SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter period ended September 30, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number
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Norwood Financial Corp.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2828306
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(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
717 Main Street, Honesdale, Pennsylvania 18431
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (717)253-1455
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N/A
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Former name, former address and former fiscal year,
if changed since last report.
Indicated by check (x) whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding as of October 31, 1997
- --------------------------------------- 830,475 shares
common stock, par value $0.10 per share ----------------------------------
NORWOOD FINANCIAL CORP.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
INDEX
Page
Number
Part I - CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD
FINANCIAL CORP.
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Part II - OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Materially Important Events 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
NORWOOD FINANCIAL CORP.
Consolidated Balance Sheets (unaudited)
(dollars in thousands)
September 30, December 31,
1997 1996
--------- ---------
ASSETS
Cash and due from banks $ 7,426 $ 7,072
Interest bearing deposits with banks 601 1,187
Federal funds sold 9,565 6,850
Investment securities available for sale 43,983 48,906
Investment securities (fair value of $9,097
and $9,040) 8,808 8,805
Loans and leases (net of unearned income) 188,713 174,554
Less: Allowance for loan and lease losses 3,080 2,616
--------- ---------
Net loans and leases 185,633 171,938
--------- ---------
Bank premises and equipment, net 7,452 7,779
Other real estate 697 2,283
Accrued interest receivable 1,407 1,558
Other assets 2,142 3,707
--------- ---------
TOTAL ASSETS $ 267,714 $ 260,085
========= =========
LIABILITIES
Deposits:
Noninterest-bearing demand $ 31,371 $ 25,256
Interest-bearing deposits 198,314 204,073
--------- ---------
Total deposits 229,658 229,329
Short-term borrowings 9,490 3,227
Other borrowed funds 2,457 2,442
Accrued interest payable 1,964 2,224
Other liabilities 462 1,344
--------- ---------
TOTAL LIABILITIES 244,058 238,566
--------- ---------
STOCKHOLDERS' EQUITY
Common Stock, $.10 par value, authorized 10,000,000 shares
issued 900,796 and outstanding 889,566 shares 90 90
Surplus 4,448 4,444
Retained earnings 20,319 8,861
Treasury stock, at cost (11,230 shares) (345) (345)
Unearned ESOP shares (1,850) (1,950)
--------- ---------
Net unrealized gain on securities 994 419
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 23,656 21,519
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 267,714 $ 260,085
========= =========
See accompanying notes to the unaudited consolidated financial statements
3
NORWOOD FINANCIAL CORP.
Consolidated Statements of Income (unaudited)
(dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------- ----------------------
1997 1996 1997 1996
--------- --------- --------- ---------
INTEREST INCOME
Interest and fees on loans and leases $ 4,158 $ 3,643 $ 12,065 $ 10,738
Investment securities 810 858 2,638 2,553
Federal funds sold and deposits
with banks 30 73 112 172
--------- --------- --------- ---------
Total interest income 4,998 4,574 14,815 13,463
INTEREST EXPENSE
Deposits 1,984 1,894 6,063 5,578
Short-term borrowings 126 52 316 203
Other borrowed funds 56 54 165 163
--------- --------- --------- ---------
Total interest expense 2,166 2,000 6,544 5,944
--------- --------- --------- ---------
NET INTEREST INCOME 2,832 2,574 8,271 7,519
PROVISION FOR LOAN AND LEASE
LOSSES 555 250 1,105 600
--------- --------- --------- ---------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN AND LEASE
LOSSES 2,277 2,324 7,166 6,919
OTHER INCOME
Service charges and fees 238 204 626 522
Trust department income 42 46 127 127
Investment securities gains/(losses) 7 (43) 70 (43)
Other 69 30 182 128
--------- --------- --------- ---------
Total other income 356 237 1,005 734
OTHER EXPENSES
Salaries and benefits 886 966 2,738 2,833
(Gain) on termination of pension plan (616) -- (616) --
Occupancy, furniture & equipment, net 342 285 964 824
Shares tax 60 55 180 164
Other real estate owned operations 78 198 245 325
Other 661 537 1,840 1,644
--------- --------- --------- ---------
Total other expenses 1,411 2,041 5,351 5,790
INCOME BEFORE INCOME TAXES 1,222 520 2,820 1,863
INCOME TAX EXPENSE 442 98 839 400
--------- --------- --------- ---------
NET INCOME $ 780 $ 422 $ 1,981 $ 1,463
========= ========= ========= =========
EARNINGS PER SHARE $ 0.94 $ 0.50 $ 2.39 $ 1.70
========= ========= ========= =========
Dividends per share $ 0.21 $ 0.21 $ 0.63 $ 0.63
========= ========= ========= =========
Average shares outstanding 830,475 837,105 830,475 861,092
See accompanying notes to the unaudited consolidated financial statements.
4
NORWOOD FINANCIAL CORP.
Consolidated Statement of Changes in Stockholders' Equity (unaudited)
(dollars in thousands)
Net
Unearned Unrealized
Common Retained Treasury ESOP Gain on
Stock Surplus Earnings Stock Shares Securities Total
------ ------- -------- -------- ------- ---------- -------
Balance, December 31, 1996 $90 $4,444 $18,861 ($345) ($1,950) $419 $21,519
Net Income 1,981 1,981
Cash dividend declared (523) (523)
Net unrealized gain/(loss) on securities 575 575
575
Release of earned ESOP shares 4 100 104
--- ------ ------- ----- ------- ----- -------
Balance, September 30, 1997 $90 $4,448 $20,319 ($345) ($1,850) $ 994 $23,656
=== ====== ======= ===== ======= ===== =======
See accompanying notes to the unaudited financial statements
5
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cashflows (Unaudited)
(dollars in thousands)
Nine Months Ended September 30,
1997 1996
-------- --------
OPERATING ACTIVITIES
Net Income $ 1,981 $ 1,463
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan and lease losses 1,105 600
Depreciation and amortization 577 448
Net amortization of investment securities 8 2
Investment security gains, net (70) 43
Loss on sale of other real estate, net 56 175
Proceeds from sales of loans 3,833 3,481
Increase in core deposit intangible, net 224 (1,707)
Decrease (increase) in accrued interest receivable 154 (90)
Increase (decrease) in accrued interest payable (213) (107)
Increase (decrease) in accrued taxes (470) (320)
Decrease (increase) in deferred taxes 1,630 (115)
Other, net 238 9
-------- --------
Net cash provided by (used for) operating activities 8,577 (3,878)
-------- --------
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from sales of investment securities 9,423 2,959
Proceeds from maturities of investment securities 3,799 9,259
Purchases of investment securities (6,681) (22,522)
Investment securities:
Proceeds from maturities of investment securities -- 3,641
Purchases of investment securities -- --
Net increase in loans and leases (19,081) (21,745)
Purchase of premises and equipment, net (206) (530)
Proceeds from sales of other real estate 1,688 758
-------- --------
Net cash (used for) investing activities (11,057) (28,180)
-------- --------
FINANCING ACTIVITIES
Increase (decrease) in deposits, net (777) 30,695
Net increase in short term borrowings 6,263 1,840
Purchase of treasury stock -- (1,733)
Issuance of common stock -- 12
Cash dividends paid (523) (540)
-------- --------
Net cash provided by financing activities 4,963 30,274
-------- --------
Increase in cash and cash equivalent 2,483 5,972
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 15,109 6,448
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 17,592 $ 12,420
======== ========
See accompany notes to consolidated financial statement
6
Notes to Unaudited Consolidated Financial Statements
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1. Basis of Presentation
---------------------
The consolidated financial statements include the accounts of Norwood
Financial Corp. (Company) and its wholly-owned subsidiary, Wayne Bank (Bank) and
the Bank's wholly-owned subsidiaries, WCB Realty Corp. and Norwood Investment
Corp. All significant intercompany transactions have been eliminated in
consolidation. The investments in subsidiaries on the Company's financial
statements are carried at the Company's equity in the underlying net assets.
The financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and revenues and expenses for the period. Actual results could differ from those
estimates. The financial statements reflect, in the opinion of management, all
normal, recurring adjustments necessary to present fairly the financial position
of the Company. The operating results for the three month and nine month period
ended September 30, 1997 are not necessarily indicative of the results that may
be expected for the period ended December 31, 1997 or any other period.
For additional information and disclosure required under generally
accepted accounting principals, reference is made to the Company's 1996 Annual
Report filed on Form 10-K (File No. 0-28366).
2. Earnings Per Share
------------------
Earnings per share computations are based on the weighted average
number of shares outstanding which was 830,475 and 837,105 for the three month
periods ending September 30, 1997 and September 30, 1996 respectively. For the
nine month periods September 30, 1997 and 1996 average shares outstanding were
830,475 and 861,092, respectively. Shares outstanding do not include ESOP shares
that were purchased and unallocated in accordance with SOP 93-6 "Employees'
Accounting for Stock Ownership Plans".
3. Cash Flow Information
---------------------
For the purposes of reporting cash flows, cash and cash equivalents
include cash and due from banks and federal funds sold.
Cash payments for interest for the nine month period ended September
30, 1997 and 1996 were $6,315,000 and $6,057,000 respectively. There were no
cash payments for income taxes in 1997 compared to $788,000 in 1996. Non-cash
investing activity for 1997 and 1996 include foreclosed mortgage loans
transferred to real estate owned of $210,000 and $1,312,000, respectively.
4. Reclassification of Comparative Amounts
---------------------------------------
Certain comparative amounts for prior years have been reclassified to
conform to current year presentation. Such reclassifications did not affect net
income.
7
5. Pending Accounting Pronouncement
--------------------------------
On March 3, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 128, "Earnings Per Share." This
statement re-defines the standards for computing earnings per share (EPS)
previously found in Accounting Principles Board Opinion No. 15, Earnings Per
Share. Statement No. 128 established new standards for computing and presenting
EPS and requires dual presentation of "basic" and "diluted" EPS on the face of
the income statement for all entities with complex capital structures. Under
Statement No. 128, basic EPS is to be computed based upon income available to
common shareholders and weighted average number of common shares outstanding for
the period. Diluted EPS is to reflect the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company. The Company will adopt Statement No. 128 on
December 31, 1997 and based on current estimates, does not believe the effect of
adoption will have a significant impact on the Company's financial position or
results of operations.
In July 1997 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income". Statement No. 130 is effective for fiscal years beginning after
December 15, 1997. This statement establishes standards for reporting and
presentation of comprehensive income and its components (revenues, expenses,
gains and losses) in a full set of general purpose financial statements. It
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is presented with the same prominence as other financial
statements. Statement No. 130 requires that companies (I) classify items of
other comprehensive income by their nature in a financial statement and (ii)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
statement of financial condition. Reclassification of financial statements for
earlier periods provided for comprehensive purposes is required.
6. Employee Benefit Plans
----------------------
Defined Benefit Pension Plan
In the third quarter of 1997, the Company terminated its defined
benefit pension plan. Upon termination, vested participants were allowed to roll
their accumulated benefits into either the Company's profit sharing plan, an
IRA, an annuity contract, an alternative retirement investment account or were
paid cash. At the time of the termination, the Company determined the amount
that the plan assets exceeded the accumulated benefit obligation of eligible
participants of which 25% ($102,000) was transferred to the Company's 401(k)
plan. The remaining plan assets were transferred to the Company, and it
recognized a pre-tax gain of $616,000 in the third quarter of 1997 as a
reduction of other expenses in the accompanying financial statements.
8
Item 2. Management Discussion and Analysis of Financial Condition and Results of
Operations
Financial Condition
- -------------------
General
- -------
Total assets at September 30, 1997, were $267.7 million, increasing
$7.6 million from $260.1 million at December 31, 1996. The increase was
principally due to $14.2 million of loan and lease growth which was funded by
cash flow from the investment portfolio, borrowings from the Federal Home Loan
Bank (FHLB) and increase in stockholders' equity. A decrease in time deposits
over $100,000, of $12 million, primarily school district deposits and other
public funds, was offset by $4 million increased borrowings from the FHLB, and
growth in core deposits.
Investments
- -----------
The fair value of investment securities available for sale, (AFS) was
$43.9 million at September 30, 1997, decreasing from $48.9 million at December
31, 1996. The decrease was principally due to sales of $9.4 million of
securities. The Company took advantage of bond market conditions in June and
September to sell certain longer-term securities. The Company sold $2 million of
tax exempt municipals during the third quarter as their benefit to the Company
has decreased due to change in tax position. The proceeds were used to fund loan
growth and invested in shorter- term instruments. The average life of the AFS
portfolio has been shortened from 4.8 years at December 31, 1996 to 3.2 years at
September 30, 1997. The held-to-maturity portfolio which consists of longer-term
municipals, at $8.8 million showed no change from December 31. The fair market
value of securities held to maturity at September 30, 1997 is $9,097,000
compared to book value of $8,807,000.
Loans and Leases
- ----------------
Total loans and leases were $188.7 million at September 30, 1997, an
increase of $14.1 million or 8.1% from year-end 1996. The growth was principally
attributable to indirect financing and automobile leasing. Indirect financing
which includes new and used automobile and marine lending increased $4.2 million
to total $29 million at September 30, 1997. Auto leasing portfolio totaled $33.2
million at September 30, 1997, increasing $16.2 million from year-end 1996. The
indirect and auto leasing volume is originated through a network of over 40
dealers geographically disbursed throughout Northeastern Pennsylvania and has an
average term of less than 50 months. Commercial and Commercial real estate loans
decreased $3.2 million and represent 33.4% of total portfolio compared to 38.1%
at year-end. The shift in loan mix provides a more diversified loan portfolio
from a credit risk perspective. Residential mortgages decreased $3.1 million
principally as a result of pay downs in adjustable rate mortgages. The Company
sells the majority of its fixed rate residential mortgages in the secondary
market with sales totaling $2.6 million during 1997. The Company sold its
student loan portfolio of $1.5 million to Sallie Mae, during the first quarter
of 1997. The Company will originate student loans through Sallie Mae, on a fee
basis, and not retain the loans in portfolio.
9
Set forth below is selected data relating to the composition of the
loan portfolio at the dates indicated:
Types of loans and leases
(dollars in thousands)
September 30, 1997 December 31, 1996
------------------------- -------------------------
$ % $ %
------------------------- -------------------------
Commercial, financial and agricultural $ 29,360 15.4% $ 29,679 16.8%
Real Estate-construction 2,590 1.4 1,602 0.9
Real Estate-mortgage 87,455 45.6 91,401 51.6
Leases to individuals (net of unearned) 33,212 17.4 16,981 9.6
Installment loans to individuals 38,120 20.2 37,502 21.2
-------- -------
Total loans and leases 190,737 100.0% 177,165 100.0%
Less: Unearned income 2,024 2,611
-------- ---------
Total loans and leases, net of unearned
income $188,713 $ 174,554
======== =========
Allowance for Loan and Lease Losses and Non-performing Assets
- -------------------------------------------------------------
Following is a summary of changes in the allowance for loan losses
for the periods indicated:
At or for the Three At or for the Nine
(dollars in thousands) Months Ended Sept. 30 Months Ended Sept.30
----------------------- --------------------
1997 1996 1997 1996
------- ------- ------- -------
Balance at beginning of period $ 2,940 $ 2,133 $ 2,616 $ 2,125
Provision for loan and lease losses 555 250 1,104 600
Charge-offs (436) (130) (735) (548)
Recoveries 21 30 95 106
------- ------- ------- -------
Net charge-offs (415) (100) (640) (442)
------- ------- ------- -------
Balance at end of period $ 3,080 $ 2,283 $ 3,080 $ 2,283
======= ======= ======= =======
Allowance to total loans and leases 1.63% 1.36% 1.63% 1.36%
Net charge-offs to average loans
and leases(annualized) .89% .25% .47% .38%
The allowance for loan and lease losses totaled $3,080,000 at
September 30, 1997 and represented 1.63% of total loans, increasing from
$2,615,000 and 1.50% at year-end, and $2,283,000 and 1.36% at September 30,
1996. The provision for loan losses for the current year was $1,104,000,
compared to $600,000 for 1996. The Bank's loan review function assess 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 a
credit review and gives consideration to areas of exposure such as concentration
of credit, economic and industry conditions, trends in delinquencies,
collections and collateral value coverage. General reserve percentages are
identified
10
by loan type and credit grading and allocated accordingly. Larger credit
exposures are individually analyzed. Management considers the allowance adequate
at September 30, 1997.
At September 30, 1997, the recorded investment in loans which are
considered to be impaired in accordance with Statement of Financial Accounting
Standards Nos. 114 and 118 was $2,475,000. This was comprised of $197,000 with
related allowance of $12,000 and loans of $2,278,000 with no related allowance
for loan losses. Impaired loans are commercial and commercial real estate loans
for which it is probable that the company will not be able to collect all
amounts due according to the contractual terms of the loan agreement. The
Company estimates credit losses on impaired loans based on present value of
expected cash flows or the fair value of the underlying collateral if loan
repayment is expected to come from sale of operations of such collateral.
At September 30, 1997, non-performing loans totaled $2,286,000 which is 1.20%
of total loans decreasing from $3,493,000, or 1.98% of total loans at December
31, 1996. The following table sets forth information regarding non-performing
loans and other real estate owned at the date indicated:
(dollars in thousands) September 30, 1997 December 31, 1996
------------------ -----------------
Non-accrual loans:
Commercial and all other $ 998 $1,633
Real Estate 1,245 1,790
Consumer 11 28
------ ------
Total 2,254 3,451
Loans accruing which are past due
90 days or more 32 42
------ ------
Total non-performing loans $2,286 $3,493
Other real estate owned 697 2,283
------ ------
Total non-performing assets $2,983 $5,776
====== ======
Allowance for loan losses as a
percent of non-performing loans 134.7% 74.90%
Non-performing loans to total loans 1.20% 1.98%
Non-performing assets to total assets 1.11% 2.22%
Other real estate owned total $697,000 at September 30, 1997,
decreasing principally due to sales, from $2,283,000 at December 31. The largest
non-performing loan relationship is $631,000, decreasing from $1,050,000 at June
30, 1997, and consists of the real estate and inventory of a marina. The
decrease is in part due to charge-off of $280,000 of the real estate value. The
Company is in the process of an orderly liquidation of the inventory and is
aggressively marketing the real estate.
11
Deposits
- --------
Total deposits at September 30, 1997, were $229.7 million, a
decrease of $400,000 from December 31, 1996. A decrease in time deposits greater
than $100,000, of $12 million, consisting principally of school district
deposits and other public funds was offset by increases in core transaction and
savings accounts. Non-interest bearing demand deposits totaled $31.3 million at
September 30, 1997 representing 13.6% of total deposits compared to $25.2
million and 11% at year-end. A new tiered rate money market account, introduced
in June, totaled $4.8 million at September 30, 1997 with over 50% new funds.
Short-term Borrowings
- ---------------------
Short-term borrowings at September 30, 1997 totaled $9,490,000,
increasing from $3,227,000 at December 31, 1996. The increase is partially due
to $3 million borrowing from the Federal Home Loan Bank with original term of
three months maturing on October 22, 1997. Corporate cash management accounts
and repurchase agreement were $5,490,000 at September 30, 1997 compared to
$2,604,000 at December 31, 1996.
Stockholders' Equity and Capital Ratios
- ---------------------------------------
Total stockholders' equity at September 30, 1997, was $23,656,000
compared to $21,519,000 at December 31, 1996. A comparison of capital ratios is
as follows:
September 30, 1997 December 31, 1996
------------------ -----------------
Leverage 8.2% 7.7%
Tier 1 Capital 10.7% 10.3%
Total Capital 11.9% 11.5%
The minimum capital requirements imposed by the FDIC for leverage,
Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Bank is also
subject to more stringent Pennsylvania Department of Banking (PDB) guidelines.
Although not adopted in regulation form, the PDB utilizes capital standards
requiring a minimum of 6.5% leverage capital and 10% total capital. The Company
and the Bank were in compliance in both FDIC and PDB capital requirements at
June 30, 1997 and December 31, 1996.
Liquidity and Interest Rate Sensitivity
- ---------------------------------------
Maintenance of liquidity is coordinated by the Asset/Liability
Committee (ALCO). Liquidity Policy is established by the Board of Directors with
certain key ratios used to measure liquidity. The Company's liquidity can be
viewed as the ability to fund customers borrowing needs and their deposit
withdrawal requests while supporting asset growth. Primary sources of liquidity
include deposit generation, borrowings available from other financial
institutions, asset maturities and cash flows from loan repayments and
investments.
12
The Company maintains established lines of credit with the Federal
Home Loan Bank of Pittsburgh (FHLB) and other correspondents. At September 30,
1997 the maximum borrowing capacity with the FHLB was $48,200,000 with
$3,000,000 repurchase agreement outstanding at September 30, 1997 compared to no
outstandings at December 31, 1996.
During the nine months ended September 30, 1997, the Company
substituted short-term borrowings, which increased $6.2 million, for public fund
time deposits which decreased $12 million. Core retail deposit generation is the
major source of liquidity for the Company. Core deposits including savings and
transactions accounts increased $12.4 million during the period. Sources of
liquidity are also available in the investment portfolio. The Company did sell
$9.4 million of securities during the nine months, with part of the proceeds
used to fund loan growth. Scheduled maturities, anticipated repayments and
projected calls total $16 million over the next twelve months. Cash flow is also
provided by scheduled pay downs in the loan portfolio. The Company believes its
liquidity position is adequate at September 30, 1997.
Interest rate sensitivity and the repricing characteristics of
assets and liabilities are managed by ALCO. The principal objective of ALCO is
to maximize net interest income within acceptable levels of risk which are
established by policy. Interest rate risk is 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 affected by interest rate movements. To manage the impact of the
rate changes, the balance sheet must be structured so that repricing
opportunities exist for both assets and liabilities at approximately the same
time intervals. ALCO monitors these repricing characteristics and identifies
strategies, including management of liability costs and maturities, structure of
the investment portfolio, and various lending activities to insulate net
interest income from the effects of changes in interest rates. The Company
employs net interest simulation modeling to assist in interest rate risk
management. The process includes simulating various interest rate environments
and their impact on net interest income. At September 30, 1997, the level of net
interest income at risk in a 200 basis points increase or decrease was within
policy limits.
Imbalance in repricing opportunities at a given point in time
reflect interest-sensitivity gaps - the difference between interest-sensitive
assets and interest-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 September 30, 1997, the Company had a positive 90 day gap
position of $13,746,000. A positive gap means interest-sensitive assets are
higher than interest-sensitive liabilities at the time interval. This would
indicate that in a declining rate
13
environment, the yield on earning assets would decrease faster than the cost of
interest-bearing liabilities in the 90 day time frame. This risk is managed by
ALCO strategies, including investment portfolio structure, pricing of deposit
liabilities, loan pricing and structure of fixed and variable rate products.
The Company analyzes and measures the time periods in which
interest-earning assets and interest-bearing liabilities will mature or reprice
in accordance with their contractual terms. Management believes that the
assumptions used to evaluate the vulnerability of the Company's operations to
changes in interest rates are reasonable. The interest rate sensitivity of the
Company's 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. 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.
Results of Operation
Comparison of Operating Results for Nine Months Ended September 30, 1997 and
- --------------------------------------------------------------------------------
1996
- ----
General
- -------
For the nine months of 1997 net income totaled $1,981,000 or $2.39
per share compared to $1,463,000 or $1.70 per share for the prior year. Return
on average assets and return on average equity for the period were 1.02% and
11.86% respectively, improving from .83% and 8.73% respectively in 1996.
Net Interest Income
- -------------------
Net interest income, on a fully taxable equivalent basis (fte) for
the nine months of 1997 was $8,553,000, an increase of $709,000, or 9%, over
1996. The resultant fte net interest spread and net interest margin for 1997
were 4.12% and 4.71%, respectively, compared to 4.28% and 4.84%, respectively,
in 1996. The decrease in net interest margin was principally the result of lower
earning asset yields, 8.32% in 1997 declining 19 basis points from 8.51% in
1996. Changes in volume accounted for increase in net interest income of
$1,102,000, partially offset by unfavorable rate changes of $393,000.
Interest income on an fte basis totaled $15,097,000 for the period,
an increase of $1,309,000. The increase was due to $25.7 million growth in
average earning assets. The average yield on investment securities decreased 7
basis points from 1996. The yield on the loan portfolio for the period of 1997
was 8.80%,
14
compared to 9.12%. The decline in yield was due to change in the mix of the loan
portfolio. On average, loans and leases increased $25.8 million, or 16.5%. The
increase consisted principally of growth in lower yielding indirect automobile
lending, $10.5 million and automobile leasing, $23 million, offset by lower
levels of higher yielding commercial and real estate loans. The income earned on
the loan portfolio, was $12,070,000 increasing from $10,743,000 in 1996.
Total interest expense for the current period was $6,544,000
compared to $5,944,000 in 1996, for a resulting average cost of interest-bearing
liabilities of 4.20%, decreasing slightly from 4.22% in the first nine months of
1996. On average the Company funded its growth in earning assets principally
from deposit growth. Average interest bearing deposits increased $17.1 million,
of which $6.5 million represents deposits purchased from Meridian Bank in March
1996. The average cost of deposits declined 3 basis points to 4.11%, with
decreases in all categories. The mix of deposits become more expensive with time
deposits representing 54% increasing from 51% of interest-bearing deposits.
Non-interest Income
- -------------------
Non-interest income for nine months of 1997 totaled $1,005,000.
This includes $70,000 in investment securities gains principally related to sale
of an equity holding in another financial institution. Excluding this gain,
non-interest income was $935,000 compared to $777,000 in 1996, an increase of
$158,000, or 20.3%. Service charges and fees increased $104,000 to $626,000
principally due to $67,000 of ATM surcharge fee income. Commissions on sales of
annuities and mutual funds through Norwood Investment Corp. were $56,000 for the
nine months. Other increases in fee income include debit card introduced in
April 1997 and improvements in merchant card processing.
Non-interest Expense
- --------------------
Non-interest expense totaled $5,351,000 for nine months 1997. This
includes the gain on termination of the defined benefit pension plan of
$616,000. The gain represents the excess market value of the plan assets over
the liabilities paid out to plan participants and the reversal of previously
accrued pension expense. The gain is net of contribution of 25% of the excess
asset value to the Company's 401(k) plan.
Excluding this gain, non-interest expenses total $5,967,000, an
increase of $177,000 or 3.1% over 1996. The increase was principally due to the
nine month effect of three branches acquired from Meridian Bank in March 1996
with amortization of intangible expense at $267,000 in 1997 compared to $88,000
in 1996. Total salary and benefit costs were $2,738,000 in 1997 compared to
$2,833,000 in 1996 with full time equivalent staff of 120 at September 30, 1997
decreasing from 124 at September 30, 1996.
The Company continues to incur expenses related to other real
estate which includes loss on sale, write downs to realizable and other costs
related to resolving
15
non-performing assets, however, at a lesser rate than in prior years. Nine
months of 1997 ORE expense totaled $245,000, decreasing from $325,000 in 1996.
Additional legal costs related to non-performing loans totaled $118,000 for 1997
compared to $96,000 in 1996. The Company reduced certain expenditures during the
nine months including; marketing costs by $69,000; supply expenses by $35,000 as
result of outsourcing the purchasing function; and consulting/training fees by
$64,000 with costs related to technology, sales training and human resources
incurred in 1996. The efficiency ratio for nine months, excluding the gain on
pension termination, improved to 62.8% from 67.2% in 1996.
Timely and accurate data processing is essential to the operation
of the Company. Certain computer programs used by the Company may be impacted by
the programming weakness regarding the year 2000. Many computer programs that
can only distinguish the final two digits of the year entered are expected to
misread the year 2000 as the year 1900. This could cause the incorrect
computation regarding loans and deposit status. The Company is actively working
with all of its computer software vendors to correct any program weaknesses.
Though not anticipating any delays, unresolved issues could have an adverse
impact on the results of operations of the Company.
Income Tax Expense
- ------------------
Income taxes for the period total $839,000 for an effective tax
rate of 29.8% compared to $400,000 and 21.4% in 1996. The increase in the
effective rate is principally due to a lower level of tax exempt securities,
higher amount of pre-tax income and 20% excise tax on a portion of the gain on
the pension termination.
Comparison of Operating Results for Three Months Ended September 30, 1997 and
- --------------------------------------------------------------------------------
September 30, 1996
- ------------------
General
- -------
For the three months ended September 30, 1997, net income was
$780,000 an increase of $358,000 or 85% from $422,000 earned for the third
quarter of 1996. Earnings per share for 1997 period were $.94 compared to $.50
in 1996. Resultant return on assets and return on equity for second quarter of
1997 were 1.20% and 13.52% respectively, improving from .70% and 7.86%
respectively, in 1996.
Net Interest Income
- -------------------
Interest income on an fte basis totaled $5,079,000, an increase of
8.7% from the 1996 period. The increase was principally due to higher level of
earning assets in 1997. The yield on loans was 8.86% decreasing from 8.94% in
1996, primarily due to change in loan mix to lower yielding indirect lending and
auto leasing. The total yield on earning assets was 8.39% in 1997, a decrease of
4 basis points from 1996.
Total interest expense for 1997 third quarter was $2,166,000
compared to $2,000,000 in 1996, an increase of 8.3%. The total cost of funds in
1997 was 4.23% compared to 4.15% in 1996. The increase was principally due to
more expensive
16
deposit mix with higher level of certificates of deposit and increased
short-term borrowings.
With a decrease in earning asset yield and increase in cost of
funds, the net interest spread for three months 1997 decreased to 4.15% from
4.28% in 1996, and net interest margin 4.80% down from 4.82% in 1996. Net
interest margin was positively impacted by a higher earning asset percentage,
93.5% in 1997, compared to 91.5% in 1996. Also earning assets to interest
bearing liabilities improved to 118% from 115%. With growth in earning assets,
net interest income on an FTE basis increased $232,000 or 8.7% , to $2,906,000.
Non-Interest Income
- -------------------
Non-interest income totaled $356,000 for the third quarter of 1997
which included $7,000 gain on sales of securities. Excluding the investment
securities transactions, non-interest income was $349,000, an increase of
$69,000 over third quarter of 1996. The increase was principally due to ATM
surcharge income, mutual fund sales and fees associated with debit card and
merchant card processing. The third quarter of 1996 had losses on investment
security sales of $43,000.
Non-Interest Expense
- --------------------
Non-interest expense totaled $1,411,000 for the third quarter of
1997. This includes the benefit of the gain on termination of the defined
benefit pension plan of $616,000. The gain represents the excess market value of
the plan assets over the liabilities paid out to plan participants and the
reversal of previously accrued pension expense. The gain is net of contribution
of 25% of the excess asset value to the Company's 401(k) plan.
Excluding the gain, non-interest expense totals $2,027,000, a
decrease of $14,000 from 1996. The decrease is principally due to lower level of
staffing costs of $80,000 and less ORE costs of $120,000 reflecting fewer number
of foreclosed properties. During the quarter the Bank closed its limited service
location in Thompson, PA, with total deposits of $1.6 million, which was
acquired from Meridian Bank in March 1996. The Company took an additional
$25,000 of deposit premium amortization to reflect the closure. The efficiency
ratio for the quarter, excluding the gain on pension termination, was 62.2%
compared to 69.1% in 1996.
Income Taxes
- ------------
Income taxes totaled $442,000 for the quarter for an effective tax
rate of 36% compared to $98,000 and 18.9% in 1996. The increase in effective
rate is principally due to lower level of tax-exempt income, higher per-tax
income and excise tax of $61,000 on the gain on pension termination.
17
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Nine Months Ended September 30
-----------------------------------------------------------------------
1997 1996
----------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(2) (1) (3) (2) (1) (3)
(Tax equivalent basis, dollars in thousands)
Assets
Interest-earning assets:
Federal funds sold ................................. $ 1,939 $ 82 5.62% $ 3,937 $ 156 5.27%
Interest bearing deposits with banks ............... 789 30 5.06 414 16 5.14
Investment securities .............................. 8,806 561 8.47 10,837 673 8.26
Investment securities available for sale:
Taxable investments .............................. 43,024 2,098 6.49 39,341 1,929 6.52
Tax-exempt securities ............................ 4,354 256 7.82 4,453 271 8.09
--------- --------- -------- -------
Total investment securities available for sale 47,378 2,354 6.61 43,794 2,200 6.68
Loans and leases (4) (5) ......................... 182,380 12,070 8.80 156,612 10,743 9.12
--------- --------- -------- -------
Total interest earning assets ................. 241,292 15,097 8.32 215,594 13,788 8.51
Non-interest earning assets:
Cash and due from banks ............................ 6,254 6,338
Allowance for loan and lease losses ................ (2,844) (2,176)
Other assets ....................................... 14,535 15,180
--------- -------
Total non-interest earning assets .................. 17,945 19,342
--------- -------
Total Assets .......................................... $ 259,237 $234,936
======== =======
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand deposits ................... $ 46,306 905 2.60% $ 44,341 934 2.80
Savings deposits ................................... 44,866 909 2.69 43,648 914 2.79
Time deposits ...................................... 105,112 4,249 5.38 91,237 3,729 5.44
--------- --------- -------- -------
Total interest bearing deposits ................. 196,284 6,063 4.11 179,226 5,577 4.14
Short-term borrowings ................................. 8,547 316 4.92 5,396 204 5.03
Other borrowings ...................................... 2,448 165 8.96 2,582 163 8.40
--------- --------- -------- -------
Total interest bearing liabilities ................. 207,279 6,544 4.20 187,204 5,944 4.22
Non-interest bearing liabilities:
Demand deposits .................................... 25,662 22,242
Other liabilities .................................. 4,027 3,155
--------- --------
Total non-interest bearing liabilities .......... 29,689 25,397
--------- --------
Shareholders' equity ............................... 22,269 22,335
--------- --------
Total Liabilities and Stockholders' Equity ............ $ 259,237 $234,936
========= ========
Net interest income (tax equivalent basis) ............ 8,553 4.12% 7,844 4.28%
==== ====
Tax-equivalent basis adjustment ....................... (282) (325)
--------- --------
Net interest income ................................... $8,271 $ 7,519
========= ========
Net interest margin (tax equivalent basis) ............ 4.71% 4.84%
==== ====
- ---------------
(1) Interest and yields are presented on a tax-equivalent basis using a
marginal tax rate of 34%.
(2) Average balances have been calculated based on daily balances.
(3) Annualized
(4) Loan balances include non-accrual loans and are net of unearned income.
(5) Loan yields include the effect of amortization of deferred fees, net
of costs.
18
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)
-----------------------------------------------
Nine months ended September 30,1997 Compared to
Nine months ended September 30, 1996
-----------------------------------------------
Variance due to
-----------------------------------------------
Volume Rate Net
------- ------- -------
(dollars in thousands)
Assets
Interest earning assets:
Federal funds sold ...................... $ (90) $ 16 $ (74)
Interest bearing deposits with banks .... 14 -- 14
Investment securities ................... (139) 27 (112)
Investment securities available for sale:
Taxable investments .................. 186 (17) 169
Tax-exempt securities ................ (6) (9) (15)
------- ------- -------
Total investment securities ....... 180 (26) 154
Loans and leases ........................ 1,922 (595) 1,327
------- ------- -------
Total interest earning assets.......... 1,887 (578) 1,309
Interest bearing liabilities:
Interest bearing demand deposits ....... 57 (86) (29)
Savings deposits ....................... 34 (39) (5)
Time deposits .......................... 586 (66) 520
------- ------- -------
Total interest bearing deposits ..... 677 (191) 486
Short term borrowings ................... 119 (7) 112
Other borrowed funds .................... (12) 13 1
------- ------- -------
Total interest bearing liabilities .. 784 (185) 600
Net interest income (tax-equivalent basis) $ 1,103 $ (393) $ 709
======= ======= =======
- --------------
(1) 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.
19
Part II. Other Information
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Materially Important Events
None
Item 6. Exhibits and Reports on Form 8-K
On September 17, 1997, the Company filed a Form 8-K with the Commission
announcing a change in auditors. On September 30, 1997 and October 3, 1997, the
Company filed Amendments to the Form 8-K.
20
Signatures
- ----------
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
NORWOOD FINANCIAL CORP.
Date: 10/31/97 By: /s/ William W. Davis, Jr.
---------------------- ------------------------------------------
William W. Davis, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: 10/31/97 By: /s/ Lewis J. Critelli
---------------------- ------------------------------------------
Lewis J. Critelli
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
21