 4,638
-----------------------
13,598 13,329
Accumulated depreciation (7,856) (7,309)
-----------------------
$ 5,742 $ 6,020
=======================
44
NOTE 5 - PREMISES AND EQUIPMENT (CONTINUED)
Certain facilities are leased under various operating leases. Rental
expense for these leases was $283,000, $222,000, and $203,000, for the years
ended December 31, 2007, 2006 and 2005. Future minimum rental commitments under
noncancellable leases as of December 31, 2007 were as follows (in thousands):
2008 $ 279
2009 266
2010 228
2011 239
2012 248
Thereafter 2,553
-------
$ 3,813
=======
NOTE 6 - DEPOSITS
Aggregate time deposits in denominations of $100,000 or more were
$62,263,000 and $56,736,000 at December 31, 2007 and 2006, respectively.
At December 31, 2007, the scheduled maturities of time deposits are as
follows (in thousands):
2008 $144,982
2009 15,778
2010 4,502
2011 4,748
2012 6,571
--------
$176,581
========
NOTE 7 - BORROWINGS
Short-term borrowings at December 31 consist of the following:
2007 2006
------------------
(In Thousands)
Securities sold under agreements to repurchase $24,885 $21,736
Federal funds purchased 800 -
U.S. Treasury demand notes 1,001 1,000
------------------
$26,686 $22,736
==================
The outstanding balances and related information of short-term
borrowings are summarized as follows:
Years Ended December 31,
-------------------------------
2007 2006 2005
-------------------------------
(Dollars In Thousands)
Average balance during the year $22,443 $22,209 $15,059
Average interest rate during the year 4.15% 4.39% 2.76%
Maximum month-end balance during the year $33,024 $29,677 $24,956
Weighted average interest rate at the end of the year 3.60% 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 $27,127,000 and $27,410,000, respectively at December 31, 2007
and $24,535,000 and $24,720,000, respectively at December 31, 2006 were pledged
as collateral for these agreements. The securities underlying the agreements
were under the Company's control.
45
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, 2007 and 2006. The Company has a line of credit commitment available from
Atlantic Central Bankers Bank for $7,000,000 which expires in May 2008 and
Wachovia Bank for $2,000,000 which has no set expiration date. There were no
borrowings under these lines of credit at December 31, 2007 and 2006. The
Company has a line of credit commitment available which has no set expiration
date from PNC Bank for $12,000,000 at December 31, 2007. Borrowings under this
line of credit were $800,000 at December 31, 2007 and $-0- at December 31, 2006.
Long-term debt consisted of the following at December 31, 2007 and
2006:
2007 2006
--------------------
(In Thousands)
Notes with the Federal Home Loan Bank (FHLB):
Fixed note due April 2008 at 4.17% $ 5,000 $ 5,000
Convertible note due April 2009 at 4.83% - 5,000
Convertible note due January 2011 at 5.24% 3,000 3,000
Convertible note due October 2012 at 4.37% 5,000 -
Convertible note due January 2017 at 4.71% 10,000 -
--------------------
$23,000 $13,000
====================
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 17 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, 2007 are as
follows (in thousands):
2008 $ 5,000
2009 -
2010 -
2011 3,000
2012 5,000
Thereafter 10,000
-------
$23,000
=======
The Bank's maximum borrowing capacity with the Federal Home Loan Bank
was $240,172,000 of which $23,000,000 was outstanding at December 31, 2007.
Advances from the Federal Home Loan Bank are secured by qualifying assets of the
Bank.
NOTE 8 - EMPLOYEE BENEFIT PLANS
The Company has a defined contributory profit-sharing plan which
includes provisions of a 401(k) plan. The plan permits employees to make pre-tax
contributions up to 15% of the employee's compensation. The amount of
contributions to the plan, including matching contributions, is at the
discretion of the Board of Directors. All employees over the age of 21 are
eligible to participate in the plan after one year of employment. Employee
contributions are vested at all times, and any Company contributions are fully
vested after five years. The Company's contributions are expensed as the cost is
incurred, funded currently, and amounted to $400,000, $181,000, and $207,000 for
the years ended December 31, 2007, 2006 and 2005, respectively.
46
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, 2007 and 2006,
other liabilities include approximately $966,000 and $858,000 accrued under the
Plan. Compensation expense includes approximately $108,000, $138,000, and
$140,000, relating to the supplemental executive retirement plan for 2007, 2006
and 2005, 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, 2007 and 2006, the cash value of
these policies was $7,767,000 and $7,479,000, 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 made 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 was secured by the shares of the stock purchased and was paid
off in 2006.
As the debt was repaid, shares were 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 $-0- and $12,000 for the years ended December 31,
2007 and 2006, respectively. The total employer contribution was $-0- and
$143,000 for the years ended December 31, 2007 and 2006, respectively.
Compensation expense for the ESOP was $-0-, $444,000, and $588,000 for
the years ended December 31, 2007, 2006, and 2005, respectively. .
The status of the ESOP shares at December 31 are as follows:
2007 2006
--------------------
Allocated shares 160,243 162,690
Shares released from allocation 30,666 28,219
Unreleased shares - -
--------------------
Total ESOP shares 190,909 190,909
====================
Fair value of unreleased shares $ - $ -
====================
NOTE 9 - INCOME TAXES
The components of the provision for federal income taxes are as
follows:
Years Ended December 31,
-------------------------
2007 2006 2005
-------------------------
(In Thousands)
Current $2,780 $2,787 $2,378
Deferred (151) (108) (37)
--------------------------
$2,629 $2,679 $2,341
==========================
47
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,
-----------------------------------------
2007 2006 2005
-----------------------------------------
Tax at statutory rates 34.0 % 34.0 % 34.0 %
Tax exempt interest income, net of interest expense disallowance (3.4) (3.6) (4.7)
Increase in fair market value of ESOP - 1.2 1.6
Incentive Stock Options 0.8 0.5 -
Earnings on life insurance (1.1) (1.0) (1.1)
Other (1.5) 0.1 0.1
-----------------------------------------
28.8 % 31.2 % 29.9 %
=========================================
The income tax provision includes $6,000, $22,000, and $14,000, of
income taxes relating to realized securities gains for the years ended December
31, 2007, 2006, and 2005, respectively.
The net deferred tax asset included in other assets in the accompanying
balance sheets includes the following amounts of deferred tax assets and
liabilities:
2007 2006
------------------------
(In Thousands)
Deferred tax assets:
Allowance for loan losses $ 1,271 $ 1,142
Deferred compensation 345 292
Intangible assets 68 94
Net unrealized losses on securities - 1
Other 29 21
------------------------
Total Deferred Tax Assets 1,713 1,550
------------------------
Deferred tax liabilities:
Premises and equipment 226 215
Deferred loan fees 307 305
Net unrealized gains on securities 549 -
------------------------
Total Deferred Tax Liabilities 1,082 520
------------------------
Net Deferred Tax Asset $ 631 $ 1,030
========================
48
NOTE 9 - INCOME TAXES (CONTINUED)
Effective January 1, 2007, the Company adopted the provisions of
Financial Accounting Standards (FASB) Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes." The Interpretation provides clarification on
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." The Interpretation
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return, and also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. As a result of the Company's evaluation of the
implementation of FIN 48, no significant income tax uncertainties were
identified. Therefore, the Company recognized no adjustment for unrecognized
income tax benefits for the year ended December 31, 2007. Our policy is to
recognize interest and penalties on unrecognized tax benefits in income taxes
expense in the Consolidated Statements of Income. The amount of interest and
penalties for the year ended December 31, 2007 was immaterial. The tax years
subject to examination by the taxing authorities are the years ended December
31, 2006, 2005, 2004 and 2003.
Effective January 1, 2007, the Company adopted the provision of FASB
Staff Position ("FSP") FIN 48-1 "Definition of Settlement in FASB Interpretation
No. 48" (FSP FIN 48-1). FSP FIN 48-1 provides guidance on how to determine
whether a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits. FSP FIN 48-1 is effective retroactively to
January 1, 2007. The implementation of this standard did not have a material
impact on our consolidated financial position or results of operations.
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, 2007 and 2006 such loans amounted to $5,635,000 and $5,959,000,
respectively. During 2007, new loans to such related parties totaled $228,000
and repayments and other reductions aggregated $552,000.
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, 2007, that the Company and the Bank meet
all capital adequacy requirements to which they are subject.
As of December 31, 2007, 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.
49
NOTE 11 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY (CONTINUED)
The Bank's actual capital amounts and ratios are presented in the table:
To Be Well Capitalized
under Prompt
For Capital Adequacy Corrective Action
Actual Purposes Provisions
--------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------
(Dollars in Thousands)
As of December 31, 2007:
Total capital (to risk-weighted assets) $57,968 17.43 % $>26,606 >8.00 % $>33,258 >10.00 %
- - - -
Tier 1 capital (to risk-weighted assets) 53,545 16.10 >13,303 >4.00 >19,955 > 6.00
- - - -
Tier 1 capital (to average assets) 53,545 11.14 >19,226 >4.00 >24,033 > 5.00
- - - -
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
- - - -
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, 2007 and 2006 was approximately $266,000 and
$253,000, respectively.
Under Pennsylvania banking law, the Bank is subject to certain
restrictions on the amount of dividends that it may declare without prior
regulatory approval. At December 31, 2007, $48,809,000 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. Under this plan, the Company granted 22,000
options in 2007 which included 4,000 options granted to outside directors and
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.
Total unrecognized compensation cost related to nonvested options under
the Plan was $154,000 as of December 31, 2007 and $251,000 as of December 31,
2006. Salaries and employee benefits expense includes $251,000 and $136,000
related to the adoption of Statement No.123(R) for the years ended December 31,
2007 and 2006, respectively. Net income was reduced by $236,000 and $129,000 for
the years ended December 31, 2007 and 2006 respectively.
50
NOTE 12 - STOCK OPTION PLANS (CONTINUED)
A summary of the Company's stock option activity and related
information for the years ended December 31 follows:
2007 2006 2005
----------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average Average Average
Exercise Intrinsic Exercise Intrinsic Exercise
Options Price Value Options Price Value Options Price
----------------------------------------------------------------------------------------
Outstanding,
beginning of year 183,645 $21.81 140,296 $18.45 149,997 $18.25
Granted 22,000 31.25 47,700 30.91 - -
Exercised (24,723) 13.76 (4,351) 13.05 (9,701) 15.44
Forfeited (500) 31.50 - - - -
---------------------------------------------------------------------------------------
Outstanding,
end of year 180,422 $24.04 $1,301,000 183,645 $21.81 $1,780,000 140,296 $18.45
=======================================================================================
Exercisable,
at end of year 158,422 $23.04 $1,301,000
==============================
Exercise prices for options outstanding as of December 31, 2007 ranged
from $10.37 to $31.50 per share. The weighted average remaining contractual life
is 6.1 years.
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,
----------------------------
2007 2006 2005
----------------------------
Dividend yield 2.75% 2.70% -%
Expected life 7 years 7 years -
Expected volatility 24.17% 25.12% -%
Risk-free interest rate 3.53% 4.85% -%
Weighted average fair value of options granted $ 6.99 $ 8.11 $ -
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 $341,000 in 2007. 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 2007, all the shares issued in connection
with stock option exercises, 24,723 shares in total, were issued from available
treasury shares.
51
NOTE 12 - STOCK OPTION PLANS (CONTINUED)
As of December 31, 2007, outstanding stock options consist of the
following:
Average Average
Options Exercise Remaining Options Exercise
Outstanding Price Life, Years Exercisable Price
----------- ----- ----------- ----------- -----
14,962 $15.24 1.0 14,962 $15.24
14,174 14.12 2.0 14,174 14.12
9,450 10.36 3.0 9,450 10.36
16,537 16.98 4.0 16,537 16.98
16,537 19.05 5.0 16,537 19.05
19,612 23.95 6.0 19,612 23.95
20,475 30.00 7.0 20,475 30.00
24,675 30.38 8.3 24,675 30.38
22,000 31.50 9.0 22,000 31.50
22,000 31.25 10.0 - -
------- -------
Total 180,422 $24.04 6.1 158,422 $23.04
======= =======
NOTE 13 - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share:
Years Ended December 31,
------------------------
2007 2006 2005
------------------------
(In Thousands, Except per Share Data)
Numerator, net income $6,511 $5,910 $5,497
========================
Denominator:
Denominator for basic earnings per share, weighted
average shares 2,777 2,795 2,800
Effect of dilutive securities, employee stock options 49 55 59
------------------------
Denominator for diluted earnings per share, adjusted weighted average
shares and assumed conversions 2,826 2,850 2,859
========================
Basic earnings per common share $ 2.34 $ 2.11 $ 1.96
========================
Diluted earnings per common share $ 2.30 $ 2.07 $ 1.92
========================
NOTE 14 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
52
NOTE 14 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS (CONTINUED)
A summary of the Bank's financial instrument commitments is as follows:
December 31,
--------------------
2007 2006
--------------------
(In Thousands)
Commitments to grant loans $10,835 $12,611
Unfunded commitments under lines of credit 34,146 34,150
Standby letters of credit 2,348 7,215
--------------------
$47,329 $53,976
====================
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since some of the commitments are expected to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. The Bank evaluates each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the customer and generally consists of real
estate.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. The majority
of these standby letters of credit expire within the next twelve months. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending other loan commitments. The Bank requires collateral
supporting these letters of credit when deemed necessary. Management believes
that the proceeds obtained through a liquidation of such collateral would be
sufficient to cover the maximum potential amount of future payments required
under the corresponding guarantees. The current amount of the liability as of
December 31, 2007 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, 2007 and 2006:
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.
53
NOTE 15 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
o The fair value of the investment in FHLB stock is the carrying amount.
o The fair value of accrued interest receivable and accrued interest payable
is the carrying amount.
o The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits for similar remaining maturities.
o The fair value of short-term borrowings approximate their carrying amount.
o The fair value of long-term debt is estimated using discounted cash flow
analyses based upon the Company's current borrowing rates for similar types
of borrowing arrangements.
o The fair value of commitments to extend credit and for outstanding letters
of credit is estimated using the fees currently charged to enter into
similar agreements.
The estimated fair values of the Company's financial instruments are as
follows:
December 31, 2007 December 31, 2006
-----------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-----------------------------------------
(In Thousands)
Financial assets:
Cash and due from banks and interest-bearing
deposits with banks $ 9,064 $ 9,064 $ 9,517 $ 9,517
Securities 124,692 124,708 113,866 113,883
Loans receivable, net 327,215 326,482 311,739 305,779
Investment in FHLB stock 2,072 2,072 1,687 1,687
Accrued interest receivable 2,343 2,343 2,129 2,129
Financial liabilities:
Deposits 370,000 370,159 358,103 357,691
Short-term borrowings 26,686 26,686 22,736 22,736
Long-term debt 23,000 22,097 13,000 12,974
Accrued interest payable 3,198 3,198 2,894 2,894
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding
letters of credit - - - -
54
NOTE 16 - NORWOOD FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
BALANCE SHEETS December 31,
-----------------
2007 2006
-----------------
(In Thousands)
ASSETS
Cash on deposit in bank subsidiary $ 148 $ 552
Securities available for sale 623 808
Investment in bank subsidiary 54,678 50,781
Other assets 1,058 731
-----------------
$56,507 $52,872
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 688 $ 641
Stockholders' equity 55,819 52,231
-----------------
$56,507 $52,872
=================
STATEMENTS OF INCOME
Years Ended December 31,
-----------------------------
2007 2006 2005
-----------------------------
(In Thousands)
Income:
Dividends from bank subsidiary $ 4,156 $ 2,369 $ 1,997
Interest income from bank subsidiary - 5 16
Other interest income 30 28 26
Net realized gain (loss) on sales of securities 17 15 -
-----------------------------
4,203 2,417 2,039
Expenses 177 175 198
-----------------------------
4,026 2,242 1,841
Income tax expense (benefit) (51) (43) (53)
-----------------------------
4,077 2,285 1,894
Equity in undistributed earnings of subsidiary 2,434 3,625 3,603
-----------------------------
Net Income $ 6,511 $ 5,910 $ 5,497
=============================
STATEMENTS OF CASH FLOWS
Years Ended December 31,
-----------------------------
2007 2006 2005
-----------------------------
(In Thousands)
Cash Flows from Operating Activities
Net income $ 6,511 $ 5,910 $ 5,497
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (2,434) (3,625) (3,603)
Release of ESOP shares - 421 565
Other, net (168) (131) (615)
-----------------------------
Net Cash Provided by Operating Activities 3,909 2,575 1,844
-----------------------------
Cash Flows from Investing Activities
Proceeds from sale of securities 74 30 -
Purchase of securities available for sale - (43) (52)
-----------------------------
Net Cash Provided by (Used) in Investing Activities 74 (13) (52)
-----------------------------
Cash Flows from Financing Activities
Stock options exercised 341 60 150
ESOP purchase of shares from treasury stock 144 120 114
Acquisition of treasury stock (2,313) (890) (819)
Cash dividends paid (2,559) (2,289) (1,916)
-----------------------------
Net Cash Used in Financing Activities (4,387) (2,999) (2,471)
-----------------------------
Net Decrease in Cash and Cash Equivalents (404) (437) (679)
Cash and Cash Equivalents - Beginning 552 989 1,668
-----------------------------
Cash and Cash Equivalents - Ending $ 148 $ 552 $ 989
=============================
55
INVESTOR INFORMATION
STOCK LISTING
Norwood Financial Corp. stock is traded on the Nasdaq Global Market
under the symbol NWFL. The following firms are known to make a market in the
Company's stock:
Ferris Baker Watts Janney Montgomery Scott, LLC
Baltimore, MD Scranton, PA 18503
410-659-4616 800-638-4417
Legg Mason, Inc. Boenning & Scattergood, Inc.
Scranton, PA 18507 West Conshohoken, PA
570-346-9300 800-496-1170
Stifel Nicolaus
800-793-7226
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 annual report on Form 10-K for its fiscal year
ended December 31, 2007 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, Secretary, and Chief Financial Officer,
Norwood Financial Corp., 717 Main Street, PO Box 269, Honesdale, PA 18431,
570-253-1455.
56
[PICTURE OMITTED]
At our Annual Reorganizational Meeting held on
April 24, 2007, John Marshall, Director since 1983,
succeeded long-standing Chairman, Russell L. Ridd.
Mr. Ridd had a 44-year career at Wayne Bank. He
joined the bank in 1963, was appointed to President
and Director in 1980, and Chairman in 1993. The
Board unanimously passed a resolution designating
Mr. Ridd, Director Emeritus of Norwood Financial
Corp and Wayne Bank.
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NORWOOD FINANCIAL CORP - DIRECTORY OF OFFICERS
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NORWOOD FINANCIAL CORP Karyn Vashlishan Vice President
John E. Marshall Chairman of the Board Karen R. Gasper Internal Auditor & Assistant
William W. Davis, Jr. President & Chief Executive Officer Vice President
Lewis J. Critelli Executive Vice President, Chief Financial Sandra Halas Assistant Vice President
Officer & Secretary Norma J. Kuta Assistant Vice President
Edward C. Kasper Senior Vice President Renee M. Gilbert Community Office Manager
John H. Sanders Senior Vice President Marianne M. Glamann Community Office Manager
Joseph A. Kneller Senior Vice President Teresa Melucci Community Office Manager
Sandra Mruczkewycz Community Office Manager
WAYNE BANK Nancy M. Worobey Community Office Manager
John E. Marshall Chairman of the Board Laurie J. Bishop Assistant Community Office Manager
William W. Davis, Jr. President & Chief Executive Officer Wendy L. Davis Assistant Community Office Manager
Lewis Critelli Executive Vice President, Chief Financial Christine Ferdinando Assistant Community Office Manager
Office and Secretary Jill Melody Assistant Community Office Manager
Edward C. Kasper Senior Vice President & Senior Loan Diane L. Richter Assistant Community Office Manager
Officer/Corporate Bank Toni M. Stenger Assistant Community Office Manager
John H. Sanders Senior Vice President/Retail Bank Gary D. Henry Consumer Lending Officer
Joseph A. Kneller Senior Vice President Thomas Kowalski Resource Recovery Manager
Wayne D. Wilcha Senior Vice President & Trust Officer William E. Murray Mortgage Originator
Robert J. Behrens, Jr. Vice President Sarah J. Rapp Human Resources Officer
John F. Carmody Vice President Nilda I. Ramos Business Development Officer
JoAnn Fuller Vice President Doreen A. Swingle Residential Mortgage Lending Officer
Carolyn K. Gwozdziewycz Vice President Karen Verbeke Training Officer
Nancy A. Hart Vice President, Controller &
Assistant Secretary NORWOOD INVESTMENT CORP
Raymond C. Hebden Vice President William W. Davis, Jr. President & Chief Executive Officer
William J. Henigan, Jr. Vice President Lewis J. Critelli Executive Vice President
Jennifer Jaycox Vice President Scott C. Rickard Senior Investment Representative,
William R. Kerstetter Vice President Invest Financial Corp
Kelley J. Lalley Vice President & Assistant Secretary
Linda M. Moran Vice President MONROE COUNTY ASSOCIATE BOARD
MaryAlice Petzinger Vice President Michael J. Baxter James H. Ott
Barbara A. Ridd Vice President & Assistant Secretary Sara Cramer Marvin Papillon
Gary H. Sipe Vice President Andrew Forte Ray Price
Eli T. Tomlinson Vice President Ralph A. Matergia Ron Sarajian
Vice President Randy R. Motts
NORWOOD
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FINANCIAL CORP
VISIT US AT:
WAYNEBANK.COM