SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number 0-28366
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Norwood Financial Corp.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2828306
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(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
717 Main Street, Honesdale, Pennsylvania 18431
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (570) 253-1455
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N/A
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Former name, former address and former fiscal year, if changed since last
report.
Indicate by check (x) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant is a large an accelerated
filer, an accelerated filer, or non-accelerated filer. See definition of
"accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as
defined in rule 12b-2 of Exchange Act): Yes [ ] No [ x]
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 August 11, 2006
---------------------------------------
Common stock, par value $0.10 per share 2,799,897
1
NORWOOD FINANCIAL CORP.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2006
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 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 1A. Risk Factors 27
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities 27
Item 3. Defaults upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5 Other Information 28
Item 6 Exhibits 28
Signatures 29
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
----------------------------
NORWOOD FINANCIAL CORP.
Consolidated Balance Sheets
(dollars in thousands, except per share data)
June 30, December 31,
2006 2005
-------- --------
(Unaudited)
ASSETS
Cash and due from banks $ 10,509 $ 9,746
Interest bearing deposits with banks 179 70
Federal funds sold 13,615 --
-------- --------
Cash and cash equivalents 24,303 9,816
Securities available for sale 114,441 115,814
Securities held to maturity, fair value 2006:
$971, 2005: $1,480 954 1,452
Loans receivable (net of unearned income) 299,366 290,890
Less: Allowance for loan losses 3,794 3,669
-------- --------
Net loans receivable 295,572 287,221
Investment in FHLB Stock, at cost 2,294 1,620
Bank premises and equipment, net 5,457 5,393
Accrued interest receivable 1,965 1,812
Other assets 10,173 10,428
-------- --------
TOTAL ASSETS $455,159 $433,556
======== ========
LIABILITIES
Deposits:
Non-interest bearing demand $ 59,538 $ 50,891
Interest bearing 293,929 289,712
-------- --------
Total deposits 353,467 340,603
Short-term borrowings 13,687 18,564
Other borrowings 35,000 23,000
Accrued interest payable 1,760 1,691
Other liabilities 2,053 1,590
-------- --------
TOTAL LIABILITIES 405,967 385,448
STOCKHOLDERS' EQUITY
Common stock, $.10 par value, authorized 10,000,000
shares, issued 2006: 2,840,872, 2005: 2,705,715 284 270
Surplus 9,997 5,648
Retained earnings 41,249 43,722
Treasury stock at cost: 2006: 40,975 shares, 2005: 21,189 (1,205) (633)
Unearned ESOP shares (27) (127)
Accumulated other comprehensive loss (1,106) (772)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 49,192 48,108
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $455,159 $433,556
======== ========
See accompanying notes to the consolidated financial statements
3
NORWOOD FINANCIAL CORP.
Consolidated Statements of Income (unaudited)
(dollars in thousands, except per share data)
Three Months Ended Six Months Ended
------------------ -----------------
June 30, June 30,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
INTEREST INCOME
Loans receivable, including fees $ 5,201 $ 4,288 $10,145 $ 8,208
Securities 1,066 1,020 2,116 2,061
Other 83 5 85 17
------- ------- ------- -------
Total interest income 6,350 5,313 12,346 10,286
INTEREST EXPENSE
Deposits 1,738 1,102 3,328 2,089
Short-term borrowings 163 112 350 211
Other borrowings 420 303 713 620
------- ------- ------- -------
Total interest expense 2,321 1,517 4,391 2,920
------- ------- ------- -------
NET INTEREST INCOME 4,029 3,796 7,955 7,366
PROVISION FOR LOAN LOSSES 55 90 125 190
------- ------- ------- -------
NET INTEREST INCOME AFTER
PROVSION FOR LOAN LOSSES 3,974 3,706 7,830 7,176
OTHER INCOME
Service charges and fees 644 603 1,234 1,182
Income from fiduciary activities 95 92 172 176
Net realized gains on sales of securities 14 3 21 80
Gain on sale of loans and servicing rights 107 15 107 55
Other 143 152 293 292
------- ------- ------- -------
Total other income 1,003 865 1,827 1,785
OTHER EXPENSES
Salaries and employee benefits 1,456 1,334 2,862 2,721
Occupancy, furniture & equipment, net 369 365 749 749
Data processing related 170 153 326 313
Taxes, other than income 111 109 224 207
Professional fees 104 139 217 248
Other 631 577 1,229 1,090
------- ------- ------- -------
Total other expenses 2,841 2,677 5,607 5,328
INCOME BEFORE INCOME TAXES 2,136 1,894 4,050 3,633
INCOME TAX EXPENSE 660 564 1,241 1,060
------- ------- ------- -------
NET INCOME $ 1,476 $ 1,330 $ 2,809 $ 2,573
======= ======= ======= =======
BASIC EARNINGS PER SHARE $ 0.53 $ 0.47 $ 1.00 $ 0.92
======= ======= ======= =======
DILUTED EARNINGS PER SHARE $ 0.52 $ 0.46 $ 0.98 $ 0.90
======= ======= ======= =======
See accompanying notes to the consolidated financial statements
4
NORWOOD FINANCIAL CORP.
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
(dollars in thousands, except per share data)
Accumulated
Number of Unearned Other
Shares Common Retained Treasury ESOP Comprehensive
Issued Stock Surplus Earnings Stock Shares Income(Loss) Total
------ ----- ------- -------- ----- ------ ------------ -----
Balance December 31, 2004 2,705,715 $270 $5,336 $40,222 ($149) ($327) $333 $45,685
Comprehensive Income:
Net Income 2,573 2,573
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax effects (436) (436)
-------
Total comprehensive income 2,137
-------
Cash dividends declared, $.34 per share (958) (958)
Stock options exercised (3) 86 83
Tax benefit of stock options exercised 13 13
Release of treasury stock for ESOP 22 22
Acquisition of treasury stock (408) (408)
Release of earned ESOP shares 179 78 257
--------- ---- ------ ------- ------- ---- ------- -------
Balance, June 30, 2005 2,705,715 $270 $5,525 $41,837 ($449) ($249) ($103) $46,831
========= ==== ====== ======= ===== ===== ===== =======
Accumulated
Number of Unearned Other
Shares Common Retained Treasury ESOP Comprehensive
Issued Stock Surplus Earnings Stock Shares Loss Total
------ ----- ------- -------- ----- ------ ---- -----
Balance December 31, 2005 2,705,715 $270 $5,648 $43,722 ($633) ($127) ($772) $48,108
Comprehensive Income:
Net Income 2,809 2,809
Change in unrealized gains (losses) on
securities available for sale, net of
reclassification adjustment and tax effects (334) (334)
-------
Total comprehensive income 2,475
-------
Cash dividends declared, $.41 per share (1,143) (1,143)
5% Stock dividend at $30.59 per share 135,157 14 4,121 (4,139) (4)
Acquisition of treasury stock (584) (584)
Stock options exercised 12 12
Tax benefit of stock options exercised (2) (2)
Stock options issued 34 34
Release of earned ESOP shares 196 100 296
--------- ---- ------ ------- ------- ---- ------- -------
Balance, June 30, 2006 2,840,872 $284 $9,997 $41,249 ($1,205) ($27) ($1,106) $49,192
========= ==== ====== ======= ======= ==== ======= =======
See accompanying notes to the consolidated financial statements
5
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Six Months Ended June 30,
-------------------------
2006 2005
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 2,809 $ 2,573
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 125 190
Depreciation 249 268
Amortization of intangible assets 26 26
Deferred income taxes (252) (159)
Net amortization of securities premiums and discounts 173 227
Net realized gain on sales of securities (6) (79)
Earnings on life insurance policy (129) (126)
Net gain on sale of mortgage loans (107) (55)
Gain on sale of bank premises and equipment and foreclosed real estate (12) (2)
Mortgage loans originated for sale (426) (5,099)
Proceeds from sale of mortgage loans and servicing rights 533 5,154
Tax benefit of stock options exercised (2) 13
Compensation expense related to stock options 34 -
Release of ESOP shares 296 279
(Increase) decrease in accrued interest receivable and other assets 522 (3)
Increase in accrued interest payable and other liabilities 677 336
-------- --------
Net cash provided by operating activities 4,510 3,543
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales 30 5,097
Proceeds from maturities and principal reductions on mortgage-backed securities 11,622 6,242
Purchases (10,960) (6,748)
Securities held to maturity- proceeds 505 2,420
(Increase) decrease in investment in FHLB stock (674) 252
Net increase in loans (8,541) (20,906)
Purchase of bank premises and equipment (313) (220)
Proceeds from sale of bank premises and equipment and foreclosed real estate 12 9
-------- --------
Net cash used in investing activities (8,319) (13,854)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 12,864 20,288
Net decrease in short-term borrowings (4,877) (12,054)
Repayments of long-term debt - (5,000)
Proceeds from other borrowings 12,000 5,000
Stock options exercised 12 83
Acquisition of treasury stock (584) (408)
Cash dividends paid (1,119) (960)
-------- --------
Net cash provided by financing activities 18,296 6,949
-------- --------
Increase (decrease) in cash and cash equivalents 14,487 (3,362)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 9,816 20,666
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,303 $ 17,304
======== ========
See accompanying notes to the consolidated financial statements
6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
1. BASIS OF PRESENTATION
---------------------
The consolidated financial statements include the accounts of Norwood
Financial Corp. (Company) and its wholly-owned subsidiary, Wayne Bank (Bank) and
the Bank's wholly-owned subsidiaries, WCB Realty Corp., Norwood Investment Corp.
and WTRO Properties. All significant intercompany transactions have been
eliminated in consolidation.
2. ESTIMATES
---------
The accompanying unaudited consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In preparing the
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenues and expenses for the period. Actual results could
differ from those estimates. The financial statements reflect, in the opinion of
management, all normal, recurring adjustments necessary to present fairly the
financial position of the Company. The operating results for the three and six
month periods ended June 30, 2006 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2006 or any other future
interim period.
These statements should be read in conjunction with the consolidated
financial statements and related notes which are incorporated by reference in
the Company's Annual Report on Form 10-K for the year-ended December 31, 2005.
3. 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 per share data has 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.
The following table sets forth the computations of basic and diluted
earnings per share:
(in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2006 2005 2006 2005
---- ---- ---- ----
Basic EPS weighted average shares outstanding 2,793 2,805 2,796 2,801
Dilutive effect of stock options 58 60 57 61
----- ----- ----- -----
Diluted EPS weighted average shares outstanding 2,851 2,865 2,853 2,862
===== ===== ===== =====
7
4. STOCK-BASED COMPENSATION
------------------------
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 than an employee provides service in exchange for the award. The fair
value of the share-based payments is estimated using the Black-Scholes
option-pricing model. The Company adopted Statement No. 123(R) effective January
1, 2006, using the modified-prospective transition method. Under the modified
prospective method, companies are required to record compensation cost for new
and modified awards over the related vesting period of such awards and record
compensation cost prospectively for the unvested portion, at the date of
adoption, of previously issued and outstanding awards over the remaining vesting
period of such awards. No change to prior periods presented is permitted under
the modified prospective method. The Company did not issue any stock options in
2005. The Company's shareholders approved the Norwood Financial Corp 2006 Stock
Option Plan at the annual meeting on April 25, 2006. As a result, the Company
awarded 25,200 options, all of which have a twelve month vesting period.
Included in the results for the three and six months ended June 30, 2006 was
$34,000 in compensation costs relating to the adoption of Statement No. 123(R).
Net income for the three and six months ended June 30, 2006 was reduced by
approximately $22,000. As of June 30, 2006, there was approximately $170,000 of
total unrecognized compensation cost related to nonvested options under the
plan.
The following table illustrates the effect on net income and earnings
per share, for the three and six months ended June 30, 2005, if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation" to stock-based compensation:
Three Months Ended Six Months Ended
(in thousands, except for per share data) June 30, 2005 June 30, 2005
------------------ ----------------
Net income as reported $1,330 $2,573
Total stock-based employee compensation cost, net of
tax, which would have been included in the determination
of net income if the fair value based method had been applied
to all awards (49) (98)
------ ------
Pro forma net income $1,281 $2,475
====== ======
Earnings per share (basic)
As Reported .47 .92
Pro forma .46 .88
Diluted earnings per share (assuming dilution)
As Reported .46 .90
Pro forma .45 .86
8
Weighted- Weighted-
Average Average
Exercise Remaining
Options Price Term (in years)
------- ----- ---------------
Outstanding at the beginning of the year 140,296 $18.45
Granted................................. 25,200 30.38
Exercised............................... (413) 23.95
Forfeited............................... - -
Outstanding as of June 30, 2006 165,083 20.26 6.3
Exercisable as of June 30, 2006 139,883 18.43 5.2
The fair value of options granted for the period ended June 30, were
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions:
Six Months Ended
June 30, 2006
-------------
Dividend yield.................................... 2.71%
Expected life..................................... 7 years
Expected volatility............................... 25.4%
Risk-free interest rate........................... 4.99%
Weighted average fair value of options granted.... $8.12
There were no new options granted for the six months ended June 30, 2005.
5. CASH FLOW INFORMATION
---------------------
For the purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, interest-bearing deposits with
banks and federal funds sold.
Cash payments for interest for the six months ended June 30, 2006 and
2005 were $4,311,000 and $2,971,000 respectively. Cash payments for income taxes
in 2006 were $1,244,000 compared to $1,118,000 in 2005. Non-cash investing
activities for 2006 and 2005 included foreclosed mortgage loans and repossession
of other assets of $65,000 and $67,000, respectively.
6. 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.
9
(in thousands) Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2006 2005 2006 2005
---- ---- ---- ----
Unrealized holding gains/(losses)
on available for sale securities ($287) $ 791 ($486) ($584)
Reclassification adjustment for gains
realized in net income (14) (3) (21) (80)
----- ----- ----- -----
Net unrealized gains/(losses) $(301) 788 (507) (664)
Income tax (benefit) (103) 267 (173) (228)
----- ----- ----- -----
Other comprehensive income (loss) $(198) $ 521 $(334) $(436)
===== ===== ===== =====
7. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND GUARANTEES
------------------------------------------------------
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the Bank's financial instrument commitments is as follows:
(in thousands)
June 30,
--------------------
2006 2005
---- ----
Commitments to grant loans $17,328 $11,000
Unfunded commitments under lines of credit 32,547 33,634
Standby letters of credit 7,137 1,679
------- -------
$57,012 $46,313
======= =======
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.
10
The Bank does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Generally, all letters
of credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Bank, generally, holds
collateral and/or personal guarantees supporting these commitments. Management
believes that the proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the potential amount of
future payment required under the corresponding guarantees. The current amount
of the liability as of June 30, 2006 for guarantees under standby letters of
credit issued is not material.
8. NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In June 2006, the FASB issued FASB interpretation No. 48, "Accounting for
Uncertainty in Income Taxes." The interpretation clarifies the accounting for
uncertainty in income taxes recognized in a company's financial statements in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." Specifically, the pronouncement prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax return.
The interpretation also provides guidance on the related derecognition,
classification, interest and penalties, accounting for interim periods,
disclosure and transition of uncertain tax positions. The interpretation is
effective for fiscal years beginning after December 15, 2006. The Company is
evaluating the impact of this new pronouncement on its consolidated financial
statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
--------------------------
The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward-looking statements. When used in this discussion,
the words believes, anticipates, contemplates, expects, and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties, which could cause actual results to differ
materially from those projected. Those risks and uncertainties include changes
in interest rates, risks associated with the effect of opening a new branch, the
ability to control costs and expenses, demand for real estate and general
economic conditions. The Company undertakes no obligation to publicly release
the results of any revisions to those forward-looking statements which may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES
----------------------------
Note 2 to the Company's consolidated financial statements (incorporated
by reference in Item 8 of the form 10-K) lists significant accounting policies
used in the development and presentation of its financial statements. This
discussion and analysis, the significant accounting policies, and other
financial statement disclosures identify and address key variables and other
qualitative and quantitative factors that are necessary for an understanding and
evaluation of the Company and its results of operations.
Material estimates that are particularly susceptible to significant
change in the near term relate to the determination of the allowance for loan
losses, accounting for stock options, the valuation of deferred tax assets and
the determination of other-than-temporary impairment losses on securities.
Please refer to the discussion of the allowance for loan losses calculation
under "Non-performing Assets and Allowance for Loan Losses" in the "Financial
Condition" section. For periods ending prior to January 1, 2006, the Company
accounted for stock
11
option plans under the recognition and measurement principles of APB Opinion No.
25, "Accounting for Stock Issued to Employees", and related interpretations. No
stock-based employee compensation 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. However, no stock options were awarded in 2005
or for the three months ended March 31, 2006. The Norwood Financial Corp. 2006
Stock Option Plan was approved on April 25, 2006. The Company granted 25,200
options in the second quarter of 2006. See Note 4 for a discussion of this
pronouncement's impact on the Company's consolidated financial statements.
The deferred income taxes reflect temporary differences in the
recognition of the revenue and expenses for tax reporting and financial
statement purposes, principally because certain items are recognized in
different periods for financial reporting and tax return purposes. Although
realization is not assured, the Company believes it is more likely than not that
all deferred tax assets will be realized.
In estimating other-than-temporary impairment losses on securities, the
Company considers 1) the length of time and extent to which the fair value has
been less than cost 2) the financial condition of the issuer and 3) the intent
and ability of the Company to hold the security to allow for a recovery to fair
value.
CHANGES IN FINANCIAL CONDITION
------------------------------
GENERAL
-------
Total assets as of June 30, 2006 were $455.2 million compared to $433.6
million as of December 31, 2005, an increase of $21.6 million, or 5.0%.
SECURITIES
----------
The fair value of securities available for sale as of June 30, 2006 was
$114.4 million compared to $115.8 million as of December 31, 2005. The Company
purchased $11.0 million of securities to offset $12.1 million of maturities and
principal reductions on mortgage-backed securities. The purchases were
principally in short-term U.S. Government sponsored agencies and pass-through
mortgage-backed securities.
The Company has securities in an unrealized loss position. In
Management's opinion, the unrealized losses reflect changes in interest rates
subsequent to the acquisition of specific securities. The Company's
available-for-sale portfolio has an average repricing term of 1.9 years.
Interest rates in the 2-3 year section of the treasury yield curve have
increased over 100 basis points in the last year impacting the fair value of
individual securities. Management believes that the unrealized losses represent
temporary impairment of the securities, as a result of changes in interest
rates. The Company has the intent and ability to hold these investments until
maturity or market price recovery.
LOANS RECEIVABLE
----------------
Loans receivable totaled $299.4 million compared to $290.9 million as
of December 31, 2005. Commercial real estate loans decreased $2.7 million due to
the pay off of a short-term $6.7 million loan originated in the first quarter of
2005. This was offset by a $5.6 million increase in commercial term loans and
lines of credit and $8.6 million growth in residential real estate loans. The
growth in residential real estate loans has principally been in fixed rate first
lien residential mortgages. The Company does not originate any non-traditional
mortgage products such as interest-only loans or option adjustable-rate
mortgages, nor offer any terms over 30 years.
12
Set forth below is selected data relating to the composition of the
loan portfolio at the dates indicated:
Types of loans
(dollars in thousands) June 30, 2006 December 31, 2005
----------------- -------------------
$ % $ %
- - - -
Real Estate-Residential $109,353 36.5% $100,705 34.6%
Commercial 130,799 43.6 133,495 45.8
Construction 4,608 1.5 5,944 2.0
Commercial, financial and agricultural 32,262 10.8 26,755 9.2
Consumer loans to individuals 22,733 7.6 24,353 8.4
------- ----- ------- -----
Total loans 299,755 100.0% 291,252 100.0%
Deferred fees (net) (389) (362)
-------- --------
299,366 290,890
Allowance for loan losses (3,794) (3,669)
-------- --------
Net loans receivable $295,572 $287,221
======== ========
ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING ASSETS
---------------------------------------------------
Following is a summary of changes in the allowance for loan losses for
the periods indicated:
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(dollars in thousands) 2006 2005 2006 2005
---- ---- ---- ----
Balance, beginning $ 3,743 $ 3,523 $ 3,669 $ 3,448
Provision for loan losses 55 90 125 190
Charge-offs (23) (34) (50) (81)
Recoveries 19 21 50 43
------- ------- ------- -------
Net charge-offs (4) (13) - (38)
------- ------- ------- -------
Balance, ending $ 3,794 $ 3,600 $ 3,794 $ 3,600
======= ======= ======= =======
Allowance to total loans 1.27% 1.31% 1.27% 1.31%
Net charge-offs to average loans
(annualized) .01% .02% .-% .03%
The allowance for loan losses totaled $3,794,000 as of June 30, 2006
and represented 1.27% of total loans compared to $3,669,000 and 1.26% as of
December 31, 2005. Recoveries offset charge-offs for a net charge-off of -0- for
the six months ended June 30, 2006 declining from net charge-offs of $38,000 for
the similar period in 2005. The decrease was principally due to lower level of
repossessed automobiles, as the Company has lowered its exposure to indirect
automobile lending. As a result of the lower net charge-offs, the provision for
loan losses was less for the six months ended June 30, 2006, $125,000, compared
to $190,000 for the similar period in 2005.
13
The Company assesses the adequacy of the allowance for loan losses on
a quarterly basis. The process includes an analysis of the risks inherent in the
loan portfolio. It includes an analysis of impaired loans and a historical
review of credit losses by loan type. Other factors considered include:
concentration of credit in specific industries; economic and industry
conditions; trends in delinquencies and loan risk-rated classifications, large
dollar exposures and loan growth. Management considers the allowance adequate at
June 30, 2006 based on the Company's criteria. However, there can be no
assurance that the allowance for loan losses will be adequate to cover
significant losses, if any that might be incurred in the future.
As of June 30, 2006, non-performing loans totaled $314,000, which is
..10% of total loans compared to $353,000, or .12% of total loans at December 31,
2005. There was one property in foreclosed real estate, carried at $24,000 which
is actively being marketed. The following table sets forth information regarding
non-performing loans and foreclosed real estate at the date indicated:
June 30, 2006 December 31, 2005
------------- -----------------
(dollars in thousands)
Loans accounted for on a non accrual basis:
Commercial and all other $ - $ -
Real Estate 303 330
Consumer 11 11
---- ----
Total 314 341
Accruing loans which are contractually
past due 90 days or more - 12
Total non-performing loans 314 353
---- ----
Foreclosed real estate 24 -
---- ----
Total non-performing assets $338 $353
==== ====
Allowance for loan losses
coverage of non-performing loans 12.1x 10.4x
Non-performing loans to total loans .10% .12%
Non-performing assets to total assets .07% .08%
DEPOSITS
--------
Total deposits as of June 30, 2006 were $353.5 million increasing
from $340.6 million as of December 31, 2005. The increase in non-interest
bearing and interest bearing demand deposits is due in part to new commercial
accounts and the seasonality of certain corporate and municipal accounts. Time
deposits greater than $100,000 decreased $18.2 million because of an $8 million
short-term time deposit moved to a money market account and the scheduled
maturity of short-term time deposits from local school districts. Time deposits
less than $100,000 increased principally due to promotional efforts in certain
products.
14
The following table sets forth deposit balances as of the dates
indicated.
(dollars in thousands) June 30, 2006 December 31, 2005
------------- -----------------
Non-interest bearing demand $ 59,538 $ 50,891
Interest bearing demand 43,976 40,738
Money Market 63,959 52,194
Savings 51,005 53,311
Time deposits <$100,000 104,339 94,612
Time deposits >$100,000 30,650 48,857
-------- --------
Total $353,467 $340,603
======== ========
SHORT-TERM BORROWINGS
---------------------
Short-term borrowings as of June 30, 2006 were $13.7 million compared
to $18.6 million as of December 31, 2005.
Short-term borrowings consist of the following:
(dollars in thousands)
June 30, 2006 December 31, 2005
------------- -----------------
Securities sold under agreements to repurchase $13,566 $12,464
Federal Funds purchased - 5,100
U.S. Treasury demand notes 121 1,000
------- -------
$13,687 $18,564
======= =======
OTHER BORROWINGS
Other borrowings consist of notes from the Federal Home Loan Bank of
Pittsburgh. Other borrowings consist of the following: (dollars in thousands)
June 30, 2006 December 31, 2005
------------- -----------------
Convertible note due December 2006 at 6.19% $ 5,000 $ 5,000
Fixed rate note due April 2008 at 4.17% 5,000 5,000
Convertible note due April 2009 at 4.83% 5,000 5,000
Convertible note due April 2009 at 5.07% 5,000 5,000
Convertible note due January 2011 at 5.24% 3,000 3,000
Convertible note due July 2006 at 5.11% 12,000 -
------- -------
$35,000 $23,000
======= =======
15
OFF-BALANCE SHEET ARRANGEMENTS
------------------------------
The Bank is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheet.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
A summary of the contractual amount of the Company's financial
instrument commitments is as follows:
June 30, December 31,
2006 2005
---- ----
(in thousands)
Commitments to grant loans $17,328 $16,078
Unfunded commitments under lines of credit 32,547 29,969
Standby letters of credit 7,137 6,791
------- -------
$57,012 $52,838
======= =======
STOCKHOLDERS' EQUITY AND CAPITAL RATIOS
---------------------------------------
At June 30, 2006, total stockholders' equity totaled $49.2 million,
compared to $48.1 million as of December 31, 2005. The net change in
stockholders' equity was primarily due to $2,809,000 in net income, that was
partially offset by $1,143,000 of cash dividends declared. In addition,
accumulated other comprehensive loss increased $334,000 due to a decrease in
fair value of securities in the available for sale portfolio. This decrease in
fair value is the result of a change in interest rates, which may impact the
fair value of the securities. Because of interest rate volatility, the Company's
accumulated other comprehensive loss could materially fluctuate for each interim
and year-end period.
A comparison of the Company's regulatory capital ratios is as follows:
June 30, 2006 December 31, 2005
------------- -----------------
Tier 1 Capital
(To average assets) 11.08% 11.05%
Tier 1 Capital
(To risk-weighted assets) 15.23% 15.29%
Total Capital
(To risk-weighted assets) 16.56% 16.63%
The minimum capital requirements imposed by the FDIC on the Bank for
leverage, Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Company
has similar capital requirements imposed by the Board of Governors of the
Federal Reserve System (FRB). The Bank is also subject to more stringent
Pennsylvania Department of Banking (PDB) guidelines. The Bank's capital ratios
do not differ significantly from the Company's ratios. Although not adopted in
regulation form, the PDB utilizes capital standards requiring a minimum of 6.5%
leverage capital and 10% total capital. The Company and the Bank were in
compliance with the FRB, FDIC and PDB capital requirements as of June 30, 2006
and December 31, 2005.
16
LIQUIDITY
---------
As of June 30, 2006, the Company had cash and cash equivalents of
$24.3 million in the form of cash, due from banks, federal funds sold and
short-term deposits with other institutions. In addition, the Company had total
securities available for sale of $114.4 million which could be used for
liquidity needs. This totals $138.7 million and represents 30.4% of total assets
compared to $125.6 million and 29% of total assets as of December 31, 2005. The
Company also monitors other liquidity measures, all of which were within the
Company's policy guidelines as of June 30, 2006 and December 31, 2005. Based
upon these measures, the Company believes its liquidity is adequate.
The Company maintains established lines of credit with the Federal
Home Loan Bank of Pittsburgh (FHLB), the Atlantic Central Bankers Bank (ACBB)
and other correspondent banks, which are available to support liquidity needs.
There were no outstandings on the lines of credit as of June 30, 2006 compared
to $5.1 million as of December 31, 2005. The approximate borrowing capacity from
the FHLB was $164 million, with $35 million outstanding as of June 30, 2006, of
which $12 million matures on July 17, 2006, compared to $23 million outstanding
as of December 31, 2005.
17
RESULTS OF OPERATIONS
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Three Months Ended June 30,
----------------------------------------------------------------------
2006 2005
------------------------------- ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 6,468 $ 82 5.07% $ 707 $ 4 2.26%
Interest bearing deposits with banks 97 1 4.12 121 1 3.31
Securities held-to-maturity (1) 954 21 8.81 4,047 122 12.06
Securities available for sale:
Taxable 98,966 901 3.64 97,856 771 3.15
Tax-exempt 16,953 227 5.36 18,679 257 5.50
-------- ------ -------- ------
Total securities available for sale (1) 115,919 1,128 3.89 116,535 1,028 3.53
Loans receivable (4) (5) 295,870 5,232 7.07 271,614 4,326 6.37
-------- ------ -------- ------
Total interest earning assets 419,308 6,464 6.17 393,024 5,481 5.58
Non-interest earning assets:
Cash and due from banks 8,799 8,662
Allowance for loan losses (3,776) (3,577)
Other assets 17,159 16,606
-------- --------
Total non-interest earning assets 22,182 21,691
-------- --------
Total Assets $441,490 $414,715
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $101,235 450 1.78% $ 90,163 209 0.93%
Savings 51,581 59 0.46 58,795 69 0.47
Time 133,001 1,229 3.70 124,359 824 2.65
-------- ------ -------- ------
Total interest bearing deposits 285,817 1,738 2.43 273,317 1,102 1.61
Short-term borrowings 16,380 163 3.98 17,550 112 2.55
Other borrowings 32,626 420 5.15 23,000 303 5.27
-------- ------ -------- ------
Total interest bearing liabilities 334,823 2,321 2.77 313,867 1,517 1.93
Non-interest bearing liabilities:
Demand deposits 54,508 51,604
Other liabilities 3,068 2,743
-------- --------
Total non-interest bearing liabilities 57,576 54,347
Stockholders' equity 49,091 46,501
-------- --------
Total Liabilities and Stockholders' Equity $441,490 $414,715
======== ========
Net interest income (tax equivalent basis) 4,143 3.39% 3,964 3.65%
Tax-equivalent basis adjustment (114) ==== (168) ====
------ ------
Net interest income $4,029 $3,796
====== ======
Net interest margin (tax equivalent basis) 3.95% 4.03%
==== ====
(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.
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.
Increase/(Decrease)
-------------------
Three Months Ended June 30, 2006 Compared to
--------------------------------------------
Three Months Ended June 30, 2005
--------------------------------
Variance due to
---------------
Volume Rate Net
-------------------------
(dollars in thousands)
Interest earning assets:
Federal funds sold $ 68 $ 10 $ 78
Interest bearing deposits with banks (1) 1 -
Securities held to maturity (75) (26) (101)
Securities available for sale:
Taxable 9 121 130
Tax-exempt securities (23) (7) (30)
----- ----- -----
Total securities (14) 114 100
Loans receivable 405 501 906
----- ----- -----
Total interest earning assets 383 600 983
Interest bearing liabilities:
Interest-bearing demand and money market 28 213 241
Savings (8) (2) (10)
Time 61 344 405
----- ----- -----
Total interest bearing deposits 81 555 636
Short-term borrowings (48) 99 51
Other borrowings 163 (46) 117
----- ----- -----
Total interest bearing liabilities 196 608 804
----- ----- -----
Net interest income (tax-equivalent basis) $ 187 $ (8) $ 179
===== ===== =====
19
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2006 TO JUNE
--------------------------------------------------------------------------------
30, 2005
--------
GENERAL
-------
For the three months ended June 30, 2006, net income totaled
$1,476,000, an increase of $146,000, or 10.9% over the $1,330,000 earned in the
similar period of 2005. Earnings per share for the current period were $.53
basic and $.52 on a diluted basis compared to $.47 basic and $.46 on a diluted
basis for the three months ended June 30, 2005. The resulting annualized return
on average assets and return on average equity for the three months ended June
30, 2006 were 1.34% and 12.06%, respectively, improving from 1.29% and 11.48%
respectively, for the similar period in 2005.
The following table sets forth changes in net income:
(dollars in thousands) Three Months Ended
------------------
June 30, 2006 to June 30, 2005
------------------------------
Net income three months ended June 30, 2005 $1,330
------
Net interest income 233
Provision for loan losses 35
Net realized gains on sales of securities 11
Gains on sale of mortgage loans and servicing rights 92
All other income 35
Salaries and employee benefits (122)
All other expenses (42)
Income tax effect (96)
------
Net income three months ended June 30, 2006 $1,476
======
NET INTEREST INCOME
-------------------
Net interest income on a fully taxable equivalent basis (fte) for the
three months ended June 30, 2006 totaled $4,143,000, an increase of $179,000 or
4.5% over the similar period in 2005. The fte net interest spread and net
interest margin were 3.39% and 3.95%, respectively, compared to 3.65% and 4.03%,
respectively for the three months ended June 30, 2005. The decrease in net
interest margin was principally due to the increase in the cost of
interest-bearing liabilities from 1.93% in the 2005 period to 2.77% in the
current period.
Interest income (fte) totaled $6,464,000 with an average yield of
6.17%, for the three months ended June 30, 2006 increasing from $5,481,000 and
5.58% for the similar period in 2005. The increase was due in part to the growth
in the loan portfolio. Average loans increased $24.3 million and represented
70.6% of average earning assets compared to 69.1% of average earning assets for
the 2005 period. The average yield on loans also increased to 7.07% for the
three months ended June 30, 2006 compared to 6.37% for the similar period in
2005. The increase was due in part to the rise in the prime interest rate which
was 8.25% as of June 30, 2006 compared to 6.25% as of June 30, 2005. The
increase in prime rate increases the yield on the Company's floating rate
commercial loan portfolio and on its home equity lines of credit.
20
Interest expense for the three months ended June 30, 2006 totaled
$2,321,000 at an average cost of 2.77% increasing from $1,517,000 and 1.93% for
the similar period in 2005. As a result of the increase in short-term interest
rates the Company has increased rates paid on its money market accounts,
short-term CDs and cash management accounts, included in short-term borrowings.
The cost of time deposits averaged 3.70% for the period in 2006 compared to
2.65% for the similar period in 2005. The Company expects the cost of time
deposits to continue to increase in 2006 as lower rate instruments are maturing
and then repricing at the current higher interest rates. Deposits have also
shifted to higher costing instruments. Average savings at a cost of .46%
decreased $7.2 million, with an increase of $8.6 million in time deposits.
OTHER INCOME
------------
Other income totaled $1,003,000 for the three months ended June 30,
2006, an increase of $138,000 or 16.0%, over the $865,000 for the similar period
in 2005. The increase was principally due to $107,000 of gains on the sale of
mortgage loans and servicing rights in 2006 compared to $15,000 in such gains in
2005. The gain in 2006 was primarily related to the sale of $13.7 million of
mortgage servicing rights to a third party, on loans previously sold in the
secondary market to FNMA..
OTHER EXPENSES
--------------
Other expenses for the three months ended June 30, 2006 totaled
$2,841,000, an increase of $164,000 or 6.1%, over the $2,677,000 for the similar
period in 2005. Salaries and employee benefit expenses increased $122,000
principally due to increased costs related to health care insurance and $34,000
expense recognition of stock options in 2006. The Company also recorded a
$40,000 loss (included in other) on a fraudulent check claim from another
financial institution.
INCOME TAX EXPENSE
------------------
Income tax expense totaled $660,000 for the three months ended June
30, 2006, for an effective tax rate of 30.9% compared to $564,000 and an
effective tax rate of 29.8% for the similar period in 2005. The increase in the
marginal rate was due in part to a lower level of tax exempt income.
21
RESULTS OF OPERATIONS
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
(Tax-Equivalent Basis, dollars in thousands)
Six Months Ended June 30,
----------------------------------------------------------------------
2006 2005
------------------------------- ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(2) (1) (3) (2) (1) (3)
Assets
Interest-earning assets:
Federal funds sold $ 3,252 $ 82 5.04% $ 1,278 $ 16 2.50%
Interest bearing deposits with banks 123 3 4.88 99 1 2.02
Securities held-to-maturity (1) 1,007 46 9.14 4,725 251 10.62
Securities available for sale:
Taxable 99,096 1,759 3.55 100,006 1,558 3.12
Tax-exempt 18,038 494 5.48 18,622 512 5.50
-------- ------- -------- -----
Total securities available for sale (1) 117,134 2,253 3.85 118,628 2,070 3.49
Loans receivable (4) (5) 293,156 10,226 6.98 265,034 8,276 6.25
-------- ------- -------- -----
Total interest earning assets 414,672 12,610 6.08 389,764 10,614 5.45
Non-interest earning assets:
Cash and due from banks 8,458 8,096
Allowance for loan losses (3,742) (3,537)
Other assets 16,911 15,563
-------- --------
Total non-interest earning assets 21,627 20,122
-------- --------
Total Assets $436,299 $409,886
======== ========
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market $ 99,113 809 1.63% $ 89,462 376 0.84%
Savings 52,148 120 0.46 59,134 138 0.47
Time 135,595 2,399 3.54 124,133 1,575 2.54
-------- ------- -------- -----
Total interest bearing deposits 286,856 3,328 2.32 272,729 2,089 1.53
Short-term borrowings 17,494 350 4.00 17,334 211 2.43
Other borrowings 27,840 713 5.12 23,000 620 5.39
-------- ------- -------- -----
Total interest bearing liabilities 332,190 4,391 2.64 313,063 2,920 1.87
Non-interest bearing liabilities:
Demand deposits 52,373 48,658
Other liabilities 2,912 1,917
-------- --------
Total non-interest bearing liabilities 55,285 50,575
Stockholders' equity 48,824 46,248
-------- --------
Total Liabilities and Stockholders' Equity $436,299 $409,886
======== ========
Net interest income (tax equivalent basis) 8,219 3.44% 7,694 3.58%
Tax-equivalent basis adjustment (264) ==== (328) ====
------- ------
Net interest income $ 7,955 $7,366
======= ======
Net interest margin (tax equivalent basis) 3.96% 3.95%
==== ====
(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.
22
RATE/VOLUME ANALYSIS
The following table shows the fully taxable equivalent effect of changes in
volumes and rates on interest income and interest expense. 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.
Increase/(Decrease)
-------------------
Six Months Ended June 30, 2006 Compared to
------------------------------------------
Six Months Ended June 30, 2005
------------------------------
Variance due to
---------------
Volume Rate Net
--------------------------
(dollars in thousands)
Interest earning assets:
Federal funds sold $ 41 $ 25 $ 66
Interest bearing deposits with banks - 2 2
Securities held to maturity (174) (31) (205)
Securities available for sale:
Taxable (41) 242 201
Tax-exempt securities (16) (2) (18)
----- ------ ------
Total securities (57) 240 183
Loans receivable 928 1,022 1,950
----- ------ ------
Total interest earning assets 738 1,258 1,996
Interest bearing liabilities:
Interest-bearing demand and money market 44 389 433
Savings (16) (2) (18)
Time 155 669 824
----- ------ ------
Total interest bearing deposits 183 1,056 1,239
Short-term borrowings 2 137 139
Other borrowings 174 (81) 93
----- ------ ------
Total interest bearing liabilities 359 1,112 1,471
----- ------ ------
Net interest income (tax-equivalent basis) $ 379 $ 146 $ 525
===== ====== ======
COMPARISON OF OPERATING RESULTS FOR SIX MONTHS ENDED JUNE 30, 2006 AND JUNE 30,
--------------------------------------------------------------------------------
2005
----
GENERAL
-------
Net income for the six months ended June 30, 2006 totaled $2,809,000,
increasing $236,000, or 9.2% over the $2,573,000 earned in the similar period in
2005. Basic and diluted earnings per share were $1.00 and $.98, respectively, in
the 2006 period compared to $.92 and $.90, respectively, for the similar period
in 2005. The resulting annualized return on average assets for the six months
ended June 30, 2006 was 1.30%, with an annualized return on average equity of
11.60% improving from 1.27% and 11.22% , respectively, for the similar period in
2005.
23
The following table sets forth changes in net income:
(dollars in thousands)
Net income six months ended June 30, 2005 $ 2,573
-------
Net interest income 589
Provision for loan losses 65
Net realized gains on sales of securities (59)
Gains on sales of mortgage loans and servicing rights 52
All other income 49
Salaries and employee benefits (141)
All other expenses (138)
Income tax effect (181)
-------
Net income six months ended June 30, 2006 $ 2,809
=======
NET INTEREST INCOME
-------------------
Net interest income on a fte basis for the six months ended June 30,
2006 totaled $8,219,000 an increase of $525,000, or 6.8%, over $7,694,000 for
the similar period in 2005. The fte net interest spread and net interest margin
were 3.44% and 3.96%, respectively compared to 3.58% and 3.95%, respectively, in
2005.
Interest income (fte) totaled $12,610,000 with an average yield of
6.08% for the six months ended June 30, 2006 increasing from $10,614,000 and
5.45% for the similar period in 2005. The increase was principally due to $28.1
million growth in average loans. For the 2006 period average loans totaled
$293.1 million and represented 70.7% of total average earning assets increasing
from $265.0 million and 68.0% for the similar period in 2005. The average yield
on loans also increased to 6.98% for the 2006 period from 6.25% for the similar
period in 2005. The increase was principally due to the rise in the prime rate
of interest which was 8.25% as of June 30, 2006 compared to 6.25% as of June 30,
2005. The increase in prime rate increases the yield on the Company's floating
rate commercial loan portfolio and on home equity lines of credit.
Interest expense for the six months ended June 30, 2006 totaled
$4,391,000 at an average cost of 2.64% compared to $2,920,000 at an average cost
of 1.87% for the similar period in 2005. The increase is principally due to
rising short-term interest rates which have caused increased costs in money
market accounts, time deposits and short-term borrowings. The cost of time
deposits averaged 3.54% for the 2006 period compared to 2.54% in 2005 period.
The Company expects the cost of time deposits to continue to increase in 2006 as
lower rate instruments mature and then reprice at the current higher interest
rates. Deposits have also shifted to higher costing instruments. Average
savings, at a cost of .46%, decreased $6.9 million, and was offset by $11.4
million increase in higher costing time deposits.
OTHER INCOME
------------
Other income totaled $1,827,000 for the six months ended June 30,
2006 compared to $1,785,000 for the similar period in 2005. The increase was due
in part to a $52,000 increase in service charges and fees related in part to
increase in debit card activity of $19,000, and an overdraft fee increase of
$17,000. Gains on sales of mortgage loans and servicing rights totaled $107,000
in 2006 period compared $55,000 in such gains in 2005 period. The gain in 2006
was primarily due to the sale of $13.7 million of mortgage servicing rights to a
third party, on laons previously sold in the secondary market to FNMA. Net
realized gain on the sales of securities was $21,000 decreasing from such gains
of $80,000 for the 2005 period.
24
OTHER EXPENSE
-------------
Other expense totaled $5,607,000 for the six months ended June 30,
2006, an increase of $279,000, or 5.2%, over $5,328,000 for the similar period
in 2005. Salaries and employee benefit costs increased $141,000 due to
escalating health insurance, $70,000, and expense related to stock options of
$34,000. The 2006 period included $50,000 robbery loss and $40,000 loss related
to a fraudulent check included in other expense.
INCOME TAX EXPENSE
------------------
Income tax expense totaled $1,241,000 for an effective tax rate of
30.6% for the six months ended June 30, 2006 compared to $1,060,000 and an
effective tax rate of 29.2% for the similar period in 2005. The increase in
taxes was principally due to $417,000, or 11.5%, increase in pre-tax income and
a lower level of tax exempt income The decrease in tax-exempt income was
principally due to maturites of tax-exempt municipal bonds.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
-----------
Interest rate sensitivity and the repricing characteristics of assets
and liabilities are managed by the Asset and Liability Management Committee
(ALCO). The principal objective of ALCO is to maximize net interest income
within acceptable levels of risk, which are established by policy. Interest rate
risk is monitored and managed by using financial modeling techniques to measure
the impact of changes in interest rates.
Net interest income, which is the primary source of the Company's
earnings, is impacted by changes in interest rates and the relationship of
different interest rates. To manage the impact of the rate changes, the balance
sheet must be structured so that repricing opportunities exist for both assets
and liabilities at approximately the same time intervals. The Company uses net
interest simulation to assist in interest rate risk management. The process
includes simulating various interest rate environments and their impact on net
interest income. As of June 30, 2006, the level of net interest income at risk
in a 200 basis points change in interest rates was within the Company's policy
limits. The Company's policy allows for a decline of no more than 8% of net
interest income.
Imbalance in repricing opportunities at a given point in time 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.
As of June 30, 2006, the Bank had a positive 90 day interest
sensitivity gap of $47.2 million or 10.4% of total assets, increasing from $24.4
million, 5.6% of total assets as of December 31, 2005. The change was
principally due to a $13.6 million increase in federal funds sold. A positive
gap means that rate-sensitive assets are greater than rate-sensitive liabilities
at the time interval. This would indicate that in a rising rate environment, the
yield on interest-earning assets would increase faster than the cost of
interest-bearing liabilities in the 90 day time frame. The repricing intervals
are managed by ALCO strategies, including adjusting the average life of the
investment portfolio, pricing of deposit liabilities to attract longer term time
deposits, loan pricing to encourage variable rate products and evaluation of
loan sales of long-term fixed rate mortgages.
25
June 30, 2006
-------------
Rate Sensitivity Table
----------------------
(dollars in thousands)
3 Months 3-12 Months 1 to 3 Years 3 Years Total
-------- ----------- ------------ ------- -----
Federal funds sold and interest bearing deposits $ 13,794 $ - $ - $ - $ 13,794
Securities 14,856 42,016 39,350 19,173 115,395
Loan Receivable 98,475 43,423 67,098 90,370 299,366
-------- -------- ------- ------- -------
Total RSA 127,125 85,439 106,448 109,543 428,555
Non-maturity interest-bearing deposits 24,894 27,593 72,416 34,037 158,940
Time deposits 21,716 78,507 27,366 7,400 134,989
Other 33,333 4,610 10,744 - 48,687
-------- -------- ------- ------- -------
Total RSL 79,943 110,710 110,526 41,437 342,616
Interest Sensitivity Gap $47,182 $(25,271) $(4,078) $68,106 $ 85,939
Cumulative gap 47,182 21,911 17,833 85,939
RSA/RSL-Cumulative 159.0% 111.5% 105.9% 125.1%
December 31, 2005
Interest Sensitivity Gap $24,402 $ (5,676) $ 1,642 $56,582 $76,950
Cumulative gap 24,402 18,726 20,368 76,950
RSA/RSL-cumulative 126.6% 110.7% 107.1% 123.2%
ITEM 4. CONTROLS AND PROCEDURES
The Company's management evaluated, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, the effectiveness
of the Company's disclosure controls and procedures, as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer concluded that the Company's disclosure controls
and procedures are effective to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
There were no changes in the Company's internal control over
financial reporting that occurred during the Company's last fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 1A. RISK FACTORS
There have been no significant changes in the risk factors affecting the Company
that were identified in Item 1A of Part I of the Company's Form 10-K for the
year ended December 31, 2005.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Issuer Purchases of
--------------------
Equity Securities
-----------------
Maximum number
--------------
Total number of of shares (or approximate
--------------- -------------------------
shares purchased dollar value) that may yet
---------------- --------------------------
Total number Average price as part of publicly be purchased
------------ ------------- ---------- -------- ------------
of shares paid per announced plans under the plans
--------- -------- --------------- ---------------
purchased share or programs or programs
--------- ----- ----------- -----------
April 1 - April 30, 2006 - - - -
May 1 - May 31, 2006 5,732 $30.57 5,732 103,363
June 1 - June 30, 2006 - - - -
----- ------ ----- -------
5,732 $30.57 5,732 103,363
===== ====== ===== =======
(1) Purchases related to the Company's Employee Stock Ownership Plan (ESOP)
related to purchase of shares from terminated participants.
(2) On June 15, 2005, the Registrant announced its intention to repurchase up to
5% of its outstanding common stock (approximately 134,000 shares) in the open
market.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on April 25, 2006.
The following incumbent directors were nominated and duly elected to the Board
of Directors for a three-year term expiring in 2009.
FOR WITHHELD
--- --------
William W. Davis, Jr. 2,290,539 20,475
John E. Marshall 2,164,201 146,813
There were no abstentions or broker non-votes.
Approve the Norwood Financial Corp 2006 Stock Option Plan
FOR AGAINST ABSTAIN
--- ------- -------
1,866,018 104,955 25,265
There were no broker non-votes.
Ratify the appointment of Beard Miller Company LLP as independent accountant of
the Company for the fiscal year ending December 31, 2006.
FOR AGAINST ABSTAIN
--- ------- -------
2,304,120 307 6,587
There were no broker non-votes.
27
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) 3(i) Articles of Incorporation of Norwood Financial Corp.*
3(ii) Bylaws of Norwood Financial Corp.*
4.0 Specimen Stock Certificate of Norwood Financial Corp.*
10.1 Amended Employment Agreement with William W. Davis, Jr.***
10.2 Amended Employment Agreement with Lewis J. Critelli ***
10.3 Form of Change-In-Control Severance Agreement with seven key employees of the Bank*
10.4 Consulting Agreement with Russell L. Ridd**
10.5 Wayne Bank Stock Option Plan*
10.6 Salary Continuation Agreement between the Bank and William W. Davis, Jr.***
10.7 Salary Continuation Agreement between the Bank and Lewis J. Critelli***
10.8 Salary Continuation Agreement between the Bank and Edward C. Kasper***
10.9 1999 Directors Stock Compensation Plan***
10.10 Salary Continuation Agreement between the Bank and Joseph A. Kneller****
10.11 Salary Continuation Agreement between the Bank and John H. Sanders****
10.12 2006 Stock Option Plan*****
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
32 Section 1350 Certification
___________________________
* Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10 Registration Statement initially filed with
the Commission on April 29, 1996.
** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 31,
1997.
*** Incorporated herein by reference into the identically numbered exhibits
of the Registrant's Form 10-K filed with the Commission on March 20,
2000.
**** Incorporated herein by reference to the identically numbered exhibit
to the Registrant's Form 10-K filed with the Commission on March 22,
2004.
***** Incorporated herein by reference to the Registrants Form 8-K filed
with the Commission on April 25, 2006.
28
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORWOOD FINANCIAL CORP.
Date: August 11, 2006 By: /s/William W. Davis, Jr.
-------------------------------------
William W. Davis, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Date: August 11, 2006 By: Lewis J. Critelli
-------------------------------------
Lewis J. Critelli
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
29