f10q_063015-0160.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 June 30, 2015
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to _________
 
Commission File No. 0-28364

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)
 

Registrant’s Telephone Number, Including Area Code: (570) 253-1455

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 July 31, 2015
          Common stock, par value $0.10 per share                                                3,681,246

 
1

 



NORWOOD FINANCIAL CORP.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2015


     
   
 
 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
34
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
50
Item 4.
Controls and Procedures
51
PART II -
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
52
Item 1A.
Risk Factors
52
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
52
Item 3.
Defaults upon Senior Securities
52
Item 4.
Mine Safety Disclosures
52
Item 5.
Other Information
52
Item 6.
Exhibits
52
     
Signatures
 
54




 
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)

             
             
   
June 30,
   
December 31,
 
   
2015
   
2014
 
ASSETS
           
Cash and due from banks
  $ 8,505     $ 8,081  
Interest bearing deposits with banks
    11,937       4,295  
Cash and cash equivalents
    20,442       12,376  
                 
Securities available for sale, at fair value
    151,304       156,395  
Loans receivable
    538,870       501,135  
Less:  Allowance for loan losses
    5,947       5,875  
Net loans receivable
    532,923       495,260  
Regulatory stock, at cost
    2,240       1,714  
Bank premises and equipment, net
    6,555       6,734  
Bank owned life insurance
    18,551       18,284  
Accrued interest receivable
    2,340       2,339  
Foreclosed real estate owned
    1,382       3,726  
Goodwill
    9,715       9,715  
Other intangibles
    334       389  
Deferred tax asset
    4,071       3,285  
Other assets
    1,664       1,418  
TOTAL ASSETS
  $ 751,521     $ 711,635  
                 
LIABILITIES
               
Deposits:
               
Non-interest bearing demand
  $ 107,610     $ 98,064  
Interest-bearing
    468,004       461,880  
   Total deposits
    575,614       559,944  
Short-term borrowings
    33,842       25,695  
Other borrowings
    37,211       22,200  
Accrued interest payable
    988       966  
Other liabilities
    3,948       3,789  
TOTAL LIABILITIES
    651,603       612,594  
                 
STOCKHOLDERS’ EQUITY
               
Common stock, $.10 par value per share,
               
 authorized 10,000,000 shares; issued 3,718,018  shares
    372       372  
Surplus
    35,268       35,206  
Retained earnings
    65,797       64,078  
Treasury stock at cost: 2015: 37,162 shares,
    (997 )     (1,077 )
   2014: 40,576 shares
               
Accumulated other comprehensive (loss) income
    (522 )     462  
TOTAL STOCKHOLDERS’ EQUITY
    99,918       99,041  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 751,521     $ 711,635  

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
   
Six Months Ended
 
 
 
June 30,
   
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
INTEREST INCOME
                       
Loans receivable, including fees
  $ 5,924     $ 5,933     $ 11,985     $ 11,913  
Securities
    950       1,025       1,974       2,013  
Other
    8       2       12       2  
Total interest income
    6,882       6,960       13,971       13,928  
                                 
INTEREST EXPENSE
                               
Deposits
    618       618       1,222       1,253  
Short-term borrowings
    16       20       29       42  
Other borrowings
    199       167       364       333  
Total interest expense
    833       805       1,615       1,628  
NET INTEREST INCOME
    6,049       6,155       12,356       12,300  
PROVISION FOR LOAN LOSSES
    420       420       1,040       840  
NET INTEREST INCOME AFTER
                               
PROVISION FOR LOAN LOSSES
    5,629       5,735       11,316       11,460  
                                 
OTHER INCOME
                               
Service charges and fees
    622       583       1,194       1,159  
Income from fiduciary activities
    109       99       215       203  
Net realized gains on sales of securities
    134       509       445       603  
Gains on sale of loans and servicing rights, net
    12       26       30       66  
Earnings and proceeds on bank owned life insurance
    166       175       330       343  
Other
    90       76       198       147  
Total other income
    1,133       1,468       2,412       2,521  
                                 
OTHER EXPENSES
                               
Salaries and employee benefits
    2,071       2,172       4,208       4,336  
Occupancy, furniture & equipment, net
    542       518       1,098       1,096  
Data processing related
    201       229       435       441  
Taxes, other than income
    175       161       350       326  
Professional fees
    124       174       307       340  
Federal Deposit Insurance Corporation insurance assessment
    65       102       159       216  
Foreclosed real estate owned
    232       396       390       461  
Amortization of intangibles
    27       31       56       64  
Other
    731       690       1,352       1,325  
Total other expenses
    4,168       4,473       8,355       8,605  
                                 
INCOME BEFORE INCOME TAXES
    2,594       2,730       5,373       5,376  
INCOME TAX EXPENSE
    631       696       1,369       1,378  
NET INCOME
  $ 1,963     $ 2,034     $ 4,004     $ 3,998  
                                 
BASIC EARNINGS PER SHARE
  $ 0.53     $ 0.56     $ 1.09     $ 1.10  
                                 
DILUTED EARNINGS PER SHARE
  $ 0.53     $ 0.56     $ 1.08     $ 1.10  


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
 
   
June 30,
 
   
2015
   
2014
 
Net income
  $ 1,963     $ 2,034  
Other comprehensive (loss) income:
               
Investment securities available for sale:
               
   Unrealized holding gains (losses)
    (2,037 )     2,032  
    Tax effect
    693       (691 )
   Reclassification of gains recognized in net income
    (134 )     (509 )
    Tax effect
    45       173  
Other comprehensive (loss) income:
    (1,433 )     1,005  
Comprehensive Income
  $ 530     $ 3,039  



             
             
   
Six Months Ended
 
   
June 30,
 
   
2015
   
2014
 
Net income
  $ 4,004     $ 3,998  
Other comprehensive (loss) income:
               
Investment securities available for sale:
               
   Unrealized holding gains (losses)
    (1,048 )     4,556  
    Tax effect
    358       (1,551 )
   Reclassification of gains recognized in net income
    (445 )     (603 )
    Tax effect
    151       205  
Other comprehensive (loss) income:
    (984 )     2,607  
Comprehensive Income
  $ 3,020     $ 6,605  




See accompanying notes to the unaudited consolidated financial statements.

 
5

 


NORWOOD FINANCIAL CORP.
Consolidated Statements of Changes in Stockholders’ Equity (unaudited)
Six Months Ended June 30, 2015
(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, 2014
    3,718,018     $ 372     $ 35,206     $ 64,078       40,576     $ (1,077 )   $ 462     $ 99,041  
Net Income
                            4,004                               4,004  
Other comprehensive loss
                                                    (984 )     (984 )
Cash dividends declared ($.62 per share)
                            (2,285 )                             (2,285 )
Compensation expense related to restricted stock
                    27                                       27  
Acquisition of  treasury  stock
                                    4,374       (127 )             (127 )
Stock options exercised
                    (7 )             (7,788 )     207               200  
Tax benefit of stock options
                    9                                       9  
Compensation expense related to stock options
                    33                                       33  
 
                                                               
Balance, June 30, 2015
    3,718,018     $ 372     $ 35,268     $ 65,797       37,162     $ (997 )   $ (522 )   $ 99,918  




See accompanying notes to the unaudited consolidated financial statements.

 
6

 


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

             
(dollars in thousands)
           
 
 
Six Months Ended June 30,
 
   
2015
   
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net Income
  $ 4,004     $ 3,998  
Adjustments to reconcile net income to net cash provided by operating  activities:
               
Provision for loan losses
    1,040       840  
Depreciation
    277       294  
Amortization of intangible assets
    56       64  
Deferred income taxes
    (279 )     (291 )
Net amortization of securities premiums and discounts
    475       424  
Net realized gain on sales of securities
    (445 )     (603 )
Earnings and proceeds on bank owned life insurance
    (330 )     (343 )
Loss on sale of foreclosed real estate
    275       159  
Gain on sale of mortgage loans
    (40 )     (72 )
Mortgage loans originated for sale
    (1,803 )     (2,228 )
Proceeds from sale of mortgage loans originated for sale
    1,843       2,300  
Compensation expense related to stock options
    33       80  
Compensation expense related to restricted stock
    27       -  
Increase in accrued interest receivable and other assets
    (145 )     (409 )
Increase in accrued interest payable and other liabilities
    140       443  
Net cash provided by operating activities
    5,128       4,656  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Securities available for sale:
               
Proceeds from sales
    23,384       31,865  
Proceeds from maturities and principal reductions on mortgage-backed securities
    12,377       8,001  
Purchases
    (32,193 )     (32,528 )
Proceeds from maturities on securities held to maturity
    -       175  
Purchase of regulatory stock
    (768 )     (751 )
Redemption of regulatory stock
    242       1,191  
Net increase in loans
    (38,970 )     (3,730 )
Proceeds from life insurance policies
    -       75  
Purchase of premises and equipment
    (99 )     (79 )
Proceeds from sale of foreclosed real estate
    2,299       140  
Net cash (used in) provided by investing activities
    (33,728 )     4,359  
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
    15,670       13,532  
Net increase (decrease) in short-term borrowings
    8,147       (11,905 )
Repayments of other borrowings
    (989 )     (778 )
Proceeds from other borrowings
    16,000       -  
Stock options exercised
    200       14  
Tax benefit of stock options exercised
    9       1  
Purchase of treasury stock
    (127 )     (179 )
Cash dividends paid
    (2,244 )     (2,185 )
Net cash  provided by (used in) financing activities
    36,666       (1,500 )
Increase in cash and cash equivalents
    8,066       7,515  
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    12,376       7,863  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 20,442     $ 15,378  

See accompanying notes to the unaudited consolidated financial statements.

 
7

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


             
(dollars in thousands)
           
 
Six Months Ended June 30,
 
 
2015
 
2014
 
Supplemental Disclosures of Cash Flow Information
           
Cash payments for:
           
Interest on deposits and borrowings
  $ 1,593     $ 1,713  
Income taxes paid, net of refunds
    1,431       1,337  
 Supplemental Schedule of Noncash Investing Activities
               
Transfers of loans to foreclosed real estate and repossession of other assets
  $ 251     $ 3,583  
Cash dividends declared
    1,141       1,091  


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 six month periods ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 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, 2014.


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
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
Basic EPS weighted average shares outstanding
    3,680       3,643       3,680       3,643  
Dilutive effect of stock options
    11       10       11       10  
Diluted EPS weighted average shares outstanding
    3,691       3,653       3,691       3,653  

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 20,700 as of June 30, 2014 based upon the closing price of Norwood common stock of $28.50 per share on June 30, 2014.  There was no anti-dilutive effect at June 30, 2015.

 
9

 

3.         Stock-Based Compensation

  No awards were granted during the six month period ending June 30, 2015. As of June 30, 2015, there was $33,000 of total unrecognized compensation cost related to non-vested stock options granted in 2014 under the 2014 Stock Option Plan, which will be fully amortized by December 31, 2015. Total compensation cost related to stock options during the six month period ending June 30, 2015 was $33,000.

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, 2015
 206,463
 
$
 26.74
 
 5.7
Yrs.
 
$
 478
Granted
 -
   
 -
 
 -
     
 -
Exercised
 (7,788)
   
 25.71
 
 5.2
     
 -
Forfeited
 (9,583)
   
 27.02
 
 4.5
     
 -
Outstanding at June 30, 2015
 189,092
 
$
 26.77
 
 5.2
   
$
 483
                     
Exercisable at June 30, 2015
 177,092
 
$
 26.61
 
 5.0
 Yrs.
 
$
 480

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 $29.32 as of June 30, 2015 and $29.05 as of December 31, 2014.

A summary of the Company’s restricted stock activity and related information for the six month period ended June 30, 2015 is as follows:


         
       
Weighted-Average
 
Number of
   
Grant Date
 
Restricted Stock
   
Fair Value
Outstanding, January 1, 2015
 9,300
 
$
 29.08
Granted
 -
   
 -
Vested
 -
   
 -
Forfeited
 -
   
 -
Non-vested at June 30, 2015
 9,300
 
$
 29.08



The expected future compensation expense relating to the 9,300 shares of non-vested restricted stock outstanding as of June 30, 2015 is $243,000 to be recognized over the next 4.5 years. Total compensation cost related to restricted stock during the six month period ending June 30, 2015 was $27,000.

 
10

 

4.         Accumulated Other Comprehensive Income (Loss)

The following table presents the changes in accumulated other comprehensive income (in thousands) by component net of tax for the three months and six months ended June 30, 2015 and 2014:


     
     
 
Unrealized gains (losses) on
 
available for sale
 
securities (a)
Balance as of December 31, 2014
$
 462
Other comprehensive loss before reclassification
 
 (690)
Amount reclassified from accumulated other comprehensive income  (loss)
 
 (294)
Total other comprehensive loss
 
 (984)
Balance as of June 30, 2015
$
 (522)
     
     
     
 
Unrealized gains (losses) on
 
available for sale
 
securities (a)
Balance as of  December 31, 2013
$
 (2,602)
Other comprehensive income before reclassification
 
 3,005
Amount reclassified from accumulated other comprehensive income  (loss)
 
 (398)
Total other comprehensive income
 
 2,607
Balance as of June 30, 2014
$
 5
     
     
 
Unrealized gains (losses) on
 
available for sale
 
securities (a)
Balance as of  March 31, 2015
$
 911
Other comprehensive loss before reclassification
 
 (1,344)
Amount reclassified from accumulated other comprehensive income  (loss)
 
 (89)
Total other comprehensive loss
 
 (1,433)
Balance as of June 30, 2015
$
 (522)
     
     
 
Unrealized gains (losses) on
 
available for sale
 
securities (a)
Balance as of  March 31, 2014
$
 (1,000)
Other comprehensive income before reclassification
 
 1,341
Amount reclassified from accumulated other comprehensive income  (loss)
 
 (336)
Total other comprehensive income
 
 1,005
Balance as of June 30, 2014
$
 5

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


 
11

 
The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) (in thousands) for the three and six months ended June 30, 2015 and 2014:

                   
                   
   
Amount Reclassified
   
   
From Accumulated
 
Affected Line Item in
   
Other
 
the Statement Where
   
Comprehensive
 
Net Income is
Details about other comprehensive income (loss)
 
Income (loss) (a)
 
Presented
                   
     
Three months ended
   
     
June 30,
   
     
2015
     
2014
   
Unrealized gains on available for sale securities
 
$
 134
   
$
 509
 
Net realized gains on sales of securities
     
 (45)
     
 (173)
 
Income tax expense
   
$
 89
   
$
 336
 
Net of tax
                   
                   
     
Six months ended
   
     
June 30,
   
     
2015
   
 
2014
   
Unrealized gains on available for sale securities
 
$
 445
   
$
 603
 
Net realized gains on sales of securities
     
 (151)
     
 (205)
 
Income tax expense
   
$
 294
   
$
 398
 
Net of tax
 
(a)  Amounts in parentheses indicate debits to net income

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.


 
12

 

A summary of the Bank’s financial instrument commitments is as follows:
             
             
(in thousands)
June 30,
 
 
2015
 
2014
 
             
Unfunded availability under loan commitments
  $ 18,772     $ 22,851  
Unfunded commitments under lines of credit
    45,026       43,019  
Standby letters of credit
    5,769       5,668  
    $ 69,567     $ 71,538  

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 June 30, 2015 for guarantees under standby letters of credit issued is not material.
 
6.         Securities

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

                         
                         
 
June 30, 2015
 
       
Gross
 
Gross
       
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
 
 
(In Thousands)
 
Available for Sale:
                       
U.S. Government agencies
  $ 24,068     $ 70     $ (146 )   $ 23,992  
States and political subdivisions
    59,973       848       (919 )     59,902  
Corporate obligations
    4,988       73       (9 )     5,052  
Mortgage-backed securities-
                               
government sponsored entities
    62,766       92       (885 )     61,973  
Total debt securities
    151,795       1,083       (1,959 )     150,919  
Equity securities-financial services
    292       93       -       385  
    $ 152,087     $ 1,176     $ (1,959 )   $ 151,304  
                                 
                                 
 
 
 
13

 

 
 
December 31, 2014
 
       
Gross
 
Gross
       
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
 
Cost
 
Gains
 
Losses
 
Value
 
                         
 
(In Thousands)
 
Available for Sale:
                       
U.S. Government agencies
  $ 29,289     $ 42     $ (356 )   $ 28,975  
States and political subdivisions
    52,685       1,750       (103 )     54,332  
Corporate obligations
    6,387       110       (11 )     6,486  
Mortgage-backed securities-government
                               
sponsored entities
    67,032       109       (937 )     66,204  
Total debt securities
    155,393       2,011       (1,407 )     155,997  
Equity securities-financial services
    292       106       -       398  
    $ 155,685     $ 2,117     $ (1,407 )   $ 156,395  
                                 
                                 


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):


 
June 30, 2015
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
U.S. government agencies
  $ 6,127     $ (40 )   $ 8,080     $ (106 )   $ 14,207     $ (146 )
States and political subdivisions
    30,153       (830 )     2,439       (89 )     32,592       (919 )
Corporate obligations
    1,705       (9 )     -       -       1,705       (9 )
Mortgage-backed securities-government
sponsored agencies
    31,364       (295 )     18,884       (590 )     50,248       (885 )
    $ 69,349     $ (1,174 )   $ 29,403     $ (785 )   $ 98,752     $ (1,959 )
 
 
 
December 31, 2014
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
U.S. government agencies
  $ 4,965     $ (17 )   $ 15,051     $ (339 )   $ 20,016     $ (356 )
States and political subdivisions
    3,195       (20 )     4,633       (83 )     7,828       (103 )
Corporate obligations
    -       -       1,144       (11 )     1,144       (11 )
Mortgage-backed securities-government
sponsored agencies
    22,090       (189 )     26,050       (748 )     48,140       (937 )
    $ 30,250     $ (226 )   $ 46,878     $ (1,181 )   $ 77,128     $ (1,407 )
 

 
 
14

 
At June 30, 2015, the Company has 84 debt securities in an unrealized loss position in the less than twelve months category and 32 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 2015.  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 June 30, 2015 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
  $ 640     $ 649  
Due after one year through five years
    27,236       27,231  
Due after five years through ten years
    11,059       11,090  
Due after ten years
    50,094       49,976  
                 
Mortgage-backed securities-government sponsored agencies
    62,766       61,973  
    $ 151,795     $ 150,919  


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


 
Three Months
 
Six Months
 
 
Ended June 30,
 
Ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
Gross realized gains
  $ 134     $ 523     $ 445     $ 617  
Gross realized losses
    -       (14 )     -       (14 )
Net realized gain
  $ 134     $ 509     $ 445     $ 603  
Proceeds from sales of securities
  $ 9,408     $ 19,785     $ 23,384     $ 31,865  


 
15

 

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)
 
 
 
                   
 
June 30, 2015
   
December 31, 2014
 
Real Estate Loans:
                     
Residential
$
 161,181
 
29.9
%
 
$
 158,139
 
31.5
%
Commercial
 
 266,798
 
49.5
     
 261,956
 
52.2
 
Construction
 
 19,773
 
3.7
     
 19,221
 
3.9
 
Commercial, financial and agricultural
 
 67,440
 
12.5
     
 42,514
 
8.5
 
Consumer loans to individuals
 
 24,025
 
4.4
     
 19,704
 
3.9
 
Total loans
 
 539,217
 
 100.0
%
   
 501,534
 
100.0
%
Deferred fees, net
 
 (347)
         
 (399)
     
Total loans receivable
 
 538,870
         
 501,135
     
Allowance for loan losses
 
 (5,947)
         
 (5,875)
     
Net loans receivable
$
 532,923
       
$
 495,260
     

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


           
           
 
2015
 
2014
Balance at beginning of period
$
 8
 
$
 20
Accretion
 
 -
   
 (12)
Reclassification and other
 
 -
   
     -
Balance at end of period
$
 8
 
$
 8

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


           
           
 
June 30, 2015
 
December 31, 2014
           
Outstanding Balance
$
 594
 
$
 1,057
Carrying Amount
$
 586
 
$
 1,049

There were no material increases or decreases in the expected cash flows of these loans since the acquisition date.  As of December 31, 2014, for loans that were acquired with or 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 individually.  We do not aggregate such
 
 
16

 
 
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.

Foreclosed assets acquired in settlement of loans are carried at fair value less estimated costs to sell and are included in foreclosed real estate owned on the Consolidated Balance Sheets.  As of June 30, 2015 and December 31, 2014, foreclosed real estate owned totaled $1,382,000 and $3,726,000, respectively.  As of June 30, 2015, included within foreclosed real estate owned is $207,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end.  As of June 30, 2015, the Company has initiated formal foreclosure proceedings on $464,000 of consumer residential mortgage loans.

The following tables show 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
 
June 30, 2015
(In thousands)
 
                                     
  Individually evaluated for impairment
  $ 35     $ 11,206     $ -     $ -     $ -     $ 11,241  
  Loans acquired with deteriorated credit quality
    216       370       -       -       -       586  
  Collectively evaluated for impairment
    160,930       255,222       19,773       67,440       24,025       527,390  
Total Loans
  $ 161,181     $ 266,798     $ 19,773     $ 67,440     $ 24,025     $ 539,217  


                   
Commercial
 
Consumer
       
 
Residential
 
Commercial
 
Construction
 
Loans
 
Loans
 
Total
 
 
(In thousands)
 
December 31, 2014
                                   
                                     
  Individually evaluated for impairment
  $ -     $ 10,556     $ -     $ -     $ -     $ 10,556  
  Loans acquired with deteriorated credit quality
    225       824       -       -       -       1,049  
  Collectively evaluated for impairment
    157,914       250,576       19,221       42,514       19,704       489,929  
Total Loans
  $ 158,139     $ 261,956     $ 19,221     $ 42,514     $ 19,704     $ 501,534  
 
 
 
17

 
The following tables include 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
 
June 30, 2015
       
(in thousands)
       
With no related allowance recorded:
                 
Real Estate Loans
                 
  Residential
  $ 251     $ 259     $ -  
  Commercial
    8,401       9,063       -  
Subtotal
    8,652       9,322       -  
With an allowance recorded:
                       
Real Estate Loans
                       
Commercial
    3,175       4,038       802  
Subtotal
    3,175       4,038       802  
Total:
                       
Real Estate Loans
                       
  Residential
    251       259       -  
  Commercial
    11,576       13,101       802  
Total Impaired Loans
  $ 11,827     $ 13,360     $ 802  


         
Unpaid
       
   
Recorded
   
Principal
   
Associated
 
   
Investment
   
Balance
   
Allowance
 
December 31, 2014
       
(in thousands)
       
With no related allowance recorded:
                 
Real Estate Loans
                 
Residential
  $ 225     $ 233     $ -  
Commercial
    8,407       8,566       -  
Subtotal
    8,632       8,799       -  
With an allowance recorded:
                       
Real Estate Loans
                       
Commercial
    2,973       3,837       293  
Subtotal
    2,973       3,837       293  
Total:
                       
Real Estate Loans
                       
Residential
    225       233       -  
Commercial
    11,380       12,403       293  
Total Impaired Loans
  $ 11,605     $ 12,636     $ 293  


 
18

 


The following information for impaired loans is presented (in thousands) for the six months ended June 30, 2015 and 2014:


 
Average Recorded
 
Interest Income
 
 
Investment
 
Recognized
 
 
2015
 
2014
 
2015
 
2014
 
 
                       
Real Estate Loans:
                       
Residential
  $ 232     $ 237     $ 2     $ 2  
Commercial
    11,333       8,220       465       99  
Total
  $ 11,565     $ 8,457     $ 467     $ 101  


The following information for impaired loans is presented (in thousands) for the three months ended June 30, 2015 and 2014:



 
Average Recorded
 
Interest Income
 
 
Investment
 
Recognized
 
 
2015
 
2014
 
2015
 
2014
 
 
                       
Real Estate Loans:
                       
Residential
  $ 236     $ 235     $ 1     $ 1  
Commercial
    11,382       8,116       69       42  
Total
  $ 11,618     $ 8,351     $ 70     $ 43  


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 June 30, 2015, troubled debt restructured loans totaled $8.6 million and resulted in a specific allowance of $457,000.  As of December 31, 2014, troubled debt restructured loans totaled $8.8 million and resulted in a specific allowance of $293,000.  For the period ended June 30, 2015, there was one residential mortgage loan identified as troubled debt restructuring due to the deferral of unpaid principal and interest.  The balance of this loan was $5,000 on June 30, 2015.  In 2015, the Company recognized write-downs in the amount of $373,000 on two loans previously identified as troubled debt restructurings with a carrying value of $2.3 million as of June 30, 2015.


               
 
For the Six Months Ended June 30, 2015
       
Pre-Modification
   
Post-Modification
       
Outstanding Recorded
   
Outstanding Recorded
 
Number of Contracts
   
Investment
   
Investment
Troubled Debt Restructurings
             
               
Real Estate Loans:
             
   Residential
1
 
$
5
 
$
5

 
 
19

 


For the period ended June 30, 2014, there were no new loans identified as troubled debt restructurings, nor were there any loan modifications classified as troubled debt restructurings that subsequently defaulted during the period.
 
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 for loan losses.

The following tables present 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  June 30, 2015 and December 31, 2014 (in thousands):


      Special          Doubtful       
 
Pass
 
Mention
 
Substandard
   
or Loss
 
Total
 
June 30, 2015
                             
Commercial real estate loans
  $ 252,275     $ 2,212     $ 12,311     $ -     $ 266,798  
Commercial loans
    67,440       -       -       -       67,440  
Total
  $ 319,715     $ 2,212     $ 12,311     $ -     $ 334,238  
 
 
       Special         Doubtful       
 
Pass
 
Mention
 
Substandard
   
or Loss
 
Total
 
December 31, 2014
                             
Commercial real estate loans
  $ 246,629     $ 1,983     $ 13,344     $ -     $ 261,956  
Commercial loans
    42,514       -       -       -       42,514  
Total
  $ 289,143     $ 1,983     $ 13,344     $ -     $ 304,470  


 
20

 

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits.  Nonperforming loans include loans which are in nonaccrual status and loans past due over 90 days and still accruing.  The following tables present the recorded investment in the loan classes based on payment activity as of June 30, 2015 and December 31, 2014 (in thousands):

 
 
Performing
 
Nonperforming
 
Total
June 30, 2015
               
Residential real estate loans
$
 160,146
 
$
 1,035
 
$
 161,181
Construction
 
 19,773
   
 -
   
 19,773
Consumer loans
 
 24,023
   
 2
   
 24,025
Total
$
 203,942
 
$
 1,037
 
$
 204,979


 
Performing
 
Nonperforming
 
Total
December 31, 2014
               
Residential real estate loans
$
 156,464
 
$
 1,675
 
$
 158,139
Construction
 
 19,221
   
 -
   
 19,221
Consumer loans
 
 19,700
   
 4
   
 19,704
Total
$
 195,385
 
$
 1,679
 
$
 197,064

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 tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2015 and December 31, 2014 (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
 
June 30, 2015
                                         
Real Estate loans
                                         
Residential
  $ 159,909     $ 232     $ 5     $ -     $ 1,035     $ 1,272     $ 161,181  
Commercial
    256,815       261       -       -       9,722       9,983       266,798  
Construction
    19,773       -       -       -       -       -       19,773  
Commercial  loans
    67,428       12       -       -       -       12       67,440  
Consumer  loans
    23,983       31       9       -       2       42       24,025  
Total
  $ 527,908     $ 536     $ 14     $ -     $ 10,759     $ 11,309     $ 539,217  
                                                         
                                                         
 
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, 2014
                                                       
Real Estate loans
                                                       
Residential
  $ 156,242     $ 222     $ -     $ -     $ 1,675     $ 1,897     $ 158,139  
Commercial
    252,495       5,100       440       -       3,921       9,461       261,956  
Construction
    19,221       -       -       -       -       -       19,221  
Commercial  loans
    42,500       14       -       -       -       14       42,514  
Consumer  loans
    19,606       94       -       -       4       98       19,704  
Total
  $ 490,064     $ 5,430     $ 440     $ -     $ 5,600     $ 11,470     $ 501,534  


 
21

 

The following tables present 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, 2014
  $ 1,323     $ 3,890     $ 222     $ 256     $ 184     $ 5,875  
Charge Offs
    (113 )     (827 )     -       -       (43 )     (983 )
Recoveries
    4       -       -       -       11       15  
Provision for loan losses
    (129 )     1,089       (125 )     149       56       1,040  
Ending balance, June 30, 2015
  $ 1,085     $ 4,152     $ 97     $ 405     $ 208     $ 5,947  
Ending balance individually evaluated
for impairment
  $ -     $ 802     $ -     $ -     $ -     $ 802  
Ending balance collectively evaluated
for impairment
  $ 1,085     $ 3,350     $ 97     $ 405     $ 208     $ 5,145  
                                                 
                                                 
(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, March 31, 2015
  $ 1,353     $ 3,994     $ 115     $ 353     $ 192     $ 6,007  
Charge Offs
    (26 )     (434 )     -       -       (28 )     (488 )
Recoveries
    2       -       -       -       6       8  
Provision for loan losses
    (244 )     592       (18 )     52       38       420  
Ending balance, June 30, 2015
  $ 1,085     $ 4,152     $ 97     $ 405     $ 208     $ 5,947  


(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
    (98 )     (829 )     -       -       (27 )     (954 )
Recoveries
    -       -       -       -       17       17  
Provision for loan losses
    (149 )     1,704       (693 )     (5 )     (17 )     840  
Ending balance, June 30, 2014
  $ 1,194     $ 3,900     $ 205     $ 179     $ 133     $ 5,611  
Ending balance individually evaluated
for impairment
  $ -     $ 209     $ -     $ -     $ -     $ 209  
Ending balance collectively evaluated
for impairment
  $ 1,194     $ 3,691     $ 205     $ 179     $ 133     $ 5,402  
                                                 
                                                 
(In thousands)
Residential
Real Estate
 
Commercial
Real Estate
 
Construction
 
Commercial
 
Consumer
 
Total
 
Beginning balance, March 31, 2014
  $ 1,332     $ 3,842     $ 231     $ 184     $ 138     $ 5,727  
Charge Offs
    (23 )     (500 )     -       -       (16 )     (539 )
Recoveries
    -       -       -       -       3       3  
Provision for loan losses
    (115 )     558       (26 )     (5 )     8       420  
Ending balance, June 30, 2014
  $ 1,194     $ 3,900     $ 205     $ 179     $ 133     $ 5,611  
 
 
 
22

 
The Company’s primary business activity as of June 30, 2015 and December 31, 2014 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 June 30, 2015, the Company considered its concentration of credit risk to be acceptable.  The highest concentration was in the hospitality lodging industry, with loans outstanding of $55.8 million, or 10.3% of loans outstanding.  During 2015, the Company did not record a loss in the named concentration.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $40,000 and $0, respectively, in the first six months of 2015 compared to $72,000 and $0, respectively, in the same period in 2014.  The proceeds from the sales of residential mortgage loans totaled $1.8 million and $2.3 million for the six months ended June 30, 2015 and 2014, respectively.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $16,000 and $0, respectively, for the three months ended June 30, 2015 compared to $28,000 and $0, respectively, in the same period in 2014.  The proceeds from the sales of residential mortgage loans totaled $1.0 million and $1.1 million for the three months ended June 30, 2015 and 2014, respectively.


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.

 
23

 

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2015 and December 31, 2014 are as follows:


   
Fair Value Measurement Using
 
   
Reporting Date
 
                         
                         
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
                         
June 30, 2015
                       
Available for Sale:
                       
U.S. Government agencies
  $ 23,992     $ -     $ 23,992     $ -  
States and political subdivisions
    59,902       -       59,902       -  
Corporate obligations
    5,052       -       5,052       -  
Mortgage-backed securities-government
                               
  sponsored agencies
    61,973       -       61,973       -  
Equity securities-financial services
    385       385       -       -  
Total
  $ 151,304     $ 385     $ 150,919     $ -  
                                 
December 31, 2014
                               
Available for Sale:
                               
U.S. Government agencies
  $ 28,975     $ -     $ 28,975     $ -  
States and political subdivisions
    54,332       -       54,332       -  
Corporate obligations
    6,486       -       6,486       -  
Mortgage-backed securities-government
                               
  sponsored agencies
    66,204       -       66,204       -  
Equity securities-financial services
    398       398       -       -  
Total
  $ 156,395     $ 398     $ 155,997     $ -  

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

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.

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.


 
24

 

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2015 and December 31, 2014 are as follows:

                         
                         
         
Fair Value Measurement Reporting Date using Reporting Date
                         
(In thousands)
                       
                         
Description
 
Total
 
 Level 1
 
Level 2
 
Level 3
June 30, 2015
                       
Impaired Loans
 
$
 11,025
 
$
 -
 
$
 -
 
$
 11,025
Foreclosed Real Estate Owned
   
 1,382
   
 -
   
 -
   
 1,382
                         
                         
December 31, 2014
                       
Impaired Loans
 
$
 11,312
 
$
 -
 
$
 -
 
$
 11,312
Foreclosed Real Estate Owned
   
 3,726
   
 -
   
 -
   
 3,726

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)
June 30, 2015
             
Impaired loans
$
 10,592
 
Appraisal of
collateral(1)
Appraisal
adjustments(2)
 
10-60% (21.39%)
Impaired loans
$
 433
 
Present value of future cash flows
Loan discount rate
 
6.25 - 7.00% (6.67%)
               
Foreclosed real estate owned
$
 1,382
 
Appraisal of
collateral(1)
Liquidation
Expenses(2)
 
10%

               
               
 
Quantitative Information about Level 3 Fair Value Measurements
(In thousands)
Fair Value Estimate
 
Valuation Techniques
Unobservable Input
 
Range (Weighted Average)
December 31, 2014
             
Impaired loans
$
 11,312
 
Appraisal of
collateral(1)
Appraisal
adjustments(2)
 
6-33% (23.35%)
               
Foreclosed real estate owned
$
 3,726
 
Appraisal of
collateral(1)
Liquidation
Expenses(2)
 
10%


 
25

 

(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.

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 June 30, 2015 and December 31, 2014.

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 June 30, 2015, the fair value investment in impaired loans totaled $11,025,000 which included five loan relationships for $3,175,000 for which a valuation allowance of $802,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and thirteen loans for $8,652,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of June 30, 2015, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $1,525,000 over the life of the loans.

 
26

 
As of December 31, 2014, the fair value investment in impaired loans totaled $11,312,000 which included three loans for $2,973,000 for which a valuation allowance of $293,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and fourteen loans for $8,632,000 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, 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.
 
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.

 
27

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


The estimated fair values of the Company’s financial instruments were as follows at June 30, 2015 and December 31, 2014. (In thousands)


 
Fair Value Measurements at June 30, 2015
 
Carrying Amount
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
                           
Cash and cash equivalents
$
 20,442
 
$
 20,442
 
$
 20,442
 
$
 -
 
$
 -
Securities
 
 151,304
   
 151,304
   
 385
   
 150,919
   
 -
Loans receivable, net
 
 532,923
   
 542,615
   
 -
   
 -
   
 542,615
Mortgage servicing rights
 
 261
   
 289
   
 -
   
 289
   
 -
Regulatory Stock
 
 2,240
   
 2,240
   
 2,240
   
 -
   
 -
Bank owned life insurance
 
 18,551
   
 18,551
   
 18,551
   
 -
   
 -
Accrued interest receivable
 
 2,340
   
 2,340
   
 2,340
   
 -
   
 -
                             
Financial liabilities:
                           
Deposits
 
 575,614
   
 575,889
   
 367,310
   
 -
   
 208,579
Short-term borrowings
 
 33,842
   
 33,842
   
 33,842
   
 -
   
 -
Other borrowings
 
 37,211
   
 38,333
   
 -
   
 -
   
 38,333
Accrued interest payable
 
 988
   
 988
   
 988
   
 -
   
 -
                           
 
Off-balance sheet financial instruments:
                           
 Commitments to extend credit and
outstanding letters of credit
 
 -
   
 -
   
 -
   
 -
   
 -


 
28

 



 
Fair Value Measurements at December 31, 2014
 
Carrying Amount
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial assets:
                           
Cash and cash equivalents
$
 12,376
 
$
 12,376
 
$
 12,376
 
$
 -
 
$
 -
Securities
 
 156,395
   
 156,395
   
 398
   
 155,997
   
 -
Loans receivable, net
 
 495,260
   
 507,833
   
 -
   
-
   
 507,833
Mortgage servicing rights
 
 271
   
 277
   
 -
   
 277
   
 -
Regulatory stock
 
 1,714
   
 1,714
   
 1,714
   
 -
   
 -
Bank owned life insurance
 
 18,284
   
 18,284
   
 18,284
   
 -
   
 -
Accrued interest receivable
 
 2,339
   
 2,339
   
 2,339
   
 -
   
 -
                             
Financial liabilities:
                           
Deposits
 
 559,944
   
 560,243
   
 338,112
   
 -
   
 222,131
Short-term borrowings
 
 25,695
   
 25,695
   
 25,695
   
 -
   
 -
Other borrowings
 
 22,200
   
 23,228
   
 -
   
 -
   
 23,228
Accrued interest payable
 
 966
   
 966
   
 966
   
 -
   
 -
                             
Off-balance sheet financial instruments:
                           
 Commitments to extend credit and
outstanding letters of  credit
 
 -
   
 -
   
 -
   
 -
   
 -

9.           New and Recently Adopted Accounting Pronouncements

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. This Update did not 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
 
 
29

 
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 has included the disclosures related to this Update in Note 7.

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.

In June 2014, the FASB issued ASU 2014-11, 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 did not 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
 
 
30

 
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.  This Update did not have a significant impact on the Company’s financial statements.

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, 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.

In November 2014, the FASB issued ASU 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force).  This ASU clarifies how current U.S. GAAP should be interpreted in subjectively evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Public business entities are required to implement the new requirements in fiscal years and interim periods within those fiscal years beginning after December 15, 2015. This Update is not expected to have a significant impact on the Company’s financial statements.

In November 2014, the FASB issued ASU 2014-17, Business Combinations (Topic 805): Pushdown Accounting. The amendments in this Update apply to the separate financial statements of an acquired entity and its subsidiaries that are a business or nonprofit activity (either public or nonpublic) upon the occurrence of an event in which an acquirer (an individual or an entity) obtains control of the acquired entity.  An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs. If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity's most recent change-in-control event. The amendments in this Update are effective on November 18, 2014. After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event. This Update is not expected to have a significant impact on the Company’s financial statements.
 
In January 2015, the FASB issued ASU 2015-01, Income Statement –Extraordinary and Unusual Items, as part of its initiative to reduce complexity in accounting standards.  This Update eliminates from GAAP the concept of extraordinary items.  The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption.  This Update is not expected to have a significant impact on the Company’s financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810). The amendments in this Update affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the
 
 
31

 
amendments (1) Modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities; (2) Eliminate the presumption that a general partner should consolidate a limited partnership; (3) Affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; (4) Provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds.  The amendments in this Update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015.  For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017.  This Update is not expected to have a significant impact on the Company’s financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30), as part of its initiative to reduce complexity in accounting standards.  To simplify presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update.  For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016.  An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. This Update is not expected to have a significant impact on the Company’s financial statements.
 
In April 2015, the FASB issued ASU 2015-04, Compensation-Retirement Benefits (Topic 715), as part of its initiative to reduce complexity in accounting standards.  For an entity with a fiscal year-end that does not coincide with a month-end, the amendments in this Update provide a practical expedient that permits the entity to measure defined benefit plan assets and obligations using the month-end that is closest to the entity's fiscal year-end and apply that practical expedient consistently from year to year. The practical expedient should be applied consistently to all plans if an entity has more than one plan. The amendments in this Update are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. Earlier application is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

In April 2015, the FASB issued ASU 2015-05, Intangible – Goodwill and Other Internal Use Software (Topic 350-40), as part of its initiative to reduce complexity in accounting standards. This guidance  will help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The amendments in this Update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract.  For public business entities, the Board decided that the amendments will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. For all other entities, the amendments will be effective for annual periods beginning after December 15, 2015, and interim periods in annual periods beginning after December 15, 2016. Early adoption is permitted for all entities.  This Update is not expected to have a significant impact on the Company’s financial statements.

 
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In April 2015, the FASB issued ASU 2015-06, Earnings Per Share (Topic 260):Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions.  Topic 260, Earnings Per Share, contains guidance that addresses master limited partnerships that originated from Emerging Issues Task Force (EITF) Issue No. 07-4, Application of the Two-Class Method under FASB Statement No. 128 to Master Limited Partnerships. Under Topic 260, master limited partnerships apply the two-class method of calculating earnings per unit because the general partner, limited partners, and incentive distribution rights holders each participate differently in the distribution of available cash in accordance with the contractual rights contained in the partnership agreement. The amendments in this Update specify that for purposes of calculating historical earnings per unit under the two-class method, the earnings (losses) of a transferred business before the date of a dropdown transaction should be allocated entirely to the general partner. In that circumstance, the previously reported earnings per unit of the limited partners (which is typically the earnings per unit measure presented in the financial statements) would not change as a result of the dropdown transaction. Qualitative disclosures about how the rights to the earnings (losses) differ before and after the dropdown transaction occurs for purposes of computing earnings per unit under the two-class method also are required. The amendments in this Update are effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Earlier application is permitted.  This Update is not expected to have a significant impact on the Company’s financial statements.
 
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).  The Update applies to reporting entities that elect to measure the fair value of an investment using the net asset value per share (or its equivalent) practical expedient. Under the amendments in this Update, investments for which fair value is measured at net asset value per share (or its equivalent) using the practical expedient should not be categorized in the fair value hierarchy. Removing those investments from the fair value hierarchy not only eliminates the diversity in practice resulting from the way in which investments measured at net asset value per share (or its equivalent) with future redemption dates are classified, but also ensures that all investments categorized in the fair value hierarchy are classified using a consistent approach. Investments that calculate net asset value per share (or its equivalent), but for which the practical expedient is not applied will continue to be included in the fair value hierarchy. A reporting entity should continue to disclose information on investments for which fair value is measured at net asset value (or its equivalent) as a practical expedient to help users understand the nature and risks of the investments and whether the investments, if sold, are probable of being sold at amounts different from net asset value. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. A reporting entity should apply the amendments retrospectively to all periods presented. The retrospective approach requires that an investment for which fair value is measured using the net asset value per share practical expedient be removed from the fair value hierarchy in all periods presented in an entity's financial statements. Earlier application is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

In May 2015, the FASB issued ASU 2015-08, Business Combinations - Pushdown Accounting - Amendment to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115. This ASU was issued to amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115.  This Update is not expected to have a significant impact on the Company’s financial statements.

In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance (Topic 944) - Disclosure about Short-Duration Contracts. The amendments apply to all insurance entities that issue short-duration contracts as defined in Topic 944, Financial Services-Insurance. The amendments require insurance entities to disclose for annual reporting periods certain information about the liability for unpaid claims and claim
 
 
33

 
adjustment expenses. The amendments also require insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including reasons for the change and the effects on the financial statements.  Additionally, the amendments require insurance entities to disclose for annual and interim reporting periods a rollforward of the liability for unpaid claims and claim adjustment expenses, described in Topic 944. For health insurance claims, the amendments require the disclosure of the total of incurred-but-not-reported liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses. For public business entities, the amendments in this Update are effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016.  For all other entities, the amendments in this Update are effective for annual periods beginning after December 15, 2016, and interim periods within annual periods beginning after December 15, 2017.  This Update is not expected to have a significant impact on the Company’s financial statements.

In June 2015, the FASB issued ASU 2015-10, Technical Corrections and Improvements. The amendments in this Update represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this Update. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this Update.  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:

     
 
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
 
 
 
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common stock may lose value
 
competitive environment
 
issuing additional shares may dilute ownership
 
extensive and complex governmental regulation and associated cost
 
interest rate risks
 
cybersecurity

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, 2014 (incorporated by reference in Item 8 of the Form 10-K) lists significant accounting policies used in the development and presentation of its financial statements.  This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the 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 “Allowance for Loan Losses and Non-performing Assets” in the “Changes in Financial Condition” section.

The Company uses the modified prospective transition method to account for stock options.  Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.  Restricted shares vest over a five year period.  The product of the number of shares granted and the grant date market price of the Company’s common stock determines the fair value of restricted stock.

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 June 30, 2015 and December 31, 2014 represent temporary impairment of the securities, related to changes in interest rates.

 
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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 prior years, 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 June 30, 2015.

In connection with the acquisition of North Penn Bancorp, Inc. (“North Penn”), we 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 the 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 Company or 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 June 30, 2015 were $751.5 million compared to $711.6 million as of December 31, 2014, an increase of $39.9 million due primarily to a $37.7 million increase in loans receivable which was funded by a $23.2 million increase in borrowed funds and a $15.7 million increase in deposits.

Securities

The fair value of securities available for sale as of June 30, 2015 was $151.3 million compared to $156.4 million as of December 31, 2014.  The Company purchased $32.2 million of securities principally using the proceeds from $35.8 million of sales, calls, maturities and principal reductions of securities.
 
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The carrying value of the Company’s securities portfolio (Available-for Sale and Held-to Maturity) consisted of the following:


 
June 30, 2015
   
December 31, 2014
 
(dollars in thousands)
 
Amount
 
% of portfolio
     
Amount
 
% of portfolio
 
                       
U.S. Government agencies
$
 23,992
 
 15.8
%
 
$
 28,975
 
 18.5
%
States and political subdivisions
 
 59,902
 
 39.6
     
 54,332
 
 34.7
 
Corporate obligations
 
 5,052
 
 3.3
     
 6,486
 
 4.2
 
Mortgage-backed securities-
             
 
     
  government sponsored entities
 
 61,973
 
 41.0
     
 66,204
 
 42.3
 
Equity securities-financial services
 
 385
 
 0.3
     
 398
 
 0.3
 
  Total
$
 151,304
 
 100.0
%
 
$
 156,395
 
 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.

Loans

Loans receivable totaled $538.9 million at June 30, 2015 compared to $501.1 million as of December 31, 2014.  The $37.8 million increase recorded in the six month period ending June 30, 2015 was attributed to a $21.6 million increase in municipal financing, a $4.8 million increase in commercial mortgage loans and a $4.2 million increase in indirect auto and marine financing.  Residential mortgage loans also increased $3.0 million during the period.  The increase in municipal financing reflects management’s strategy for growth in high quality credits resulting from opportunities within our local markets.

The allowance for loan losses totaled $5,947,000 as of June 30, 2015 and represented 1.10% of total loans, compared to $5,875,000, or 1.17% of total loans, at December 31, 2014, and $5,611,000, or 1.12% of total loans, as of June 30, 2014.  The Company had net charge-offs for the six months ended June 30, 2015 of $968,000 compared to $937,000 in the corresponding period in 2014.  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 June 30, 2015 based on the Company’s criteria.  However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future.

As of June 30, 2015, non-performing loans totaled $10.8 million, or 2.00% of total loans compared to $5.6 million, or 1.12% of total loans at December 31, 2014. The increase was due primarily to the transfer of a $5.0 million credit to non-accrual status during the second quarter of 2015 due to weak cash flow projections. At June 30, 2015, non-performing assets totaled $12.1 million, or 1.62%, of total assets compared to $9.3 million, or 1.31 %, of total assets at December 31, 2014.  The increase reflects the transfer of the previously mentioned credit to non-accrual status, which was partially offset by a reduction in foreclosed real estate owned due to the sale of a property with a carrying value of $1.9 million as of December 31, 2014.

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



(dollars in thousands)
 
June 30, 2015
         
December 31, 2014
       
Loans accounted for on a non-accrual basis:
                       
Commercial
  $ -           $ -        
Real Estate
    10,757             5,596        
Consumer
    2             4        
Total non-accrual loans *
    10,759             5,600        
                             
Accruing loans which are contractually
                           
past due 90 days or more
    -             -        
Total non-performing loans
    10,759             5,600        
Foreclosed real estate
    1,382             3,726        
Total non-performing assets
  $ 12,141           $ 9,326        
Allowance for loans losses
  $ 5,947           $ 5,875        
Coverage of non-performing loans
    55.27 x             104.91        
Non-performing loans to total loans
    2.00 %  
 
      1.12 %  
 
 
Non-performing loans to total assets
    1.43 %  
 
      0.79  
 
 
Non-performing assets to total assets
    1.62  
 
      1.31  
 
 

*Includes non-accrual TDRs of $7.5 million as of June 30, 2015 and $2.2 million on December 31, 2014. The Company also had $1.1 million and $6.6 million of accruing TDRs on those dates.

Deposits

During the period, total deposits increased $15.7 million due primarily to a $10.8 million increase in NOW and money market accounts and a $9.5 million increase in non-interest bearing demand deposits.  Time certificates of deposit over $100,000 decreased $13.2 million as municipalities utilized funds to meet cash flow needs.  All other deposit products increased $8.6 million, net.

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

(dollars in thousands)
 
June 30, 2015
   
December 31, 2014
 
             
Non-interest bearing demand
  $ 107,610     $ 98,064  
Interest bearing demand
    53,236       46,441  
Money market deposit accounts
    131,357       120,603  
Savings
    75,107       73,004  
Time deposits <$100,000
    125,762       126,118  
Time deposits >$100,000
    82,542       95,714  
                 
Total
  $ 575,614     $ 559,944  


 
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Borrowings

Short-term borrowings as of June 30, 2015 totaled $33.8 million compared to $25.7 million as of December 31, 2014.  Short-term borrowings, which consist of securities sold under agreements to repurchase, increased $8.1 million principally due to the seasonality of municipal cash management accounts.
 
Other borrowings consisted of the following:

(dollars in thousands)
 
June 30, 2015
 
December 31, 2014
Notes with the FHLB:
         
Convertible note due July 2015 at 4.34%
$
 7,016
 
$
 7,111
Convertible note due January 2017 at 4.71%
 
 10,000
   
 10,000
Amortizing fixed rate borrowing due January 2018 at 0.91%
 
 1,567
   
 1,866
Amortizing fixed rate borrowing due December 2018 at 1.425%
 
 2,830
   
 3,223
Amortizing fixed rate borrowing due June 2020 at 1.490%
 
 10,000
   
 -
Amortizing fixed rate borrowing due March 2022 at 1.748%
 
 5,798
   
 -
 
$
 37,211
 
$
 22,200

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 19 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 fixed rate borrowing due July 2015 includes a $16,000 fair value adjustment recorded at the time of the North Penn acquisition.


Stockholders’ Equity and Capital Ratios

As of June 30, 2015, stockholders’ equity totaled $99.9 million, compared to $99.0 million as of December 31, 2014.   The net change in stockholders’ equity included $4.0 million of net income that was partially offset by $2.3 million of dividends declared, a $127,000 reduction due to an increase in Treasury Stock, and a $242,000 increase due to the exercise and vesting of stock options.  Total equity decreased $1.0 million due to a decrease in the fair value of securities in the available for sale portfolio, net of tax.  This decrease 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:

 
 
June 30, 2015
 
December 31, 2014
Tier 1 Capital
     
(To average assets)
12.39%
 
12.58%
Tier 1 Capital
     
(To risk-weighted assets)
16.46%
 
17.33%
Common Equity Tier 1 Capital
     
(To risk-weighted assets)
16.46%
 
N/A
Total Capital
     
(To risk-weighted assets)
17.55%
 
18.49%


 
39

 
Effective January 1, 2015, the Company and the Bank became subject to new regulatory capital rules which, among other things, impose a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), set the minimum leverage ratio for all banking organizations at a uniform 4% of total assets, increase the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assign a higher risk-weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property.  The new rules also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt out is exercised which the Company and the Bank have done.  The final rule limits a banking organization’s dividends, stock repurchases and other capital distributions, and certain discretionary bonus payments to executive officers, if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above regulatory minimum risk-based requirements.  The capital conservation buffer requirements will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer will be effective.  The Company and the Bank are in compliance with their respective new capital requirements, including the capital conservation buffer, as of June 30, 2015.
 
Liquidity

As of June 30, 2015, the Company had cash and cash equivalents of $20.4 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 $151.3 million which could be used for liquidity needs.  This totals $171.7 million of liquidity and represents 22.8% of total assets compared to $168.8 million and 23.7% of total assets as of December 31, 2014.  The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of June 30, 2015 and December 31, 2014.  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.  There were no borrowings under this line as of June 30, 2015 and December 31, 2014.

The Company has a line of credit commitment from Atlantic Community Bankers Bank for $7,000,000 which expires June 30, 2016.  There were no borrowings under this line as of June 30, 2015 and December 31, 2014.

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 June 30, 2015 and December 31, 2014.

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 June 30, 2015 and December 31, 2014.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $280,400,000 as of June 30, 2015, of which $37,200,000 and $22,200,000 was outstanding at June 30, 2015 and December 31, 2014, respectively.  Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.

 
40

 
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 42 and 46.  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.


 
41

 

Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates


(Tax-Equivalent Basis, dollars in thousands)
 
Three Months Ended June 30,
 
   
2015
   
2014
 
   
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
  $ 12,626     $ 8       0.25 %   $ 2,442     $ 1       0.16 %
   Securities held-to-maturity (1)
    -       -       -       58       1       6.90  
   Securities available for sale:
                                               
     Taxable
    97,133       484       1.99       98,487       513       2.08  
     Tax-exempt (1)
    60,437       708       4.69       61,561       776       5.04  
        Total securities available for sale (1)
    157,570       1,192       3.03       160,048       1,289       3.22  
     Loans receivable (1) (4) (5)
    524,335       6,022       4.59       500,851       6,003       4.79  
        Total interest-earning assets
    694,531       7,222       4.16       663,399       7,294       4.40  
Non-interest earning assets:
                                               
   Cash and due from banks
    8,481                       8,467                  
   Allowance for loan losses
    (6,182 )                     (5,873 )                
   Other assets
    44,914                       44,171                  
        Total non-interest earning assets
    47,213                       46,765                  
Total Assets
  $ 741,744                     $ 710,164                  
Liabilities and Stockholders' Equity
                                               
Interest-bearing liabilities:
                                               
   Interest bearing demand and money market
  $ 180,106     $ 76       0.17     $ 177,153     $ 78       0.18  
   Savings
    75,066       9       0.05       71,718       8       0.04  
   Time
    217,284       533       0.98       204,103       532       1.04  
      Total interest-bearing deposits
    472,456       618       0.52       452,974       618       0.55  
Short-term borrowings
    29,350       16       0.22       38,391       20       0.21  
Other borrowings
    30,598       199       2.60       23,185       167       2.88  
   Total interest-bearing liabilities
    532,404       833       0.63       514,550       805       0.63  
Non-interest bearing liabilities:
                                               
   Demand deposits
    104,127                       95,444                  
   Other liabilities
    4,226                       4,128                  
      Total non-interest bearing liabilities
    108,353                       99,572                  
   Stockholders' equity
    100,987                       96,042                  
Total Liabilities and Stockholders' Equity
  $ 741,744                     $ 710,164                  
                                                 
Net interest income (tax equivalent basis)
            6,389       3.53 %             6,489       3.77 %
Tax-equivalent basis adjustment
            (340 )                     (334 )        
Net interest income
          $ 6,049                     $ 6,155          
Net interest margin (tax equivalent basis)
                    3.68 %                     3.91 %
 
(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.


 
42

 


Rate/Volume Analysis.  The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense.


 
 
Three months ended June 30, 2015 Compared to
 
   
Three months ended June 30, 2014
 
   
Variance due to
 
   
Volume
   
Rate
   
Net
 
                   
   
(dollars in thousands)
 
                   
Interest earning assets:
                 
Interest bearing deposits with banks
  $ 5     $ 2     $ 7  
Securities held to maturity
    (1 )     -       (1 )
Securities available for sale:
                       
Taxable
    (7 )     (22 )     (29 )
Tax-exempt securities
    (14 )     (54 )     (68 )
Total securities
    (22 )     (76 )     (98 )
Loans receivable
    275       (256 )     19  
Total interest earning assets
    258       (330 )     (72 )
                         
Interest bearing liabilities:
                       
Interest-bearing demand and money market
    1       (3 )     (2 )
Savings
    -       1       1  
Time
    34       (33 )     1  
Total interest bearing deposits
    35       (35 )     -  
Short-term borrowings
    (5 )     1       (4 )
Other borrowings
    51       (19 )     32  
Total interest bearing liabilities
    81       (53 )     28  
Net interest income (tax-equivalent basis)
  $ 177     $ (277 )   $ (100 )

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.


 
43

 

Comparison of Operating Results for The Three Months Ended June 30, 2015 to June 30, 2014

General

For the three months ended June 30, 2015, net income totaled $1,963,000 compared to $2,034,000 earned in the similar period in 2014.  The decrease in net income for the three months ended June 30, 2015 was due primarily to a $389,000 reduction in gains on sales of loans and securities as well as a $106,000 decrease in net interest income, some of which was offset by reduced salaries and employee benefits and foreclosed real estate costs.  Earnings per share for the current period were $.53 for basic and fully diluted compared to $.56 per basic and fully diluted share for the three months ended June 30, 2014.  The resulting annualized return on average assets and annualized return on average equity for the three months ended June 30, 2015 were 1.06% and 7.80%, respectively, compared to 1.15% and 8.49%, respectively, for the similar period in 2014.
 
The following table sets forth changes in net income:


(dollars in thousands)
Three months ended
 
June 30, 2015 to June 30, 2014
Net income three months ended June 30, 2014
$
 2,034
Change due to:
   
Net interest income
 
 (106)
Provision for loan losses
 
 -
Net gain on sales of loans and securities
 
 (389)
Other income
 
 54
Salaries and employee benefits
 
 101
Occupancy, furniture and equipment
 
 (24)
Foreclosed real estate owned
 
 164
All other expenses
 
 64
Income tax expense
 
 65
     
Net income three months ended June 30, 2015
$
 1,963


Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the three months ended June 30, 2015 totaled $6,389,000 which was $100,000 lower than the comparable period in 2014.  The decrease in net interest income largely reflects new loan growth and repricing in the current low interest rate environment.  The fte net interest spread and net interest margin were 3.53% and 3.68%, respectively, for the three months ended June 30, 2015 compared to 3.77% and 3.91%, respectively, for the similar period in 2014.

Interest income (fte) totaled $7,222,000 with a yield on average earning assets of 4.16% compared to $7,294,000 and 4.40% for the 2014 period. Average loans increased $23.5 million over the comparable period of last year but a 20 basis point reduction in the yield earned limited the increase in fte loan income to $19,000.  The yield on securities also decreased 19 basis points, resulting in a $98,000 reduction in earnings.  Average earning assets totaled $694.5 million for the three months ended June 30, 2015, an increase of $31.1 million over the average balance for the similar period in 2014.  This increase in average earning assets helped offset the decline in yield.

 
44

 

 
Interest expense for the three months ended June 30, 2015 totaled $833,000 at an average cost of 0.63% compared to $805,000 and 0.63% for the similar period in 2014.  The cost of time deposits, which is the most significant component of funding, declined to 0.98% from 1.04% 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 each of the three months ended June 30, 2015 and 2014 was $420,000.  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 $480,000 for the quarter ended June 30, 2015 compared to $537,000 for the similar period in 2014.

Other Income

Other income totaled $1,133,000 for the three months ended June 30, 2015 compared to $1,468,000 for the similar period in 2014.  Net gains from the sale of securities decreased $375,000 compared to the same period of 2014 due to reduced opportunities. All other items of other income increased $40,000, net, compared to the second quarter of last year.

Other Expense

Other expense for the three months ended June 30, 2015 totaled $4,168,000 or $305,000 lower than the same period of 2014.  Costs associated with foreclosed real estate properties decreased $164,000 while salaries and employee benefit costs decreased $101,000 due to a reduction in sales incentives and health care costs.  All other operating expenses decreased $40,000, net.

Income Tax Expense

Income tax expense totaled $631,000 for an effective tax rate of 24.3% for the period ending June 30, 2015 compared to $696,000 for an effective tax rate of 25.5% for the similar period in 2014.


 
45

 

Results of Operations
NORWOOD FINANCIAL CORP.
Consolidated Average Balance Sheets with Resultant Interest and Rates

(Tax-Equivalent Basis, dollars in thousands)
 
Six Months Ended June 30,
 
   
2015
   
2014
 
   
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
  $ 9,643     $ 12       0.25 %   $ 1,652     $ 2       0.24 %
   Securities held-to-maturity (1)
    -       -       -       115       4       6.96  
   Securities available for sale:
                                               
     Taxable
    99,474       1,055       2.12       99,160       1,001       2.02  
     Tax-exempt (1)
    58,543       1,392       4.76       60,780       1,529       5.03  
        Total securities available for sale (1)
    158,017       2,447       3.10       159,940       2,530       3.16  
     Loans receivable (1) (4) (5)
    515,026       12,147       4.72       500,518       12,043       4.81  
        Total interest-earning assets
    682,686       14,606       4.28       662,225       14,579       4.40  
Non-interest earning assets:
                                               
   Cash and due from banks
    8,297                       8,055                  
   Allowance for loan losses
    (6,095 )                     (5,879 )                
   Other assets
    45,685                       43,193                  
        Total non-interest earning assets
    47,887                       45,369                  
Total Assets
  $ 730,573                     $ 707,594                  
Liabilities and Stockholders' Equity
                                               
Interest-bearing liabilities:
                                               
   Interest-bearing demand and money market
  $ 176,013     $ 14       0.17     $ 172,733     $ 157       0.18  
   Savings
    74,470       18       0.05       70,845       17       0.05  
   Time
    219,372       1,057       0.96       207,305       1,079       1.04  
      Total interest-bearing deposits
    469,855       1,222       0.52       450,883       1,253       0.56  
Short-term borrowings
    26,977       29       0.21       40,150       42       0.21  
Other borrowings
    26,792       364       2.72       23,379       333       2.85  
   Total interest bearing liabilities
    523,624       1,615       0.62       514,412       1,628       0.63  
Non-interest bearing liabilities:
                                               
   Demand deposits
    101,907                       94,027                  
   Other liabilities
    4,185                       4,062                  
      Total non-interest bearing liabilities
    106,092                       98,089                  
   Stockholders' equity
    100,857                       95,093                  
Total Liabilities and Stockholders' Equity
  $ 730,573                     $ 707,594                  
                                                 
Net interest income (tax equivalent basis)
            12,991       3.66 %             12,951       3.77 %
Tax-equivalent basis adjustment
            (635 )                     (651 )        
Net interest income
          $ 12,356                     $ 12,300          
Net interest margin (tax equivalent basis)
                    3.81 %                     3.91 %
 
(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.


 
46

 
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)
 
 
 
Six months ended June 30, 2015 Compared to
 
   
Six months ended June 30, 2014
 
   
Variance due to
 
   
Volume
   
Rate
   
Net
 
                   
   
(dollars in thousands)
 
                   
Interest earning assets:
                 
Interest bearing deposits with banks
  $ 10     $ -     $ 10  
Securities held to maturity
    (4 )     -       (4 )
Securities available for sale:
                       
Taxable
    3       51       54  
Tax-exempt securities
    (55 )     (82 )     (137 )
Total securities
    (56 )     (31 )     (87 )
Loans receivable
    339       (235 )     104  
Total interest earning assets
    293       (266 )     27  
                         
Interest bearing liabilities:
                       
Interest-bearing demand and money market
    1       (11 )     (10 )
Savings
    1       -       1  
Time
    61       (83 )     (22 )
Total interest bearing deposits
    63       (94 )     (31 )
Short-term borrowings
    (13 )     -       (13 )
Other borrowings
    47       (16 )     31  
Total interest bearing liabilities
    97       (110 )     (13 )
Net interest income (tax-equivalent basis)
  $ 196     $ (156 )   $ 40  

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.

 
47

 

Comparison of Operating Results for The Six Months Ended June 30, 2015 to June 30, 2014

General

For the six months ended June 30, 2015, net income totaled $4,004,000 compared to $3,998,000 earned in the similar period in 2014.  The increase in net income for the six months ended June 30, 2015 was due primarily to a $250,000 decrease in operating expenses which offset an increased loan loss provision and reduced gains from the sale of loans and securities. Earnings per share for the current period were $1.09 for basic and $1.08 fully diluted compared to $1.10 for basic and diluted for the six months ended June 30, 2014.  The resulting annualized return on average assets and annualized return on average equity for the six months ended June 30, 2015 were 1.11% and 8.01%, respectively, compared to 1.14% and 8.48%, respectively, for the similar period in 2014.
 
 
The following table sets forth changes in net income:
     
     
   
(dollars in thousands)
Six months ended
 
June 30, 2015 to June 30, 2014
Net income six months ended June 30, 2014
$
 3,998
Change due to:
   
Net interest income
 
 56
Provision for loan losses
 
 (200)
Gain on sales of loans and securities
 
 (194)
Other income
 
 85
Salaries and employee benefits
 
 128
Occupancy, furniture and equipment
 
 (2)
Foreclosed real estate owned
 
 71
All other expenses
 
 53
Income tax expense
 
 9
     
Net income six months ended June 30, 2015
$
 4,004

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the six months ended June 30, 2015 totaled $12,991,000 which was $40,000 higher than the comparable period in 2014.  The increase in net interest income largely reflects an increase in average loans outstanding 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 3.66% and 3.81%, respectively, for the six months ended June 30, 2015 compared to 3.77% and 3.91%, respectively, for the similar period in 2014.

Interest income (fte) totaled $14,606,000 with a yield on average earning assets of 4.28% compared to $14,579,000 and 4.40% for the 2014 period. Average loans increased $14.5 million over the comparable period of last year but a 9 basis point reduction in the yield earned limited the improvement in fte loan income to $104,000.  The yield on securities also declined  6 basis points, resulting in an $87,000 decrease in earnings.  Average earning assets totaled $682.7 million for the six months ended June 30, 2015, an increase of $20.5 million over the average balance for the similar period in 2014.  This increase in average earning assets helped offset the decline in yield.

 
48

 
Interest expense for the six months ended June 30, 2015 totaled $1,615,000 at an average cost of 0.62% compared to $1,628,000 and 0.63% for the similar period in 2014.  The cost of time deposits, which is the most significant component of funding, declined from 1.04% to 0.96% in 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 six months ended June 30, 2015 was $1,040,000 compared to $840,000 for the six months ended June 30, 2014.  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 $968,000 for the six months ended June 30, 2015 compared to $937,000 for the similar period in 2014.

Other Income

Other income totaled $2,412,000 for the six months ended June 30, 2015 compared to $2,521,000 for the similar period in 2014.  The decrease was due primarily to a $158,000 reduction in gains from the sale of securities compared to the same period of 2014. All other items of other income increased $49,000, net, compared to the same period of last year.

Other Expense

Other expense for the six months ended June 30, 2015 totaled $8,355,000 or $250,000 lower than the same period of 2014.  Salaries and employee benefits expense decreased $128,000 due to reductions in sales incentives and health care costs while costs associated with foreclosed real estate properties decreased $71,000.  All other operating expenses decreased $51,000, net.

Income Tax Expense

Income tax expense totaled $1,369,000 for an effective tax rate of 25.5% for the period ending June 30, 2014 compared to $1,378,000 and an effective tax rate of 25.6% for the similar period in 2014.


 
49

 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Market Risk

Interest rate sensitivity and the repricing characteristics of assets and liabilities are managed by the Asset and Liability Management Committee (ALCO).  The principal objective of ALCO is to maximize net interest income within acceptable levels of risk, which are established by policy.  Interest rate risk is monitored and managed by using financial modeling techniques to measure the impact of changes in interest rates.

Net interest income, which is the primary source of the Company’s earnings, is impacted by changes in interest rates and the relationship of different interest rates.  To manage the impact of the rate changes, the balance sheet must be structured so that repricing opportunities exist for both assets and liabilities at approximately the same time intervals.  The Company uses net interest simulation to assist in interest rate risk management.  The process includes simulating various interest rate environments and their impact on net interest income.  As of June 30, 2015, the level of net interest income at risk in a both a rising and declining 200 basis point shift in interest rates was within the Company’s policy limits.  The Company’s policy allows for a decline of no more than 8% of net interest income for a ± 200 basis point shift in interest rates.

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 June 30, 2015, the Company had a positive 90 day interest sensitivity gap of $58.3 million or 7.8% of total assets, compared to the $64.4 million or 9.0% of total assets as of December 31, 2014.  Rate sensitive assets repricing within 90 days increased $12.4 million due primarily to a $7.6 million increase in overnight liquidity and a $3.7 million increase in loans repricing within the period.  Rate sensitive liabilities increased $18.5 million since year end due primarily to a $9.3 million increase in borrowings and a $6.1 million increase 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.

Certain interest-bearing deposits with no stated maturity dates are included in the interest-sensitivity table below.  The balances allocated to the respective time periods represent an estimate of the total outstanding balance that has the potential to migrate through withdrawal or transfer to time deposits, thereby impacting the interest-sensitivity position of the Company.  The estimates were derived from industry-wide statistical information and do not represent historical results.


 
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June 30, 2015
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
  $ 11,937     $ -     $ -     $ -     $ 11,937  
Securities
    6,143       7,963       25,597       111,601       151,304  
Loans Receivable
    127,024       118,523       153,909       139,414       538,870  
  Total RSA
  $ 145,104     $ 126,486     $ 179,506     $ 251,015     $ 702,111  
                                         
Non-maturity interest-bearing deposits
  $ 41,524     $ 47,233     $ 124,885     $ 46,058     $ 259,700  
Time Deposits
    29,972       66,869       76,458       35,005       208,304  
Other
    15,343       15,071       32,832       7,807       71,053  
  Total RSL
  $ 86,839     $ 129,173     $ 234,175     $ 88,870     $ 539,057  
                                         
                                         
Interest Sensitivity Gap
  $ 58,265     $ (2,687 )   $ (54,669 )   $ 162,145     $ 163,054  
Cumulative Gap
    58,265       55,578       909       163,054          
RSA/RSL-cumulative
    167.1 %     125.7 %     100.2 %     130.2 %        
                                         
December 31, 2014
                                       
                                         
Interest Sensitivity Gap
  $ 64,389     $ (9,788 )   $ (40,674 )   $ 138,122     $ 152,049  
Cumulative Gap
    64,389       54,601       13,927       152,049          
RSA/RSL-cumulative
    194.2 %     125.6 %     103.2 %     129.8 %        



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.


 
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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, 2014.

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)
 
 
 
52

 
 
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)
10.15
Addendum to Change in Control Severance Agreement with William S. Lance(12)
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



(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 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.

(12)  
Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on February 18, 2015.

 
53

 

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


           
         
NORWOOD FINANCIAL CORP.
 
           
Date:
August 7, 2015
 
By:
 
/s/ Lewis J. Critelli
 
         
Lewis J. Critelli
 
         
President and Chief Executive Officer
 
         
(Principal Executive Officer)
 
             
Date:
August 7, 2015
 
By:
 
/s/ William S. Lance
 
         
William S. Lance
 
         
Executive Vice President and
 
         
Chief Financial Officer
 
         
(Principal Financial Officer)
 
 
54