f10q_093014-0160.htm
UNITED STATES
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 September 30, 2014
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period _______________ to ___________________
 
Commission file number 0-28366  
Norwood Financial Corp.
(Exact name of Registrant as specified in its charter)

Pennsylvania
 
23-2828306
(State or other jurisdiction of
Incorporation or organization)
 
(I.R.S. employer identification no.)

717 Main Street, Honesdale, Pennsylvania
 
18431
 
(Address of principal executive offices)
 
(Zip Code)
 

(570) 253-1455
(Registrant’s telephone number, including area code)

N/A
(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 has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer[ ]               Accelerated filer [ X]                       
Non-accelerated filer [ ]            Smaller reporting company [ ]
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): [ ] 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 November 3, 2014    
Common stock, par value $0.10 per share
 
3,645,699
   
 
1

 



NORWOOD FINANCIAL CORP.
 
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2014


     
   
 
 Page
Number
PART I -
CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD
FINANCIAL CORP.
 
     
Item 1.
Financial Statements (unaudited)
  3
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
47
Item 4.
Controls and Procedures
48
PART II -
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
49
Item 1A.
Risk Factors
49
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49
Item 3.
Defaults upon Senior Securities
49
Item 4.
Mine Safety Disclosures
49
Item 5.
Other Information
49
Item 6.
Exhibits
49
     
Signatures
 
51




 
2

 

PART I.  FINANCIAL INFORMATION
Item 1. Financial Statements
NORWOOD FINANCIAL CORP.
Consolidated Balance Sheets  (unaudited)
(dollars in thousands, except share and per share data)

 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
ASSETS
           
Cash and due from banks
  $ 13,105     $ 7,528  
Interest bearing deposits with banks
    158       335  
Cash and cash equivalents
    13,263       7,863  
                 
Securities available for sale, at fair value
    158,701       158,132  
Securities held to maturity, fair value 2013:  $177
    -       174  
                 
Loans receivable (net of unearned income)
    500,844       503,097  
Less:  Allowance for loan losses
    5,651       5,708  
Net loans receivable
    495,193       497,389  
Regulatory stock, at cost
    3,210       2,877  
Bank premises and equipment, net
    6,825       7,125  
Bank owned life insurance
    18,143       17,790  
Accrued interest receivable
    2,367       2,422  
Foreclosed real estate owned
    4,962       1,009  
Goodwill
    9,715       9,715  
Other intangibles
    418       510  
Deferred tax asset
    3,691       4,819  
Other assets
    1,725       1,409  
TOTAL ASSETS
  $ 718,213     $ 711,234  
                 
LIABILITIES
               
Deposits:
               
Non-interest bearing demand
  $ 102,343     $ 92,684  
Interest-bearing
    445,995       448,498  
  Total deposits
    548,338       541,182  
Short-term borrowings
    44,704       49,914  
Other borrowings
    22,592       23,761  
Accrued interest payable
    975       1,022  
Other liabilities
    4,197       3,491  
TOTAL LIABILITIES
    620,806       619,370  
                 
STOCKHOLDERS’ EQUITY
               
Common stock, $.10 par value per share,
               
 authorized 10,000,000 shares; issued 3,708,718  shares
    371       371  
Surplus
    35,143       35,010  
Retained  earnings
    63,637       60,798  
Treasury stock at cost: 2014: 63,019 shares,
               
   2013: 64,628 shares
    (1,673 )     (1,713 )
Accumulated other comprehensive loss
    (71 )     (2,602 )
TOTAL STOCKHOLDERS’ EQUITY
    97,407       91,864  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 718,213     $ 711,234  

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,
 
   
2014
   
2013
   
2014
   
2013
 
INTEREST INCOME
                       
Loans receivable, including fees
  $ 5,972     $ 6,202     $ 17,885     $ 18,557  
Securities
    968       939       2,981       2,685  
Other
    1       5       3       17  
Total interest income
    6,941       7,146       20,869       21,259  
                                 
INTEREST EXPENSE
                               
Deposits
    600       701       1,852       2,174  
Short-term borrowings
    19       17       62       44  
Other borrowings
    168       158       501       525  
Total interest expense
    787       876       2,415       2,743  
NET INTEREST INCOME
    6,154       6,270       18,454       18,516  
PROVISION FOR LOAN LOSSES
    420       400       1,260       2,000  
NET INTEREST INCOME AFTER
                               
PROVISION FOR LOAN LOSSES
    5,734       5,870       17,194       16,516  
                                 
OTHER INCOME
                               
Service charges and fees
    587       614       1,746       1,834  
Income from fiduciary activities
    125       111       328       285  
Net realized gains on sales of securities
    301       198       904       590  
(Losses) gains on sale of loans and servicing rights
    (15 )     (12 )     50       (9 )
Earnings and proceeds on bank owned life insurance
    170       150       514       1,224  
Other
    94       155       241       381  
Total other income
    1,262       1,216       3,783       4,305  
                                 
OTHER EXPENSES
                               
Salaries and employee benefits
    2,028       2,103       6,364       6,438  
Occupancy, furniture & equipment, net
    505       507       1,601       1,586  
Data processing related
    240       221       680       673  
Taxes, other than income
    161       179       488       531  
Professional fees
    136       139       475       498  
Federal Deposit Insurance Corporation insurance assessment
    104       114       320       335  
Foreclosed real estate owned
    271       217       733       494  
Other
    679       693       2,068       2,052  
Total other expenses
    4,124       4,173       12,729       12,607  
                                 
INCOME BEFORE INCOME TAXES
    2,872       2,913       8,248       8,214  
INCOME TAX EXPENSE
    754       777       2,132       1,930  
NET INCOME
  $ 2,118     $ 2,136     $ 6,116     $ 6,284  
                                 
BASIC EARNINGS PER SHARE
  $ 0.58     $ 0.59     $ 1.68     $ 1.73  
                                 
DILUTED EARNINGS PER SHARE
  $ 0.58     $ 0.59     $ 1.68     $ 1.73  


See accompanying notes to the unaudited consolidated financial statements.


 
4

 
 
NORWOOD FINANCIAL CORP.
Consolidated Statements of Comprehensive Income (unaudited)
(dollars in thousands)
 
 
Three Months Ended
 
Three Months Ended
 
 
September 30, 2014
 
September 30, 2013
 
Net income
$ 2,118   $ 2,136  
Other comprehensive income (loss):
           
Investment securities available for sale:
           
   Unrealized holding gains (losses)
  186     (385 )
    Tax effect
  (63 )   130  
   Reclassification of gains recognized in net income
  (301 )   (198 )
    Tax effect
  102     68  
Other comprehensive loss
  (76 )   (385 )
Comprehensive Income
$ 2,042   $ 1,751  



 
Nine Months Ended
 
Nine Months Ended
 
 
September 30, 2014
 
September 30, 2013
 
Net income
$
 6,116
 
$
 6,284
 
Other comprehensive income (loss):
           
Investment securities available for sale:
           
   Unrealized holding gains (losses)
 
 4,742
   
 (6,028)
 
    Tax effect
 
 (1,614)
   
 2,048
 
   Reclassification of gains recognized in net income
 
 (904)
   
 (590)
 
    Tax effect
 
 307
   
 201
 
Other comprehensive income (loss)
 
 2,531
   
 (4,369)
 
Comprehensive Income
$
 8,647
 
$
 1,915
 

 
See accompanying notes to the unaudited consolidated financial statements.

 
5

 

NORWOOD FINANCIAL CORP.
Consolidated Statements of Changes in Stockholders’ Equity (unaudited)
Nine Months Ended September 30, 2014
(dollars in thousands, except share and per share data)
 
                                      
Accumulated
       
                                     
Other
       
 
Common Stock
       
Retained
 
Treasury Stock
 
Comprehensive
       
 
Shares
 
Amount
 
Surplus
 
Earnings
 
Shares
 
Amount
 
Income (Loss)
 
Total
 
Balance December 31, 2013
    3,708,718     $ 371     $ 35,010     $ 60,798       64,628     $ (1,713 )   $ (2,602 )   $ 91,864  
Net Income
                            6,116                               6,116  
Other comprehensive income
                                                    2,531       2,531  
Cash dividends declared ($.90 per share)
                            (3,277 )                             (3,277 )
Acquisition of  treasury  stock
                                    6,669       (179 )             (179 )
Stock options exercised
                    8               (8,278 )     219               227  
Tax benefit of stock options
                    5                                       5  
Compensation expense related to stock 
  options
                    120                                       120  
 
                                                               
Balance, September 30, 2014
    3,708,718     $ 371     $ 35,143     $ 63,637       63,019     $ (1,673 )   $ (71 )   $ 97,407  




See accompanying notes to the unaudited consolidated financial statements.

 
6

 
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)
           
 
 
Nine Months Ended September 30,
 
   
2014
   
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net Income
  $ 6,116     $ 6,284  
Adjustments to reconcile net income to net cash provided by operating  activities:
               
Provision for loan losses
    1,260       2,000  
Depreciation
    433       447  
Amortization of intangible assets
    92       104  
Deferred income taxes
    (179 )     (36 )
Net amortization of securities premiums and discounts
    645       831  
Net realized gain on sales of securities
    (904 )     (590 )
Gain on life insurance policy
    (5 )     (770 )
Net increase in value of life insurance
    (509 )     (454 )
Loss on sale of bank premises and equipment and foreclosed real estate
    182       290  
Net gain on sale of mortgage loans
    (72 )     (25 )
Mortgage loans originated for sale
    (2,228 )     (1,609 )
Proceeds from sale of mortgage loans originated for sale
    2,300       1,634  
Compensation expense related to stock options
    120       119  
(Increase) decrease in accrued interest receivable and other assets
    (157 )     428  
Increase in accrued interest payable and other liabilities
    659       1,006  
Net cash provided by operating activities
    7,753       9,659  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Securities available for sale:
               
Proceeds from sales
    39,117       29,962  
Proceeds from maturities and principal reductions on mortgage-backed securities
    12,021       16,998  
Purchases
    (47,611 )     (59,334 )
Proceeds from maturities on securities held to maturity
    175       -  
Purchase of FHLB stock
    (1,811 )     -  
Redemption of FHLB stock
    1,478       489  
Net increase in loans
    (3,752 )     (12,908 )
Proceeds from life insurance policy
    75       1,859  
Purchase of bank premises and equipment
    (145 )     (371 )
Proceeds from sale of bank premises and equipment and foreclosed real estate
    547       333  
Net cash provided by (used in) investing activities
    94       (22,972 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
    7,156       24,273  
Net (decrease) increase in short-term borrowings
    (5,210 )     9,769  
Repayments of other borrowings
    (1,169 )     (5,531 )
Proceeds from other borrowings
    -       3,000  
Stock options exercised
    227       320  
Tax benefit of stock options exercised
    5       23  
Acquisition of treasury stock
    (179 )     (319 )
Cash dividends paid
    (3,277 )     (3,103 )
Net cash (used in) provided by financing activities
    (2,447 )     28,432  
Increase in cash and cash equivalents
    5,400       15,119  
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    7,863       12,295  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 13,263     $ 27,414  

See accompanying notes to the unaudited consolidated financial statements.
 
7

 
 
NORWOOD FINANCIAL CORP.
Consolidated Statements of Cash Flows (Unaudited) (continued)

(dollars in thousands)
           
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
Supplemental Disclosures of Cash Flow Information
           
Cash payments for:
           
Interest on deposits and borrowings
  $ 2,462     $ 2,910  
Income taxes paid, net of refunds
    2,016       1,664  
 Supplemental Schedule of Noncash Investing Activities
               
Transfers of loans to foreclosed real estate and repossession of other assets
  $ 4,670     $ 787  


See accompanying notes to the unaudited consolidated financial statements.


 
8

 

Notes to the Unaudited Consolidated Financial Statements
1.         Basis of Presentation
The unaudited 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., Norwood Settlement Services, LLC,  and WTRO Properties, Inc.   All significant intercompany transactions have been eliminated in consolidation.

The accompanying unaudited consolidated  financial statements have been prepared in conformity with generally accepted accounting principles for interim financial statements and with instructions to Form 10-Q. 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 and results of operations of the Company.  The operating results for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 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, 2013.


2.         Earnings Per Share
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 reflect 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 weighted average shares outstanding used in the computations of basic and diluted earnings per share.

(in thousands)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Basic EPS weighted average shares outstanding
    3,642       3,626       3,641       3,624  
Dilutive effect of stock options
    10       12       10       13  
Diluted EPS weighted average shares outstanding
    3,652       3,638       3,651       3,637  

Stock options which had no intrinsic value, because their effect would be anti-dilutive and therefore would not be included in the diluted EPS calculation were 19,600 as of September 30, 2014 based upon the closing price of Norwood common stock of $28.60 per share on September 30, 2014. There were no anti-dilutive shares at September 30, 2013 based on Norwood’s closing price of $28.95.

 
9

 

3.         Stock-Based Compensation

The Company’s shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the Annual Meeting held on April 25, 2006 and the Norwood Financial Corp 2014 Equity Incentive Plan at the Annual Meeting held on April 22, 2014.  No awards were granted during the nine month period ending September 30, 2014. As of September 30, 2014, there was $37,000 of total unrecognized compensation cost related to non-vested options granted in 2013 under the 2006 Stock Option Plan, which will be fully amortized by December 31, 2014.

A summary of stock options from all plans, adjusted for stock dividends declared, is shown below.

        
Weighted
                 
       
Average Exercise
   
Weighted Average
 
Aggregate
 
       
Price
   
Remaining
 
Intrinsic Value
 
    Options   Per Share     Contractual Term   (000)  
                                   
Outstanding at January 1, 2014
    219,540     $ 26.64       6.1  
Yrs.
          $ 147  
Granted
    -       -       -                 -  
Exercised
    8,278       27.49       3.3                 15  
Forfeited
    -       -       -                 -  
Outstanding at September 30, 2014
    211,262       26.61       5.3                 422  
                                           
Exercisable at September 30, 2014
    183,762     $ 26.54       4.8  
 Yrs.
          $ 379  

Intrinsic value represents the amount by which the market price of the stock on the measurement date exceeded the exercise price of the option.  The stock price was $28.60 as of September 30, 2014 and $26.90 as of December 31, 2013.

4.         Accumulated Other Comprehensive Income

The following table presents the changes in accumulated other comprehensive income (in thousands) by component net of tax for the three months and nine months ended September 30, 2014 and 2013:

 
Unrealized gains (losses) on
 
 
available for sale
 
 
securities (a)
 
Balance as of December 31, 2013
  $ (2,602 )
Other comprehensive income before reclassification
    3,128  
Amount reclassified from accumulated other comprehensive income
    (597 )
Total other comprehensive income
    2,531  
Balance as of September 30, 2014
  $ (71 )
         
         
         
 
Unrealized gains (losses) on
 
 
available for sale
 
 
securities (a)
 
Balance as of  December 31, 2012
  $ 2,797  
Other comprehensive loss before reclassification
    (3,980 )
Amount reclassified from accumulated other comprehensive income
    (389 )
Total other comprehensive loss
    (4,369 )
Balance as of September 30, 2013
  $ (1,572 )

 
10

 
 
 
Unrealized gains (losses) on
 
 
available for sale
 
 
securities (a)
 
Balance as of June 30, 2014
  $ 5  
Other comprehensive income before reclassification
    123  
Amount reclassified from accumulated other comprehensive income
    (199 )
Total other comprehensive loss
    (76 )
Balance as of September 30, 2014
  $ (71 )
         
         
 
Unrealized gains (losses) on
 
 
available for sale
 
 
securities (a)
 
Balance as of June 30, 2013
  $ (1,187 )
Other comprehensive loss before reclassification
    (255 )
Amount reclassified from accumulated other comprehensive income
    (130 )
Total other comprehensive loss
    (385 )
Balance as of September 30, 2013
  $ (1,572 )

 

 (a)  All amounts are net of tax.  Amounts in parentheses indicate debits.

The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) (in thousands) for the three and nine months ended September 30, 2014 and 2013:

   
Amount Reclassified
   
   
From Accumulated
 
Affected Line Item in
   
Other
 
the Statement Where
   
Comprehensive
 
Net Income is
Details about other comprehensive income
 
Income (a)
 
Presented
               
   
Three months
   
Three months
   
   
ended
   
ended
   
   
September 30,
   
September 30,
   
   
2014
   
2013
   
Unrealized gains on available for sale securities
  $ 301     $ 198  
Net realized gains on sales of securities
      (102 )     (68 )
Income tax expense
    $ 199     $ 130  
Net of tax
                   
   
Nine months
   
Nine months
   
   
ended
   
ended
   
   
September 30,
   
September 30,
   
     2014      2013    
Unrealized gains on available for sale securities
  $ 904     $ 590  
Net realized gains on sales of securities
      (307 )     (201 )
Income tax expense
    $ 597     $ 389  
Net of tax
 
(a)  Amounts in parentheses indicate debits to net income
 
11

 
 

5.         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)
September 30,
 
 
2014
 
2013
 
             
Unfunded availability under loan commitments
  $ 26,495     $ 23,223  
Unfunded commitments under lines of credit
    45,830       46,597  
Standby letters of credit
    5,688       6,991  
    $ 78,013     $ 76,811  

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.

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 payments required under the corresponding guarantees.  The current amount of the liability as of September 30, 2014 for guarantees under standby letters of credit issued is not material.
 
 
12

 
 
6.         Securities

The amortized cost and fair value of securities were as follows:

 
September 30, 2014
 
       
Gross
 
Gross
       
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
 
 
(In Thousands)
 
Available for Sale:
                       
U.S. Treasury securities
  $ 965     $ -     $ (2 )   $ 963  
U.S. Government agencies
    27,900       3       (548 )     27,355  
States and political subdivisions
    52,895       1,563       (159 )     54,299  
Corporate obligations
    6,422       93       (30 )     6,485  
Mortgage-backed securities-
                               
government sponsored entities
    70,329       139       (1,229 )     69,239  
Equity securities-financial services
    292       68       -       360  
    $ 158,803     $ 1,866     $ (1,968 )   $ 158,701  
                                 
                                 


 
December 31, 2013
 
       
Gross
 
Gross
       
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
 
 
(In Thousands)
 
Available for Sale:
                       
U.S. Government agencies
  $ 34,471     $ -     $ (1,058 )   $ 33,413  
States and political subdivisions
    60,174       650       (1,794 )     59,030  
Corporate obligations
    3,667       84       (40 )     3,711  
Mortgage-backed securities-government
                               
sponsored entities
    63,467       81       (1,898 )     61,650  
Equity securities-financial services
    293       50       (15 )     328  
    $ 162,072     $ 865     $ (4,805 )   $ 158,132  
Held to Maturity:
                               
States and political subdivisions
  $ 174     $ 3     $ -     $ 177  


 
13

 

The following tables show the Company’s investments’ gross unrealized losses and fair value aggregated by length of time that individual securities have been in a continuous unrealized loss position (in thousands):


 
September 30, 2014
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
U.S. Treasury securities
  $ 963     $ (2 )   $ -     $ -     $ 963     $ (2 )
U.S. government agencies
    7,291       (32 )     17,902       (516 )     25,193       (548 )
States and political subdivisions
    1,379       (2 )     7,835       (157 )     9,214       (159 )
Corporate obligations
    2,806       (13 )     1,146       (17 )     3,952       (30 )
Mortgage-backed securities-
government sponsored agencies
    27,385       (180 )     26,487       (1,049 )     53,872       (1,229 )
    $ 39,824     $ (229 )   $ 53,370     $ (1,739 )   $ 93,194     $ (1,968 )

 

 
December 31, 2013
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
U.S. Treasury securities
  $ 32,481     $ (990 )   $ 932     $ (68   $ 33,413     $ (1,058 )
State and political subdivisions
    26,281       (1,415 )     4,228       (379 )     30,509       (1,794 )
Corporate obligations
    1,145       (40 )     -       -       1,145       (40 )
Mortgage-backed securities-
government sponsored agencies
    47,014       (1,524 )     7,478       (374 )     54,492       (1,898 )
Equity securities - financial services
    170       (15 )     -       -       170       (15 )
    $ 107,091     $ (3,984 )   $ 12,638     $ (821 )   $ 119,729     $ (4,805 )
 
At September 30, 2014, the Company has 32 debt securities in an unrealized loss position in the less than twelve months category and 60 debt securities in the twelve months or more category. In Management’s opinion the unrealized losses reflect changes in interest rates subsequent to the acquisition of specific securities.  No other-than-temporary-impairment charges were recorded in 2014.  Management believes that all unrealized losses represent temporary impairment of the securities as the Company does not have the intent to sell the securities and it is more likely than not that it will not have to sell the securities before recovery of its cost basis.

The amortized cost and fair value of debt securities as of September 30, 2014 by contractual maturity are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

   
Available for Sale
   
 (In Thousands)
 
Amortized Cost
   
Fair Value
   
               
               
Due in one year or less
  $ 747     $ 764    
Due after one year through five years
    21,635       21,490    
Due after five years through ten years
    22,090       21,797    
Due after ten years
    43,710       45,051    
                   
Mortgage-backed securities-government sponsored agencies
    70,329       69,239    
    $ 158,511     $ 158,341    


 
14

 
 
Gross realized gains and gross realized losses on sales of securities available for sale were as follows (in thousands):


 
Three Months
 
Nine Months
 
 
Ended September 30,
 
Ended September 30,
 
 
2014
 
2013
 
2014
 
2013
 
Gross realized gains
  $ 301     $ 198     $ 918     $ 608  
Gross realized losses
    -       -       (14 )     (18 )
Net realized gain
  $ 301     $ 198     $ 904     $ 590  
Proceeds from sales of securities
  $ 7,252     $ 14,663     $ 39,117     $ 29,962  

 
7.        Loans Receivable and Allowance for Loan Losses

Set forth below is selected data relating to the composition of the loan portfolio at the dates indicated:

 
Types of loans
 
 
(dollars in thousands)
 
                         
 
September 30, 2014
 
December 31, 2013
 
Real Estate-Residential
  $ 157,945       31.5 %   $ 158,842       31.6 %
Commercial
    262,960       52.5       273,144       54.2  
Construction
    19,061       3.8       20,551       4.1  
Commercial, financial and agricultural
    41,962       8.4       35,745       7.1  
Consumer loans to individuals
    19,325       3.8       15,295       3.0  
Total loans
    501,253       100.0 %     503,577       100.0 %
Deferred fees, net
    (409 )             (480 )        
Total loans receivable
    500,844               503,097          
Allowance for loan losses
    (5,651 )             (5,708 )        
Net loans receivable
  $ 495,193             $ 497,389          

Changes in the accretable yield for purchased credit-impaired loans were as follows for the nine months ended September 30 (in thousands):



 
2014
 
2013
 
Balance at beginning of period
  $ 20     $ 76  
Accretion
    (12 )     (49 )
Reclassification and other
    -       -  
Balance at end of period
  $ 8     $ 27  


 
15

 
 
The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):


 
September 30, 2014
 
December 31, 2013
 
             
Outstanding Balance
  $ 1,069     $ 1,110  
Carrying Amount
  $ 1,061     $ 1,090  

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and September 30, 2014.  Adjustments to the allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of May 31, 2011 have been accounted for through the allowance for loan loss adequacy calculation. There has been no allowance for loan losses on these loans reversed.  For loans that were acquired without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation.

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans.  Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers.  Specific loan loss allowances are established for identified losses based on a review of such information.  A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probably that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans identified as impaired are evaluated independently.  We do not aggregate such loans for evaluation purposes.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider.  Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk.
 
 
16

 
 
The following table shows the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:


  
Real Estate Loans
                   
                   
Commercial
 
Consumer
       
 
Residential
 
Commercial
 
Construction
 
Loans
 
Loans
 
Total
 
September 30, 2014
(In thousands)
 
                                     
Individually evaluated for  impairment
  $ -     $ 5,853     $ -     $ -     $ -     $ 5,853  
Loans acquired with deteriorated credit quality
    228       832       -       -       -       1,060  
Collectively evaluated for impairment
    157,717       256,275       19,061       41,962       19,325       494,340  
Total Loans
  $ 157,945     $ 262,960     $ 19,061     $ 41,962     $ 19,325     $ 501,253  
 
 
 
Real Estate Loans
                   
                   
Commercial
 
Consumer
       
 
Residential
 
Commercial
 
Construction
 
Loans
 
Loans
 
Total
 
 
(In thousands)
 
December 31, 2013
                                   
                                     
Individually evaluated for impairment
  $ -     $ 11,519     $ -     $ -     $ -     $ 11,519  
Loans acquired with deteriorated credit quality
    242       848       -       -       -       1,090  
Collectively evaluated for impairment
    158,600       260,777       20,551       35,745       15,295       490,968  
Total Loans
  $ 158,842     $ 273,144     $ 20,551     $ 35,745     $ 15,295     $ 503,577  


 
17

 
 
The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable.  Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.


         
Unpaid
       
   
Recorded
   
Principal
   
Associated
 
   
Investment
   
Balance
   
Allowance
 
September 30, 2014
    (in thousands)  
With no related allowance recorded:
                 
Real Estate Loans
                 
  Residential
  $ 228     $ 228     $ -  
  Commercial
    4,699       4,792       -  
Subtotal
    4,927       5,020       -  
With an allowance recorded:
                       
Real Estate Loans
                       
Commercial
    1,986       2,850       61  
Subtotal
    1,986       2,850       61  
Total:
                       
Real Estate Loans
                       
  Residential
    228       228       -  
  Commercial
    6,685       7,642       61  
Total Impaired Loans
  $ 6,913     $ 7,870     $ 61  


         
Unpaid
       
   
Recorded
   
Principal
   
Associated
 
   
Investment
   
Balance
   
Allowance
 
December 31, 2013
    (in thousands)  
With no related allowance recorded:
                 
Real Estate Loans
                 
Residential
  $ 242     $ 251     $ -  
Commercial
    10,644       14,400       -  
Subtotal
    10,886       14,651       -  
With an allowance recorded:
                       
Real Estate Loans
                       
Commercial
    1,723       1,723       53  
Subtotal
    1,723       1,723       53  
Total:
                       
Real Estate Loans
                       
Residential
    242       251       -  
Commercial
    12,367       16,123       53  
Total Impaired Loans
  $ 12,609     $ 16,374     $ 53  


 
18

 


The following information for impaired loans is presented (in thousands) for the nine months ended September 30, 2014 and 2013:

 
Average Recorded
 
Interest Income
 
 
Investment
 
Recognized
 
 
2014
 
2013
 
2014
 
2013
 
Total:
                       
Real Estate Loans
                       
Residential
  $ 235     $ 255     $ 4     $ 4  
Commercial
    6,577       10,120       150       47  
Total Loans
  $ 6,812     $ 10,375     $ 154     $ 51  


The following information for impaired loans is presented (in thousands) for the three months ended September 30, 2014 and 2013:
 
 
Average Recorded
 
Interest Income
 
 
Investment
 
Recognized
 
 
2014
 
2013
 
2014
 
2013
 
Total:
                       
Real Estate Loans
                       
Residential
  $ 230     $ 245     $ 2     $ 2  
Commercial
    6,730       9,124       51       30  
Total Loans
  $ 6,960     $ 9,369     $ 53     $ 32  


Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.  As of September 30, 2014, troubled debt restructured loans totaled $4.0 million and resulted in specific reserves of $61,000.  As of December 31, 2013, troubled debt restructured loans totaled $9.2 million and resulted in specific reserves of $53,000.  For the period ended September 30, 2014, there were no new loans identified as troubled debt restructurings.  During 2014, the Company recognized write-downs in the amount of $227,000 on two loans identified as troubled debt restructurings with a carrying value of $1.2 million as of September 30, 2014.  During 2013, one loan with a balance of $1.3 million was classified as a troubled debt restructuring.  The restructuring resulted in a decrease in the borrower’s debt but the remaining balance was classified as troubled debt since it would be unlikely that the borrower could obtain comparable financing elsewhere.
 

 
 
19

 
 
Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio.  The first four categories are considered not criticized, and are aggregated as “Pass” rated.  The criticized rating categories utilized by management generally follow bank regulatory definitions.  The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  All loans greater than 90 days past due are considered Substandard.  Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event.  The Company’s Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis.  Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration.  Loan Review also annually reviews relationships of $1,000,000 and over to assign or re-affirm risk ratings.  Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of  September 30, 2014 and December 31, 2013 (in thousands):


       
Special
          Doubtful
 
     
 
Pass
 
Mention
 
Substandard
   
and Loss
 
Total
 
September 30, 2014
                             
Commercial real estate loans
  $ 247,168     $ 3,450     $ 12,342     $ -     $ 262,960  
Commercial loans
    41,962       -       -       -       41,962  
Total
  $ 289,130     $ 3,450     $ 12,342     $ -     $ 304,922  
 
 
                               
                               
       
Special
          Doubtful        
 
Pass
 
Mention
 
Substandard
   
and Loss
 
Total
 
December 31, 2013
                             
Commercial real estate loans
  $ 250,566     $ 3,651     $ 18,927     $ -     $ 273,144  
Commercial loans
    35,745       -       -       -       35,745  
Total
  $ 286,311     $ 3,651     $ 18,927     $ -     $ 308,889  

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits.  The following table presents the recorded investment in the loan classes based on payment activity as of September 30, 2014 and December 31, 2013 (in thousands):


 
Performing
 
Nonperforming
 
Total
 
September 30, 2014
                 
Residential real estate loans
  $ 156,167     $ 1,778     $ 157,945  
Construction
    19,061       -       19,061  
Consumer loans
    19,325       -       19,325  
Total
  $ 194,553     $ 1,778     $ 196,331  

 
 
20

 

 
Performing
 
Nonperforming
 
Total
 
December 31, 2013
                 
Residential real estate loans
  $ 157,138     $ 1,704     $ 158,842  
Construction
    20,551       -       20,551  
Consumer loans
    15,295       -       15,295  
Total
  $ 192,984     $ 1,704     $ 194,688  

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of September 30, 2014 and December 31, 2013 (in thousands):

   
Current
   
31-60 Days Past Due
   
61-90 Days Past Due
   
Greater than 90 Days Past Due and still accruing
   
Non-Accrual
   
Total Past Due
and Non-Accrual
   
Total Loans
 
September 30, 2014
                                         
Real Estate loans
                                         
Residential
  $ 155,278     $ 755     $ 134     $ -     $ 1,778     $ 2,667     $ 157,945  
Commercial
    258,345       283       201       -       4,131       4,615       262,960  
Construction
    19,061       -       -       -       -       -       19,061  
Commercial  loans
    41,962       -       -       -       -       -       41,962  
Consumer  loans
    19,255       51       4       15       -       70       19,325  
Total
  $ 493,901     $ 1,089     $ 339     $ 15     $ 5,909     $ 7,352     $ 501,253  
 
   
Current
   
31-60 Days Past Due
   
61-90 Days Past Due
   
Greater than 90 Days Past Due and still accruing
   
Non-Accrual
   
Total Past Due
and Non-Accrual
   
Total Loans
 
December 31, 2013
                                         
Real Estate loans
                                         
Residential
  $ 156,066     $ 1,018     $ 54     $ -     $ 1,704     $ 2,776     $ 158,842  
Commercial
    263,837       977       487       -       7,843       9,307       273,144  
Construction
    20,551       -       -       -       -       -       20,551  
Commercial  loans
    35,717       28       -       -       -       28       35,745  
Consumer  loans
    15,228       57       10       -       -       67       15,295  
Total
  $ 491,399     $ 2,080     $ 551     $ -     $ 9,547     $ 12,178     $ 503,577  

The following table presents the allowance for loan losses by the classes of the loan portfolio:

(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, December 31, 2013
  $ 1,441     $ 3,025     $ 898     $ 184     $ 160     $ 5,708  
Charge Offs
    (132 )     (1,177 )     -       -       (36 )     (1,345 )
Recoveries
    -       -       -       -       28       28  
Provision for loan losses
    (57 )     2,005       (704 )     14       2       1,260  
Ending balance, September 30, 2014
  $ 1,252     $ 3,853     $ 194     $ 198     $ 154     $ 5,651  
Ending balance individually evaluated
for impairment
  $ -     $ 61     $ -     $ -     $ -     $ 61  
Ending balance collectively evaluated
for impairment
  $ 1,252     $ 3,792     $ 194     $ 198     $ 154     $ 5,590  
 
 
21

 
 
(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, June 30, 2014
  $ 1,194     $ 3,900     $ 205     $ 179     $ 133     $ 5,611  
Charge Offs
    (34 )     (348 )     -       -       (9 )     (391 )
Recoveries
    -       -       -       -       11       11  
Provision for loan losses
    92       301       (11 )     19       19       420  
Ending balance, September 30, 2014
  $ 1,252     $ 3,853     $ 194     $ 198     $ 154     $ 5,651  

 
(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, December 31, 2012
  $ 1,797     $ 3,183     $ 119     $ 223     $ 180     $ 5,502  
Charge Offs
    (547 )     (1,308 )     (40 )     -       (74 )     (1,969 )
Recoveries
    9       -       -       -       17       26  
Provision for loan losses
    406       1,288       329       (76 )     53       2,000  
Ending balance, September 30, 2013
  $ 1,665     $ 3,163     $ 408     $ 147     $ 176     $ 5,559  
Ending balance individually evaluated
for impairment
  $ -     $ -     $ -     $ -     $ -     $ -  
Ending balance collectively evaluated
for impairment
  $ 1,665     $ 3,163     $ 408     $ 147     $ 176     $ 5,559  
                                                 
                                                 
(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, June 30, 2013
  $ 1,764     $ 3,318     $ 363     $ 147     $ 157     $ 5,749  
Charge Offs
    (157 )     (380 )     (40 )     -       (28 )     (605 )
Recoveries
    9       -       -       -       6       15  
Provision for loan losses
    49       225       85       -       41       400  
Ending balance, September 30, 2013
  $ 1,665     $ 3,163     $ 408     $ 147     $ 176     $ 5,559  
 

The Company’s primary business activity as of September 30, 2014 and December 31, 2013 is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy.

As of September 30, 2014, the Company considered its concentration of credit risk to be acceptable.  The highest concentrations are in the hospitality lodging industry, automobile dealers, property owners associations and resorts with loans outstanding of $36.1 million, or 40.6% of capital, to the hospitality lodging industry, $13.6 million, or 15.3% of capital to automobile dealers, $13.3 million, or 15.0% of capital, to property owners associations and $9.0 million, or 10.1% of capital, to the resort industry.  During 2014, the Company recorded a write down of $422,000 on a motel property which has been sold.

 
22

 
 
Gross realized gains and gross realized losses on sales of residential mortgage loans were $72,000 and $0, respectively, in the first nine months of 2014 compared to $32,000 and $7,000, respectively, in the same period in 2013.  The proceeds from the sales of residential mortgage loans totaled $2.3 million and $1.6 million for the nine months ended September 30, 2014 and 2013, respectively.

There were no sales of residential mortgage loans during the three month periods ended September 30, 2014 or 2013.


8.         Fair Value Measurements

Fair value estimates are based on quoted market prices, if available, quoted market prices of similar assets or liabilities, or the present value of expected future cash flows and other valuation techniques.  These valuations are significantly affected by discount rates, cash flow assumptions and risk assumptions used.  Therefore, fair value estimates may not be substantiated by comparison to independent markets and are not intended to reflect the proceeds that may be realizable in an immediate settlement of the instruments.

Fair value is determined at one point in time and is not representative of future value.  These amounts do not reflect the total value of a going concern organization.  Management does not have the intention to dispose of a significant portion of its assets and liabilities and therefore, the unrealized gains or losses should not be interpreted as a forecast of future earnings and cash flows.


The following is a discussion of assets and liabilities measured at fair value on a recurring basis and valuation techniques applied:

Securities:

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.
 
Impaired loans (generally carried at fair value):

The Company measures impairment generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the lowest level of input that is significant to the fair value measurements.

 
23

 

Foreclosed real estate owned (carried at fair value):

Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less estimated cost to sell.  Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral.  These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2014 and December 31, 2013 are as follows:


   
Fair Value Measurement Using
 
   
Reporting Date
 
                         
                         
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
                         
September 30, 2014
                       
Available for Sale:
                       
U.S. Treasury securities
  $ 963     $ -     $ 963     $ -  
U.S. Government agencies
    27,355       -       27,355       -  
States and political subdivisions
    54,299       -       54,299       -  
Corporate obligations
    6,485       -       6,485       -  
Mortgage-backed securities-government
                               
  sponsored agencies
    69,239       -       69,239       -  
Equity securities-financial services
    360       360       -       -  
Total
  $ 158,701     $ 360     $ 158,341     $ -  
                                 
December 31, 2013
                               
Available for Sale:
                               
U.S. Government agencies
  $ 33,413     $ -     $ 33,413     $ -  
States and political subdivisions
    59,030       -       59,030       -  
Corporate obligations
    3,711       -       3,711       -  
Mortgage-backed securities-government
                               
  sponsored agencies
    61,650       -       61,650       -  
Equity securities-financial services
    328       328       -       -  
Total
  $ 158,132     $ 328     $ 157,804     $ -  


 
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For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2014 and December 31, 2013 are as follows:

         
Fair Value Measurement Reporting Date using
 
Description
 
Total
 
Level 1
 
Level 2
 
Level 3
 
September 30, 2014
                         
Impaired Loans
    $ 6,852     $ -     $ -     $ 6,852  
Foreclosed Real Estate Owned
      4,962       -       -       4,962  
                                   
                                   
December 31, 2013
                                 
Impaired Loans
    $ 12,556     $ -     $ -     $ 12,556  
Foreclosed Real Estate Owned
      1,009       -       -       1,009  

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:


   
Quantitative Information about Level 3 Fair Value Measurements
 
(In thousands)
Fair Value Estimate
 
Valuation Techniques
Unobservable Input
 
Range (Weighted Average)
 
September 30, 2014
               
Impaired loans
  $ 6,852  
Appraisal of collateral(1)
Appraisal adjustments(2)
    10% (10%)  
                     
Foreclosed real estate owned
  $ 4,962  
Appraisal of collateral(1)
Liquidation Expenses(2)
    10% (10%)  
 
                 
                 
 
Quantitative Information about Level 3 Fair Value Measurements
 
(In thousands)
Fair Value Estimate
 
Valuation Techniques
Unobservable Input
 
Range (Weighted Average)
 
December 31, 2013
               
Impaired loans
  $ 12,556  
Appraisal of collateral(1)
Appraisal adjustments(2)
   10-15%  10.67%)   
                     
Foreclosed real estate owned
  $ 1,009  
Appraisal of collateral(1)
Liquidation Expenses(2)
   10% (10%)  
 
(1)  
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable, less any associated allowance.
(2)  
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

 
 
25

 
 
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.  The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at September 30, 2014 and December 31, 2013.

Cash and cash equivalents (carried at cost):
The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities:
The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.

Loans receivable (carried at cost):
The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired loans (generally carried at fair value):
The Company measures impairment generally based on the fair value of the loan’s collateral.  Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the lowest level of input that is significant to the fair value measurements.

As of September 30, 2014, the fair value investment in impaired loans totaled $6,852,000 which included two loans for $1,986,000 for which a valuation allowance of $61,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and fourteen loans for $4,927,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of September 30, 2014, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $1,022,000 over the life of the loans.

As of December 31, 2013, the fair value investment in impaired loans totaled $12,556,000 which included one loan for $1,723,000 for which a valuation allowance of $53,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and twenty loans for $10,886,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of December 31, 2013, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $3,714,000 over the life of the loans.

 
26

 
 
Mortgage servicing rights (generally carried at cost)
The Company utilizes a third party provider to estimate the fair value of certain loan servicing rights.  Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation.

Foreclosed real estate owned (carried at fair value):
Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

Restricted investment in Federal Home Loan Bank stock (carried at cost):
The Company, as a member of the Federal Home Loan Bank (FHLB) system is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula. This regulatory stock has no quoted market value and is carried at cost.

Bank owned life insurance (carried at cost):
The fair value is equal to the cash surrender value of the Bank owned life insurance.

Accrued interest receivable and payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings (carried at cost):
The carrying amounts of short-term borrowings approximate their fair values.

Other borrowings (carried at cost):
Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Off-balance sheet financial instruments (disclosed at cost):
Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

 
27

 
 

The estimated fair values of the Bank’s financial instruments were as follows at September 30, 2014 and December 31, 2013. (In thousands)


   
Fair Value Measurements at September 30, 2014
 
   
Carrying Amount
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
                             
Cash and cash equivalents
  $ 13,263     $ 13,263     $ 13,263     $ -     $ -  
Securities
    158,701       158,701       360       158,341       -  
Loans receivable, net
    495,193       508,966       -       -       508,966  
Mortgage servicing rights
    267       267       -       -       267  
Regulatory Stock
    3,210       3,210       3,210       -       -  
Bank owned life insurance
    18,143       18,143       18,143       -       -  
Accrued interest receivable
    2,367       2,367       2,367       -       -  
                                         
Financial liabilities:
                                       
Deposits
    548,338       548,701       354,004       -       194,697  
Short-term borrowings
    44,704       44,704       44,704       -       -  
Other borrowings
    22,592       23,769       -       -       23,769  
Accrued interest payable
    975       975       975       -       -  
                                         
Off-balance sheet financial instruments:
                                       
  Commitments to extend credit and 
   
outstanding letters of credit
    -       -       -       -       -  


 
28

 
 
   
Fair Value Measurements at December 31, 2013
 
   
Carrying Amount
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
                             
Cash and cash equivalents
  $ 7,863     $ 7,863     $ 7,863     $ -     $ -  
Securities
    158,306       158,309       328       157,981       -  
Loans receivable, net
    497,389       506,113       -       -       506,113  
Mortgage servicing rights
    289       289       -       289       -  
Regulatory stock
    2,877       2,877       2,877       -       -  
Bank owned life insurance
    17,790       17,790       17,790       -       -  
Accrued interest receivable
    2,422       2,422       2,422       -       -  
                                         
Financial liabilities:
                                       
Deposits
    541,182       542,123       329,753       -       212,370  
Short-term borrowings
    49,914       49,914       49,914       -       -  
Other borrowings
    23,761       25,923       -       -       25,923  
Accrued interest payable
    1,022       1,022       1,022       -       -  
                                         
Off-balance sheet financial instruments:
                                       
  Commitments to extend credit and 
   
outstanding letters of  credit
    -       -       -       -       -  
 

9.           New and Recently Adopted Accounting Pronouncements


In June 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-08, Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements. The amendments in this Update affect the scope, measurement, and disclosure requirements for investment companies under U.S. GAAP. The amendments do all of the following: (1) change the approach to the investment company assessment in Topic 946, clarify the characteristics of an investment company, and provide comprehensive guidance for assessing whether an entity is an investment company; (2) require an investment company to measure noncontrolling ownership interests in other investment companies at fair value rather than using the equity method of accounting; and (3) require the following additional disclosures: (a) the fact that the entity is an investment company and is applying the guidance in Topic 946, (b) information about changes, if any, in an entity’s status as an investment company, and (c) information about financial support provided or contractually required to be provided by an investment company to any of its investees. The amendments in this Update are effective for an entity’s interim and annual reporting periods in fiscal years that begin after December 15, 2013. Earlier application is prohibited. This Update did not have a significant impact on the Company’s financial statements.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This Update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a
 
 
29

 
 
tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.  This Update did not have a significant impact on the Company’s financial statements.

In January 2014, the FASB issued ASU 2014-01, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. The amendments in this Update permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit).  The amendments in this Update should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this Update are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014.  Early adoption is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method.  The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The Update’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is evaluating the effect of adopting this new accounting Update.
 
 
30

 
 
In June 2014, the FASB issued ASU 2014-10, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  The amendments in this Update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting.  For repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement.  The amendments also require enhanced disclosures.  The accounting changes in this Update are effective for the first interim or annual period beginning after December 15, 2014.  An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application is prohibited.  The disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date.  This Update is not expected to have a significant impact on the Company’s financial statements.

In June 2014, the FASB issued ASU 2014-12, Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments when the Terms of an Award Provide that a Performance Target Could Be Achieved After the Requisite Service Period.  The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this Update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Additionally, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2014, the FASB issued ASU 2014-14, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40).  The amendments in this Update require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met:  (1) the loan has a government guarantee that is not separable from the loan before foreclosure, (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.  Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor.  The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014.  The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements -Going Concern (Subtopic 205-40).  The amendments in this Update provide guidance in accounting principles generally accepted in the United States of America about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures.  The amendments in this Update are effective for the annual period ending after December 15,

 
31

 
 
2016, and for annual periods and interim periods thereafter. Early application is permitted. This Update is not expected to have a significant impact on the Company’s 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 are as follows:

     
 
our ability to realize the anticipated benefits from our acquisition of North Penn Bancorp, Inc.
 
possible future impairment of intangible assets
 
our ability to effectively manage future growth
 
loan losses in excess of our allowance
 
risks inherent in commercial lending
 
real estate collateral which is subject to declines in value
 
potential other-than-temporary impairments
 
higher deposit insurance premiums
 
soundness of other financial institutions
 
increased compliance burden under new financial reform legislation
 
current market volatility
 
potential liquidity risk
 
availability of capital
 
regional economic factors
 
loss of senior officers
 
comparatively low legal lending limits
 
risks of new capital requirements
 
limited market for the Company’s stock
 
restrictions on ability to pay dividends
 
common stock may lose value
 
competitive environment
 
issuing additional shares may dilute ownership
 
extensive and complex governmental regulation and associated cost
 
interest rate risks

Norwood Financial Corp. 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 for the year ended December 31, 2013 (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
 
 
32

 
 
qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the fair value of financial instruments, the determination of goodwill impairment and the determination of other-than-temporary impairment on securities.  Please refer to the discussion of the allowance for loan losses calculation under “Loans” in the “Changes in Financial Condition” section.

The Company uses the modified prospective transition method to account for stock based compensation.  Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.

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 that it is more likely than not that all deferred tax assets will be realized.

Bonds, notes and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the term of the security.

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each Consolidated Balance Sheet date.

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, the Company considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis.  The Company believes that the unrealized loss on all other securities at September 30, 2014 and December 31, 2013 represent temporary impairment of the securities, related to changes in interest rates.

The Company, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula.  This restricted stock has no quoted market value and is carried at cost.

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB.

Management considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and the new shares of FHLB stock continue to change hands at the $100 par value.  Management believes no impairment charge is necessary related to FHLB stock as of September 30, 2014.
 
 
33

 
 
In connection with the acquisition of North Penn Bancorp, Inc. (“North Penn”), the Company recorded goodwill in the amount of $9.7 million, representing the excess of amounts paid over the fair value of net assets of the institution acquired in a purchase transaction, at its fair value at the date of acquisition.  Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value.  The value of the goodwill can change in the future.  We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Bank.  If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss.


Changes in Financial Condition

General

Total assets as of September 30, 2014 were $718.2 million compared to $711.2 million as of December 31, 2013, an increase of $7.0 million due primarily to an increase in cash and cash equivalents resulting from an increase in cash from new deposits which exceeded the cash needed to fund new loans and investments.

Securities

The fair value of securities available for sale as of September 30, 2014 was $158.7 million compared to $158.1 million as of December 31, 2013.  The Company purchased $47.6 million of securities principally using the proceeds from $51.3 million of sales, calls, maturities and principal reductions of securities.

The carrying value of the Company’s securities portfolio (Available-for Sale and Held-to Maturity) consisted of the following:


   
September 30, 2014
   
December 31, 2013
 
(dollars in thousands)
 
Amount
   
% of portfolio
   
Amount
   
% of portfolio
 
                         
U.S. Treasury securities
  $ 963       0.6 %   $ -       - %
U.S. Government agencies
    27,355       17.3       33,413       21.1  
States and political subdivisions
    54,299       34.2       59,204       37.4  
Corporate obligations
    6,485       4.1       3,711       2.3  
Mortgage-backed securities-
                               
  government sponsored entities
    69,239       43.6       61,650       39.0  
Equity securities-financial services
    360       0.2       328       0.2  
  Total
  $ 158,701       100.0 %   $ 158,306       100.0 %

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.  Management believes that the unrealized losses on all holdings represent temporary impairment of the securities, as the Company has the intent and ability to hold these investments until maturity or market price recovery.
 
 
34

 


Loans

Loans receivable totaled $500.8 million at September 30, 2014 compared to $503.1 million as of December 31, 2013.  The $2.3 million decrease recorded in the nine month period ending September 30, 2014 was attributed to a $10.2 million decrease in commercial real estate loans and a $900,000 decrease in residential mortgage loans.  Commercial loans increased $6.2 million during the period while all other loans increased $2.6 million, net.

The allowance for loan losses totaled $5,651,000 as of September 30, 2014 and represented 1.13% of total loans, compared to $5,708,000, or 1.13% of total loans, at December 31, 2013, and $5,558,000, or 1.14% of total loans, as of September 30, 2013.  The Company had net charge-offs for the nine months ended September 30, 2014 of $1,317,000 compared to $1,943,000 in the corresponding period in 2013.  The Company’s loan review process 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 classifications, large dollar exposures and loan growth.  Management considers the allowance adequate at September 30, 2014 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 September 30, 2014, non-performing loans totaled $5.9 million, or 1.18% of total loans compared to $9.5 million, or 1.90% of total loans at December 31, 2013. At September 30, 2014, non-performing assets totaled $10.9 million, or 1.52%, of total assets compared to $10.6 million, or 1.48%, of total assets at December 31, 2013.  The decrease in non-performing loans principally reflects the transfer of two properties with a carrying value of $4.2 million on September 30, 2014 to foreclosed real estate.

The following table sets forth information regarding non-performing loans and foreclosed real estate at the dates indicated:

(dollars in thousands)
 
September 30, 2014
   
December 31, 2013
     
Loans accounted for on a non-accrual basis:
               
Commercial and all other
  $ -     $ -      
Real Estate
    5,909       9,547      
Total non-accrual loans *
    5,909       9,547      
                     
Accruing loans which are contractually
                   
past due 90 days or more
    15       -      
Total non-performing loans
    5,924       9,547      
Foreclosed real estate
    4,962       1,009      
Total non-performing assets
  $ 10,886     $ 10,556      
Allowance for loans losses
  $ 5,651     $ 5,708      
Coverage of non-performing loans
    0.95     0.60 x    
Non-performing loans to total loans
    1.18     1.90
 
 
Non-performing loans to total assets
    0.82     1.34
 
 
Non-performing assets to total assets
    1.52     1.48
 
 

*Includes non-accrual TDRs of $2.3 million as of September 30, 2014 and $6.2 million on December 31, 2013. The Company also had $1.7 million and $3.0 million of accruing TDRs on those dates.

 
35

 
 
Deposits

During the period, total deposits increased $7.2 million due primarily to an $11.9 million increase in NOW and money market accounts and a $9.7 million increase in non-interest bearing demand deposits.  The $17.1 million decrease in time deposits includes an $11.7 million decrease in certificates of deposit over $100,000 as municipalities utilized funds to meet cash flow needs.  All other deposit products increased $2.7 million, net.

The following table sets forth deposit balances as of the dates indicated:

(dollars in thousands)
 
September 30, 2014
   
December 31, 2013
 
             
Non-interest bearing demand
  $ 102,343     $ 92,684  
Interest bearing demand
    56,755       45,444  
Money market deposit accounts
    123,020       122,423  
Savings
    71,885       69,202  
Time deposits <$100,000
    126,420       131,793  
Time deposits >$100,000
    67,915       79,636  
                 
Total
  $ 548,338     $ 541,182  

Borrowings

Short-term borrowings as of September 30, 2014 totaled $44.7 million compared to $49.9 million as of December 31, 2013.  Short-term borrowings, which consist of securities sold under agreements to repurchase and overnight borrowings from the FHLB, decreased $5.2 million principally due to the seasonality of municipal cash management accounts.

Other borrowings consisted of the following:

(dollars in thousands)
   
September 30, 2014
   
December 31, 2013
 
Notes with the FHLB:
           
Convertible note due July 2015 at 4.34%
  $ 7,159     $ 7,301  
Convertible note due January 2017 at 4.71%
    10,000       10,000  
Amortizing fixed rate borrowing due January 2018 at 0.91%
    2,015       2,460  
Amortizing fixed rate borrowing due December 2018 at 1.425%
    3,418       4,000  
    $ 22,592     $ 23,761  

The convertible notes contain an option which allows the FHLB, at quarterly intervals to change the note to an adjustable-rate advance at three month LIBOR plus 17 to 22 basis points.  If the notes are converted, the option allows the Bank to put the funds back to the FHLB at no charge.  The borrowing due July 2015 includes a $159,000 fair value adjustment recorded at the time of the North Penn acquisition.

Off-Balance Sheet Arrangements

The Bank is 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.
 
 
36

 
 
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.  Commitments to grant loans totaled $26.5 million as of September 30, 2014 compared to $22.8 million as of December 31, 2013.

A summary of the contractual amount of the Company’s financial instrument commitments is as follows:

(in thousands)
           
   
September 30, 2014
   
December 31, 2013
 
             
Unfunded availability under loan commitments
  $ 26,495     $ 22,845  
Unfunded commitments under lines of credit
    45,830       42,575  
Standby letters of credit
    5,688       5,701  
                 
    $ 78,013     $ 71,121  

Stockholders’ Equity and Capital Ratios

As of September 30, 2014, stockholders’ equity totaled $97.4 million, compared to $91.9 million as of December 31, 2013.   The net change in stockholders’ equity included $6.1 million of net income that was partially offset by $3.3 million of dividends declared, a $179,000 reduction due to an increase in Treasury Stock, and a $352,000 increase due to the exercise and vesting of stock options.  In addition, total equity increased $2.5 million due to an increase in the fair value of securities in the available for sale portfolio, net of tax.  This increase in fair value is the result of a change in interest rates and spreads, which may impact the value of the securities. Because of interest rate volatility, the Company’s accumulated other comprehensive income could materially fluctuate for each interim and year-end period.

A comparison of the Company’s consolidated regulatory capital ratios is as follows:

   
September 30, 2014
   
December 31, 2013
 
Tier 1 Capital
           
(To average assets)
    12.48 %     12.09 %
Tier 1 Capital
               
(To risk-weighted assets)
    16.99 %     16.53 %
Total Capital
               
(To risk-weighted assets)
    18.09 %     17.66 %

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 and Securities (PDB&S) guidelines.  The Bank’s capital ratios do not differ significantly from the Company’s ratios.  Although not adopted in regulation form, the PDB&S utilizes capital standards requiring a minimum of 6.5% leverage capital and 10% total capital.  The Company and the Bank were in compliance with FRB, FDIC and PDB&S capital requirements as of September 30, 2014 and December 31, 2013.

 
37

 

Liquidity

As of September 30, 2014, the Company had cash and cash equivalents of $13.3 million in the form of cash, due from banks and short-term deposits with other institutions.  In addition, the Company had total securities available for sale of $158.7 million which could be used for liquidity needs.  This totals $172.0 million of liquidity and represents 23.9% of total assets compared to $166.0 million and 23.3% of total assets as of December 31, 2013.  The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of September 30, 2014 and December 31, 2013.  Based upon these measures, the Company believes its liquidity is adequate.

Capital Resources

The Company has a line of credit commitment available from the Federal Home Loan Bank (FHLB) of Pittsburgh for borrowings of up to $20,000,000 which expires in December 2016.  Borrowings under this line were $13.5 million and $13.4 million at September 30, 2014 and December 31, 2013, respectively.

The Company has a line of credit commitment from Atlantic Central Bankers Bank for $7,000,000 which expires June 30, 2015.  There were no borrowings under this line as of September 30, 2014 and December 31, 2013.

The Company has a line of credit commitment available which has no stated expiration date from PNC Bank for $16,000,000.  There were no borrowings under this line as of September 30, 2014 and December 31, 2013.

The Company has a line of credit commitment available which has no stated expiration date from Zions Bank for $17,000,000.  There were no borrowings under this line as of September 30, 2014 and December 31, 2013.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $276,434,000 as of September 30, 2014, of which $35,973,000 and $37,200,000 was outstanding at September 30, 2014 and December 31, 2013, respectively.  Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.

Non-GAAP Financial Measures

This report contains or references fully taxable-equivalent (fte) interest income and net interest income, which are non-GAAP financial measures.  Interest income (fte) and net interest income (fte) are derived from GAAP interest income and net interest income using an assumed tax rate of 34%.  We believe the presentation of interest income (fte) and net interest income (fte) ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.  Net interest income (fte) is reconciled to GAAP net interest income on pages 39 and 43.  Although the Company believes that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP measures.


 
38

 
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
 
(Tax-Equivalent Basis, dollars in thousands)
 
Three Months Ended September 30,
 
   
2014
   
2013
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
     (2)      (1)      (3)      (2)      (1)      (3)  
Assets
                                               
Interest-earning assets:
                                               
  Interest bearing deposits with banks
  $ 2,015     $ 1       0.20 %   $ 7,965     $ 5       0.25 %
   Securities held-to-maturity (1)
    -       -       -       174       3       6.90  
   Securities available for sale:
                                               
     Taxable
    101,199       512       2.02       95,071       412       1.73  
     Tax-exempt (1)
    56,105       691       4.93       63,006       796       5.05  
        Total securities available for sale (1)
    157,304       1,203       3.06       158,077       1,208       3.06  
     Loans receivable (1) (4) (5)
    500,739       6,050       4.83       483,333       6,238       5.16  
        Total interest earning assets
    660,058       7,254       4.40       649,549       7,454       4.59  
Non-interest earning assets:
                                               
   Cash and due from banks
    8,792                       9,390                  
   Allowance for loan losses
    (5,751 )                     (5,865 )                
   Other assets
    46,981                       38,857                  
        Total non-interest earning assets
    50,022                       42,382                  
Total Assets
  $ 710,080                     $ 691,931                  
Liabilities and Stockholders' Equity
                                               
Interest bearing liabilities:
                                               
   Interest bearing demand and money market
  $ 179,665     $ 74       0.16     $ 176,779     $ 97       0.22  
   Savings
    72,625       9       0.05       69,581       9       0.05  
   Time
    195,816       517       1.05       203,889       595       1.17  
      Total interest bearing deposits
    448,106       600       0.53       450,249       701       0.62  
Short-term borrowings
    36,552       19       0.22       32,677       17       0.21  
Other borrowings
    22,797       168       2.95       20,058       158       3.15  
   Total interest bearing liabilities
    507,455       787       0.62       502,984       876       0.70  
Non-interest bearing liabilities:
                                               
   Demand deposits
    100,720                       93,851                  
   Other liabilities
    4,479                       4,257                  
      Total non-interest bearing liabilities
    105,199                       98,108                  
   Stockholders' equity
    97,426                       90,839                  
Total Liabilities and Stockholders' Equity
  $ 710,080                     $ 691,931                  
                                                 
Net interest income (tax equivalent basis)
            6,467       3.78 %             6,578       3.89 %
Tax-equivalent basis adjustment
            (313 )                     (308 )        
Net interest income
          $ 6,154                     $ 6,270          
Net interest margin (tax equivalent basis)
                    3.92 %                     4.05 %
 
(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.
 
 
39

 


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)
 
 
 
Three months ended September 30, 2014 Compared to
 
   
Three months ended September 30, 2013
 
   
Variance due to
 
   
Volume
   
Rate
   
Net
 
                   
   
(dollars in thousands)
 
                   
Interest earning assets:
                 
Interest bearing deposits with banks
  $ (3 )   $ (1 )   $ (4 )
Securities held to maturity
    (3 )     -       (3 )
Securities available for sale:
                       
Taxable
    28       72       100  
Tax-exempt securities
    (85 )     (20 )     (105 )
Total securities
    (57 )     52       (5 )
Loans receivable
    1,081       (1,269 )     (188 )
Total interest earning assets
    1,018       (1,218 )     (200 )
                         
Interest bearing liabilities:
                       
Interest-bearing demand and money market
    10       (33 )     (23 )
Savings
    2       (2 )     -  
Time
    (23 )     (55 )     (78 )
Total interest bearing deposits
    (11 )     (90 )     (101 )
Short-term borrowings
    2       -       2  
Other borrowings
    62       (52 )     10  
Total interest bearing liabilities
    53       (142 )     (89 )
Net interest income (tax-equivalent basis)
  $ 965     $ (1,076 )   $ (111 )

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.

 

 
40

 

Comparison of Operating Results for The Three Months Ended September 30, 2014 to September 30, 2013

General

For the three months ended September 30, 2014, net income totaled $2,118,000 compared to $2,136,000 earned in the similar period in 2013.  The decrease in net income for the three months ended September 30, 2014 was due primarily to a $116,000 decrease in net interest income which was partially offset by a $100,000 increase in gains on the sales of loans and securities.  Earnings per share for the current period were $.58 for basic and fully diluted compared to $.59 per basic and fully diluted share for the three months ended September 30, 2013.  The resulting annualized return on average assets and annualized return on average equity for the three months ended September 30, 2014 were 1.18% and 8.62%, respectively, compared to 1.22% and 9.33%, respectively, for the similar period in 2013.
 
 
The following table sets forth changes in net income:


(dollars in thousands)
 
Three months ended
 
   
September 30, 2014 to September 30, 2013
 
Net income three months ended September 30, 2013
  $ 2,136  
Change due to:
       
Net interest income
    (116 )
Provision for loan losses
    (20 )
Gain on sales of loans and securities
    100  
Earnings and proceeds on bank-owned life insurance
    20  
Other income
    (74 )
Salaries and employee benefits
    75  
Occupancy, furniture and equipment
    2  
Foreclosed real estate owned
    (54 )
All other expenses
    26  
Income tax expense
    23  
         
Net income three months ended September 30, 2014
  $ 2,118  


Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the three months ended September 30, 2014 totaled $6,467,000 which was $111,000 lower than the comparable period in 2013.  The decrease in net interest income largely reflects reduced earnings on loans due to repricing in the current low interest rate environment.  The fte net interest spread and net interest margin were 3.78% and 3.92%, respectively, for the three months ended September 30, 2014 compared to 3.89% and 4.05%, respectively, for the similar period in 2013.

Interest income (fte) totaled $7,254,000 with a yield on average earning assets of 4.40% compared to $7,454,000 and 4.59% for the 2013 period. Average loans increased $17.4 million over the comparable period of last year but a 33 basis point reduction in the yield earned resulted in a $188,000 reduction in fte loan income.  Average earning assets totaled $660.1 million for the three months ended September 30, 2014, an increase of $10.5 million over the average for the similar period in 2013.  This increase in average earning assets helped offset the decline in loan yields.
 
 
41

 
 
Interest expense for the three months ended September 30, 2014 totaled $787,000 at an average cost of 0.62% compared to $876,000 and 0.70% for the similar period in 2013.  As a result of the continued low interest rate environment, the Company further reduced rates paid on its money market accounts.  The cost of time deposits, which is the most significant component of funding, declined to 1.05% from 1.17% for the similar period in the prior year.  As time deposits matured, they repriced at the current lower rates resulting in the decrease.

Provision for Loan Losses

The Company’s provision for loan losses for the three months ended September 30, 2014 was $420,000 compared to $400,000 for the three months ended September 30, 2013.  The Company makes provisions for loan losses in an amount necessary to maintain the allowance for loan losses at an acceptable level.  Net charge-offs were $380,000 for the quarter ended September 30, 2014 compared to $590,000 for the similar period in 2013.

Other Income

Other income totaled $1,262,000 for the three months ended September 30, 2014 compared to $1,216,000 for the similar period in 2013.  Net gains from the sale of loans and securities increased $100,000 compared to the same period of 2013 due to increased activity. All other items of other income decreased $54,000, net, compared to the third quarter of last year.

Other Expense

Other expense for the three months ended September 30, 2014 totaled $4,124,000 which was $49,000 lower than the same period of 2013.  Costs associated with foreclosed real estate properties increased $54,000 while all other operating expenses decreased $103,000, net.

Income Tax Expense

Income tax expense totaled $754,000 for an effective tax rate of 26.3% for the period ending September 30, 2014 compared to $777,000 for an effective tax rate of 26.7% for the similar period in 2013.


 
42

 
Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates
 
(Tax-Equivalent Basis, dollars in thousands)
 
Nine Months Ended September 30,
 
   
2014
   
2013
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
     (2)      (1)      (3)      (2)      (1)      (3)  
Assets
                                               
Interest-earning assets:
                                               
  Interest bearing deposits with banks
  $ 1,775     $ 3       0.23 %   $ 9,138     $ 17       0.25 %
   Securities held-to-maturity (1)
    77       5       8.66       173       10       7.71  
   Securities available for sale:
                                               
     Taxable
    99,847       1,513       2.02       91,909       1,208       1.75  
     Tax-exempt (1)
    59,204       2,219       5.00       58,386       2,228       5.09  
        Total securities available for sale (1)
    159,051       3,732       3.13       150,295       3,436       3.05  
     Loans receivable (1) (4) (5)
    500,593       18,093       4.82       480,975       18,676       5.18  
        Total interest earning assets
    661,496       21,833       4.40       640,581       22,139       4.61  
Non-interest earning assets:
                                               
   Cash and due from banks
    8,303                       9,154                  
   Allowance for loan losses
    (5,836 )                     (5,765 )                
   Other assets
    44,469                       42,104                  
        Total non-interest earning assets
    46,936                       45,493                  
Total Assets
  $ 708,432                     $ 686,074                  
Liabilities and Stockholders' Equity
                                               
Interest bearing liabilities:
                                               
   Interest bearing demand and money market
  $ 175,069     $ 231       0.18     $ 173,171     $ 311       0.24  
   Savings
    71,445       26       0.05       69,436       35       0.07  
   Time
    203,434       1,595       1.05       207,832       1,828       1.17  
      Total interest bearing deposits
    449,948       1,852       0.55       450,439       2,174       0.64  
Short-term borrowings
    38,938       62       0.21       27,425       44       0.21  
Other borrowings
    23,183       501       2.88       22,617       525       3.10  
   Total interest bearing liabilities
    512,069       2,415       0.63       500,481       2,743       0.73  
Non-interest bearing liabilities:
                                               
   Demand deposits
    96,282                       88,830                  
   Other liabilities
    4,202                       4,107                  
      Total non-interest bearing liabilities
    100,484                       92,937                  
   Stockholders' equity
    95,879                       92,656                  
Total Liabilities and Stockholders' Equity
  $ 708,432                     $ 686,074                  
                                                 
Net interest income (tax equivalent basis)
            19,418       3.77 %             19,396       3.88 %
Tax-equivalent basis adjustment
            (964 )                     (880 )        
Net interest income
          $ 18,454                     $ 18,516          
Net interest margin (tax equivalent basis)
                    3.91 %                     4.04 %
 
(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.
 
 
43

 

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, 2014 Compared to
 
   
Nine months ended September 30, 2013
 
   
Variance due to
 
   
Volume
   
Rate
   
Net
 
                   
   
(dollars in thousands)
 
                   
Interest earning assets:
                 
Interest bearing deposits with banks
  $ (13 )   $ (1 )   $ (14 )
Securities held to maturity
    (7 )     2       (5 )
Securities available for sale:
                       
Taxable
    110       195       305  
Tax-exempt securities
    43       (52 )     (9 )
Total securities
    153       143       296  
Loans receivable
    1,062       (1,645 )     (583 )
Total interest earning assets
    1,195       (1,501 )     (306 )
                         
Interest bearing liabilities:
                       
Interest-bearing demand and money market
    6       (86 )     (80 )
Savings
    2       (11 )     (9 )
Time
    (38 )     (195 )     (233 )
Total interest bearing deposits
    (30 )     (292 )     (322 )
Short-term borrowings
    19       (1 )     18  
Other borrowings
    19       (43 )     (24 )
Total interest bearing liabilities
    8       (336 )     (328 )
Net interest income (tax-equivalent basis)
  $ 1,187     $ (1,165 )   $ 22  

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.
 
 
44

 

Comparison of Operating Results for The Nine Months Ended September 30, 2014 to September 30, 2013

General

For the nine months ended September 30, 2014, net income totaled $6,116,000 compared to $6,284,000 earned in the similar period in 2013.  The decrease in net income for the nine months ended September 30, 2014 was due primarily to a $710,000 decrease in earnings and proceeds on bank-owned life insurance as well as a $239,000 increase in foreclosed real estate costs and a $202,000 increase in income tax expense.  A reduced loan loss provision and higher gains from the sale of loans and securities partially offset the negative variances. Earnings per share for the current period were $1.68 for basic and fully diluted compared to $1.73 for basic and  diluted for the nine months ended September 30, 2013.  The resulting annualized return on average assets and annualized return on average equity for the nine months ended September 30, 2014 were 1.15% and 8.53%, respectively, compared to 1.22% and 9.07%, respectively, for the similar period in 2013.
 
 
The following table sets forth changes in net income:



(dollars in thousands)
 
Nine months ended
 
   
September 30, 2014 to September 30, 2013
 
Net income nine months ended September 30, 2013
  $ 6,284  
Change due to:
       
Net interest income
    (62 )
Provision for loan losses
    740  
Gain on sales of loans and securities
    373  
Earnings and proceeds on bank-owned life insurance
    (710 )
Other income
    (185 )
Salaries and employee benefits
    74  
Occupancy, furniture and equipment
    (15 )
Foreclosed real estate owned
    (239 )
All other expenses
    58  
Income tax expense
    (202 )
         
Net income nine months ended September 30, 2014
  $ 6,116  
 

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the nine months ended September 30, 2014 totaled $19,418,000 which was $22,000 higher than the comparable period in 2013.  The increase in net interest income largely reflects the improved mix and growth of the balance sheet which offset the reduced earnings on loans due to repricing in the current low interest rate environment.  The fte net interest spread and net interest margin were 3.77% and 3.91%, respectively, for the nine months ended September 30, 2014 compared to 3.88% and 4.04%, respectively, for the similar period in 2013.

Interest income (fte) totaled $21,833,000 with a yield on average earning assets of 4.40% compared to $22,139,000 and 4.61% for the 2013 period. Average loans increased $19.6 million over the comparable period of last year but a 36 basis point reduction in the yield earned resulted in a $583,000 reduction in fte loan income.  Average securities increased $8.7 million and the yield on securities improved 8 basis points, resulting in a $291,000 increase in earnings, to partially offset the reduced earnings on loans.  Average earning assets totaled $661.5 million for the nine months ended September 30, 2014, an increase of $20.9 million over the
 
 
45

 
 
average for the similar period in 2013.  This increase in average earning assets helped offset the decline in loan yields.

Interest expense for the nine months ended September 30, 2014 totaled $2,415,000 at an average cost of 0.63% compared to $2,743,000 and 0.73% for the similar period in 2013.  As a result of the continued low interest rate environment, the Company further reduced rates paid on its money market accounts.  The cost of time deposits, which is the most significant component of funding, declined to 1.05% from 1.17% for the similar period in the prior year.  As time deposits matured, they repriced at the current lower rates resulting in the decrease.

Provision for Loan Losses

The Company’s provision for loan losses for the nine months ended September 30, 2014 was $1,260,000 compared to $2,000,000 for the nine months ended September 30, 2013.  The Company makes provisions for loan losses in an amount necessary to maintain the allowance for loan losses at an acceptable level.  Net charge-offs were $1,317,000 for the nine months ended September 30, 2014 compared to $1,943,000 for the similar period in 2013.

Other Income

Other income totaled $3,783,000 for the nine months ended September 30, 2014 compared to $4,305,000 for the similar period in 2013.  The decrease was due primarily to $770,000 of non-recurring income from life insurance proceeds received in 2013 compared to $5,000 in the 2014 period. Net gains from the sale of loans and securities increased $373,000 compared to the same period of 2013 to partially offset the lower level of insurance income. All other items of other income decreased $185,000, net, compared to the same period of last year.

Other Expense

Other expense for the nine months ended September 30, 2014 totaled $12,729,000 or $122,000 higher than the same period of 2013.  Costs associated with foreclosed real estate properties increased $239,000 while all other operating expenses decreased $117,000, net.

Income Tax Expense

Income tax expense totaled $2,132,000 for an effective tax rate of 25.9% for the period ending September 30, 2014 compared to $1,930,000 for an effective tax rate of 23.5% for the similar period in 2013.  The reduced tax rate in 2013 reflects a higher level of insurance proceeds which are exempt from income tax.

 
46

 
 
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 September 30, 2014, the level of net interest income at risk in a 200 basis point increase in interest rates was within the Company’s policy limits, while a 200 basis point decrease in rates would result in a net interest fluctuation that exceeds the policy limit.  The Company’s policy allows for a decline of no more than 8% of net interest income for a ± 200 basis point shift in interest rates. Based on the current level of interest rates, the risk in the declining 200 basis point scenario is considered acceptable.

Imbalance in repricing opportunities at a given point in time reflects interest-sensitivity gaps measured as the difference between rate-sensitive assets (RSA) and rate-sensitive liabilities (RSL).  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 September 30, 2014, the Company had a positive 90-day interest sensitivity gap of $41.5 million or 5.8% of total assets, compared to the $51.9 million or 7.3% of total assets as of December 31, 2013.  Rate sensitive assets repricing within 90 days decreased $14.2 million due primarily to a $10.3 million decrease in loans repricing and a $3.6 million decrease in securities cashflow repricing within the period.  Rate sensitive liabilities decreased $3.8 million since year end due primarily to a $5.5 million reduction in time deposits maturing within three months.  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 could 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.

 
47

 

September 30, 2014
Rate Sensitivity Table
(dollars in thousands)


   
3 Months
   
3-12 Months
   
1 to 3 Years
   
Over 3 Years
   
Total
 
Federal funds sold and interest bearing deposits
  $ 158     $ -     $ -     $ -     $ 158  
Securities
    4,371       15,434       27,747       111,149       158,701  
Loans Receivable
    124,064       121,506       156,136       99,138       500,844  
  Total RSA
  $ 128,593     $ 136,940     $ 183,883     $ 210,287     $ 659,703  
                                         
Non-maturity interest-bearing deposits
  $ 40,592     $ 45,005     $ 119,942     $ 46,121     $ 251,660  
Time Deposits
    25,593       58,668       85,445       24,629       194,335  
Other
    20,865       18,765       26,435       1,231       67,296  
  Total RSL
  $ 87,050     $ 122,438     $ 231,822     $ 71,981     $ 513,291  
                                         
                                         
Interest Sensitivity Gap
  $ 41,543     $ 14,502     $ (47,939 )   $ 138,306     $ 146,412  
Cumulative Gap
    41,543       56,045       8,106       146,412          
RSA/RSL-cumulative
    147.7 %     126.7 %     101.8 %     128.5 %        
                                         
December 31, 2013
                                       
                                         
Interest Sensitivity Gap
  $ 51,870     $ 11,886     $ (48,607 )   $ 124,416     $ 139,565  
Cumulative Gap
    51,870       63,756       15,149       139,565          
RSA/RSL-cumulative
    157.1 %     128.7 %     103.4 %     126.7 %        

 
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.


 
48

 
 
Part II.  OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable

Item 1A. Risk Factors

There have been no material changes in the risk factors affecting the Company that were identified in Item 1A of Part 1 of the Company’s Form 10-K for the year ended December 31, 2013.

Item 2. Unregistered Sales of Equity Sales and Use of Proceeds

None

Item 3.  Defaults Upon Senior Securities

Not applicable

Item 4.  Mine Safety Disclosures

Not applicable

Item 5.  Other Information

None

Item 6.  Exhibits

   
No.
Description
   
3(i)
Articles of Incorporation of Norwood Financial Corp.(1)
3(ii)
Bylaws of Norwood Financial Corp. (2)
4.0
Specimen Stock Certificate of Norwood Financial Corp. (1)
10.1
Employment Agreement with Lewis J. Critelli (3)
10.2
Change in Control Severance Agreement with William S. Lance(3)
10.3
Norwood Financial Corp. Stock Option Plan (4)
10.4
Change in Control Severance Agreement with Robert J. Mancuso(5)
10.5
Salary Continuation Agreement between the Bank and William W. Davis, Jr. (6)
10.6
Salary Continuation Agreement between the Bank and Lewis J. Critelli (6)
10.7
1999 Directors Stock Compensation Plan (4)
10.8
Salary Continuation Agreement between the Bank and John H. Sanders (7)
10.9
2006 Stock Option Plan (8)
10.10
First and Second Amendments to Salary Continuation Agreement with William W. Davis, Jr. (9)
10.11
First and Second Amendments to Salary Continuation Agreement with Lewis J. Critelli (9)
10.12
First and Second Amendments to Salary Continuation Agreement with John H. Sanders (9)
10.13
Change In Control Severance Agreement with James F. Burke(10)
10.14
2014 Equity Incentive Plan(11)
31.1
Rule 13a-14(a)/15d-14(a) Certification of CEO
31.2
Rule 13a-14(a)/15d-14(a) Certification of CFO
32
Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of Sarbanes Oxley Act of 2002
101
Interactive Data Files

 
 
49

 


(1)  
Incorporated herein by reference into this document from the Exhibits to Form 10, Registration Statement initially filed with the Commission on April 29, 1996, Registration No. 0-28364

(2)  
Incorporated by reference into this document from the identically numbered exhibit to the Registrant’s Form 10-Q filed with the Commission on August 8, 2014.

(3)  
Incorporated by reference into this document from the identically numbered exhibits to the Registrant’s Form 10-K filed with the Commission on March 15, 2010.

(4)  
Incorporated herein by reference to the identically numbered exhibits of the Registrant’s Form 10-K filed with the Commission on March 23, 2000.

(5)  
Incorporated by reference into this document from the identically numbered exhibit to the Registrant’s Form 10-K filed with the Commission on March 14, 2013, File No. 0-28364.

(6)  
Incorporated by reference into this document from the Exhibits to Form S-8 filed with the Commission on August 14, 1998, File No. 333-61487.

(7)  
Incorporated herein by reference to the identically numbered exhibit to the Registrant’s Form 10-K filed with the Commission on March 22, 2004.

(8)  
Incorporated by reference to this document from Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-134831) filed with the Commission on June 8, 2006.

(9)  
Incorporated herein by reference from the Exhibits to the Registrant’s Current Report on Form 8-K filed on April 4, 2006.

(10)  
Incorporated by reference from the identically numbered exhibit to the Registrant’s Form 10-Q filed with the Commission on November 7, 2013.

(11)  
Incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-8 (File No. 333-195643) filed with the Commission on May 2, 2014.

 
50

 

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:
November 7, 2014
 
By:
 
/s/ Lewis J. Critelli
 
         
Lewis J. Critelli
 
         
President and Chief Executive Officer
 
         
(Principal Executive Officer)
 
             
Date:
November 7, 2014
 
By:
 
/s/ William S. Lance
 
         
William S. Lance
 
         
Executive Vice President and
 
         
Chief Financial Officer
 
         
(Principal Financial Officer)