SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

For the quarterly period ended March 31, 2009  

OR

 

For the transition period from _________________ to ________________

 

Commission file number 0-28366

 

 

 

 

 

 

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 o

 

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 o No o

 

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.

 

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

 

NORWOOD FINANCIAL CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2009

 

 

 

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NORWOOD FINANCIAL CORP.

Consolidated Balance Sheets (unaudited)

(dollars in thousands, except per share data)

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

NORWOOD FINANCIAL CORP. Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share data)

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

NORWOOD FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity (unaudited)

Three Months Ended March 31, 2009 and 2008

(dollars in thousands, except per share data)

 

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

NORWOOD FINANCIAL CORP.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

Notes to Unaudited Consolidated Financial Statements

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. and WTRO Properties. 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 month period ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009 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, 2008.

 

Basic earnings per share represents income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

 

The following table sets forth the weighted average shares outstanding used in the computations of basic and diluted earnings per share: 

 

(in thousands)

 

 

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 113,150 and 40,000 as of March 31, 2009 and 2008, respectively.

 

 

3. Stock-Based Compensation

 

The Company’s shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the annual meeting on April 25, 2006 and the Company awarded 47,700 options in 2006, 22,000 options in 2007 and 24,000 options in 2008, all of which have a twelve month vesting period. As of March 31, 2009, there was $98,000 of total unrecognized compensation cost related to nonvested options granted in 2008 under the plan, which will be fully amortized by December 31, 2009.

 

No stock options were granted during the three months ended March 31, 2009. A summary of stock options from all plans is shown below.

 

 

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 intrinsic value of options exercised during the three months ended March 31, 2009 was $14,000, cash received from such exercises was $9,000 and the tax benefit recognized was $5,000.

 

For the purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits with banks all of which mature within 90 days and federal funds sold.

 

Cash payments for interest for the periods ended March 31, 2009 and 2008 were $2,312,000 and $3,401,000 respectively. Cash payments for income taxes for the periods ending March 31, 2009 and 2008 were $2,000 and $4,000 respectively. Non-cash investing activity for 2009 and 2008 included repossession of other assets and foreclosed mortgage loans transferred to real estate owned of $132,000 and $11,000, respectively. Non-cash financing activity for 2009 includes $3,607,000 relating to the payable on the sale of deposits.

 

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The components of other comprehensive income and related tax effects are as follows.

 

 

 

 

 

 

The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

 

A summary of the Bank’s financial instrument commitments is as follows:

 

 

 

 

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 March 31, 2009 for guarantees under standby letters of credit issued is not material.

 

 

Financial Accounting Board Statement No. 157, Fair Value Measurements (“SFAS 157”) establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are as follows:

 

 

 

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2009 and December 31, 2008 are as follows:

 

 

 

 

 

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2009 and December 31, 2008 are as follows:

 

 

Securities:

 

The fair value of securities available for sale (carried at fair value) 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 2). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.

 

Impaired loans (generally carried at fair value):

 

Impaired loans are those that are accounted for under FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS 114”), in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value investment in impaired loans was $3,078,000 as of March 31, 2009 and $2,976,000 as of December 31, 2008.

 

 

Foreclosed real estate owned

 

Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less 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. A property consisting of a residential one family residence was acquired through foreclosure in the period ending March 31, 2009 and is carried at its net realizable value of $108,000, based on a current appraisal.  At March 31, 2009 the Company was also carrying a property it acquired in the previous year with a net realizable value of $660,000, based on an appraisal at the time the property was acquired.

 

 

In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP FAS 157-4). FASB Statement 157, Fair Value Measurements, defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. FSP FAS 157-4 provides additional guidance on determining when the volume and level of activity for the asset or liability has significantly decreased. The FSP also includes guidance on identifying circumstances when a transaction may not be considered orderly.

 

FSP FAS 157-4 provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with Statement 157.

 

This FSP clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The FSP provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

 

This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting FSP FAS 157-4 must also early adopt FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. The Company is currently reviewing the effect this new pronouncement will have on its consolidated financial statements.

 

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS 115-2 and FAS 124-2). FSP FAS 115-2 and FAS 124-2 clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment. Previously, this assessment required management to assert it has both the intent and the ability to hold a security for a period of time sufficient to allow for an anticipated recovery in fair value to avoid recognizing an other-than-temporary impairment. This change does not affect the need to forecast recovery of the value of the security through either cash flows or market price.

 

 

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, FSP FAS 115-2 and FAS 124-2 changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

 

This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting FSP FAS 115-2 and FAS 124-2 must also early adopt FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. The Company is currently reviewing the effect this new pronouncement will have on its consolidated financial statements.

 

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods.

 

This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting FSP FAS 107-1 and APB 28-1 must also early adopt FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly and FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. The Company is currently reviewing the effect this new pronouncement will have on its consolidated financial statements.

 

9. Branch Closure

 

On December 26, 2008, the Company filed notifications with the Pennsylvania Department of Banking and the FDIC, requesting authorization to discontinue branch operations at its Hamlin Office, as the lease for the location expires in 2009, with no renewal options available. The Company entered into an agreement with NBT Bank to assume the deposits of the Hamlin location and the office was closed. The Company recorded a net payable to NBT Bank of $3,607,000, which was paid subsequent to March 31, 2009. The gain on the transaction was $150,000 with expense related to the closing, including final lease payments, of $46,000, included in other expense in the consolidated income statement.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words believes, anticipates, contemplates, expects, and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, risks associated with the effect of opening a new branch, the ability to control costs and expenses, demand for real estate and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

Critical Accounting Policies

 

Note 2 to the Company’s consolidated financial statements for the year ended December 31, 2008 (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, potential impairment of restricted stock, accounting for stock options, the valuation of deferred tax assets and the determination of other-than-temporary impairment losses on securities. Please refer to the discussion of the allowance for loan losses calculation under “Non-performing Assets and Allowance for Loan Losses” in the “Financial Condition” section.

 

The Company adopted SFAS No. 123(R), “Share-Based Payment” as of January 1, 2006, using the modified prospective transition method. Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.

 

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.

 

Restricted stock which represents required investment in the common stock of correspondent banks is carried at cost and as of March 31, 2009 and December 31, 2008, consists of the common stock of Federal Home Loan Bank of Pittsburgh. In December 2008, the FHLB of Pittsburgh notified member banks that it was suspending dividend payments and the repurchase of capital stock.

 

Management evaluates the restricted stock for impairment in accordance with Statement of Position (SOP) 01-6, Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary decline in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and length of time this situation has persisted, (2) commitments by the

 

 

FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to the restricted stock as of March 31, 2009 and December 31, 2008.

 

In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost 2) the financial condition of the issuer and 3) the intent and ability of the Company to hold the security to allow for a recovery to fair value. The Company believes that the unrealized losses in certain specific securities at March 31, 2009 and December 31, 2008 represent temporary impairment of the securities.

 

Changes in Financial Condition

 

General

Total assets as of March 31, 2009 were $511.4 million compared to $504.3 million as of December 31, 2008 an increase of $7.1 million. The increase reflects a $11.5 million increase in the cash and cash equivalents and a $2.0 million increase in loans receivable partially offset by a $5.9 million decrease in securities available for sale.

 

Securities

The fair value of securities available for sale as of March 31, 2009 was $124.2 million compared to $130.1 million as of December 31, 2008. The Company purchased $15.1 million of securities principally using the proceeds from $16.9 million of securities called, maturities and principal reductions.            

 

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

 

 

The Company has securities in an unrealized loss position. In management’s opinion, the unrealized losses in the mortgage-backed securities reflect changes in interest rates subsequent to the acquisition of specific securities. The unrealized losses in the State and Political Subdivisions and Corporate Obligations also reflect a widening of spreads due to liquidity and credit concerns in the financial markets. The Company holds a small amount of equity securities in other financial institutions, the value of which has been impacted by the weakening conditions of the financial markets. Management believes that the unrealized losses represent temporary impairment of the securities, as the Company has the intent and ability to hold these investments until maturity or market price recovery.

 

 

Loans Receivable

Loans receivable totaled $351.4 million compared to $349.4 million as of December 31, 2008. Residential real estate loans decreased $4.2 million principally due to the sale of $9.7 million of residential mortgages. The loans were sold for interest rate risk management to shorten the average life of the mortgage loan portfolio. Commercial real estate loans increased $7.2 million during the period as a result of continued activity in the Monroe and Pike area.

 

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

 

 

 

Allowance for Loan Losses and Non-performing Assets

 

 

 

The allowance for loan losses totaled $4,413,000 as of March 31, 2009 and represented 1.26% of total loans, compared to $4,233,000 at year end, and $4,137,000 as of March 31, 2008. The Company had net charge-offs for the three months ended March 31, 2009 of $45,000 compared to $19,000 in the comparable period in 2008 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 March 31, 2009 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 March 31, 2009, non-performing loans totaled $1,692,000, which is .48% of total loans compared to $2,087,000, or 0.60% of total loans at December 31, 2008. The decrease was principally due to a pay down as a result of a third party refinance on a portion of a land development loan. The following table sets forth information regarding non-performing loans and foreclosed real estate at the dates indicated:

 

 

 

 

Deposits  

Total deposits as of March 31, 2009 were $370.4 million compared to $359.6 million as of December 31, 2008, an increase of $10.8 million. This growth in deposits was after the sale of $3.6 million related to a branch closure as described in Note 9. Deposit growth was attributable to a $4.7 million increase in money market deposit accounts and $4.6 million increase in time deposits under $100,000. The increase in time deposits was due to a promotional 13 month product. The growth in deposits was used to reduce short-term borrowings with the remaining portion temporarily invested in Federal Funds sold.

 

 

 

 

 

 

 

Borrowings

Short-term borrowings as of March 31, 2009 totaled $29.4 million compared to $38.1 million as of December 31, 2008. Securities sold under agreements to repurchase declined $5.2 million principally due to the seasonality of municipal cash management accounts. Short-term borrowings consist of the following:

 

 

 

 

(dollars in thousands)

 

 

The convertible notes contain an option which allows the FHLB, at quarterly intervals to change the note to an adjustable-rate advance at three month LIBOR plus 11 to 19 basis points. If the notes are converted, the option allows the Bank to put the funds back to the FHLB at no charge.                

 

Off-Balance Sheet Arrangements

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

 

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

 

 

Stockholders’ Equity and Capital Ratios

As of March 31, 2009, stockholders’ equity totaled $60.2 million, compared to $58.7 million as of December 31, 2008. The net change in stockholders’ equity included $1,737,000 in net income, that was partially offset by $741,000 of dividends declared. In addition, accumulated other comprehensive income increased $486,000 due to an increase in fair value of securities in the available for sale portfolio, net of tax. This increase in fair value is the result of a change in interest rates, 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.

 

 

 

 

The minimum capital requirements imposed by the FDIC on the Bank for leverage, Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Company has similar capital requirements imposed by the Board of Governors of the Federal Reserve System (FRB). The Bank is also subject to more stringent Pennsylvania Department of Banking (PDB) guidelines. The Bank’s capital ratios do not differ significantly from the Company’s ratios. Although not adopted in regulation form, the PDB utilizes capital standards requiring a

 

 

minimum of 6.5% leverage capital and 10% total capital. The Company and the Bank were in compliance with FRB, FDIC and PDB capital requirements as of March 31, 2009 and December 31, 2008.

 

Liquidity

As of March 31, 2009, the Company had cash and cash equivalents of $18.0 million in the form of cash, due from banks, Federal Funds sold and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $124.2 million which could be used for liquidity needs. This totals $142.2 million and represents 27.8% of total assets compared to $136.6 million and 27.1% of total assets as of December 31, 2008. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of March 31, 2009 and December 31, 2008. 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 2011. There were no borrowings under this line at March 31, 2009 and December 31, 2008.

 

The Company has a line of credit commitment from Atlantic Central Bankers Bank for $7,000,000 which expires in May 2009. There were no borrowings under these lines as of March 31, 2009 and December 31, 2008. The Company has a line of credit commitment available which has no stated expiration date from PNC for $12,000,000. Borrowings under this line were $-0- as of March 31, 2009 and $3,600,000 as of December 31, 2008.

 

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $235,056,000 of which $54,000,000 was outstanding at March 31, 2009 and at December 31, 2008. Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.

 

Non-GAAP Financial Measures

This report contains or references fully taxable-equivalent (fte) interest income and net interest income, which are non-GAAP financial measures. Interest income (fte) and net interest income (fte) are derived from GAAP interest income and net interest income using an assumed tax rate of 34%. We believe the presentation of interest income (fte) and net interest income (fte) ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Net interest income (fte) is reconciled to GAAP net interest income on page 21. 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.

 

 

Results of Operations

NORWOOD FINANCIAL CORP.

Consolidated Average Balance Sheets with Resultant Interest and Rates

   (Tax-Equivalent Basis, dollars in thousands)

 

 

 

 

 

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

 

 

Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.

 

 

 

 

 

 

Comparison of Operating Results for The Three Months Ended March 31, 2009 to March 31, 2008

 

General

For the three months ended March 31, 2009, net income totaled $1,737,000 compared to $1,779,000 earned in the similar period in 2008. Earnings per share for the current period were $.63 for basic and fully diluted compared to $.65 per share basic and $.64 per share on a fully diluted basis for the three months ended March 31, 2008. The resulting annualized return on average assets and annualized return on average equity for the three months ended March 31, 2009 was 1.39% and 11.80%, respectively, compared to 1.49% and 12.71%, respectively, for the similar period in 2008.

 

 

 

Net Interest Income

 

Net interest income on a fully taxable equivalent basis (fte) for the three months ended March 31, 2009, totaled $4,842,000, an increase of $361,000 or 8.1% over the similar period in 2008. The fte net interest spread and net interest margin were 3.54% and 3.96%, respectively, for the three months ended March 31, 2009 compared to 3.25% and 3.90%, respectively for the similar period in 2008.

 

Interest income (fte) totaled $6,851,000 with a yield on average earning assets of 5.61% compared to $7,306,000 and 6.37% for the 2008 period. The decrease in yield was due in part to the lower prime interest rate which was 3.25% as of March 31, 2009 compared to 5.25% at March 31, 2008. The Company has $69 million of floating rate loans tied to prime rate. In addition, residential mortgage rates have declined causing a portion of the portfolio to refinance at lower rates. As a result, the fte yield on loans declined to 6.05% in the current period from 6.93% for the same period in the prior year. The yield on investment securities also declined 22 basis points reflecting the reinvestment of cash flow, maturities and calls at the current lower rates. The yield on earning assets was also adversely impacted by a higher level of Fed Funds and interest-bearing deposits, $8.7 million on average at .27% for the current period compared to $2.5 million at 3.06% for the prior-year period. Average earning assets totaled $488.7 million for the three months ended March 31, 2009, an increase of $29.6 million over the average for the similar period in 2008. This increase in average earning assets helped offset the decline in asset yields.

 

Interest expense for the three months ended March 31, 2009 totaled $2,009,000 at an average cost of 2.07% compared to $2,825,000 and 3.12% for the similar period in 2008. As a result of the decrease in short-term interest rates, the Company reduced rates paid on its money market accounts and cash management products, which are included in short-term borrowings. The cost of time deposits, which is the most significant component of funding, declined to 3.01% from 4.31% for the similar period in the prior year. As time deposits matured, they repriced at the current lower rates resulting in the decrease.        

 

Other Income

 

Other income totaled $1,281,000 for the three months ended March 31, 2009 compared to $1,262,000 for the similar period in 2008. The current period includes $133,000 gain on the sale of $9.7 million of fixed residential mortgages compared to $388,000 in gains on the sale of $13.9 million of mortgages in the similar period of 2008. The current period includes a $161,000 gain on the sale of investment securities with no such gains in the 2008 period. The Company closed its branch office in Hamlin, PA and recorded a gain of $150,000 on the sale of deposits to another financial institution.

 

Other Expense

 

Other expense for the three months ended March 31, 2009 totaled $3,275,000, an increase of $314,000 from $2,961,000 for the similar period in 2008. FDIC insurance assessments increased $114,000 as a result of an increase in the assessment rates and utilization of credits in the prior period. Expense related to the Hamlin branch closing totaled $46,000.

 

The FDIC has additionally announced that it will impose a special assessment equal to 20 basis points on deposits as of June 30, 2009 to be paid on September 30, 2009.  The FDIC has indicated that it may decrease the special assessment to 10 basis points if its line of credit from the U.S. Treasury is increased to $100 million.

 

Income Tax Expense

 

Income tax expense totaled $725,000 for an effective tax rate of 29.5% for the period ending March 31, 2009 compared to $771,000 for an effective tax rate of 30.2% for the similar period in 2008.

 

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 March 31, 2009, the level of net interest income at risk in a 200 basis points change in interest rates was within the Company’s policy limits. The Company’s policy allows for a decline of no more than 8% of net interest income.

 

Imbalance in repricing opportunities at a given point in time 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 March 31, 2009, the Bank had a positive 90 day interest sensitivity gap of $44.2 million or 8.6% of total assets, increasing from $20.4 million or 4% of total assets as of December 31, 2008. The change was principally due to a lower level of time deposits maturing in the 90 day time frame $16.8 million and a higher level of overnight investments, $12.3 million as of March 31, 2009. A positive gap means that rate-sensitive assets are greater than rate-sensitive liabilities at the time interval. This would indicate that in a declining rate environment, the yield on interest-earning assets could decrease 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.

 

March 31, 2009

Rate Sensitivity Table

(dollars in thousands)

 

 

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.

 

 

 

 

Part II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Not applicable

 

Item 1A. Risk Factors

 

No material changes from those disclosed in the Form 10-K for the year ended December 31, 2008.

 

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

 

On January 14, 2009, the Registrant issued 788 shares of common stock pursuant to the exercise of options by a director under the 1999 Directors Stock Option Plan in a transaction that was exempt from registration pursuant to section 4(2) of the Securities Act of 1933. Such shares were sold for cash at an exercise price equal to the fair market value of the common stock on the date that the option was granted.

 

 

(1) Purchases related to the Company’s Employee Stock Ownership Plan (ESOP) related to purchases of shares from terminated employees and voluntary diversification.

 

(2) On March 19, 2008 the Company announced its intention to repurchase up to 5% of its outstanding common stock (approximately 137,000 shares) in the open market.

 

 

Item 3. Defaults Upon Senior Securities

 

Not applicable

 

Item 4. Submission of Matters to a Vote of Security Holders

 

None

 

Item 5. Other Information

 

None

 

Item 6. Exhibits

 

 

 

 

 

 

 

 

 

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.