[GRAPHIC OMITTED]
NORWOOD
--------------
FINANCIAL CORP
BANK WITH CONFIDENCE.
2008 ANNUAL REPORT TO SHAREHOLDERS
[GRAPHIC OMITTED]
NORWOOD FINANCIAL CORP SUMMARY OF SELECTED FINANCIAL DATA
(dollars in thousands, except per share data)
For the years ended December 31, 2008 2007 2006 2005 2004
- -----------------------------------------------------------------------------------------------------
Net interest income $ 18,401 $ 17,272 $ 16,183 $ 15,263 $ 14,012
Provision for loan losses 735 315 220 350 455
Other income 4,105 3,507 3,517 3,506 3,088
Net realized gains (losses)
on sales of securities (18) 17 66 42 458
Other expense 12,240 11,341 10,957 10,623 10,090
Income before income taxes 9,513 9,140 8,589 7,838 7,013
Income tax expense 2,836 2,629 2,679 2,341 2,003
NET INCOME $ 6,677 $ 6,511 $ 5,910 $ 5,497 $ 5,010
Net income per share - Basic $ 2.44 $ 2.34 $ 2.11 $ 1.96 $ 1.80
Net income per share - Diluted $ 2.41 $ 2.30 $ 2.07 $ 1.92 $ 1.77
Cash dividends declared 1.02 0.94 0.85 0.71 0.66
Dividend pay-out ratio 41.80% 40.17% 40.28% 36.41% 36.51%
Return on average assets 1.36% 1.39% 1.33% 1.31% 1.27%
Return on average equity 11.79% 12.10% 11.85% 11.72% 11.39%
BALANCES AT YEAR-END
Total assets $ 504,296 $ 480,610 $ 454,356 $ 433,556 $ 411,626
Loans receivable 349,404 331,296 315,567 290,890 254,757
Allowance for loan losses 4,233 4,081 3,828 3,669 3,448
Total deposits 359,635 370,000 358,103 340,603 318,645
Shareholders' equity 58,690 55,819 52,231 48,108 45,685
Trust assets under management 90,069 101,714 96,879 86,972 83,397
Book value per share $ 21.45 $ 20.27 $ 18.67 $ 17.07 $ 16.14
Tier 1 Capital to risk-adjusted assets 16.22% 16.26% 15.67% 15.29% 15.91%
Total Capital to risk-adjusted assets 17.50% 17.60% 16.99% 16.63% 17.34%
Allowance for loan losses to total loans 1.21% 1.23% 1.21% 1.26% 1.35%
Non-performing assets to total assets 0.54% 0.03% 0.09% 0.08% 0.02%
[GRAPHIC OMITTED] FROM THE PRESIDENT
"This marks the It is truly a pleasure to report to you that your Company had a very
seventeenth strong financial performance in what was an extremely challenging
consecutive year economic environment in 2008. We had record earnings of
of increased cash $6,677,000 for the year ended December 31, 2008, an increase of
dividends for our $166,000, or 2.6% over the prior year. Earnings per share on a fully
shareholders." diluted basis were $2.41 for the current year, compared to $2.30 in
2007. Your Company declared dividends totaling $1.02 per share in
2008, an increase of $.08 per share, or 8.5% over the $.94 declared
in 2007. This marks the seventeenth consecutive year of increased
cash dividends for our shareholders. The return on average assets
for the year was 1.36% with a return on average equity of 11.79%.
Total assets exceeded $500 million for the first time in 2008 and
reached $504.3 million as of December 31, 2008. Loan receivable
totaled $349.4 million as of year-end 2008, with total deposits of
$359.6 million and stockholders' equity of $58.7 million. Our capital
position is extremely strong and we are at the top level of our peer
group in all measures of capital. With our strong capital position
we elected not to participate in the Treasury Department's TARP
Capital Purchase Program.
Loan receivable increased $18.1 million or 5.5% from the prior
year. The increase in loans centered in commercial real estate
which grew by 19.4%. As a result of the general slow down in the
local economy and a softer real estate market, the Company did
experience an increase in non-performing assets and net charge-offs
in 2008. As of December 31, 2008, total non-performing assets were
$2,747,000 and represented .54% of total assets compared to $613,000,
or .03% as of December 31, 2007. The increase was principally due
to two credit facilities to one borrower, both of which have been
written-down to their net realizable value. Net charge-offs for
1
"...we realize that the year total $583,000 compared to $62,000 in 2007. With the
each down-trend increase in non-performing loans and charge-offs we increased our
also creates provision for loan losses to $735,000 in 2008 compared to $315,000
opportunities." in 2007. As of December 31, 2008, the allowance for loan losses was
$4,233,000 increasing from $4,081,000 at December 31, 2007. We
- ------------------------------------- are continually monitoring our credit quality and are aggressively
addressing any issues as they arise, as we certainly recognize the
NET INCOME current stress on the economy and its impact on our customers.
--------------
(in thousands) For the year, net interest income (fully taxable equivalent) totaled
$19,030,000, an increase of $1,219,000 or 6.8% over 2007. Our net
[Bar graph with following data points] interest margin increased nine basis points to 4.07% in 2008. During
$5,010 $5,497 $5,910 $6,511 $6,677 2008, we offset a 400 basis point decrease in prime rate from 7.25%
04 05 06 07 08 to 3.25% by managing our costs of funds and growing the loan
portfolio.
[GRAPHIC OMITTED] Other income for 2008 total $4,087,000 compared to $3,524,000 in
2007. The increase was principally due to a $499,000 gain on the sale
of $14.4 million of mortgage loans and servicing rights in 2008. For
the year, other expenses totaled $12,240,000, an increase of $899,000
or 7.9% over the prior year. The increase, was due in part to $582,000
of costs related to a parcel of foreclosed real estate and includes a
write-down of the property to its current realizable value.
We strongly encourage you to read the financial section of this
Annual Report for a more detailed analysis of our results.
During the year, the national media reported that the banking
industry was hesitant to lend money in 2008. This was not the
case at Wayne Bank. Our retail banking division generated
over $50 million of loans in 2008. We continued to use the same
mortgage underwriting standards that have served us so well for 137
years. Making sound loans to credit-worthy borrowers benefits the
2
customer, the community and the Bank. [GRAPHIC OMITTED]
Our Commercial Lending Division was also very active in 2008. The
Bank's Commercial Lenders worked with our local businesses to TOTAL LOANS
develop commercial real estate projects, generate jobs, expand tourism -------------
efforts and stimulate the local economy. We were instrumental in (in millions)
financing motels, summer camps, shopping centers and many other
local projects. Although we are facing challenging economic times, [Bar graph with following data points]
we believe investing in the business community is crucial both to the $254.8 $290.9 $315.6 $331.3 $349.5
local community and to the Bank. 04 05 06 07 08
We are well aware that 2008 presented one of the most challenging --------------------------------------
periods for the financial and investment markets. Our Wealth
Management and Trust Services Division was certainly not immune "...the same
from the turbulent markets. However, by maintaining investment mortgage
discipline, on a relative basis we are encouraged by our results. underwriting
Market cycles are nothing new, and we realize that each down-trend standards that
also creates opportunities. have served us so
well for 137 years."
Wayne Bank's success in 2008, and in prior years, can be attributed
to many components such as maintaining expenses within the
organization, having a seasoned staff of committed employees, and
cost effectively promoting our products and services to existing
and new customers. In addition, another factor that contributed
to our success is the due diligence in basing loans on solid credit
fundamentals. Our philosophy is to grow at a sustainable and
consistent rate that best serves our shareholders in the long-
term. That has been proven, year after year, to be the best course. A
very important and integral part of this is the fact that Wayne Bank
is a locally managed community bank. This differentiates us from
regional and national banks as we are much more entrenched in local
events and organizations within the communities we serve. We live
3
ALLOWANCE FOR and work in our marketplace, our customers know us, and we know
------------- them. In many cases, we know their parents, or their brothers and
LOAN LOSSES sisters too. We have a history together - Wayne Bank founded in
----------- 1871 has been the financial institution of choice for generations in
(in thousands) Wayne County and we hope to continue that trend with our locations
in Pike and Monroe Counties.
[Bar graph with following data points]
$3,448 $3,669 $3,828 $4,081 $4,233 By supporting the communities we operate in, the Bank is a vital
04 05 06 07 08 link to many nonprofit organizations that help a great number of
people, primarily children and families. Whether it is the local high
- -------------------------------------- school band, the church bingo, the Historical Society, conservation
groups, the local Chamber of Commerce, the Red Cross or United
"...doing our part Way, Wayne Bank has donated to these causes and more. Wayne
to support the Bank gives not only monetary donations, but also through employee
"green" philosophy involvement, as many Directors, Officers and Employees give of their
and cutting costs time and energy to nonprofit boards, as well as, being members of an
at the same time" organization - from The Dorflinger-Suydam Wildlife Sanctuary to
the Wayne County YMCA, Wayne Bank has helped support many
[GRAPHIC OMITTED] local organizations.
Wayne Bank has been pursing a strategy with the use of technology
to improve customer service and attract new business. In the first
quarter of 2008, Business Link, a Remote Deposit Capture system
for business customers who routinely deposit checks, launched. This
service, using Internet technology, a personal computer and a
specially designed document-scanning device adds convenience,
efficiency and speed in collecting checks deposited directly at the
customer's location, any time of day, 7-days a week. Using resources
similar to remote deposit technology enable our community offices
to convert all teller transaction documents to digital images for
electronic transmission to our central processing headquarters and
eliminated significant weekly expenditures for courier services. Of
4
[GRAPHIC OMITTED]
course, this too, contributes to the environment by reducing the SENIOR MANAGEMENT
emissions and fuel usage of courier vehicles. -----------------
Other technology based services including online banking and Standing From Left to Right:
bill payment, direct deposit of payroll and benefit payments, Wayne D. Wilcha, William W. Davis, Jr.
electronic collection of loan payments, debit cards, ATMs and other Lewis J. Critelli
electronic funds transfer options all promote customer convenience,
operational efficiencies and make the world we live in cleaner and Seated, From Left to Right:
greener. Wayne Bank is doing our part to support the "green" Edward C. Kasper, John H. Sanders,
philosophy and cutting costs at the same time. For example, in just Joseph A. Kneller
one year, Wayne Bank recycled over 15,026 pounds of paper and we
have been converting our processes to paperless transactions. --------------------------------------
As with any organization, the foundation of success lies in acquiring TIER 1 CAPITAL RATIO
and retaining a strong workforce. During 2008, in keeping with --------------------
tradition, a number of employees were duly recognized and promoted
for their contributions and commitment to the Bank. Karen Gasper, [Bar graph with following data points]
Internal Auditor and Assistant Vice President promoted to Vice 15.91% 15.29% 15.67% 16.26% 16.22%
President, and Marianne Glamann, Community Office Manager of 04 05 06 07 08
the Marshalls Creeks Office promoted to Assistant Vice President and
Regional Manager of the Monroe County market. Other promotions
included Julie Kuen promoted to Electronic Banking Officer, Wendy
5
"Even in these Davis to Community Office Manager of Wayne Bank's Shohola
unprecedented Office and Rossie Demorizi-Ortiz to Community Office Manager
times, of the Tannersville Office. Gary Henry, Consumer Lending Officer
we are extremely is now the Community Officer Manager in Waymart. Notably, we
pleased with our had a number of employees who attained significant years of tenure
operating results." with the Bank including Sally Timko who achieved the status of
twenty-five years, as well as four employees who attained ten-years
of service and five employees who reached five years of service.
NET INTEREST INCOME
------------------- Even in these unprecedented times, we are extremely pleased with
(FTE $ in 000) our operating results. Our core earnings are strong, our net interest
margin has improved and our loan pipeline is encouraging. We
[Bar graph with following data points] should also emphasize Wayne Bank never participated in the sub-
$14,653 $15,889 $16,708 $17,811 $19,030 prime mortgage business. However, we are certainly aware that a
04 05 06 07 08 slowing economy and increasing unemployment will continue to
affect some cusomters' ability to save or borrow funds in 2009.
- -------------------------------------------
Wayne Bank will continue to monitor the economy and to take
DILUTED EARNINGS advantage of every opportunity that presents itself throughtout 2009
---------------- as we continue to market our products and services aggressively as
PER SHARE we have in the past to garner new deposits and loans suitable for the
---------- Bank and our customers.
[Bar graph with following data points] For almost 140 years, Wayne Bank has been a symbol of strength,
$1.77 $1.92 $2.07 $2.30 $2.41 safety and security for the communities, customers and stockholders
04 05 06 07 08 we serve. We are proud to continue that tradition. Please consider
us for all your financial needs. We genuinely appreciate all your
support.
Sincerely yours,
/s/ William W. Davis, Jr.
William W. Davis, Jr.
President & Chief Executive Officer
6
Norwood Financial Corp 2008 Board of Directors
[GRAPHIC OMITTED] [GRAPHIC OMITTED] [GRAPHIC OMITTED]
John E. Marshall, Gary P. Rickard Daniel J. O'Neill
Chairman of the Board
[GRAPHIC OMITTED] [GRAPHIC OMITTED] [GRAPHIC OMITTED]
William W. Davis, Jr. Dr. Kenneth A. Phillips Richard L. Snyder
President and CEO
[GRAPHIC OMITTED] [GRAPHIC OMITTED] [GRAPHIC OMITTED]
Susan Gumble-Cottell Ralph A. Matergia, Esq. Dr. Andrew A. Forte
Russell L. Ridd - Director Emeritus
7
[GRAPHIC OMITTED] Administrative Office:
717 Main Street
P.O. Box 269
Honesdale, PA 18431
Community Offices:
717 Main Street
Honesdale, PA 18431
245 Willow Avenue
Honesdale, PA 18431
Belmont & Water Streets
Waymart, PA 18472
Route 6 East
Hawley, PA 18428
111 West Harford Street
Milford, PA 18337
107 Richardson Avenue
Shohola, PA 18458
Route 370 & Lake Como Road
Lakewood, PA 18439
Route 611 & Stroud Mall
Stroudsburg, PA 18360
637 Route 739
Lords Valley Shopping Plaza
Lords Valley, PA 18428
Route 209, 5165 Milford Road
Marshalls Creek, PA 18335
Route 611, Fountain Springs East II
Tannersville, PA 18372
Online at: waynebank.com
(800) 598-5002
8
NORWOOD
FINANCIAL CORP
2008
CONSOLIDATED FINANCIAL REPORT
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS 10
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING 31
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 32
CONSOLIDATED BALANCE SHEETS 34
CONSOLIDATED STATEMENTS OF INCOME 35
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 36
CONSOLIDATED STATEMENTS OF CASH FLOWS 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 38
INVESTOR INFORMATION 64
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, 2008 and 2007 and for
the years ended December 31, 2008, 2007, and 2006. 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, 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,
the potential impairment of restricted stock, 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.
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.
Restricted stock which represents required investment in the common stock
of correspondent banks is carried at cost and as of December 31, 2008 and 2007,
consists of the common stock of Federal Home Loan Bank of Pittsburgh. In
December 2008, the FHLB of Pittsburgh notified member banks that it was
suspending dividend payments and the repurchase of capital stock.
Management evaluates the restricted stock for impairment in accordance with
Statement of Position (SOP)01-6, Accounting by Certain Entities (Including
Entities With Trade Receivables) That Lend to or Finance the Activities of
Others. Management's determination of whether these investments are impaired is
based on their assessment of the ultimate recoverability of their cost rather
than by recognizing temporary decline in value. The determination of whether a
decline affects the ultimate recoverability of their cost is influenced by
criteria such as (1) the significance of the decline in net assets of the FHLB
as compared to the capital stock amount for the FHLB and length of time this
situation has persisted, (2) commitments by the FHLB to make payments required
by law or regulation and the level of such payments in relation to the operating
performance of the FHLB, and (3) the impact of legislative and regulatory
changes on institutions and, accordingly, on the customer base of the FHLB.
Management believes no impairment charge is necessary related to the restricted
stock as of December 31, 2008.
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, 2008 and
2007 represent temporary impairment of the securities.
EMERGENCY ECONOMIC STABILIZATION ACT OF 2008
In response to recent unprecedented market turmoil, the Emergency Economic
Stabilization Act of 2008 ("ESSA") was enacted on October 3, 2008. EESA
authorizes the Secretary of the Treasury to purchase up to $700 billion in
troubled assets from financial institutions under the Troubled Asset Relief
Program or TARP.
Among its many provisions, the EESA increased the maximum deposit insurance
amount up to $250,000 until December 31, 2009 and removes the statutory limits
on the FDIC's ability to borrow from the Treasury during this period. The FDIC
may not take the temporary increase in deposit insurance coverage into account
when setting assessments. EESA allows financial institutions to treat any loss
on the preferred stock of the Federal National Mortgage Association or Federal
Home Loan Mortgage Corporation as an ordinary loss for tax purposes.
Pursuant to his authority under EESA, the Secretary of the Treasury created
the TARP Capital Purchase Plan (CPP) under which the Treasury Department will
invest up to $250 billion in senior preferred stock of U.S. banks and savings
associations or their holding companies. Qualifying financial institutions may
issue
11
senior preferred stock with a value equal to not less than 1% of risk-weighted
assets and not more than the lesser of $25 billion or 3% of risk-weighted
assets. The senior preferred stock will pay dividends at the rate of 5% per
annum until the fifth anniversary of the investment and thereafter at the rate
of 9% per annum. The senior preferred stock may not be redeemed for three years
except with the proceeds from an offering of common stock or preferred stock
qualifying as Tier 1 capital in an amount equal to not less than 25% of the
amount of the senior preferred. After three years, the senior preferred may be
redeemed at any time in whole or in part by the financial institution. No
dividends may be paid on common stock unless dividends have been paid on the
senior preferred stock. Until the third anniversary of the issuance of the
senior preferred, the consent of the U.S. Treasury will be required for any
increase in the dividends on the common stock or for any stock repurchases
unless the senior preferred has been redeemed in its entirety or the Treasury
has transferred the senior preferred to third parties. The senior preferred will
not have voting rights other than the right to vote as a class on the issuance
of any preferred stock ranking senior, any change in its terms or any merger,
exchange or similar transaction that would adversely affect its rights. Prior to
issuance, the financial institution and its senior executive officers must
modify or terminate all benefit plans and arrangements to comply with EESA.
Senior executives must also waive any claims against the Department of Treasury.
In connection with the issuance of the senior preferred, publicly traded
participating institutions must issue the Secretary immediately exercisable
10-year warrants to purchase common stock with an aggregate market price equal
to 15% of the amount of senior preferred.
Due to its strong capital position, the Company decided not to participate
in the CPP.
RESULTS OF OPERATIONS - SUMMARY
Net income for the Company for the year-ended December 31, 2008 totaled
$6,677,000, an increase of $166,000, or 2.6% over the $6,511,000 earned in 2007.
Basic and diluted earnings per share were $2.44 and $2.41, respectively,
increasing from $2.34 and $2.30, respectively in 2007. The return on average
assets (ROA) for the year ended December 31, 2008 was 1.36% with a return on
average equity (ROE) of 11.79% compared to an ROA of 1.39% and ROE of 12.10% for
the prior year. The increase in earnings was principally attributable to an
increase in net interest income on a fully-taxable equivalent basis (fte) of
$1,219,000 which offset a higher provision for loan losses of $420,000 and
$582,000 of write-down and costs to maintain a property in foreclosed real
estate.
Net interest income (fte) totaled $19,030,000 in 2008, an increase of
$1,219,000 or 6.8% over the $17,811,000 in the prior year. Net interest income
was favorably impacted by a $20.5 million increase in average earning assets for
2008 compared to average earning assets in 2007. The net interest margin
increased 9 basis points to 4.07% in 2008. The Company offset a 400 basis point
decrease in prime rate of interest by managing its cost of funds. During 2008,
the cost of interest-bearing liabilities declined 76 basis points to offset a 52
basis point drop in earning asset yields.
Loans receivable increased $18.1 million or 5.5% from the prior year end.
The increase in loans was centered in commercial real estate which increased
$25.9 million, which was partially offset by a lower level of construction
financing and commercial term loans. As a result of the general economic slow
down and a softer real estate market, the Company did experience an increase in
non-performing assts and net charge-offs in 2008. As of December 31, 2008, total
non-performing assets were $2,747,000 and represented .54% of total assets
compared to $163,000, or .03% as of December 31, 2007. The increase was
principally due to
12
two credit facilities to one borrower, both of which have been written-down to
their net realizable value. Net charge-offs for the year totaled $583,000
compared to $62,000 in 2007. The Company increased its provision for loan losses
to $735,000 in the current year compared to $315,000 in 2007.
Other income for the year ended December 31, 2008 totaled $4,087,000
increasing $563,000 from $3,524,000 in the prior year. The increase was
principally due to a $499,000 gain on the sale of $14.4 million of mortgage
loans and servicing rights compared to $23,000 in similar gains in 2007. For the
current year, other expenses totaled $12,240,000, an increase of $899,000 or
7.9% over the prior year. The increase was principally due to a $582,000
write-down to current realizable value of a foreclosed real estate property as
well as costs to maintain the real estate. Excluding costs related to foreclosed
real estate, other expenses increased 2.8%.
The following table sets forth changes in net income (in thousands):
Net income 2007 $ 6,511
Net interest income 1,129
Provision for loan losses (420)
Gain on sale of mortgage loans and servicing rights 476
Other income 87
Salaries and employee benefits (221)
Foreclosed real estate owned (582)
Other expense (96)
Income tax expense (207)
-------
Net income for 2008 $ 6,677
=======
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.
13
The Company's loan quality metrics improved 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 $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 recognized 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.
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 and servicing rights (124)
Other income 65
Salaries and employee benefits (170)
Occupancy (119)
Other expense (95)
Income tax expense 50
-------
Net income for 2007 $ 6,511
=======
FINANCIAL CONDITION
TOTAL ASSETS
Total assets as of December 31, 2008, were $504.3 million compared to
$480.6 million as of year-end 2007, an increase of $23.7 million or 4.9%.
LOANS RECEIVABLE
As of December 31, 2008, loans receivable totaled $349.4 million compared
to $331.3 million as of year-end 2007, an increase of $18.1 million, or 5.5%.
Loan growth, principally in commercial real estate and to a lesser extent in
residential mortgages was partially offset by lower construction financing,
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 $133.4
million as of December 31, 2008, compared to $129.9 million as of year-end 2007,
an increase of $3.5 million. 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 $14.4 million of 30 year
fixed rate loans sold into the secondary market during 2008. In the current low
interest rate environment, the
14
Company expects to continue selling mortgage loans in 2009. The Company also had
growth in home equity lending in 2008 through its branch system. Total
outstandings increased $1.2 million to $53.7 million as of December 31, 2008.
The increase was principally in home equity lines of credit.
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 $159.5 million as
of December 31, 2008, increasing from $133.6 million as of December 31, 2007, an
increase of $25.9 million or 19.4%. The terms for commercial real estate loans
are typically 15 to 20 years, with adjustable rates based on a spread to the
prime rate or fixed for the initial three to five year period then adjusting to
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 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
$3.3 million to $25.9 million as of December 31, 2008. 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 $1.6 million to $10.0 million as of December 31, 2008. The
Company has de-emphasized indirect automobile lending and has also experienced a
general slow down in marine and non-titled vehicle indirect financing.
ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING ASSETS
The allowance for loan losses was $4,233,000 as of December 31, 2008 and
represented 1.21% of total loans receivable compared to $4,081,000 and 1.23% of
total loans as of year end 2007. Net charge-offs for 2008 totaled $583,000 and
represented .17% of average loans compared to $62,000 and .02% of average loans
in 2007. The increase in charge-offs was principally due to a $380,000
write-down of a commercial real estate land development loan with collateral
consisting of several parcels of real estate. With increasing net charge-offs
and recognizing the softness in the economy, the Company increased its loan loss
provision to $735,000 for the year end December 31, 2008 from $315,000 for the
year 2007.
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, 2008, the Company considered its concentration of
credit risk profile to be acceptable. As a result of weaker economic conditions,
the Company has seen an increase in its internally risk-rated loans. The local,
regional and national economy weakened in 2008 as unemployment increased,
financial markets declined and the real estate market slowed which has caused an
increasing trend in loan delinquencies. The Company has modestly increased its
number of large commercial credits. As a result of its analysis, after applying
these factors, management considers the allowance as of December 31, 2008,
adequate. However, there can be no assurance that the allowance for loan losses
will be adequate to cover all losses, if any that might be incurred in the
future.
15
The following table sets forth information with respect to the Company's
allowance for loan losses for the periods indicated:
Year-ended December 31,
-------------------------------------------------------
(dollars in thousands)
2008 2007 2006 2005 2004
-------------------------------------------------------
Allowance balance at beginning of period $ 4,081 $ 3,828 $ 3,669 $ 3,448 $ 3,267
Charge-offs:
Commercial and all other (7) - - (4) (19)
Real Estate (465) (4) - (6) (10)
Consumer (171) (117) (150) (200) (342)
Lease Financing - - - - (11)
-------------------------------------------------------
Total (643) (121) (150) (210) (382)
Recoveries:
Commercial and all other - - 18 12 13
Real Estate 1 2 2 18 8
Consumer 59 54 65 46 78
Lease Financing - 3 4 5 9
-------------------------------------------------------
Total 60 59 89 81 108
Provision expense 735 315 220 350 455
-------------------------------------------------------
Allowance balance at end of period $ 4,233 $ 4,081 $ 3,828 $ 3,669 $ 3,448
=======================================================
Allowance for loan losses as a percent
of total loans outstanding 1.21% 1.23% 1.21% 1.26% 1.35%
Net loans charged off as a percent of
average loans outstanding .17% .02% .02% .05% .11%
Allowance coverage of non-performing loans 2.0x 25.0x 9.4x 10.4x 51.5x
Non-performing assets consist of non-performing loans and real estate owned
as a result of 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 is
reversed from current earnings.
As of December 31, 2008, non-performing loans totaled $2,087,000 and
represented .60% of total loans increasing from $163,000 and .05% of total loans
as of December 31, 2007. The increase is principally due to one commercial real
estate land development loan of $1,693,000, which reflects a $380,000 write-down
taken in 2008. In 2008, the Company acquired a property with a deed in lieu of
foreclosure with a net realizable value of $660,000. The property consists of
undeveloped residential building lots in Monroe County.
16
The following table sets forth information regarding non-performing assets.
As of December 31, 2008, the Company had $2,976,000 of impaired and collateral
dependent loans compared to $3,208,000 at year-end 2007, with no required
allowance as of years-end December 31, 2008 and 2007.
December 31,
----------------------------------------------
(dollars in thousands)
2008 2007 2006 2005 2004
----------------------------------------------
Non-accrual loans:
Commercial and all other $ - $ - $ - $ - $ -
Real estate 2,087 109 392 330 32
Consumer - 2 17 11 8
----------------------------------------------
Total 2,087 111 409 341 40
Accruing loans which are contractually
past due 90 days or more - 52 - 12 27
----------------------------------------------
Total non-performing loans 2,087 163 409 353 67
Foreclosed real estate 660 - - - -
----------------------------------------------
Total non-performing assets $2,747 $ 163 $ 409 $ 353 $ 67
==============================================
Non-performing loans to total loans .60% .05% .13% .12% .03%
Non-performing loans to total assets .41% .03% .09% .08% .02%
Non-performing assets to total assets .54% .03% .09% .08% .02%
SECURITIES
The securities portfolio consists principally of issues of United States
Government agencies, including mortgage-backed securities, municipal obligations
and corporate debt. In accordance with SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" the Company classifies its
investments into two categories: held to maturity (HTM) and available for sale
(AFS). The Company does not have a trading account. Securities classified as HTM
are those in which the Company has the ability and the intent to hold the
security until contractual maturity. As of December 31, 2008, the HTM portfolio
totaled $707,000 and consisted of two municipal obligations. Securities
classified as AFS are eligible to be sold due to liquidity needs or interest
rate risk management. These securities are adjusted to and carried at their fair
market value with any unrealized gains or losses recorded net of deferred income
taxes, as an adjustment to capital and reported in the equity section of the
balance sheet as other comprehensive income (loss). As of December 31, 2008,
$130.1 million in securities were so classified and carried at their fair market
value, with unrealized appreciation; net of tax, of $1,279,000, included in
Accumulated other comprehensive income in stockholders' equity.
17
As of December 31, 2008, the average life of the portfolio was 2.6
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 $45.3 million with securities called, maturities and cash flow
of $39.3 million and proceeds from sales of $67,000. The purchases were funded
principally by cash flow from the portfolio. As of December 31, 2008 the
carrying value of the Company's securities portfolio (HTM and AFS) totaled
$130.8 million with the mix as follows:
2008 2007
--------------------------------------------------
(dollars in thousands)
Carrying Carrying
Value % of portfolio Value % of portfolio
--------------------------------------------------
US Government agencies $ 35,813 27.5% $ 41,508 33.4%
States & political subdivisions 25,916 19.8% 22,622 18.1%
Corporate Securities 5,625 4.3% 4,994 4.0%
Mortgage-backed securities 62,318 47.5% 54,082 43.3%
Equity securities 1,155 0.9% 1,486 1.2%
--------------------------------------------------
Total $130,827 100.0% $124,692 100.0%
==================================================
The portfolio had $15.2 million of adjustable rate instruments, principally
adjustable rate mortgage backed securities as of December 31, 2008 compared to
$19.1 million at year end 2007. The portfolio contained no private label
mortgage backed securities, collateralized debt obligations (CDOs), trust
preferreds, 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 (FHLMC), and
Government National Mortgage Association (GNMA). The Company has no exposure to
common or preferred stock of FNMA or FHLMC. During 2008, the Company increased
its holdings of mortgage-backed securities with the expectation that the bonds
will provide regular cash flow, provide liquidity and support loan growth.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company uses fair value measurements to record fair value adjustments
to certain financial instruments and determine fair value disclosures. (See Note
16 of Notes to the Consolidated Financial Statements).
Approximately $130.1 million, which represents 25.8% of total assets at
December 31, 2008, consisted of financial instruments recorded at fair value on
a recurring basis. This amount consists entirely of the Company's available for
sale securities portfolio. The Company uses valuation methodologies involving
market-based or market derived information, collectively Level 1 and 2
measurements, to measure fair value. There were no transfers into or out of
Level 3 for any instruments for the year ending December 31, 2008.
The Company utilizes a third party provider to perform valuations of the
investments. Methods used to perform the valuations include: pricing models that
vary based on asset class, available trade and bid
18
information, actual transacted prices, and proprietary models for valuations of
state and municipal obligations. In addition, the Company has a sample of
fixed-income securities valued by an other independent source. Generally, the
Company does not adjust values received from its providers, unless it is evident
that fair value measurement is not consistent with SFAS No. 157.
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. The Company has no brokered deposits.
Total deposits as of December 31, 2008, totaled $359.6 million decreasing
from $370.0 million as of year-end 2007, a decrease of $10.4 million. The
decrease was principally due to a lower level of time deposits over $100,000,
which declined by $17.2 million. This was partially offset by an increase in
money market deposit accounts of $2.7 million, savings accounts of $1.6 million
and interest-bearing checking accounts of $2.9 million.
Time deposits over $100,000, which consist principally of school district
funds, other public funds and short-term deposits from large commercial
customers with maturities generally less than one year, totaled $45.1 million as
of December 31, 2008, compared to $62.3 million at year-end 2007. The decrease
was principally due to the scheduled maturities of time deposits from a
commercial customer. The Company also had a lower 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, 2008, non-interest bearing demand deposits totaled $56.8
million compared to $60.1 million at year-end 2007. This decrease is partially
attributable to a lower level of commercial deposits, as a result of the general
slow down in economic activity. Interest bearing demand accounts totaled $35.3
million as of December 31, 2008 compared to $32.4 million at year end 2007. The
increase was principally due to a higher level of municipal accounts. Cash
management accounts included in short-term borrowings, totaled $23.4 million at
year end 2008 compared to $24.0 million as of December 31, 2007. These balances
represent commercial and municipal customers' funds invested in over-night
securities. The Company considers these accounts as a source of core funding.
19
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 the 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, 2008, 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 of 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, 2008, the Bank had a positive 90 day interest sensitivity
gap of $20.4 million or 4.0% of total assets. A positive gap indicates that the
balance sheet has a higher level of rate-sensitive assets (RSA) than
rate-sensitive liabilities (RSL) at the specific time interval. This would
indicate that in a declining rate environment, the yield on interest-earning
assets would decrease faster than the cost of interest-bearing liabilities in
the 90 day time frame. The level of RSA and RSL for an interval is managed by
ALCO strategies, including adjusting the average life of the investment
portfolio through purchases and sales, pricing of deposit liabilities to attract
longer term time deposits, utilizing borrowings to fund loan growth, 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. The level of rates on the investment securities
may also be affected by the spread relationship between different investments.
This was evident in 2008 as the spread between certain asset classes were at
historical highs in relation to treasuries due to lack of market liquidity and
credit concerns. 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.
20
The following table displays interest-sensitivity as of December 31,
2008 (in thousands):
Rate Sensitivity Table 3 Months 3-12 Over
or Less Months 1-3 Years 3 Years Total
--------------------------------------------------------------------
Federal Funds Sold and
interest bearing deposits $ 17 $ - $ - $ - $ 17
Securities 23,215 26,814 32,507 48,291 130,827
Loans Receivable 85,608 59,004 84,180 120,612 349,404
--------------------------------------------------------------------
Total Rate Sensitive Assets (RSA) $ 108,840 $ 85,818 $ 116,687 $ 168,903 $ 480,248
====================================================================
Non-maturity interest bearing deposits $ 22,164 24,565 $ 65,086 $ 28,707 $ 140,522
Time Deposits 46,278 53,407 44,652 17,937 162,274
Other 20,008 18,118 23,000 20,000 81,126
--------------------------------------------------------------------
Total Rate Sensitive Liabilities (RSL) $ 88,450 $ 96,090 $ 132,738 $ 66,644 $ 383,922
====================================================================
Interest Sensitivity Gap $ 20,390 $ (10,272) $ (16,051) $ 102,259 $ 96,326
Cumulative gap 20,390 10,118 (5,933) 96,326
RSA/RSL-cumulative 123.1% 105.5% 98.1% 125.1%
As of December 31, 2007
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%
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, cash flow
from payments on loans and securities and access to borrowing from the Federal
Home Loan Bank and other correspondent banks.
As of December 31, 2008, the Company had cash and cash equivalents of $6.5
million in the form of cash, due from banks, and short-term deposits with other
institutions. In addition, the Company had total securities available for sale
of $130.1 million, which could be used for liquidity needs. This totals $136.6
million and represents 27.1% of total assets compared to $133.1 million and
27.7% of total assets 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, 2008. 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 $39 million, with $3.6 million outstanding at December
31, 2008 and $800,000 outstanding at December 31, 2007. The maximum borrowing
capacity from FHLB was $240.6 million. As of December 31, 2008, the Company had
$54 million in term borrowings from the FHLB, increasing from $23 million in
similar borrowings from the FHLB as of December 31, 2007. The increase in
borrowings was used to offset a decrease in Jumbo CDs and to fund loan growth.
21
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, 2008 totaled $58.1 million. They consisted of
$22.7 million in commercial real estate, construction and land developments
loans, $14.5 million in home equity lines of credit, $1.9 million in standby
letters of credit and $19.0 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, 2008
------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years Over 5 years
------------------------------------------------------------
Time deposits $162,274 $ 99,685 $ 44,651 $ 17,938 $ -
Long-term debt 43,000 - 23,000 10,000 10,000
Operating leases 3,535 266 467 498 2,304
------------------------------------------------------------
$208,809 $ 99,951 $ 68,118 $ 28,436 $ 12,304
============================================================
RESULTS OF OPERATIONS
NET INTEREST INCOME
The following analysis should be read in conjunction with the "Consolidated
Average Balance Sheets with Resultant Interest and Rates" and "Rate/Volume
Analysis" tables.
Net interest income is the most significant source of revenue for the
Company and represented 81.9% of total revenue for the year ended December 31,
2008. Net interest income (fte) totaled $19,030,000 for the year ended December
31, 2008 compared to $17,811,000 for 2007, an increase of $1,219,000 or 6.8%.
The resulting fte net interest spread and net interest margin were 3.51% and
4.07%, respectively, in 2008 compared to 3.27% and 3.98%, respectively, in 2007.
Interest income (fte) for the year ended December 31, 2008 totaled
$28,724,000 compared to $29,794,000 for 2007. The fte yield on average earning
assets for 2008 was 6.14%, decreasing 52 basis points from 6.66% in 2007.
Interest income was unfavorably impacted by the significant decrease in
short-term interest rates. During 2008, the prime interest rate declined 400
basis points from 7.25% to 3.25%. This decline in short-term rates impacts the
Company's floating rate loans principally commercial real estate, lines of
credit and home equity lines of credit. As of December 31, 2008, $67.1 million
of loans were immediately repricable. The decrease in yield was partially offset
by a $20.5 million increase in average earning assets for the year 2008 compared
to 2007.
Interest income (fte) earned on loans totaled $22,161,000 for the year
ended December 31, 2008 with a resulting fte yield of 6.61% compared to
$23,876,000 with an fte yield of 7.38% in 2007. The decrease was due to the
lower prime interest rate in 2008, partially offset by growth of $11.7 million
in average loans. The securities available-for-sale portfolio averaged $130.9
million in 2008 with interest income (fte) of
22
$6,473,000 and a yield (fte) of 4.94% compared to $118.7 million with interest
income (fte) of $5,623,000 and yield (fte) of 4.74% in 2007. The increase in
yield in 2008 was partially due to higher yielding investments purchased in 2007
having a favorable impact on the yield in 2008.
Interest expense for the year-ended December 31, 2008 totaled $9,694,000
with an average cost of interest-bearing liabilities of 2.63% compared to
interest expense of $11,983,000 with an average cost of 3.39% in 2007. The
decrease was principally due to the lower level of short-term interest rates. In
the lower rate environment, the Company reduced rates paid on money market
accounts and time deposits. The cost of time deposits decreased 76 basis points
to 3.81% in 2008 from 4.57% in 2007, as higher costing time deposits matured and
were replaced at lower rates. The Company also utilized short-term borrowings to
replace higher priced time deposits. Average short-term borrowings increased
$9.9 million to average $32.3 million at an average cost of 2.14% in 2008
compared to $22.4 million at an average cost of 4.15% in 2007.
Net interest income 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 and commercial 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 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 a 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.
23
OTHER INCOME
Other income totaled $4,087,000 for the year-ended December 31, 2008
compared to $3,524,000 in 2007. The increase was principally due to $499,000 of
gains on the sale of $14.4 million of mortgage loans and servicing rights in
2008 compared to $23,000 of similar gains in 2007. The loans were sold for
interest-rate risk management purposes. Service charges and fees increased
$91,000 to $2,600,000 principally due to a higher volume of non-sufficient fund
fees (NSF). The Company offers title and settlement services through a
subsidiary of the Bank. Revenues (included in other) from this subsidary totaled
$83,000 in 2008 compared to $29,000 in 2007 principally due to a higher level of
commercial real estate transactions.
The Company recorded a $27,000 other-than-temporary-impairment charge on
1,000 shares of Wachovia Common stock in 2008 which is included in net realized
gains (losses) on sale of securities. The Company has no holdings of common or
preferred stock of FNMA or FHLMC.
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 which was partially offset by $39,000 decrease in
business account analysis fees as the Bank began offering 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 (dollars in thousands)
For the year-ended December 31
2008 2007 2006
---------------------------
Service charges on deposit accounts $ 194 $ 226 $ 296
ATM Fees 280 241 224
NSF Fees 1,424 1,347 1,260
Safe Deposit Box Rental 55 55 55
Loan related service fees 281 236 271
Debit Card 376 328 282
Fiduciary activities 404 423 355
Commissions on mutual funds & annuities 105 120 131
Gain on sales of mortgage loans 499 23 147
Earnings on bank-owned life insurance 345 333 309
Other income 142 175 187
---------------------------
4,105 3,507 3,517
Net realized gains (losses) on sales of securities (18) 17 66
---------------------------
Total $ 4,087 $ 3,524 $ 3,583
===========================
OTHER EXPENSES
Other expenses totaled $12,240,000 for the year-ended December 31, 2008
compared to $11,341,000 in 2007, an increase of $899,000 or 7.9%. The increase
was principally due to $582,000 of costs associated with a parcel of foreclosed
real estate. Excluding these expenses, other expenses increased 2.8%.
Salaries and employee benefits expense which represented 49.4% of total
other expenses increased $221,000 or 3.8% to $6,046,000 in 2008. Equipment
expense decreased $46,000 to $507,000. The decline was principally due to lower
maintenance expenses as the Bank utilized branch document image capture
technology which reduced back-office check processing costs. The same technology
also reduced courier expense (included in other) by $48,000. Data processing
related costs totaled $753,000, an increase of
24
$63,000 principally due to branch and remote deposit capture and enhancements to
the Bank's internet banking system. 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, 2008 was 52.9% improving from 53.2% in 2007.
The Company anticipates a significant increase in the cost of federal
deposit insurance from the current levels of five to seven basis points. The
FDIC has recently increased the assessment rate for the most highly rated
institutions to between 12 and 14 basis points for the first quarter of 2009 and
to between 12 and 16 basis points thereafter. Assessment rates could be further
increased if an institution's FHLB advances exceed 25% of deposits. The FDIC
adopted an interim rule imposing a 20 basis point emergency special assessment
on June 30, 2009 payable September 30, 2009. The FDIC may impose additional
assessments of up to 10 basis points after June 30. The FDIC has also
established a program under which it fully guarantees all non-interest bearing
transaction accounts and senior unsecured debt of a bank or its holding company.
The Bank is participating in this program and will be assessed ten basis points
for non-interest bearing transaction account balances in excess of $250,000 and
75 basis points of the amount of any debt issued. At this time, the Bank has no
plans to issue any debt.
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 principally
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 for the year ended December 31, 2007 was
53.2% improving from 54.0% for 2006.
INCOME TAXES
Income tax expense for the year ended December 31, 2008 totaled $2,836,000
for an effective tax rate of 29.8% compared to an expense of $2,629,000 and an
effective tax rate of 28.8% for 2007.
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.
CAPITAL AND DIVIDENDS
Total stockholders' equity as of December 31, 2008, was $58.7 million,
compared to $55.8 million as of year-end 2007. The increase was principally due
to retention of earnings of $3,888,000 after cash dividends declared of
$2,789,000. This was partially offset by net treasury stock purchases of
$535,000. Accumulated other comprehensive income increased $225,000 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, 2008 the Company
had a
25
leverage capital ratio of 11.45%, Tier 1 risk-based capital of 16.22% and total
risk-based capital of 17.50% compared to, 11.38%, 16.26% and 17.60%,
respectively, in 2007. Due to its strong capital position, the Company elected
not to participate in the Treasury Department's TARP Capital Purchase Program.
The Company's stock is traded on the Nasdaq Global market under the symbol,
NWFL. As of December 31, 2008, there were approximately 1,500 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 2007
- ---------
First Quarter $ 33.75 $ 30.50 $ .23
Second Quarter 33.35 31.45 .23
Third Quarter 32.65 30.05 .23
Fourth Quarter 32.50 29.90 .25
Year 2008
- ---------
First Quarter $ 31.99 $ 28.90 $ .25
Second Quarter 31.00 29.00 .25
Third Quarter 30.75 27.50 .25
Fourth Quarter 32.00 27.00 .27
The book value of the common stock was $21.45 as of December 31, 2008
compared to $20.27 as of December 31, 2007. As of year-end 2008, the closing
stock price was $27.50 per share, compared to $31.25 per share as of December
31, 2007.
NON-GAAP FINANCIAL MEASURES
This annual report contains or references tax-equivalent interest income
and net interest income, which are non-GAAP financial measures. Tax-equivalent
interest income and net interest income are derived from GAAP interest income
and net interest income using an assumed tax rate of 34%. We believe the
presentation of interest income and net interest income on a tax-equivalent
basis ensures comparability of interest income and net interest income arising
from both taxable and tax exempt sources and its consistent with industry
practice. Tax-equivalent net interest income is reconciled to GAAP net interest
income on page 29. Although the company believes that these non-GAAP financial
measures enhance investors' understanding of our business and performance, these
non-GAAP financial measures should not be considered an alternative to
GAAP measures.
26
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 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, 2003 and the reinvestment of dividends
paid. The graph provides comparison at December 31, 2003 and each fiscal year
through December 31, 2008.
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 2008
[LINE GRAPH SHOWING FIVE-YEAR TOTAL RETURNS
ON NORWOOD FINANCIAL COMMON STOCK VERSUS
NASDAQ U.S. AND NASDAQ BANK INDEXES.
DATA POINTS BELOW.]
- ----------------------------------------------------------------------------------------------------------------------------
Legend
Symbol CRSP Total Returns Index for: 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08
- ------ ----------------------------- -------- -------- -------- -------- -------- --------
Norwood Financial Corp 100.0 138.3 129.0 135.8 138.9 126.2
CRSP Nasdaq U.S. Index 100.0 108.8 111.1 122.1 132.4 63.8
CRSP Nasdaq Bank Index 100.0 114.5 111.8 125.5 99.5 72.5
SIC 6020-6029, 6710-6719 US & Foreign
Notes:
- ------
A. The lines represent monthly index levels derived from compounded daily returns that include all dividends.
B. The indexes are reweighted daily, using the market capitalizaion on the previous trading day.
C. If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used.
D. The index level for all series was set to $100.0 on 12/31/2003.
- ----------------------------------------------------------------------------------------------------------------------------
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.
27
NORWOOD FINANCIAL CORP.
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
(Dollars in thousands, except per share amounts)
2008
December 31 September 30 June 30 March 31
--------------------------------------------------------------
Interest income $ 6,934 $ 7,059 $ 6,953 $ 7,149
Interest expense 2,207 2,283 2,379 2,825
--------------------------------------------------------------
Net interest income 4,727 4,776 4,574 4,324
Provision for loan losses 420 130 110 75
Other income 890 1,000 953 1,262
Net realized gains (losses) on sales of securities - (27) 9 --
Other expense 2,946 3,361 2,972 2,961
--------------------------------------------------------------
Income before income taxes 2,251 2,258 2,454 2,550
Income tax expense 666 666 733 771
--------------------------------------------------------------
NET INCOME $ 1,585 $ 1,592 $ 1,721 $ 1,779
==============================================================
Basic earnings per share $ 0.58 $ 0.58 $ 0.63 $ 0.65
==============================================================
Diluted earnings per share $ 0.58 $ 0.58 $ 0.62 $ 0.64
==============================================================
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
==============================================================
28
NORWOOD FINANCIAL CORP. CONSOLIDATED AVERAGE BALANCE SHEETS WITH RESULTANT
INTEREST AND RATES
(Tax-Equivalent Basis, dollars in thousands)
Year Ended December 31 2008 2007 2006
--------------------------------------------------------------------------------------------
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 $ 1,082 $ 28 2.59% $ 3,895 $ 195 5.01% $ 2,778 $ 142 5.11%
Interest bearing deposits
with banks 66 1 1.52 483 26 5.38 98 5 5.10
Securities held to maturity 706 61 8.64 830 74 8.92 981 90 9.17
Securities available for sale
Taxable 108,809 5,207 4.79 99,399 4,571 4.60 99,571 3,712 3.73
Tax-exempt 22,108 1,266 5.73 19,320 1,052 5.45 17,070 925 5.42
------------------- ------------------ ---------------------
Total securities
available for sale 130,917 6,473 4.94 118,719 5,623 4.74 116,641 4,637 3.98
Loans receivable (3,4) 335,137 22,161 6.61 323,444 23,876 7.38 301,533 21,600 7.16
------------------- ------------------ ---------------------
Total interest
earning assets 467,908 28,724 6.14 447,371 29,794 6.66 422,031 26,474 6.27
Non-interest earning assets:
Cash and due from banks 8,102 8,128 8,857
Allowance for loan losses (4,013) (3,925) (3,785)
Other assets 17,687 17,318 16,976
-------- -------- --------
Total non-interest
earning assets 21,776 21,521 22,048
-------- -------- --------
TOTAL ASSETS $489,684 $468,892 $444,079
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Liablities:
Interest- bearing demand
and money market $102,358 1,449 1.42 $ 90,392 1,852 2.05 $ 96,882 1,688 1.74
Savings 44,510 208 0.47 45,858 215 0.47 49,937 232 0.46
Time 160,462 6,116 3.81 172,986 7,900 4.57 146,344 5,798 3.96
------------------- ------------------ ---------------------
Total interest-bearing
deposits 307,330 7,773 2.53 309,236 9,967 3.22 293,163 7,718 2.63
Short-term borrowings 32,328 693 2.14 22,443 932 4.15 19,284 823 4.27
Other borrowings 28,710 1,228 4.28 22,315 1,084 4.86 23,419 1,225 5.23
------------------- ------------------ ---------------------
Total interest
bearing liabilities 368,368 9,694 2.63 353,994 11,983 3.39 335,866 9,766 2.91
------- ------- --------
Non-interest bearing liabilities:
Non-interest bearing
demand deposits 59,759 56,523 54,798
Other liabilities 4,908 4,545 3,526
-------- -------- --------
Total non-interest
bearing liabilities 64,667 61,068 58,324
-------- -------- --------
Stockholders' equity 56,649 53,830 49,889
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $489,684 $468,892 $444,079
======== ======== ========
Net interest income
(tax-equivalent basis) 19,030 3.51% 17,811 3.27% 16,708 3.36%
Tax-equivalent basis adjustment (629) ==== (539) ==== (525) ====
------- ------- --------
Net Interest Income $18,401 $17,272 $ 16,183
======= ======= ========
Net Interest margin
(tax-equivalent basis) 4.07% 3.98% 3.96%
==== ==== ====
1. Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
2. Average balances have been calculated based on daily balances.
3. Loan balances include non-accrual loans and are net of unearned income.
4. Loan yields include the effect of amortization of deferred fees net of
costs.
29
RATE/VOLUME ANALYSIS
The following table shows the fully taxable equivalent effect of
changes in volumes and rates on interest income and interest expense.
Increase/(Decrease)
------------------------------------------------------------
(dollars in thousands) 2008 compared to 2007 2007 compared to 2006
------------------------------------------------------------
Variance due to Variance due to
------------------------------------------------------------
Volume Rate Net Volume Rate Net
------------------------------------------------------------
INTEREST EARNING ASSETS:
- -----------------------------------------------------------------------------------------------------------
Federal funds sold $ (100) $ (67) $ (167) $ 56 $ (3) $ 53
Interest bearing deposits
with banks (14) (11) (25) 21 -- 21
Securities held to maturity (11) (2) (13) (14) (2) (16)
Securities available for sale
Taxable 445 191 636 (6) 865 859
Tax-exempt 158 56 214 122 5 127
------------------------------------------------------------
Total securities available
for sale 603 247 850 116 870 986
Loans receivable 840 (2,555) (1,715) 1,603 673 2,276
------------------------------------------------------------
Total interest earning assets 1,318 (2,388) (1,070) 1,783 1,537 3,320
------------------------------------------------------------
INTEREST BEARING LIABILITIES:
- -----------------------------------------------------------------------------------------------------------
Interest- bearing demand
and money market 222 (625) (403) (119) 283 164
Savings (6) (1) (7) (19) 2 (17)
Time (543) (1,241) (1,784) 1,143 959 2,102
------------------------------------------------------------
Total interest-bearing deposits (327) (1,867) (2,194) 1,006 1,243 2,249
Short-term borrowings 316 (555) (239) 132 (23) 109
Other borrowings 284 (140) 144 (56) (85) (141)
------------------------------------------------------------
Total interest bearing liabilities 273 (2,562) (2,289) 1,081 1,136 2,217
------------------------------------------------------------
Net interest income
(tax-equivalent basis) $ 1,045 $ 174 $ 1,219 $ 701 $ 401 $ 1,103
==============================================================
Changes in net interest income that could not be specifically identified as
either a rate or volume change were allocated proportionately to changes in
volume and changes in rate.
30
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
TO THE STOCKHOLDERS 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 Untied 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, 2008. 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, 2008.
Norwood's Independent Registered Public Accounting Firm has audited the
effectiveness of Norwood's internal control over financial reporting. Their
report appears on page 33.
/s/William W. Davis, Jr. /s/Lewis J. Critelli
William W. Davis, Jr. Lewis J. Critelli
President and Chief Executive Vice President,
Exeutive Officer Secretary and Chief
Financial Officer
31
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, 2008 and 2007, 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, 2008. 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, 2008 and 2007, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2008 in conformity with accounting
principles generally accepted in the United States of America.
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,
2008, 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 10, 2009 expressed an unqualified opinion.
/s/Beard Miller Company LLP
Beard Miller Company LLP
Lancaster, Pennsylvania
March 10, 2009
32
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, 2008, 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 subsidary maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2008, 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 consolidated statements of income, stockholders' equity
and cash flows of Norwood Financial Corp. and its subsidiary, and our report
dated March 10, 2009 expressed an unqualified opinion.
/s/Beard Miller Company LLP
Beard Miller Company, LLP
Lancaster, Pennsylvania
March 10, 2009
33
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------
2008 2007
----------------------
(In Thousands,
Except Share Data)
ASSETS
Cash and due from banks $ 6,463 $ 9,014
Interest bearing deposits with banks 17 50
----------------------
Cash and Cash Equivalents 6,480 9,064
Securities available for sale 130,120 123,987
Securities held to maturity, fair value 2008 $720; 2007 $721 707 705
Loans receivable, net of allowance for loan losses 2008 $4,233; 2007 $4,081 345,171 327,215
Investment in FHLB stock, at cost 3,538 2,072
Bank premises and equipment, net 5,490 5,742
Bank owned life insurance 8,068 7,767
Accrued interest receivable 2,179 2,343
Foreclosed real estate owned 660 --
Other assets 1,883 1,715
----------------------
Total Assets $ 504,296 $ 480,610
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest bearing demand $ 56,839 $ 60,061
Interest-bearing demand 35,322 32,426
Money market deposit accounts 60,623 57,970
Savings 44,577 42,962
Time 162,274 176,581
----------------------
Total Deposits 359,635 370,000
Short-term borrowings 38,126 26,686
Other borrowings 43,000 23,000
Accrued interest payable 2,247 3,198
Other liabilities 2,598 1,907
----------------------
Total Liabilities 445,606 424,791
----------------------
Stockholders' Equity
Common stock, par value $.10 per share; authorized 10,000,000 shares;
issued: 2,840,872 284 284
Surplus 9,972 10,159
Retained earnings 50,398 47,030
Treasury stock, at cost 2008 104,310 shares; 2007 87,256 shares (3,243) (2,708)
Accumulated other comprehensive income 1,279 1,054
----------------------
Total Stockholders' Equity 58,690 55,819
----------------------
Total Liabilities and Stockholders' Equity $ 504,296 $ 480,610
======================
See notes to consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
-----------------------------------------------
2008 2007 2006
-----------------------------------------------
(In Thousands, Except per Share Data)
INTEREST INCOME
Loans receivable, including fees $ 21,983 $ 23,720 $ 21,422
Securities:
Taxable 5,207 4,571 3,712
Tax exempt 876 743 668
Other 29 221 147
-----------------------------------------------
Total Interest Income 28,095 29,255 25,949
-----------------------------------------------
INTEREST EXPENSE
Deposits 7,773 9,967 7,718
Short-term borrowings 693 932 823
Other borrowings 1,228 1,084 1,225
-----------------------------------------------
Total Interest Expense 9,694 11,983 9,766
-----------------------------------------------
Net Interest Income 18,401 17,272 16,183
PROVISION FOR LOAN LOSSES 735 315 220
-----------------------------------------------
Net Interest Income after Provision for Loan Losses 17,666 16,957 15,963
-----------------------------------------------
OTHER INCOME
Service charges and fees 2,600 2,509 2,455
Income from fiduciary activities 404 423 355
Net realized gains (losses) on sales of securities (18) 17 66
Gain on sales of loans and servicing rights 499 23 147
Earnings on life insurance policies 344 333 309
Other 258 219 251
-----------------------------------------------
Total Other Income 4,087 3,524 3,583
-----------------------------------------------
OTHER EXPENSES
Salaries and employee benefits 6,046 5,825 5,655
Occupancy 1,118 1,087 968
Furniture and equipment 507 553 479
Data processing related operations 753 690 700
Advertising 213 235 224
Professional fees 331 349 340
Postage and telephone 521 491 471
Taxes, other than income 504 414 354
Foreclosed real estate owned 582 - -
Amortization of intangible assets 52 52 52
Other 1,613 1,645 1,714
-----------------------------------------------
Total Other Expenses 12,240 11,341 10,957
-----------------------------------------------
Income before Income Taxes 9,513 9,140 8,589
INCOME TAX EXPENSE 2,836 2,629 2,679
-----------------------------------------------
Net Income $ 6,677 $ 6,511 $ 5,910
==============================================
EARNINGS PER SHARE
Basic $ 2.44 $ 2.34 $ 2.11
==============================================
Diluted $ 2.41 $ 2.30 $ 2.07
==============================================
See notes to consolidated financial statements.
35
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2008, 2007 and 2006
--------------------------------------------------------------------------------------------------
Accumulated
Common Stock Treasury Stock Other Unearned
--------------------- Retained ---------------- Comprehensive ESOP
Shares Amount Surplus Earnings Shares Amount Income (Loss) Shares Total
--------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
BALANCE - DECEMBER 31, 2005 2,705,715 $ 270 $ 5,648 $ 43,722 21,189 $ (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) 1,933 - - - (4)
Acquisition of treasury stock - - - - 28,746 (890) - - (890)
Stock options exercised - - (68) - (4,331) 128 - - 60
Tax benefit of stock options
exercised - - 10 - - - - - 10
Sale of treasury stock for ESOP - - 8 - (3,816) 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 43,721 (1,283) (44) - 52,231
Comprehensive income:
Net income - - - 6,511 - - - - 6,511
Change in unrealized gains 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 (2,313) - - (2,313)
Stock options exercised - - (404) - (24,720) 745 - - 341
Tax benefit of stock options
exercised - - 162 - - - - - 162
Sale of treasury stock for ESOP - - 1 - (4,620) 143 - - 144
Compensation expense related
to stock options - - 251 - - - - - 251
--------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2007 2,840,872 284 10,159 47,030 87,256 (2,708) 1,054 - 55,819
Comprehensive income:
Net income - - - 6,677 - - - - 6,677
Change in unrealized gains on
securities available for
sale, net of
reclassification
adjustment and tax effects - - - - - - 225 - 225
-------
Total Comprehensive Income - - - - - - - - 6,902
-------
Cash dividends declared,
$1.02 per share - - - (2,789) - - - - (2,789)
Acquisition of treasury stock - - - - 50,632 (1,583) - - (1,583)
Stock options exercised - - (455) - (27,979) 875 - - 420
Tax benefit of stock options
exercised - - 134 - - - - - 134
Sale of treasury stock for ESOP - - (20) - (5,599) 173 - - 153
Compensation expense related
to stock options - - 154 - - - - - 154
Cumulative effect of net
periodic postretirement benefit - - - (520) - - - - (520)
--------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2008 2,840,872 $ 284 $ 9,972 $ 50,398 104,310 $ (3,243) $ 1,279 $ -- $ 58,690
=================================================================================================
See notes to consolidated financial statements.
36
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-------------------------------------
2008 2007 2006
-------------------------------------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,677 $ 6,511 $ 5,910
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 735 315 220
Depreciation 577 566 503
Amortization of intangible assets 52 52 52
Deferred income taxes 36 (151) (108)
Net amortization of securities premiums and discounts 44 113 301
Net realized (gains) losses on sales of securities 18 (17)
Earnings on life insurance (301) (288) (266)
(Gain) loss on sale of bank premises and equipment and
foreclosed real estate 540 (1) (12)
Net gain on sale of mortgage loans and servicing rights (499) (23)
Mortgage loans originated for sale (866) (794) (2,065)
Proceeds from sale of mortgage loans and servicing rights originated for sale 881 817 2,212
Release of ESOP shares - - 421
Compensation expense related to stock options 154 251 136
Decrease (increase) in accrued interest receivable and
other assets (68) (414) 1,137
Increase (decrease) in accrued interest payable and other liabilities (829) (3,228) 4,543
-------------------------------------
Net Cash Provided by Operating Activities 7,151 3,709 12,771
-------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 67 74 96
Proceeds from maturities and principal reductions on
mortgage-backed securities 39,319 52,408 35,962
Purchases (45,254) (62,005) (32,291)
Securities held to maturity, proceeds from maturities - 250 505
Increase in investment in FHLB stock (1,466) (385) (67)
Net increase in loans (33,523) (15,839) (24,892)
Proceeds from sale of mortgage loans and servicing rights 13,988 - -
Purchase of bank premises and equipment (325) (288) (1,130)
Proceeds from sales of premises and equipment and foreclosed
real estate - 1 64
-------------------------------------
Net Cash Used in Investing Activities (27,194) (25,784) (21,753)
-------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (10,365) 11,897 17,500
Net increase in short-term borrowings 11,440 3,950 4,172
Proceeds from other borrowings 25,000 15,000 -
Repayments of other borrowings (5,000) (5,000) (10,000)
Stock options exercised 420 341 60
Tax benefit of stock options exercised 134 162 10
Purchase of ESOP shares from treasury stock 153 144 120
Acquisition of treasury stock (1,583) (2,313) (890)
Cash dividends paid (2,740) (2,559) (2,289)
-------------------------------------
Net Cash Provided by Financing Activities 17,459 21,622 8,683
-------------------------------------
Net Decrease in Cash and Cash Equivalents (2,584) (453) (299)
CASH AND CASH EQUIVALENTS - BEGINNING 9,064 9,517 9,816
-------------------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 6,480 $ 9,064 $ 9,517
=====================================
See notes to consolidated financial statements.
37
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 potential impairment of restricted stock and the valuation of
deferred tax assets and the determination of other-than-temporary impairment on
securities and accounting for stock options.
Group Concentrations of Credit Risk
Most of the Company's activities are with customers located within
northeastern Pennsylvania. Note 4 discusses the types of securities that the
Company invests in. Note 5 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.
38
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Management determines the appropriate classification of debt securities at
the time of purchase and re-evaluates such designation as of each balance sheet
date.
Declines in the fair value of held to maturity and available for sale
securities below their cost that are deemed to be other than temporary are
reflected in earnings as realized losses. In estimating other-than-temporary
impairment losses, management considers (1) the length of time and the extent to
which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Federal law requires a member institution of the Federal Home Loan Bank
system to hold stock of its district Federal Home Loan Bank according to a
predetermined formula. This restricted stock is carried at cost.
Restricted stock which represents required investment in the common stock
of correspondent banks is carried at cost and as of December 31, 2008 and 2007,
consists of the common stock of Federal Home Loan Bank of Pittsburgh. In
December 2008, the FHLB of Pittsburgh notified member banks that it was
suspending dividend payments and the repurchase of capital stock.
Management evaluates the restricted stock for impairment in accordance with
Statement of Position (SOP) 01-6, Accounting by Certain Entities (Including
Entities With Trade Receivables) That Lend to or Finanace the Activities of
Others. Management's determination of whether these investments are impaired is
based on their assessment of the ultimate recoverability of their cost rather
than by recognizing temporary declines in value. The determination of whether a
decline affects the ultimate recoverability of their cost is influenced by
criteria such as (1) the significance of the decline in net assets of the FHLB
as compared to the capital stock amount for the FHLB and the length of time this
situation has persisted, (2) commitments by the FHLB to make payments required
by law or regulation and the level of such payments in relation to the operating
performance of the FHLB, and (3) the impact of legislative and regulatory
changes on institutions and, accordingly, on the customer base of the FHLB.
Management believes no impairment charge is necessary related to FHLB stock as
of December 31, 2008.
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.
39
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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
40
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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
At December 31, 2008 and 2007, the Company had intangible assets of
$117,000 and $169,000, arising from the purchase of deposits in 1996, which is
net of accumulated amortization of $663,000 and $611,000, which are included in
other assets. These intangible assets will continue to be amortized on a
straight-line basis over fifteen years. Amortization expense related to
intangible assets was $52,000 for each of the years ended December 31, 2008,
2007 and 2006. The amortization expense will be $52,000 for each of the years
ended December 31, 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.
In July 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation ("FIN") No. 48, Accounting for Uncertainty in Income Taxes.
This Interpretation requires an entity to analyze each tax position taken in its
tax returns and determine the likelihood that the position will be realized.
Only tax positions that are "more-likely-than-not" to be realized can be
recognized in an entity's financial statements. For tax positions that do not
meet this recognition threshold, an entity will record an unrecognized tax
benefit for the difference between the position taken on the tax return and the
amuont recognized in the financial statements. The Company adopted this
Interpretation on January 1, 2007. The Company does not have any unrecognized
tax benefits at December 31, 2008 or 2007 or during the years then ended. No
unrecognized tax benefits are expected to arise within the next twelve months.
Advertising Costs
The Company follows the policy of charging the costs of advertising to
expense as incurred.
41
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 Accounting 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.
Fair Value Measurements
In September 2006, the FASB issued FASB Statement No. 157, Fair Value
Measurements ("SFAS 157"), which defines fair value, establishes a framework for
measuring fair value under GAAP, and expands disclosures about fair value
measurements. SFAS 157 applies to other accounting pronouncements that require
or permit fair value measurements. The standard is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and for
interim periods within those fiscal years. The Company adopted SFAS 157
effective for its fiscal year beginning January 1, 2008. In December 2007, the
FASB issued FASB Staff Position (FSP) No. SFAS 157-2, "Effective Date of FAS
157" for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value on a recurring basis (at least annually)
to fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years. In October 2008, the FASB issued FSP SFAS No. 157-3, to
clarify the application of the provisions of SFAS 157 in an inactive market and
how an entity would determine fair value in an inactive market. FSP 157-3 is
effective immediately and applies to our December 31, 2008 financial statements.
The adoption of SFAS 157 and FSP No. FAS 157-2 and FSP No. FAS 157-3 had no
impact on the amounts reported in the consolidated financial statements. The
primary effect of SFAS 157 on the Company was to expand the required disclosures
pertaining to the methods used to determine fair values.
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 of purchase.
42
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Cash payments for interest for the years ended December 31, 2008, 2007 and
2006 were $10,645,000, $11,679,000, and $8,563,000, respectively. Cash payments
for income taxes for the years ended December 31, 2008, 2007 and 2006 were
$3,138,000, $2,845,000, and $2,677,000, respectively. Non-cash investing
activities for 2008, 2007 and 2006 included foreclosed mortgage loans
transferred to foreclosed real estate and repossession of other assets of
$1,328,000, $48,000, and $154,000, 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,
--------------------------
2008 2007 2006
--------------------------
(In Thousands)
Unrealized holding gains on available for sale securities $ 311 $1,665 $1,173
Reclassification adjustment for gains (losses) realized in income (18) 17 66
--------------------------
Net Unrealized Gains 329 1,648 1,107
Income tax expense 104 550 379
--------------------------
Net of Tax Amount $ 225 $1,098 $ 728
==========================
Segment Reporting
The Company acts as an independent community financial service provider and
offers traditional banking and related financial services to individual,
business and government customers. Through its branch and automated teller
machine network, the Company offers a full array of commercial and retail
financial services, including the taking of time, savings and demand deposits;
the making of commercial, consumer and mortgage loans; and the providing of safe
deposit services. The Company also performs personal, corporate, pension and
fiduciary services through its Trust Department. Management does not separately
allocate expenses, including the cost of funding loan demand, between the
commercial, retail, mortgage banking and trust operations of the Company. As
such, discrete information is not available and segment reporting would not be
meaningful.
New Accounting Standards
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 recongizes 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
43
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 APB No. 51" was issued in December of 2007. This
Statement establishes accounting and reporting standards for the noncontrolling
interest in a subsidary and for the deconsolidation of a subsidary. 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.
In February 2008, the FASB issued a FASB Staff Position ("FSP") FAS 140-3,
"Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions." This FSP addresses the issue of whether or not these transactions
should be viewed as two separate transactions or as one "linked" transaction.
The FSP includes a "rebuttable presumption" that presumes linkage of the two
transactions unless the presumption can be overcome by meeting certain criteria.
The FSP will be effective for fiscal years beginning after November 15, 2008 and
will apply only to original transfers made after that date; early adoption will
not be allowed. The Company is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial statements.
In March 2008, the FASB issued Statement No. 161, "Disclosures about
Derivative Instruments and Hedging Activities--an amendment of FASB Statement
No. 133" ("Statement 161"). Statement 161 requires entities that utilize
derivative instruments to provide qualitative disclosures about their objectives
and strategies for using such instruments, as well as any details of
credit-risk-related contingent features contained within derivatives. Statement
161 also requires entities to disclose additional information about the amounts
and location of derivatives located within the financial statements, how the
provisions of SFAS 133 has been applied, and the impact that hedges have on an
entity's financial position, financial performance, and cash flows. Statement
161 is effective for fiscal years and interim periods beginning after November
15, 2008, with early application encouraged. The impact to the Company will be
to require the Company to expand its disclosure regarding its derivative
instruments, if applicable.
In April 2008, the FASB issued FASB Staff Position ("FSP") FAS 142-3,
"Determination of the Useful Life of Intangible Assets." This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under FASB
Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
intent of this FSP is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash flows
used to measure the fair value of the asset under SFAS 141(R), and other GAAP.
This FSP is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal years. Early
adoption is prohibited. The Company expects that FSP FAS 142-3 will not have an
impact on its consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles." This Statement identifies the sources of
accounting principles and the framework for selecting
44
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the principles used in the preparation of financial statements. This Statement
is effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles." The Company
expects that (FSP) FAS 142-3 will not have an impact on its consolidated
financial statements.
In May 2008, the FASB issued FASB Staff Position ("FSP") APB 14-1,
"Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)" which clarifies the accounting
for convertible debt instruments that may be settled in cash (including partial
cash settlement) upon conversion. The FSP requires issuers to account separately
for the liability and equity components of certain convertible debt instruments
in a manner that reflects the issuer's nonconvertible debt borrowing rate when
interest cost is recognized. The FSP requires bifurcation of a component of the
debt, classification of that component in equity and the accretion of the
resulting discount on the debt to be recognized as part of interest expense. The
FSP requires retrospective application to the terms of instruments as they
existed for all periods presented. The FSP is effective for fiscal years
beginning after December 15, 2008, and interim periods within those years. Early
adoption is not permitted. The Company expects FSP APB 14-1 will not have an
impact on its consolidated financial statements.
In June 2008, the FASB issued FASB Staff Position ("FSP") EITF 03-6-1,
"Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities." This FSP clarifies that all outstanding unvested
share-based payment awards that contain rights to nonforfeitable dividends
participate in undistributed earnings with common shareholders. Awards of this
nature are considered participating securities and the two-class method of
computing basic and diluted earnings per share must be applied. This FSP is
effective for fiscal years beginning after December 15, 2008. The Company is
currently evaluating the potential impact the new pronouncement will have on its
consolidated financial statements.
In June 2008, the FASB ratified EITF Issue No. 07-5, "Determining Whether
an Instrument (or an Embedded Feature) Is Indexed to an Entity's Own Stock"
("EITF 07-5"). EITF 07-5 provides that an entity should use a two step approach
to evaluate whether an equity-linked financial instrument (or embedded feature)
is indexed to its own stock, including evaluating the instrument's contingent
exercise and settlement provisions. It also clarifies the impact of foreign
currency denominated strike prices and market-based employee stock option
valuation instruments on the evaluation. EITF 07-5 is effective for fiscal years
beginning after December 15, 2008. The Company is currently evaluating the
potential impact the new pronouncement will have on its consolidated financial
statements.
In September 2008, the FASB issued FSP 133-1 and FIN 45-4, "Disclosures
about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement
No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date
of FASB Statement No. 161" ("FSP 133-1 and FIN 45-4"). FSP 133-1 and FIN 45-4
amends and enhances disclosure requirements for sellers of credit derivatives
and financial guarantees. It also clarifies that the disclosure requirements of
SFAS No. 161 are effective for quarterly periods beginning after November 15,
2008, and fiscal years that include those periods. FSP 133-1 and FIN 45-4 is
effective for reporting periods (annual or interim) ending after November 15,
2008. The implementation of this standard will not have a material impact on our
consolidated financial position and results of operations.
45
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In September 2008, the FASB ratified EITF Issue No. 08-5, "Issuer's
Accounting for Liabilities Measured at Fair Value With a Third-Party Credit
Enhancement" ("EITF 08-5"). EITF 08-5 provides guidance for measuring
liabilities issued with an attached third-party credit enhancement (such as a
guarantee). It clarifies that the issuer of a liability with a third-party
credit enhancement should not include the effect of the credit enhancement in
the fair value measurement of the liability. EITF 08-5 is effective for the
first reporting period beginning after December 15, 2008. The Company is
currently assessing the impact of EITF 08-5 on its consolidated financial
position and results of operations.
In November 2008, the SEC released a proposed roadmap regarding the
potential use by U.S. issuers of financial statements prepared in accordance
with International Financial Reporting Standards (IFRS). IFRS is a comprehensive
series of accounting standards published by the International Accounting
Standards Board ("IASB"). Under the proposed roadmap, the Company may be
required to prepare financial statements in accordance with IFRS as early as
2014. The SEC will make a determination in 2011 regarding the mandatory adoption
of IFRS. The Company is currently assessing the impact that this potential
change would have on its consolidated financial statements, and it will continue
to monitor the development of the potential implementation of IFRS.
In December 2008, the FASB issued FSP FAS 132(R)-1, "Employers' Disclosures
about Postretirement Benefit Plan Assets". This FSP amends SFAS 132(R),
"Employers' Disclosures about Pensions and Other Postretirement Benefits", to
provide guidance on an employer's disclosures about plan assets of a defined
benefit pension or other postretirement plan. The disclosures about plan assets
required by this FSP shall be provided for fiscal years ending after December
15, 2009. The Company is currently reviewing the effect this new pronouncement
will have on its consolidated financial statements.
In November 2008, the FASB ratified Emerging Issues Task Force ("EITF")
Issue No. 08-6, "Equity Method Investment Accounting Considerations". EITF 08-6
clarifies the accounting for certain transactions and impairment considerations
involving equity method investments. EITF 08-6 is effective for fiscal years
beginning after December 15, 2008, with early adoption prohibited. The Company
is currently reviewing the effect this new pronouncement will have on its
consolidated financial statements.
In November 2008, the FASB ratified Emerging Issues Task Force Issue No.
08-7, "Accounting for Defensive Intangible Assets". EITF 08-7 clarifies the
accounting for certain separately identifiable intangible assets which an
acquirer does not intend to actively use but intends to hold to prevent its
competitors from obtaining access to them. EITF 08-7 requires an acquirer in a
business combination to account for a defensive intangible asset as a separate
unit of accounting which should be amortized to expense over the period the
asset diminishes in value. EITF 08-7 is effective for fiscal years beginning
after December 15, 2008, with early adoption prohibited. This new pronouncement
will impact the Company's accounting for any defensive intangible assets
acquired in a business combination completed beginning January 1, 2009.
In December 2008, the FASB issued FSP SFAS 140-4 and FASB Interpretation
(FIN) 46(R)-8, "Disclosures by Public Entities (Enterprises) about Transfers of
Financial Assets and Interests in Variable Interest Entities" ("FSP SFAS 140-4
and FIN 46(R)-8"). FSP SFAS 140-4 and FIN 46(R)-8 amends FASB SFAS 140
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities", to require public entities to provide additional disclosures
about transfers of financial assets. It also amends FIN 46(R), "Consolidation of
Variable Interest Entities", to require public enterprises, including sponsors
46
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
that have a variable interest in a variable interest entity, to provide
additional disclosures about their involvement with variable interest entities.
Additionally, this FSP requires certain disclosures to be provided by a public
enterprise that is (a) a sponsor of a qualifying special purpose entity (SPE)
that holds a variable interest in the qualifying SPE but was not the transferor
of financial assets to the qualifying SPE and (b) a servicer of a qualifying SPE
that holds a significant variable interest in the qualifying SPE but was not the
transferor of financial assets to the qualifying SPE. The disclosures required
by FSP SFAS 140-4 and FIN 46(R)-8 are intended to provide greater transparency
to financial statement users about a transferor's continuing involvement with
transferred financial assets and an enterprise's involvement with variable
interest entities and qualifying SPEs. FSP SFAS 140-4 and FIN 46(R) is effective
for reporting periods (annual or interim) ending after December 15, 2008. The
adoption of this pronouncement did not have a material impact on the Company's
consolidated financial statements.
In January 2009, the FASB issued FSP EITF 99-20-1, "Amendments to the
Impairment Guidance of EITF Issue No. 99-20" ("FSP EITF 99-20-1"). FSP EITF
99-20-1 amends the impairment guidance in EITF Issue No. 99-20, "Recognition of
Interest Income and Impairment on Purchased Beneficial Interests and Beneficial
Interests That Continue to Be Held by a Transferor in Securitized Financial
Assets", to achieve more consistent determination of whether an
other-than-temporary impairment has occurred. FSP EITF 99-20-1 also retains and
emphasizes the objective of an other-than-temporary impairment assessment and
the related disclosure requirements in SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", and other related guidance. FSP EITF
99-20-1 is effective for interim and annual reporting periods ending after
December 15, 2008, and shall be applied prospectively. Retrospective application
to a prior interim or annual reporting period is not permitted. The adoption of
this pronouncement did not have a material impact on the Company's consolidated
financial statements.
NOTE 3 - CHANGE IN ACCOUNTING PRINCIPLE
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 as chosen approach (b) and recorded 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.
47
NOTE 4 - SECURITIES
The amortized cost and fair value of securities were as follows:
December 31, 2008
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------
(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies $ 34,989 $ 836 $ (12) $ 35,813
States and political subdivisions 25,436 110 (337) 25,209
Corporate obligations 6,065 - (440) 5,625
Mortgage-backed securities 61,198 1,340 (220) 62,318
-----------------------------------------------
127,688 2,286 (1,009) 128,965
Equity securities 500 754 (99) 1,155
-----------------------------------------------
$ 128,188 $ 3,040 $ (1,108) $ 130,120
===============================================
HELD TO MATURITY:
States and political subdivisions $ 707 $ 13 $ - $ 720
===============================================
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
===============================================
48
NOTE 4 - SECURITIES (CONTINUED)
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, 2008
---------------------------------------------------------------------
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 $ 988 $ (12) $ - $ - $ 988 $ (12)
States and political subdivisions 13,653 (337) - - 13,653 (337)
Corporate obligations 3,886 (180) 1,739 (260) 5,625 (440)
Mortgage-backed securities 13,610 (220) - - 13,610 (220)
Equity securities 20 (3) 69 (96) 89 (99)
--------------------------------------------------------------------
$ 32,157 $ (752) $ 1,808 $ (356) $ 33,965 $ (1,108)
====================================================================
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)
====================================================================
The Company has 67 securities in the less than twelve month category and 5
securities in the twelve months or more category. In management's opinion, the
unrealized losses in the U.S. Government agencies and the mortgage-backed
securities reflect changes in interest rates subsequent to the acquisition of
specific securities. The unrealized losses in the State and Political
Subdivisions and Corporate Obligations also reflect a widening of spreads due to
liquidity and credit concerns in the financial markets. The Company holds a
small amount of equity securities in other finanacial institutions, the value of
which has been impacted by the weakening conditions of the financial markets.
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,
2008 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 $ 4,780 $ 4,786 $ - $ -
Due after one year through five years 26,296 26,403 - -
Due after five years through ten years 23,167 23,505 707 720
Due after ten years 12,247 11,953 - -
-----------------------------------------
66,490 66,647 707 720
Mortgage-backed securities 61,198 62,318 - -
-----------------------------------------
$127,688 $128,965 $ 707 $ 720
=========================================
49
NOTE 4 - SECURITIES (CONTINUED)
Gross realized gains and gross realized losses on sales of securities available
for sale were $44,000 and $62,000, respectively, in 2008, $40,000 and $23,000,
respectively, in 2007, $66,000 and $-0-, respectively, in 2006.
Securities with a carrying value of $51,444,000 and $56,398,000 at December
31, 2008 and 2007, respectively, were pledged to secure public deposits, U.S.
Treasury demand notes, securities sold under agreements to repurchase and for
other purposes as required or permitted by law.
NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
The components of loans receivable at December 31 were as follows:
2008 2007
----------------------
(In Thousands)
Real estate:
Residential $ 133,417 $ 129,888
Commercial 159,476 133,593
Construction 14,856 20,404
Commercial, financial and agricultural 25,886 29,159
Consumer loans to individuals 16,087 18,526
----------------------
349,722 331,570
Unearned income and deferred fees (318) (274)
Allowance for loan losses (4,233) (4,081)
----------------------
$ 345,171 $ 327,215
======================
The following table presents changes in the allowance for loan losses:
Years Ended December 31,
-----------------------------
2008 2007 2006
-----------------------------
(In Thousands)
Balance, beginning $ 4,081 $ 3,828 $ 3,669
Provision for loan losses 735 315 220
Recoveries 60 59 89
Loans charged off (643) (121) (150)
-----------------------------
Balance, ending $ 4,233 $ 4,081 $ 3,828
=============================
The recorded investment in impaired loans, not requiring an allowance for
loan losses was $2,976,000 (net of a charge-off against the allowance for loan
losses of $380,000) and $3,208,000 at December 31, 2008 and 2007, respectively.
The recorded investment in impaired loans requiring an allowance for loan losses
was $-0- at December 31, 2008 and 2007. For the years ended December 31, 2008,
2007 and 2006, the average recorded investment in these impaired loans was
$3,311,000, $3,127,000, and $286,000, and the interest income recognized on
these impaired loans was $143,000, $290,000, and $1,000, respectively.
Loans on which the accrual of interest has been discontinued amounted to
$2,087,000 and $111,000 at December 31, 2008 and 2007, respectively. Loan
balances past due 90 days or more and still accruing interest, but which
management expects will eventually be paid in full, amounted to $-0- and $52,000
at December 31, 2008 and 2007, respectively.
50
NOTE 6 - PREMISES AND EQUIPMENT
Components of premises and equipment at December 31 are as follows:
2008 2007
-----------------------------
(In Thousands)
Land and improvements $ 925 $ 925
Buildings and improvements 7,948 7,875
Furniture and equipment 5,050 4,798
-----------------------------
13,923 13,598
Accumulated depreciation (8,433) (7,856)
-----------------------------
$ 5,490 $ 5,742
=============================
Certain facilities are leased under various operating leases. Rental
expense for these leases was $280,000, $283,000, and $222,000, for the years
ended December 31, 2008, 2007 and 2006. Future minimum rental commitments under
noncancellable leases as of December 31, 2008 were as follows (in thousands):
2009 $ 266
2010 228
2011 239
2012 248
2013 250
Thereafter 2,304
------------
$ 3,535
============
NOTE 7 - DEPOSITS
Aggregate time deposits in denominations of $100,000 or more were
$45,095,000 and $62,263,000 at December 31, 2008 and 2007, respectively.
At December 31, 2008, the scheduled maturities of time deposits are as
follows (in thousands):
2009 $ 99,685
2010 34,433
2011 10,218
2012 11,754
2013 6,184
------------
$ 162,274
============
NOTE 8 - BORROWINGS
Short-term borrowings at December 31 consist of the following:
2008 2007
-----------------
(In Thousands)
Securities sold under agreements to repurchase $23,404 $24,885
Federal funds purchased 3,600 800
Short-term FHLB advances 11,000 -
U.S. Treasury demand notes 122 1,001
-----------------
$38,126 $26,686
=================
51
NOTE 8 - BORROWINGS (CONTINUED)
The outstanding balances and related information of short-term borrowings
are summarized as follows:
Years Ended December 31,
------------------------
2008 2007
------------------------
(Dollars In Thousands)
Average balance during the year $ 32,238 $ 22,443
Average interest rate during the year 2.14% 4.15%
Maximum month-end balance during the year $ 42,061 $ 33,024
Weighted average interest rate at the end of the year 1.11% 3.60%
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 $26,617,000 and $27,314,000 at December 31, 2008 and $27,127,000
and $27,410,000 at December 31, 2007 were pledged as collateral for these
agreements. The securities underlying the agreements were under the Company's
control.
The Company has a line of credit commitment available from the Federal Home
Loan Bank (FHLB) of Pittsburgh for borrowings of up to $20,000,000 which expires
in December 2011. There were no borrowings under this line at December 31, 2008
and 2007. At December 31, 2008 the Company had an $11,000,000 short-term
borrowing at FHLB due in January 2009 at .671%. The Company has a line of credit
commitment available from Atlantic Central Bankers Bank for $7,000,000 which
expires in May 2009. There were no borrowings under this line of credit at
December 31, 2008 and 2007. The Company has a line of credit commitment
available which has no expiration date from PNC Bank for $12,000,000 at December
31, 2008. Borrowings under this line of credit as federal funds purchased
totaled $3,600,000 at December 31, 2008 and $800,000 at December 31, 2007. The
Company had a line of credit with Wachovia Bank for $2,000,000 at December 31,
2007 with no borrowing as of December 31, 2007. The Company canceled this line
of credit in December 2008.
The Bank maintains a U.S. Treasury tax and loan note option account for the
deposit of withholding taxes, corporate income taxes and certain other payments
to the federal government. Deposits are subject to withdrawal and are evidenced
by an open-ended interest-bearing note. Borrowings under this note option
account were $122,000 and $1,001,000 at December 31, 2008 and 2007,
respectively.
Other borrowings consisted of the following at December 31, 2008 and 2007:
2008 2007
---------------------
(In Thousands)
Notes with the Federal Home Loan Bank (FHLB):
Fixed rate note due April 2008 at 4.17% $ - $ 5,000
Fixed rate note due September 2010 at 3.53% 5,000 -
Convertible note due January 2011 at 5.24% 3,000 3,000
Convertible note due August 2011 at 2.69% 10,000 -
Fixed rate note due September 2011 at 4.06% 5,000 -
Convertible note due October 2012 at 4.37% 5,000 5,000
Convertible note due May 2013 at 3.015% 5,000 -
Convertible note due January 2017 at 4.71% 10,000 10,000
---------------------
$43,000 $23,000
=====================
52
NOTE 8 - BORROWINGS (CONTINUED)
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 19 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 other borrowings at December 31, 2008 are as
follows (in thousands):
2009 $ -
2010 5,000
2011 18,000
2012 5,000
2013 5,000
Thereafter 10,000
------------
$ 43,000
============
The Bank's maximum borrowing capacity with the Federal Home Loan Bank was
$240,607,000 of which $54,000,000 was outstanding at December 31, 2008. Advances
from the Federal Home Loan Bank are secured by qualifying assets of the Bank.
NOTE 9 - 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 $317,000, $400,000, and $181,000 for
the years ended December 31, 2008, 2007 and 2006, respectively.
The Company has a non-qualified supplemental executive retirement plan for
the benefit of certain executive officers. At December 31, 2008 and 2007, other
liabilities include approximately $1,062,000 and $966,000 accrued under the
Plan. Compensation expense includes approximately $96,000, $108,000, and
$138,000, relating to the supplemental executive retirement plan for 2008, 2007
and 2006, 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, 2008 and 2007, the cash value of
these policies was $8,068,000 and $7,767,000, 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.
53
NOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED)
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.
Compensation expense for the ESOP was $-0-, $-0-, and $444,000 for the
years ended December 31, 2008, 2007, and 2006, respectively.
The status of the ESOP shares at December 31 are as follows:
2008 2007
---------------------------
Allocated shares 157,591 160,243
Shares released from allocation 33,318 30,666
Unreleased shares - -
---------------------------
Total ESOP shares 190,909 190,909
===========================
Fair value of unreleased shares $ - $ -
===========================
NOTE 10 - INCOME TAXES
The components of the provision for federal income taxes are as follows:
Years Ended December 31,
----------------------------------------------
2008 2007 2006
----------------------------------------------
(In Thousands)
Current $ 2,800 $ 2,780 $ 2,787
Deferred 36 (151) (108)
----------------------------------------------
$ 2,836 $ 2,629 $ 2,679
==============================================
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,
------------------------
2008 2007 2006
------------------------
Tax at statutory rates 34.0 % 34.0 % 34.0 %
Tax exempt interest income, net of interest expense disallowance (3.9) (3.4) (3.6)
Increase in fair market value of ESOP - - 1.2
Incentive Stock Options 0.5 0.8 0.5
Earnings on life insurance (.7) (1.1) (1.0)
Other (.1) (1.5) 0.1
------------------------
29.8 % 28.8 % 31.2 %
=========================
54
NOTE 10 - INCOME TAXES (CONTINUED)
The net deferred tax asset included in other assets in the accompanying
balance sheets includes the following amounts of deferred tax assets and
liabilities:
2008 2007
-----------------------
(In Thousands)
Deferred tax assets:
Allowance for loan losses $1,266 $1,271
Deferred compensation 361 345
Intangible Assets 47 68
Other 59 29
-----------------------
Total Deferred Tax Assets 1,733 1,713
-----------------------
Deferred tax liabilities:
Premises and equipment 328 226
Deferred loan fees 261 307
Net unrealized gains on securities 653 549
-----------------------
Total Deferred Tax Liabilities 1,242 1,082
-----------------------
Net Deferred Tax Asset $ 491 $ 631
=======================
NOTE 11 - 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, 2008 and 2007
such loans amounted to $5,960,000 and $5,635,000, respectively. During 2008, new
loans to such related parties totaled $635,000 and repayments and other
reductions aggregated $310,000.
NOTE 12 - 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, 2008, that the Company and the Bank meet
all capital adequacy requirements to which they are subject.
As of December 31, 2008, 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.
55
NOTE 12 - 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, 2008:
Total capital (to risk-weighted assets) $60,577 17.24% $>28,110 >8.00% $>35,137 >10.00%
= = = =
Tier 1 capital (to risk-weighted assets) 56,051 15.95 >14,057 >4.00 >21,085 > 6.00
= = = =
Tier 1 capital (to average assets) 56,051 11.20 >20,018 >4.00 >25,023 > 5.00
= = = =
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 11.15 >19,226 >4.00 >24,033 > 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, 2008 and 2007 was approximately $284,000 and
$266,000, 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, 2008, $49,558,000 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 13 - 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 24,000 options in 2008,
which included 4,000 options granted to outside directors in 2008, 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. Both plans expired in 2005.
56
NOTE 13 - STOCK OPTION PLANS (CONTINUED)
Total unrecognized compensation cost related to nonvested options under the
Plan was $130,000 as of December 31, 2008, $154,000 as of December 31, 2007 and
$251,000 as of December 31, 2006. Salaries and employee benefits expense
includes $154,000, $251,000 and $136,000 for the years ended December 31, 2008,
2007 and 2006, respectively related to stock option grants. Net income was
reduced by $144,000, $236,000 and $129,000 for the years ended December 31,
2008, 2007 and 2006, respectively.
A summary of the Company's stock option activity and related information
for the years ended December 31 follows:
2008 2007 2006
--------------------------------------------------------------------------------------------------
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 180,422 $ 24.04 183,645 $ 21.81 140,296 $18.45
Granted 24,000 27.50 22,000 31.25 47,700 30.91
Exercised (27,979) 14.98 (24,723) 13.76 (4,351) 13.05
Forfeited - - (500) 31.50 - -
--------------------------------------------------------------------------------------------------
Outstanding,
end of year 176,443 $ 25.95 $273,487 180,422 $ 24.04 $1,301,000 183,645 $21.81
==================================================================================================
Exercisable,
end of year 152,443 $ 25.70 $274,397
================================
Exercise prices for options outstanding as of December 31, 2008 ranged from
$10.36 to $31.50 per share. The weighted average remaining contractual life is
6.5 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,
------------------------------
2008 2007 2006
------------------------------
Dividend yield 2.79% 2.75% 2.70%
Expected life 7 years 7 years 7 years
Expected volatility 25.08% 24.17% 25.12%
Risk-free interest rate 2.01% 3.53% 4.85%
Weighted average fair value of options granted $ 5.43 $ 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 $420,000 in 2008. 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 2008, all the shares issued in connection
with stock option exercises, 27,979 shares in total, were issued from available
treasury shares.
57
NOTE 13 - STOCK OPTION PLANS (CONTINUED)
As of December 31, 2008, outstanding stock options consist of the
following:
Average Average
Options Exercise Remaining Options Exercise
Outstanding Price Life, Years Exercisable Price
-------------------------------------------------------------------
3,935 $ 14.12 1.0 3,935 $ 14.12
8,661 10.36 2.0 8,661 10.36
15,751 16.98 3.0 15,751 16.98
15,748 19.05 4.0 15,748 19.05
19,198 23.95 5.0 19,198 23.95
20,475 30.00 6.0 20,475 30.00
24,675 30.38 7.3 24,675 30.38
22,000 31.50 8.0 22,000 31.50
22,000 31.25 9.0 22,000 31.25
24,000 27.50 10.0 - -
------- -------
Total 176,443 $ 25.95 6.5 152,443 $ 25.70
======= =======
NOTE 14 - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share:
Years Ended December 31,
---------------------------
2008 2007 2006
---------------------------
(In Thousands, Except per Share Data)
Numerator, net income $ 6,677 $ 6,511 $ 5,910
Denominator:
Denominator for basic earnings per share, weighted
average shares 2,740 2,777 2,795
Effect of dilutive securities, employee stock options 29 49 55
---------------------------
Denominator for diluted earnings per share, adjusted weighted average
shares and assumed conversions 2,769 2,826 2,850
===========================
Basic earnings per common share $ 2.44 $ 2.34 $ 2.11
===========================
Diluted earnings per common share $ 2.41 $ 2.30 $ 2.07
===========================
NOTE 15 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the Bank's financial instrument commitments is as follows:
December 31,
----------------------
2008 2007
----------------------
(In Thousands)
Commitments to grant loans $19,254 $10,835
Unfunded commitments under lines of credit 36,980 34,146
Standby letters of credit 1,897 2,348
----------------------
$58,131 $47,329
======================
58
NOTE 15 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS (CONTINUED)
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,
2008 for guarantees under standby letters of credit issued is not material.
NOTE 16 - FAIR VALUE MEASUREMENTS AND FAIR VALUES 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.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement No. 157, Fair Value Measurements ("SFAS 157"), which defines fair
value, establishes a framework for measuring fair value under GAAP, and expands
disclosures about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The Company
adopted SFAS 157 effective for its fiscal year beginning January 1, 2008.
In December 2007, the FASB issued FASB Staff Position 157-2, Effective Date
of FASB Statement No. 157 ("FSP 157-2"). FSP 157-2 delays the effective date of
SFAS 157 for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value on a recurring basis (at least annually)
to fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years. As such, the Company only partially adopted the provisions
of SFAS 157, and will begin to account and report for non-financial assets and
liabilities in 2009. In October 2008, the FASB issued FASB Staff Position 157-3,
Determining the Fair Value of a Financial Asset When the Market for that Asset
is Not Active ("FSP 157-3"), to clarify the application of the provisions of
SFAS 157 in an inactive market and how an entity would determine fair value in
an inactive market. FSP 157-3 is effective immediately and applies to the
Company's December 31, 2008 consolidated financial statements. The adoption of
SFAS 157 and FSP 157-3 had no impact on the amounts reported in the consolidated
financial statements.
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to
valuation methods used to measure fair value. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements). The three levels of the fair value hierarchy
under SFAS 157 are as follows:
59
NOTE 16 - FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
(CONTINUED)
Level 1: Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are
observable either directly or indirectly, for substantially the full
term of the asset or liability.
Level 3: Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable (i.e.,
supported with little or no market activity).
An asset's or liability's level within the fair value hierarchy is based on
the lowest level of input that is significant to the fair value measurement.
For financial assets measured at fair value on a recurring basis, the fair
value measurements by level within the fair value hierarchy used at December 31,
2008 are as follows:
Fair Value Measurement Reporting Date using
(Level 1) (Level 2)
Quoted Prices in Significant (Level 3)
Active Markets Other Significant
December 31, for Identical Observable Unobservable
Description 2008 Assets Inputs Inputs
- ----------------------------------------------------------------------------------------
(In thousands)
Securities available for sale $ 130,120 $ 1,155 $ 128,965 $ -
=========================================================
For financial assets measured at fair value on a nonrecurring basis, the
fair value measurements by level within the fair value hierarchy used at
December 31, 2008 are as follows:
Fair Value Measurement Reporting Date using
(Level 1) (Level 2)
Quoted Prices in Significant (Level 3)
Active Markets Other Significant
December 31, for Identical Observable Unobservable
Description 2008 Assets Inputs Inputs
- ----------------------------------------------------------------------------------------
(In thousands)
Impaired Loans $ 2,976 $ - $ - $ 2,976
========================================================
As discussed above, the Bank has delayed its disclosure requirements of
non-financial assets and liabilities. Certain real estate owned with write-downs
subsequent to foreclosure are carried at fair value at the balance sheet date
for which the Bank has not yet adopted the provisions of SFAS 157.
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, 2008 and 2007.
60
NOTE 16 - FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
(CONTINUED)
Cash and cash equivalents (carried at cost):
The carrying amounts reported in the consolidated balance sheet for cash
and short-term instruments approximate those assets' fair values.
Securities:
The fair value of securities available for sale (carried at fair value) and
held to maturity (carried at amortized cost) are determined by obtaining quoted
market prices on nationally recognized securities exchanges (Level 1), or matrix
pricing (Level 2), which is a mathematical technique used widely in the industry
to value debt securities without relying exclusively on quoted market prices for
the specific securities but rather by relying on the securities' relationship to
other benchmark quoted prices. For certain securities which are not traded in
active markets or are subject to transfer restrictions, valuations are adjusted
to reflect illiquidy and/or non-transferability, and such adjustments are
generally based on available market evidence (Level 3). In the absence of such
evidence, management's best estimate is used. Management's best estimate
consists of both internal and external support on certain Level 3 investments.
Internal cash flow models using a present value formula that includes
assumptions market participants would use along with indicative exit pricing
obtained from broker/dealers (where available) are used to support fair values
of certain Level 3 investments, if applicable.
Loans receivable (carried at cost):
The fair values of loans are estimated using discounted cash flow analyses,
using market rates at the balance sheet date that reflect the credit and
interest rate-risk inherent in the loans. Projected future cash flows are
calculated based upon contractual maturity or call dates, projected repayments
and prepayments of principal. Generally, for variable rate loans that reprice
frequently and with no significant change in credit risk, fair values are based
on carrying values.
Impaired loans (generally carried at fair value):
Impaired loans are those that are accounted for under FASB Statement No.
114, Accounting by Creditors for Impairment of a Loan ("SFAS 114"), in which the
Bank has measured impairment generally based on the fair value of the loan's
collateral. Fair value is generally determined based upon independent
third-party appraisals of the properties, or discounted cash flows based upon
the expected proceeds. These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements. The fair value investment in impaired loans not requiring an
allowance for loan losses was $2,976,000, net of a charge-off against the
allowance for loan losses of $380,000.
Restricted investment in Federal Home Loan Bank stock (carried at cost):
The carrying amount of restricted investment in FHLB stock approximates
fair value, and considers the limited marketability of such securities.
Accrued interest receivable and payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest
payable approximates its fair value.
Deposit liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and
noninterest checking, passbook savings and money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered in the market on certificates to a schedule of
aggregated expected monthly maturities on time deposits.
61
NOTE 16 - FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
(CONTINUED)
Short-term borrowings (carried at cost):
The carrying amounts of short-term borrowings approximate their fair
values.
Other borrowings (carried at cost):
Fair values of FHLB advances are estimated using discounted cash flow
analysis, based on quoted prices for new FHLB advances with similar credit risk
characteristics, terms and remaining maturity. These prices obtained from this
active market represent a market value that is deemed to represent the transfer
price if the liability were assumed by a third party.
Off-balance sheet financial instruments (disclosed at cost):
Fair values for the Company's off-balance sheet financial instruments
(lending commitments and letters of credit) are based on fees currently charged
in the market to enter into similar agreements, taking into account, the
remaining terms of the agreements and the counterparties' credit standing.
The estimated fair values of the Bank's financial instruments were as
follows at December 31, 2008 and 2007.
December 31, 2008 December 31, 2007
------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------
(In Thousands)
Financial assets:
Cash and due from banks, interest-bearing
deposits with banks and federal funds sold $ 6,480 $ 6,480 $ 9,064 $ 9,064
Securities 130,827 130,840 124,692 124,708
Loans receivable, net 345,171 363,219 327,215 326,482
Investment in FHLB stock 3,538 3,538 2,072 2,072
Accrued interest receivable 2,179 2,179 2,343 2,343
Financial liabilities:
Deposits 359,635 361,223 370,000 370,159
Short-term borrowings 38,126 38,126 26,686 26,686
Other borrowings 43,000 46,281 23,000 22,097
Accrued interest payable 2,247 2,247 3,198 3,198
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding
letters of credit - - - -
62
NOTE 17 - NORWOOD FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
BALANCE SHEETS
December 31,
-------------------
2008 2007
-------------------
(In Thousands)
ASSETS
Cash on deposit in bank subsidiary $ 216 $ 148
Securities available for sale 408 623
Investment in bank subsidiary 57,440 54,678
Other assets 1,363 1,058
-------------------
$59,427 $56,507
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 737 $ 688
Stockholders' equity 58,690 55,819
-------------------
$59,427 $56,507
===================
STATEMENTS OF INCOME
Years Ended December 31,
---------------------------
2008 2007 2006
---------------------------
(In Thousands)
Income:
Dividends from bank subsidiary $ 3,990 $ 4,156 $ 2,369
Interest income from bank subsidiary - - 5
Other interest income 25 30 28
Net realized gain (loss) on sales of securities (62) 17 15
---------------------------
3,953 4,203 2,417
Expenses 164 177 175
---------------------------
3,789 4,026 2,242
Income tax expense (benefit) (68) (51) (43)
---------------------------
3,857 4,077 2,285
Equity in undistributed earnings of subsidiary 2,820 2,434 3,625
---------------------------
Net Income $ 6,677 $ 6,511 $ 5,910
===========================
STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------------
2008 2007 2006
------------------------------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,677 $ 6,511 $ 5,910
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary (2,820) (2,434) (3,625)
Release of ESOP shares - - 421
Other, net (56) (168) (131)
-----------------------------
Net Cash Provided by Operating Activities 3,801 3,909 2,575
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities 17 74 30
Purchase of securities available for sale - - (43)
-----------------------------
Net Cash Provided by (Used) in Investing Activities 17 74 (13)
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised 420 341 60
ESOP purchase of shares from treasury stock 153 144 120
Acquisition of treasury stock (1,583) (2,313) (890)
Cash dividends paid (2,740) (2,559) (2,289)
-----------------------------
Net Cash Used in Financing Activities (3,750) (4,387) (2,999)
-----------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 68 (404) (437)
CASH AND CASH EQUIVALENTS - BEGINNING 148 552 989
-----------------------------
CASH AND CASH EQUIVALENTS - ENDING $ 216 $ 148 $ 552
=============================
NOTE 18 - BRANCH CLOSURE
On December 26, 2008, the Company filed notifications with the Pennsylvania
Department of Banking and the FDIC requesting authorization to discontinue
branch operations at its Hamlin Office, as the lease for the location has
expired. The Company has subsequently entered into an agreement with NBT Bank to
assume the deposits of the Hamlin location. The Company expects to record a
nominal gain when the transaction is completed early in 2009 and does not expect
these events to have a material impact on its operations.
63
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 Conshohocken, 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, 2008 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.
DIRECTORY OF OFFICERS
NORWOOD FINANCIAL CORP
- ----------------------
John E. Marshall Chairman of the Board | Eli Tomlinson Vice President
William W. Davis, Jr. President & | Karyn Vashlishan Vice President
Chief Executive Officer |
Lewis J. Critelli Executive Vice President and | Marianne M. Glamann Assistant Vice President
Chief Financial Officer, | Sandra Halas Assistant Vice President
Treasurer and Secretary | Wendy L. Davis Community Office Manager
Edward C. Kasper Senior Vice President | Gary Henry Community Office Manager
John H. Sanders Senior Vice President | Teresa Melucci Community Office Manager
Joseph A. Kneller Senior Vice President | Sandra Mruczkewycz Community Office Manager
| Rossie Demorizi-Ortiz Community Office Manager
WAYNE BANK | Nancy M. Worobey Community Office Manager
- ---------- | Laurie J. Bishop Assistant Community
John E. Marshall Chairman of the Board | Office Manager
William W. Davis, Jr. President & | Christine Ferdinando Assistant Community
Chief Executive Officer | Office Manager
Lewis J. Critelli Executive Vice President and | Jill Melody Assistant Community
Chief Financial Officer, | Office Manager
and Secretary | Diane L. Richter Assistant Community
Edward C. Kasper Senior Vice President & | Office Manager
Senior Loan Officer/ | Toni M. Stenger Assistant Community
Corporate Bank | Office Manager
John H. Sanders Senior Vice President/ | Thomas Kowalski Resource Recovery Manager
Retail Bank | Julie Kuen Electronic Banking Officer
Joseph A. Kneller Senior Vice President | William E. Murray Mortgage Originator
Wayne D. Wilcha Senior Vice President | Karen Peach Training Officer
and Trust Officer | Sally J. Rapp Human Resources Officer
Robert J. Behrens, Jr. Vice President | Doreen A. Swingle Residential Mortgage
John Carmody Vice President | Lending Officer
Joann Fuller Vice President |
Karen R. Gasper Internal Auditor and | NORWOOD INVESTMENT CORP
Vice President | -----------------------
Carolyn K. Gwozdziewycz Vice President | William W. Davis, Jr. President &
Nancy A. Hart Vice President, Controller, | Chief Executive Officer
Assistant Treasurer & | Lewis J. Critelli Executive Vice President
Assistant Secretary | Scott C. Rickard Senior Investment
Raymond C. Hebden Vice President | Representative,
William J. Henigan, Jr. Vice President | Invest Financial Corp
Jennifer Jaycox Vice President |
Kelley J. Lalley Vice President & | MONROE COUNTY ASSOCIATE BOARD
Assistant Secretary | ----------------------------
Linda M. Moran Vice President | Michael J. Baxter James H. Ott
MaryAlice Petzinger Vice President | Sara Cramer Marvin Papillon
Barbara A. Ridd Vice President & | Dr. Andrew A. Forte Ray Price
Assistant Secretary | Ralph A. Matergia, Esq. Ron Sarajian
Gary H. Sipe Vice President |
NORWOOD
--------------
FINANCIAL CORP
VIST US AT:
WAYNEBANK.COM