NORWOOD FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-31 - EXHIBIT 31 - CERTIFICATIONS - NORWOOD FINANCIAL CORP	ex31.htm
EX-32 - EXHIBIT 32 - CERTIFICATIONS - NORWOOD FINANCIAL CORP	ex32.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, 2012

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to ___________________

Commission file number 0-28366

Norwood Financial Corp.

(Exact name of Registrant as specified in its charter)

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

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

(570) 253-1455

(Registrant’s telephone number, including area code)

(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 o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o
(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

Class		Outstanding as of August 1, 2012
Common stock, par value $0.10 per share		3,277,607

NORWOOD FINANCIAL CORP.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2012

		Page Number
PART I -	CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD FINANCIAL CORP.

Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44
Item 4.	Controls and Procedures	45
PART II -	OTHER INFORMATION

Item 1.	Legal Proceedings	45
Item 1A.	Risk Factors	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults upon Senior Securities	45
Item 4.	Mine Safety Disclosures	45
Item 5.	Other Information	45
Item 6.	Exhibits	46

Signatures		47

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, 2012			December 31, 2011
ASSETS
Cash and due from banks	$	9,135		$	8,974
Interest bearing deposits with banks		15,261			12,449
Cash and cash equivalents		24,396			21,423

Securities available for sale, at fair value		144,720			150,263
Securities held to maturity, fair value 2012: $177, 2011: $177		172			171
Loans receivable (net of unearned income)		479,421			457,907
Less: Allowance for loan losses		5,775			5,458
Net loans receivable		473,646			452,449
Investment in Federal Home Loan Bank Stock, at cost		3,243			3,593
Bank premises and equipment, net		7,371			7,479
Bank owned life insurance		12,119			11,887
Accrued interest receivable		2,416			2,468
Foreclosed real estate owned		1,268			2,910
Goodwill		9,715			9,715
Other intangibles		720			800
Other assets		5,081			5,656
TOTAL ASSETS	$	684,867		$	668,814

LIABILITIES
Deposits:
Non-interest bearing demand	$	82,525		$	71,959
Interest-bearing		451,632			453,808
Total deposits		534,157			525,767
Short-term borrowings		27,192			21,794
Other borrowings		27,579			27,670
Accrued interest payable		1,335			1,321
Other liabilities		4,363			4,201
TOTAL LIABILITIES		594,626			580,753

STOCKHOLDERS’ EQUITY
Common stock, $.10 par value per share, authorized 10,000,000; shares issued 2012: 3,371,849 shares, 2011: 3,371,866 shares		337			337
Surplus		24,696			24,660
Retained earnings		64,788			62,308
Treasury stock at cost: 2012: 94,242 shares, 2011: 87,370 shares		(2,739	)		(2,559	)
Accumulated other comprehensive income		3,159			3,315
TOTAL STOCKHOLDERS’ EQUITY		90,241			88,061
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	684,867		$	668,814

See accompanying notes to the unaudited consolidated financial statements.

NORWOOD FINANCIAL CORP.

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share data)

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
INTEREST INCOME
Loans receivable, including fees	$	6,431	$	5,468	$	12,804	$	10,396
Securities		1,007		1,135		2,033		2,225
Other		7		16		11		24
Total interest income		7,445		6,619		14,848		12,645

INTEREST EXPENSE
Deposits		942		932		1,903		1,817
Short-term borrowings		13		27		24		51
Other borrowings		243		342		487		678
Total interest expense		1,198		1,301		2,414		2,546
NET INTEREST INCOME		6,247		5,318		12,434		10,099
PROVISION FOR LOAN LOSSES		400		430		750		650
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		5,847		4,888		11,684		9,449

OTHER INCOME
Service charges and fees		559		592		1,113		1,141
Income from fiduciary activities		80		105		178		218
Net realized gains on sales of securities		285		12		687		224
Gains on sale of loans and servicing rights		66		98		60		241
Other		216		186		459		377
Total other income		1,206		993		2,497		2,201

OTHER EXPENSES
Salaries and employee benefits		2,047		1,832		4,198		3,533
Occupancy, furniture & equipment		490		408		977		806
Data processing related		216		187		448		402
Taxes, other than income		149		143		301		272
Professional fees		217		126		426		281
Merger related expenses		-		488		18		755
Federal Deposit Insurance Corporation insurance assessment		97		95		196		215
Foreclosed real estate owned expense		85		17		207		36
Other		656		640		1,333		1,170
Total other expenses		3,957		3,936		8,104		7,470

INCOME BEFORE INCOME TAXES		3,096		1,945		6,077		4,180
INCOME TAX EXPENSE		838		461		1,633		1,036
NET INCOME	$	2,258	$	1,484	$	4,444	$	3,144

BASIC EARNINGS PER SHARE	$	.69	$	.50	$	1.35	$	1.10

DILUTED EARNINGS PER SHARE	$	.69	$	.50	$	1.35	$	1.10

See accompanying notes to the unaudited consolidated financial statements.

NORWOOD FINANCIAL CORP

Consolidated Statement of Comprehensive Income (unaudited)

(dollars in thousands)

	Three Months Ended June 30,
	2012			2011

Net income	$	2,258		$	1,484
Other Comprehensive income:
Investment securities available for sale:
Unrealized holding gains		291			1,161
Tax effect		(100	)		(395	)
Reclassification of gains recognized in net income		(285	)		(12	)
Tax effect		97			4
Net of tax amount		3			4
Comprehensive Income	$	2,261		$	2,242

	Six Months Ended June 30,
	2012			2011

Net income	$	4,444		$	3,144
Other Comprehensive income:
Investment securities available for sale:
Unrealized holding gains		445			1,627
Tax effect		(148	)		(553	)
Reclassification of gains recognized in net income		(687	)		(224	)
Tax effect		234			76
Net of tax amount		(156	)		926
Comprehensive Income	$	4,288		$	4,070

See accompanying notes to unaudited consolidated financial statements.

NORWOOD FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity (unaudited)

Six Months Ended June 30, 2012

(dollars in thousands, except share and per share data)

	Common Stock							Retained			Treasury Stock						Accumulated Other Comprehensive
	Shares		Amount		Surplus			Earnings			Shares			Amount			Income			Total
Balance December 31, 2011		3,371,866	$	337	$	24,660		$	62,308			87,370		$	(2,559	)	$	3,315		$	88,061
Net Income									4,444												4,444
Other comprehensive income																		(156	)		(156	)
Cash dividends declared $.60 per share									(1,964	)											(1,964	)
Acquisition of treasury stock												11,647			(320	)					(320	)
Compensation expense related to stock options						66															66
Stock options exercised						(41	)					(4,775	)		140						99
Tax benefit on stock options						11															11
North Penn exchange adjustment	(17)
Balance, June 30, 2012		3,371,849	$	337	$	24,696		$	64,788			94,242		$	(2,739	)	$	3,159		$	90,241

See accompanying notes to the unaudited consolidated financial statements.

NORWOOD FINANCIAL CORP.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)
	Six Months Ended June 30,
	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	4,444		$	3,144
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		750			650
Depreciation		280			226
Amortization of intangible assets		80			27
Deferred income taxes		(259	)		(8	)
Net amortization of securities premiums and discounts		580			345
Net realized gain on sales of securities		(687	)		(224	)
Net increase in value of life insurance		(263	)		(180	)
Loss on sale of foreclosed real estate		27			-
Net gain on sale of mortgage loans		(74	)		(241	)
Mortgage loans originated for sale		(2,269	)		(6,530	)
Proceeds from sale of mortgage loans originated for sale		2,343			6,771
Compensation expense related to stock options		66			82
Decrease (increase) in accrued interest receivable and other assets		985			(182	)
(Decrease) increase in accrued interest payable and other liabilities		(1,441	)		841
Net cash provided by operating activities		4,562			4,721

CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		18,349			10,344
Proceeds from maturities and principal reductions on mortgage-backed securities		17,259			15,918
Purchases		(28,582	)		(18,769	)
Redemption of FHLB stock		350			328
Net (increase) decrease in loans		(22,883	)		8,527
Purchase of bank premises and equipment		(172	)		(63	)
Proceeds from sale of bank premises and equipment and foreclosed real estate		2,569			-
Acquisition, net of cash acquired		-			4,544
Net cash (used in) provided by investing activities		(13,110	)		20,829

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		8,390			8,990
Net increase (decrease) in short-term borrowings		5,398			(1,128	)
Repayments of other borrowings		(91	)		(3,015	)
Stock options exercised		99			-
Tax benefit of stock options exercised		11			-
Acquisition of treasury stock		(320	)		(207	)
Cash dividends paid		(1,966	)		(1,604	)
Net cash provided by financing activities		11,521			3,036
Increase (decrease) in cash and cash equivalents		2,973			28,586

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		21,423			16,625
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	24,396		$	45,211

See accompanying notes to the unaudited consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(dollars in thousands)
	Six Months ENded June 30,
	2012		2011
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest paid to depositors and borrowers	$	2,398	$	2,610
Income taxes paid, net of refunds	$	1,559	$	1,407
Supplemental Schedule of Noncash Investing Activities
Investment purchases	$	1,619		-
Transfers of loans to foreclosed real estate and repossession of other assets	$	954	$	1,036

See accompanying notes to the unaudited consolidated financial statements.

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. 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 six month period ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 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, 2011.

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 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)

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Basic EPS weighted average shares outstanding		3,276		2,937		3,280		2,852
Dilutive effect of stock options		4		2		3		3
Diluted EPS weighted average shares outstanding		3,280		2,939		3,283		2,855

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 98,275 and 165,150 as of June 30, 2012 and 2011, respectively, based upon the closing price of Norwood common stock of $28.50 and $26.15 per share on June 30, 2012 and 2011, respectively.

3. Stock-Based Compensation

As of June 30, 2012, there was $65,000 of total unrecognized compensation cost related to non-vested options granted in 2011 under the plan, which will be fully amortized by December 31, 2012.

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

	Options	Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value ($000)

Outstanding at January 1, 2012	209,914	$	28.43	6.3	Yrs.	$	113
Granted	-		-		-		-
Exercised	(4,775)		20.72	.8	Yrs.		31
Forfeited	(12,225)		29.65	5.2	Yrs.		-
Outstanding at June 30, 2012	192,914		28.54	5.9	Yrs.		170

Exercisable at June 30, 2012	164,914		28.72	5.3	Yrs.		142

Intrinsic value represents the amount by which the market price of the stock on the measurement date exceeded the exercise price of the option. The stock price was $28.50 as of June 30, 2012 and $27.47 as of December 31, 2011.

4. Off-Balance Sheet Financial Instruments and Guarantees

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

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

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

(in thousands)	June 30,
	2012		2011
Unfunded availability under loan commitments	$	50,754	$	43,395
Unfunded commitments under lines of credit		37,462		28,910
Standby letters of credit		11,248		5,586

	$	99,464	$	77,891

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, 2012 for guarantees under standby letters of credit issued is not material.

5. Securities

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

	June 30, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
Available for Sale:
U.S. Government agencies	$	2,000	$	7	$	(2	)	$	2,005
States and political subdivisions		54,163		2,648		(42	)		56,769
Corporate obligations		8,635		215		(5	)		8,845
Mortgage-backed securities-government sponsored entities		74,944		1,970		(25	)		76,889
		139,742		4,840		(74	)		144,508
Equity securities-financial services		189		23		-			212
	$	139,931	$	4,863	$	(74	)	$	144,720
Held to Maturity:
States and political subdivisions	$	172	$	5	$	-		$	177

	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
Available for Sale:
U.S. Government agencies	$	13,268	$	130	$	-		$	13,398
States and political subdivisions		54,106		2,640		-			56,746
Corporate obligations		8,733		130		(54	)		8,809
Mortgage-backed securities-government sponsored entities		68,886		2,081		(2	)		70,965
		144,993		4,981		(56	)		149,918
Equity securities-financial services		239		109		(3	)		345
	$	145,232	$	5,090	$	(59	)	$	150,263
Held to Maturity:
States and political subdivisions	$	171	$	6	$	-		$	177

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, 2012
	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	$	998	$	(2	)	$	-	$	-	$	998	$	(2	)
States and political subdivisions		3,254		(42	)		-		-		3,254		(42	)
Corporate obligations		1,457		(5	)		-		-		1,457		(5	)
Mortgage-backed securities-government sponsored agencies		6,563		(25	)		-		-		6,563		(25	)
	$	12,272	$	(74	)	$	-	$	-	$	12,272	$	(74	)

	December 31, 2011
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Corporate obligations	$	4,152	$	(54	)	$	-	$	-		$	4,152	$	(54	)
Mortgage-backed securities-government sponsored agencies		2,495		(2	)		-		-			2,495		(2	)
Equity securities-financial services		34		(2	)		15		(1	)		49		(3	)
	$	6,681	$	(58	)	$	15	$	(1	)	$	6,696	$	(59	)

At June 30, 2012, the Company has 14 debt securities in an unrealized loss position in the less than twelve months category and no debt securities in the twelve months or more category. In Management’s opinion the unrealized losses less than twelve months principally reflect changes in interest rates subsequent to the acquisition of specific securities. The Company holds a small amount of equity securities in other financial institutions. As of June 30, 2012, there were no unrealized losses on equity securities. Management believes that the other unrealized loss represents temporary impairment of the security as the Company does not have the intent to sell the security and it is more likely than not that it will not have to sell the security before recovery of its cost basis.

The amortized cost and fair value of debt securities as of June 30, 2012 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				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)

Due in one year or less	$	10,209	$	10,313	$	-	$	-
Due after one year through five years		7,466		7,690		172		177
Due after five years through ten years		17,363		18,255		-		-
Due after ten years		29,760		31,361		-		-

Mortgage-backed securities-government sponsored agencies		74,944		76,889		-		-
	$	139,742	$	144,508	$	172	$	177

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

	Three Months Ended June 30,					Six Months Ended June 30,
	2012		2011			2012		2011
Gross realized gains	$	285	$	15		$	687	$	228
Gross realized losses	-		(3		)	-		(4		)
Net realized gain	$	285	$	12		$	687	$	224
Proceeds from sales of securities	$	7,716	$	4,157		$	18,349	$	10,344

6. 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, 2012				December 31, 2011
Real Estate-Residential	$	148,051		30.8	%	$	148,148		32.3	%
Commercial		275,258		57.4			262,476		57.3
Construction		15,881		3.3			11,087		2.4
Commercial, financial and agricultural		26,518		5.5			22,684		5.0
Consumer loans to individuals		14,244		3.0			13,934		3.0
Total loans		479,952		100.0	%		458,329		100.0	%

Deferred fees (net)		(531	)				(422	)

Allowance for loan losses		(5,775	)				(5,458	)
Net loans receivable	$	473,646				$	452,449

Changes in the accretable yield for purchased credit-impaired loans were as follows for the six months ended June 30, 2012 (in thousands):

Balance at beginning of period	$	171
Accretion		(47	)
Reclassification and other		-
Balance at end of period	$	124

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

	June 30, 2012		December 31, 2011
	Acquired Loans with Specific Evidence of Deterioration in Credit Quality		Acquired Loans with Specific Evidence of Deterioration in Credit Quality
Outstanding Balance	$	1,346	$	1,412
Carrying Amount		1,222		1,246

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and June 30, 2012. There has been no allowance for loan losses recorded for acquired loans with or without specific evidence of deterioration in credit quality as of May 31, 2011 as well as those acquired without specific evidence of deterioration in credit quality as of June 30, 2012. In addition, there has been no allowance for loan losses reversed.

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 probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

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

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

	Real Estate Loans
	Residential		Commercial		Construction		Commercial Loans		Consumer Loans		Total
June 30, 2012	(In thousands)

Individually evaluated for impairment	$	-	$	12,501	$	-	$	385	$	-	$	12,886
Loans acquired with deteriorated credit quality		273		951		-		-		-		1,224
Collectively evaluated for impairment		147,778		261,806		15,881		26,133		14,244		465,842
Total loans	$	148,051	$	275,258	$	15,881	$	26,518	$	14,244	$	479,952

	Real Estate Loans
	Residential		Commercial		Construction		Commerical Loans		Consumer Loans		Total
December 31, 2011	(In thousands)

Individually evaluated for impairment	$	-	$	11,786	$	-	$	598	$	-	$	12,384
Loans acquired with deteriorated credit quality		343		903		-		-		-		1,246
Collectively evaluated for impairment		147,805		249,787		11,087		22,086		13,934		444,699
Total Loans	$	148,148	$	262,476	$	11,087	$	22,684	$	13,934	$	458,329

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

	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
	(In thousands)
June 30, 2012 With no related allowance recorded:
Real Estate Loans
Residential	$	273	$	297	$	-	$	289	$	2
Commercial		5,420		5,520		-		5,902		40
Commercial Loans		385		385		-		385		-
Total		6,078		6,202		-		6,576		42
With an allowance recorded:
Real Estate Loans
Commercial		8,031		8,031		1,120		7,379		106
Total		8,031		8,031		1,120		7,379		106
Total:
Real Estate loans
Residential		273		297		-		289		2
Commercial		13,451		13,551		1,120		13,281		146
Commercial Loans		385		385		-		385		-
Total Impaired Loans	$	14,109	$	14,233	$	1,120	$	13,955	$	148

	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
	(In thousands)
December 31, 2011 With no related allowance recorded:
Real Estate Loans
Residential	$	343	$	385	$	-	$	245	$	7
Commercial		5,866		5,995		-		5,372		340
Commercial Loans		598		598		-		496		10
Total		6,807		6,978		-		6,113		357
With an allowance recorded:
Real Estate Loans
Commercial		6,823		6,823		1,231		9,670		204
Total		6,823		6,823		1,231		9,670		204
Total:
Real Estate loans
Residential		343		385		-		245		7
Commercial		12,689		12,818		1,231		15,042		544
Commercial Loans		598		598		-		496		10
Total Impaired Loans	$	13,630	$	13,801	$	1,231	$	15,783	$	561

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, 2012, troubled debt restructured loans totaled $7.1 million and resulted in specific reserves of $991,000. There were no defaults on restructured loans during the past twelve months. During 2012 and 2011, there were no new loans identified as troubled debt restructurings. As of December 31, 2011, troubled debt restructured loans totaled $7.2 million and resulted in specific reserves of $1.2 million.

Management uses a seven point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first three 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 Bank’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 $500,000

and over to assign or re-affirm risk ratings. Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of June 30, 2012 and December 31, 2011 (in thousands):

	Pass		Special Mention		Substandard		Doubtful		Total
June 30, 2012
Commercial real estate loans	$	250,726	$	9,825	$	14,707	$	-	$	275,258
Commercial loans		25,842		238		438		-		26,518
Total	$	276,568	$	10,063	$	15,145	$	-	$	301,776

	Pass		Special Mention		Substandard		Doubtful		Total
December 31, 2011
Commercial real estate loans	$	237,407	$	11,009	$	14,060	$	-	$	262,476
Commercial loans		21,598		427		659		-		22,648
Total	$	259,005	$	11,436	$	14,719	$	-	$	285,160

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 on nonaccrual status and accruing loans which are past due over ninety days. The following table presents the recorded investment in the loan classes based on payment activity as of June 30, 2012 and December 31, 2011 (in thousands):

June 30, 2012	Performing		Nonperforming		Total
Residential real estate loans	$	145,530	$	2,521	$	148,051
Construction		15,881		-		15,881
Consumer loans		14,244		-		14,244
Total	$	175,655	$	2,521	$	178,176

December 31, 2011	Performing		Nonperforming		Total
Residential real estate loans	$	145,061	$	3,087	$	148,148
Construction		11,087		-		11,087
Consumer loans		13,934		-		13,934
Total	$	170,082	$	3,087	$	173,169

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2012 and December 31, 2011 (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, 2012
Real Estate loans
Residential	$	145,026	$	435	$	69	$	-	$	2,521	$	3,025	$	148,051
Commercial		268,298		986		-		2		5,972		6,960		275,258
Construction		15,816		65		-		-		-		65		15,881
Commercial loans		26,131		2		-		-		385		387		26,518
Consumer loans		14,144		87		12		1		-		100		14,244
Total	$	469,415	$	1,575	$	81	$	3	$	8,878	$	10,537	$	479,952

	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, 2011
Real Estate loans
Residential	$	143,550	$	160	$	1,351	$	-	$	3,087	$	4,598	$	148,148
Commercial		255,613		1,015		1,524		-		4,324		6,863		262,476
Construction		10,532		-		555		-		-		555		11,087
Commercial loans		22,086		194		-		-		404		598		22,684
Consumer loans		13,835		89		10		-		-		99		13,934
Total	$	445,616	$	1,458	$	3,440	$	-	$	7,815	$	12,713	$	458,329

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

(In thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial		Consumer			Total
Beginning balance, December 31, 2011	$	1,257		$	3,838		$	72		$	147	$	144		$	5,458
Charge Offs		(308	)		(96	)		(7	)		-		(33	)		(444	)
Recoveries		1			-			-			-		10			11
Provision Expense		609			(51	)		22			116		54			750
Ending balance, June 30, 2012	$	1,559		$	3,691		$	87		$	263	$	175		$	5,775
Ending balance individually evaluated for impairment	$	-		$	1,120			-			-		-		$	1,120
Ending balance collectively evaluated for impairment	$	1,559		$	2,571		$	87		$	263	$	175		$	4,655

(In thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial			Consumer			Total
Beginning balance, December 31, 2010	$	1,167		$	3,976		$	110		$	171		$	192		$	5,616
Charge Offs		(226	)		(764	)		-			(2	)		(41	)		(1,033	)
Recoveries		7			-			-			5			22			34
Provision Expense		148			463			(19	)		84			(26	)		650
Ending balance, June 30, 2011	$	1,096		$	3,675		$	91		$	258		$	147		$	5,267
Ending balance individually evaluated for impairment	$	-		$	1,678			-			-			-		$	1,678
Ending balance collectively evaluated for impairment	$	1,096		$	1,997		$	91		$	258		$	147		$	3,589

The Company’s primary business activity 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, 2012, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in the hospitality lodging industry and builders/contractors with loans outstanding of $44.1 million, or 49.6% of capital, to the hospitality lodging industry and $14.1 million, or 19.7% of capital, to builders/contractors. There were no losses recognized on loans to the hospitality industry or to builders/contractors during the current period.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $74,000 and $0 respectively, in the first six months of 2012 compared to $94,000 and $0, respectively, in the same period in 2011. The proceeds from the sales of residential mortgage loans totaled $2.3 million and $6.7 million for the six months ended June 30, 2012 and 2011, respectively.

7. 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) 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). 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.

We may be required from time to time to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or market accounting or write-downs of individual assets.

Impaired loans (carried at fair value):

The Company 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.

Foreclosed real estate owned (carried at fair value):

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

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2012 and December 31, 2011 are as follows:

	Fair Value Measurement Using
Description	Total			(Level 1)		(Level 2)		(Level 3)
(In thousands)
June 30, 2012
Available for Sale:
U.S. Government agencies		$	2,005	$	-	$	2,005	$	-
States and political subdivisions			56,769		-		56,769		-
Corporate obligations			8,845		-		8,845		-
Mortgage-backed securities-government sponsored agencies			76,889		-		76,889		-
Equity securities-financial services			212		212		-	-
Total		$	144,720	$	212	$	144,508	$	-

December 31, 2011
Available for Sale:
U.S. Government agencies		$	13,398	$	-	$	13,398	$	-
States and political subdivisions			56,746		-		56,746		-
Corporate obligations			8,809		-		8,809		-
Mortgage-backed securities-government sponsored agencies			70,965		-		70,965		-
Equity securities-financial services			345		345	-		-
Total		$	150,263	$	345	$	149,918	$	-

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, 2012 and December 31, 2011 are as follows:

			Fair Value Measurement using

(In thousands)


Description	Total		(Level 1)		(Level 2)		(Level 3)
June 30, 2012
Impaired Loans	$	12,990	$	-	$	-	$	12,990
Foreclosed Real Estate Owned		1,268		-		-		1,268
	$	14,258	$	-	$	-	$	14,258

December 31, 2011
Impaired Loans	$	12,399	$	-	$	-	$	12,399
Foreclosed Real Estate Owned		2,910		-		-		2,910
	$	15,309	$	-	$	-	$	15,309

There were no assets measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value at June 30, 2012.

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Norwood 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, 2012
Impaired loans	$12,990	Appraisal of collateral(1)	Appraisal adjustments(2)	0-20%
Foreclosed real estate owned	$1,268	Appraisal of collateral(1)(3)	Liquidation expenses(2)	20%

(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.
(3)	Includes qualitative adjustments by management and estimated liquidation expenses.

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, 2012 and December 31, 2011.

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.

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. The fair value of impaired loans are generally based on the fair value of the loan’s collateral.

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.

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 restricted stock has no quoted market value and is carried at cost.

Bank owned life insurance (carried at cost):

The fair value is equal to the cash surrender value of the Bank-owned life insurance.

Accrued interest receivable and payable (carried at cost):

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit liabilities (carried at cost):

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

Short-term borrowings (carried at cost):

The carrying amounts of short-term borrowings approximate their fair values.

Other borrowings (carried at cost):

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

Off-balance sheet financial instruments (disclosed at cost):

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

The estimated fair values of the Bank’s financial instruments were as follows at June 30, 2012 and December 31, 2011. (In thousands)

	Fair Value Measurements at June 30, 2012
	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks, interest-bearing deposits with banks and federal funds sold	$	24,396	$	24,396	$	24,396	$	-	$	-
Securities		144,892		144,897		212		144,685		-
Loans receivable, net		473,646		483,418		-		-		483,418
Mortgage servicing rights		288		286		286		-		-
Investment in FHLB stock		3,243		3,243		3,243		-		-
Bank owned life insurance		12,119		12,119		12,119		-		-
Accrued interest receivable		2,416		2,416		2,416		-		-

Financial liabilities:
Deposits		534,157		535,878		319,552		-		216,326
Short-term borrowings		27,192		27,192		27,192		-		-
Other borrowings		27,579		30,947		-		-		30,947
Accrued interest payable		1,335		1,335		1,335		-		-

Off-balance sheet financial instruments Commitments to extend credit and outstanding letters of credit		-		-		-		-		-

	Fair Value Measurements at December 31, 2011
	Carrying Amount		Fair Value
Financial assets:
Cash and due from banks, interest- bearing deposits with banks and federal funds sold	$	21,423	$	21,423
Securities		150,434		150,440
Loans receivable, net		452,449		463,118
Mortgage servicing rights		302		308
Investment in FHLB stock		3,593		3,593
Bank owned life insurance		11,887		11,887
Accrued interest receivable		2,468		2,468

Financial liabilities:
Deposits		525,767		527,707
Short-term borrowings		21,794		21,794
Other borrowings		27,670		30,002
Accrued interest payable		1,321		1,321

Off-balance sheet financial instruments: Commitments to extend credit and outstanding letters of credit		-		-

8. New and Recently Adopted Accounting Pronouncements

Recent Accounting Pronouncements:

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company has provided the necessary disclosure in Note 7.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive

income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Company has provided the necessary disclosure in the Consolidated Statement of Comprehensive Income.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment. The objective of this update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this Update apply to all entities, both public and nonpublic, that have goodwill reported in their financial statements and are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company has provided the necessary disclosure in Item 2 of this Form 10-Q.

In September 2011, the FASB issued ASU 2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80):Disclosures about an Employer’s Participation in a Multiemployer Plan. The amendments in this Update will require additional disclosures about an employer’s participation in a multiemployer pension plan to enable users of financial statements to assess the potential cash flow implications relating to an employer’s participation in multiemployer pension plans. The disclosures also will indicate the financial health of all of the significant plans in which the employer participates and assist a financial statement user to access additional information that is available outside the financial statements. For public entities, the amendments in this Update are effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted. The amendments should be applied retrospectively for all prior periods presented. The Company has adopted this standard.

In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary's operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. Early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Company’s financial statements.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has provided the necessary disclosure in the Consolidated Statement of Comprehensive Income.

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

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words “believes,” “anticipates,” “contemplates,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. Those risks and uncertainties are as follows:

	•	our ability to realize the anticipated benefits from our acquisition of North Penn Bancorp, Inc.
	•	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
	•	risk of failure to stabilize the financial system
	•	current market volatility
	•	potential liquidity risk
	•	availability of capital

	•	regional economic factors
	•	loss of senior officers
	•	comparatively low legal lending limits
	•	limited market for the Company’s stock
	•	restrictions on ability to pay dividends
	•	common stock may lose value
	•	competitive environment
	•	issuing additional shares may dilute ownership
	•	extensive and complex governmental regulation and associated cost
	•	interest rate risks

Norwood Financial Corp. undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

Note 2 to the Company’s consolidated financial statements for the year ended December 31, 2011 (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, the fair value of financial instruments, valuation of impaired loans, and the determination of other-than-temporary impairment losses 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 based compensation. Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.

Deferred income taxes reflect temporary differences in the recognition of the revenue and expenses for tax reporting and financial statement purposes, principally because certain items are recognized in different periods for financial reporting and tax return purposes. Although realization is not assured, the Company believes that it is more likely than not that all deferred tax assets will be realized.

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

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

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management 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, 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 not quoted market value and is carried at cost.

The FHLB incurred losses in both 2009 and 2010 and had suspended the payment of dividends. However, the FHLB has shown positive results during 2011 and 2012 which includes stock redemptions and resumed dividend payments. The losses were primarily attributable to impairment of investment securities associated with the extreme economic conditions in place during the previous several years. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. More consideration was given to the long-term prospects for the FHLB as opposed to the recent stress caused by the extreme economic conditions the world is facing. Management also considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and the new shares of FHLB stock continue to change hands at the $100 par value.

Management 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 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 June 30, 2012 and December 31, 2011.

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 loss on all other securities at June 30, 2012 and December 31, 2011 represents temporary impairment of the securities, related to changes in interest rates.

In connection with the acquisition of 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 institutions acquired in purchase transactions, 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 Company performed an assessment of key factors as of May 31, 2012 and determined that impairment of goodwill was not likely. The value of the goodwill can change in the future. We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Bank. If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss.

Changes in Financial Condition

General

Total assets as of June 30, 2012 were $684.9 million compared to $668.8 million as of December 31, 2011, an increase of $16.1 million. The increase includes $21.5 million of loan growth which was funded with an $8.4 million increase in deposits and proceeds from sales or maturities of securities.

Securities

The fair value of securities available for sale as of June 30, 2012 was $144.7 million compared to $150.3 million as of December 31, 2011. The Company purchased $28.6 million of securities principally using the proceeds from $35.6 million of securities sold, 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:

	June 30, 2012					December 31, 2011
(dollars in thousands)	Amount		% of portfolio			Amount		% of portfolio

U.S. Government agencies	$	2,005		1.4	%	$	13,398		8.9	%
States and political subdivisions		56,941		39.3			56,917		37.8
Corporate obligations		8,845		6.1			8,809		5.9
Mortgage-backed securities- government sponsored entities		76,889		53.1			70,965		47.2
Equity securities-financial services		212		0.1			345		0.2
Total	$	144,892		100.0	%	$	150,434		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 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 $479.4 million at June 30, 2012 compared to $457.9 million as of December 31, 2011. The majority of the growth recorded in 2012 was centered in commercial loans. Commercial real estate loans increased $12.8 million during the period while other commercial loans increased $3.8 million.

The allowance for loan losses totaled $5,775,000 as of June 30, 2012 and represented 1.20% of total loans, compared to $5,458,000 at December 31, 2011, and $5,267,000 as of June 30, 2011. The Company had net charge-offs for the six months ended June 30, 2012 of $433,000 compared to $999,000 in the comparable period in 2011. 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, 2012 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, 2012, non-performing loans totaled $8.9 million, which is 1.85% of total loans compared to $7,815,000, or 1.71% of total loans at December 31, 2011.

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

(dollars in thousands)	June 30, 2012			December 31, 2011
Loans accounted for on a non-accrual basis:
Commercial and all other	$	385		$	404
Real Estate		8,493			7,411
Total		8,878			7,815

Accruing loans which are contractually
past due 90 days or more		3			-
Total non-performing loans		8,881			7,815
Foreclosed real estate		1,268			2,910
Total non-performing assets	$	10,149		$	10,725
Allowance for loans losses Coverage of non-performing loans	$	5,775 .65x		$	5,458 .70x
Non-performing loans to total loans		1.85	%		1.71	%
Non-performing loans to total assets		1.30	%		1.17	%
Non-performing assets to total assets		1.48	%		1.60	%

Deposits

During the period, total deposits increased $8.4 million which includes growth of $10.6 million in non-interest bearing demand deposits, a $2.8 million increase in money market and NOW accounts, and a $2.2 million increase in savings deposits. Certificates of deposit decreased $7.2 million due primarily to the seasonality of municipal deposits.

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

(dollars in thousands)	June 30, 2012		December 31, 2011

Non-interest bearing demand	$	82,525	$	71,959
Interest bearing demand		50,001		51,161
Money market deposit accounts		118,003		114,007
Savings		69,023		66,866
Time deposits <$100,000		144,862		141,220
Time deposits >$100,000		69,743		80,554

Total	$	534,157	$	525,767

Borrowings

Short-term borrowings as of June 30, 2012 totaled $27.2 million compared to $21.8 million as of December 31, 2011. Securities sold under agreements to repurchase increased $5.4 million principally due to the seasonality of municipal cash management accounts. Short-term borrowings consist of securities sold under agreements to repurchase, which totaled $27.2 million on June 30, 2012 and $21.8 million on December 31, 2011.

Other borrowings consisted of the following:

(dollars in thousands)

	June 30, 2012		December 31, 2011
Notes with the FHLB:
Convertible note due October 2012 at 4.37%	$	5,000	$	5,000
Convertible note due May 2013 at 3.015%		5,000		5,000
Fixed rate note due July 2015 at 4.34%		7,579		7,670
Convertible note due January 2017 at 4.71%		10,000		10,000
	$	27,579	$	27,670

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. The fixed rate borrowing due July 2015 includes a $579,000 fair value adjustment recorded at the time of the North Penn acquisition.

Off-Balance Sheet Arrangements

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

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

	June 30, 2012		December 31, 2011
	(in thousands)
Unfunded availability under loan commitments	$	50,754	$	43,081
Unfunded commitments under lines of credit		37,462		29,255
Standby letters of credit		11,248		11,892

	$	99,464	$	84,228

Stockholders’ Equity and Capital Ratios

As of June 30, 2012, stockholders’ equity totaled $90.2 million, compared to $88.1 million as of December 31, 2011. The net change in stockholders’ equity included $4.4 million of net income, that was partially offset by $2.0 million of dividends declared. In addition, accumulated other comprehensive income decreased $156,000 due to a decrease in 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 regulatory capital ratios is as follows:

	June 30, 2012	December 31, 2011
Tier 1 Capital
(To average assets)	11.50%	11.29%
Tier 1 Capital
(To risk-weighted assets)	15.75%	15.86%
Total Capital
(To risk-weighted assets)	16.93%	17.04%

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 applicable FRB, FDIC and PDB capital requirements as of June 30, 2012 and December 31, 2011.

Liquidity

As of June 30, 2012, the Company had cash and cash equivalents of $24.4 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 $144.7 million which could be used for liquidity needs. This totals $169.1 million and represents 24.7% of total assets compared to $171.7 million and 25.7% of total assets as of December 31, 2011. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of June 30, 2013 and December 31, 2011. 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 at June 30, 2013 and December 31, 2011.

The Company has a line of credit commitment from Atlantic Central Bankers Bank for $7,000,000 which expires June 30, 2012. There were no borrowings under this line as of June 30, 2012 and December 31, 2011.

The Company has a line of credit commitment available which has no stated expiration date from PNC Bank for $16,000,000. Borrowings under this line were $-0- as of June 30, 2012 and December 31, 2011.

The Bank’s maximum borrowing capacity with the Federal Home Loan Bank was approximately $260,000,000 as of June 30, 2012, of which $27,000,000 was outstanding at June 30, 2012 and December 31, 2011 respectively. Advances from the Federal Home Loan Bank are secured by qualifying assets of the Bank.

Non-GAAP Financial Measures

This report contains or references fully taxable-equivalent (fte) interest income and net interest income, which are non-GAAP financial measures. Interest income (fte) and net interest income (fte) are derived from GAAP interest income and net interest income using an assumed tax rate of 34%. We believe the presentation

of interest income (fte) and net interest income (fte) ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Net interest income (fte) is reconciled to GAAP net interest income on page 37 and 41. 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)	Three Months Ended June 30,
	2012									2011
	Average Balance (2)			Interest (1)			Average Rate (3)			Average Balance (2)			Interest (1)			Average Rate (3)
Assets
Interest-earning assets:
Federal funds sold	$	-		$	-			0.00	%	$	615		$	-			0.00	%
Interest bearing deposits with banks		11,261			7			0.25			25,136			16			0.25
Securities held-to-maturity		172			3			6.98			170			4			9.41
Securities available for sale:
Taxable		89,790			527			2.35			101,963			695			2.73
Tax-exempt (1)		52,197			722			5.53			46,847			662			5.65
Total securities available for sale (1)		141,987			1,249			3.52			148,810			1,357			3.65
Loans receivable (1) (4) (5)		481,524			6,504			5.40			387,203			5,517			5.70
Total interest earning assets		634,944			7,763			4.89			561,934			6,894			4.91
Non-interest earning assets:
Cash and due from banks		9,077									7,443
Allowance for loan losses		(5,776	)								(5,753	)
Other assets		43,844									33,047
Total non-interest earning assets		47,145									34,737
Total Assets	$	682,089								$	596,671
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market	$	169,343			135			0.32		$	126,053			132			0.42
Savings		68,947			25			0.15			68,622			53			0.31
Time		223,147			782			1.40			185,475			747			1.61
Total interest bearing deposits		461,437			942			0.82			380,150			932			0.98
Short-term borrowings		19,346			13			0.27			30,634			27			0.35
Other borrowings		27,605			243			3.52			37,563			342			3.64
Total interest bearing liabilities		508,388			1,198			0.94			448,347			1,301			1.16
Non-interest bearing liabilities:
Demand deposits		79,378									67,922
Other liabilities		4,069									4,881
Total non-interest bearing liabilities		83,447									72,803
Stockholders' equity		90,254									75,521
Total Liabilities and Stockholders' Equity	$	682,089								$	596,671

Net interest income (tax equivalent basis)					6,565			3.95	%					5,593			3.75	%
Tax-equivalent basis adjustment					(318	)								(275	)
Net interest income				$	6,247								$	5,318
Net interest margin (tax equivalent basis)								4.14	%								3.98	%

(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.

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

	Increase/(Decrease)
	Three months ended June 30, 2012 Compared to Three months ended June 30, 2011 Variance due to
	Volume			Rate			Net
	(dollars in thousands)
Interest earning assets:
Interest bearing deposits with banks	$	(9	)	$	-		$	(9	)
Securities held to maturity		-			(1	)		(1	)
Securities available for sale:
Taxable		(78	)		(90	)		(168	)
Tax-exempt securities		145			(85	)		60
Total securities		67			(175	)		(108	)
Loans receivable		2,705			(1,718	)		987
Total interest earning assets		2,763			(1,894	)		869

Interest bearing liabilities:
Interest-bearing demand and money market		150			(147	)		3
Savings		2			(30	)		(28	)
Time		495			(460	)		35
Total interest bearing deposits		647			(637	)		10
Short-term borrowings		(9	)		(5	)		(14	)
Other borrowings		(88	)		(11	)		(99	)
Total interest bearing liabilities		550			(653	)		(103	)
Net interest income (tax-equivalent basis)	$	2,213		$	(1,241	)	$	972

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 June 30, 2012 to June 30, 2011

General

For the three months ended June 30, 2012, net income totaled $2,258,000 compared to $1,484,000 earned in the similar period in 2011. The increased net income for the three months ended March 31, 2012 reflects the full impact of the acquisition of North Penn Bancorp, Inc. (“North Penn”), which was completed on May 31, 2011. Earnings per share for the current period were $.69 for basic and fully diluted compared to $.50 per share for the three months ended June 30, 2011. The resulting annualized return on average assets and annualized return on average equity for the three months ended June 30, 2012 was 1.33% and 10.06%, respectively, compared to 1.00% and 7.88%, respectively, for the similar period in 2011.

The following table sets forth changes in net income:

(dollars in thousands)	Three months ended June 30, 2012 to June 30, 2011
Net income three months ended June 30, 2011	$	1,484
Change due to:
Net interest income		929
Provision for loan losses		30
Gain on sales of loans and securities		241
Other income		(28	)
Salaries and employee benefits		(215	)
Occupancy, furniture and equipment		(82	)
Merger related expenses		488
Foreclosed real estate expense		(68	)
All other expenses		(144	)
Income tax expense		(377	)

Net income three months ended June 30, 2012	$	2,258

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the three months ended June 30, 2012 totaled $6,565,000, an increase of $972,000 or 17.4% from the similar period in 2011. The increase in net interest income largely reflects the increase in interest-earning assets from the North Penn acquisition, as well as loan growth recorded during the period. The fte net interest spread and net interest margin were 3.95% and 4.14%, respectively, for the three months ended June 30, 2012 compared to 3.75% and 3.98%, respectively, for the similar period in 2011.

Interest income (fte) totaled $7,763,000 with a yield on average earning assets of 4.89% compared to $6,894,000 and 4.91% for the 2011 period. Average loans increased $94.3 million over the comparable period of last year which led to the improved interest income in spite of lower yields on loans and securities due to reinvestment at today’s lower interest rates. A decreased level of low yield money market assets also contributed to the improved net interest margin. Average earning assets totaled $634.9 million for the three months ended June 30, 2012, an increase of $73.0 million over the average for the similar period in 2011. This increase in average earning assets helped offset the decline in asset yields.

Interest expense for the three months ended June 30, 2012 totaled $1,198,000 at an average cost of .94% compared to $1,301,000 and 1.16% for the similar period in 2011. As a result of the continued

low interest rate environment, the Company further reduced rates paid on its money market and savings 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 1.40% from 1.61% for the similar period in the prior year. As time deposits matured, they repriced at the current lower rates resulting in the decrease.

Provision for Loan Losses

The Company’s provision for loan losses for the three months ended June 30, 2012 was $400,000 compared to $430,000 for the three months ended June 30, 2011. 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 $243,000 for the quarter ended June 30, 2012 compared to $943,000 for the similar period in 2011.

Other Income

Other income totaled $1,206,000 for the three months ended June 30, 2012 compared to $993,000 for the similar period in 2011. The current period includes a $285,000 gain on the sale of investment securities compared to a $12,000 gain in the second quarter of 2011. Gains on the sale of residential mortgage loans decreased $32,000 compared to the same quarter of last year due to decreased sales during the current period. All other service charges and fees decreased $28,000 compared to the second quarter of last year.

Other Expense

Other expense for the three months ended June 30, 2012 totaled $3,957,000, or an increase of $21,000 from $3,936,000 for the similar period in 2011. Expense increases related to the North Penn acquisition including staffing increases and higher occupancy costs on five community offices contributed to the increase. Foreclosed real estate costs increased $68,000 due to the costs of disposition and maintaining several properties, while merger related expenses decreased $488,000 compared to last year’s comparable period.

Income Tax Expense

Income tax expense totaled $838,000 for an effective tax rate of 27.1% for the period ending June 30, 2012 compared to $461,000 for an effective tax rate of 23.7% for the similar period in 2011. The increased effective rate reflects a 34% tax rate on $1,151,000 of additional pre-tax income.

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,
	2012									2011
	Average Balance (2)			Interest (1)			Average Rate (3)			Average Balance (2)			Interest (1)			Average Rate (3)
Assets
Interest-earning assets:
Federal funds sold	$	-		$	-			0.00	%	$	392		$	-			0.00	%
Interest bearing deposits with banks		8,490			11			0.26			17,890			24			0.27
Securities held-to-maturity		171			5			5.85			170			7			8.24
Securities available for sale:
Taxable		91,280			1,060			2.32			99,738			1,345			2.70
Tax-exempt (1)		52,966			1,467			5.54			46,739			1,326			5.67
Total securities available for sale (1)		144,246			2,527			3.50			146,477			2,671			3.65
Loans receivable (1) (4) (5)		475,730			12,941			5.44			370,255			10,487			5.66
Total interest earning assets		628,637			15,484			4.93			535,184			13,189			4.93
Non-interest earning assets:
Cash and due from banks		8,688									7,122
Allowance for loan losses		(5,660	)								(5,747	)
Other assets		44,964									27,365
Total non-interest earning assets		47,992									28,740
Total Assets	$	676,629								$	563,924
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand and money market	$	167,452			274			0.33		$	117,545			240			0.41
Savings		68,430			50			0.15			60,022			78			0.26
Time		224,553			1,579			1.41			179,234			1,499			1.67
Total interest bearing deposits		460,435			1,903			0.83			356,801			1,817			1.02
Short-term borrowings		18,902			24			0.25			29,234			51			0.35
Other borrowings		27,628			487			3.53			36,588			678			3.71
Total interest bearing liabilities		506,965			2,414			0.95			422,623			2,546			1.20
Non-interest bearing liabilities:
Demand deposits		75,728									64,907
Other liabilities		4,019									4,750
Total non-interest bearing liabilities		79,747									69,657
Stockholders' equity		89,917									71,644
Total Liabilities and Stockholders' Equity	$	676,629								$	563,924

Net interest income (tax equivalent basis)					13,070			3.97	%					10,643			3.72	%
Tax-equivalent basis adjustment					(636	)								(544	)
Net interest income				$	12,434								$	10,099
Net interest margin (tax equivalent basis)								4.16	%								3.98	%

(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.

Rate/Volume Analysis. The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense. Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.

	Increase/(Decrease)
	Six months ended June 30, 2012 Compared to Six months ended June 30, 2011 Variance due to
	Volume			Rate			Net
	(dollars in thousands)
Interest earning assets:
Interest bearing deposits with banks…………..	$	(12	)	$	(1	)	$	(13	)
Securities held to maturity............................		-			(2	)		(2	)
Securities available for sale:
Taxable...................................................		(108	)		(177	)		(285	)
Tax-exempt securities..................................		227			(86	)		141
Total securities..........................................		119			(263	)		(144	)
Loans receivable........................................		3,613			(1,159	)		2,454
Total interest earning assets...........................		3,720			(1,425	)		2,295

Interest bearing liabilities:
Interest-bearing demand and money market….		153			(119	)		34
Savings................................................		26			(54	)		(28	)
Time...................................................		635			(555	)		80
Total interest bearing deposits.......................		814			(728	)		86
Short-term borrowings................................		(15	)		(12	)		(27	)
Other borrowings......................................		(159	)		(32	)		(191	)
Total interest bearing liabilities.....................		640			(772	)		(132	)
Net interest income (tax-equivalent basis).........	$	3,080		$	(653	)	$	2,427

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 Six Months Ended June 30, 2012 to June 30, 2011

General

For the six months ended June 30, 2012, net income totaled $4,444,000 compared to $3,144,000 earned in the similar period in 2011. Earnings per share for the current period were $1.35 for basic and fully diluted compared to $1.10 per share for the six months ended June 30, 2011. The resulting annualized return on average assets and annualized return on average equity for the six months ended June 30, 2012 was 1.32% and 9.94%, respectively, compared to 1.12% and 8.85%, respectively, for the similar period in 2011.

The following table sets forth changes in net income:

(dollars in thousands)	Six months ended June 30, 2012 to June 30, 2011
Net income six months ended June 30, 2011	$	3,144
Change due to:
Net interest income		2,335
Provision for loan losses		(100	)
Gain on sales of loans and securities		282
Other income		14
Salaries and employee benefits		(665	)
Occupancy, furniture and equipment		(171	)
Merger related expenses		737
Foreclosed real estate expense		(171	)
All other expenses		(364	)
Income tax expense		(597	)

Net income six months ended June 30, 2012	$	4,444

Net Interest Income

Net interest income on a fully taxable equivalent basis (fte) for the six months ended June 30, 2012 totaled $13,070,000, an increase of $2,427,000 or 22.8% from the similar period in 2011. The increase in net interest income largely reflects the increase in interest-earning assets from the North Penn acquisition, as well as loan growth recorded during the period. The fte net interest spread and net interest margin were 3.97% and 4.16%, respectively, for the six months ended June 30, 2012 compared to 3.72% and 3.98%, respectively, for the similar period in 2011.

Interest income (fte) totaled $15,484,000 with a yield on average earning assets of 4.93% compared to $13,189,000 and 4.93% for the 2011 period. Residential mortgage rates have continued to decline causing a portion of the portfolio to refinance at lower rates. As a result, the fte yield on average loans in the current period was 5.44%, a decrease from 5.66% in the 2011 period. The yield on investment securities also declined 15 basis points reflecting the reinvestment of cash flow, maturities and calls at the current lower rate. Average earning assets totaled $628.6 million for the six months ended June 30, 2012 an increase of $93.5 million over the similar period in 2011. The growth in average earning assets helped offset the decline in loan and securities yields.

Interest expense for the six months ended June 30, 2012 totaled $2,414,000 at an average cost of .95% compared to $2,546,000 and 1.20% for the 2011 period. The Company reduced rates paid on its deposits by 19 basis points and short-term borrowings by 10 basis points. The cost of time deposits, which is the largest

component of interest expense, was 1.41% for the 2012 period decreasing from 1.67% in 2011. This reflects time deposits maturing and repricing at the current lower rates.

Provision for Loan Losses

The Company’s provision for loan losses for the six months ended June 30, 2012 was $750,000 compared to $650,000 for the six months ended June 30, 2011. The Company makes provisions for loan losses in an amount necessary to maintain the allowance for loan losses at an acceptable level. The increase in the provision was necessary to maintain the reserve at an adequate level after accounting for loan growth and charge-offs for the period ended June 30, 2012. Net charge-offs were $433,000 for the six months ended June 30, 2012 compared to $1.0 million for the similar period in 2011. During the 2011 period the charge-off total was due primarily to one credit which had been carried in nonaccrual status.

Other Income

Other income totaled $2,497,000 for the six months ended June 30, 2012 compared to $2,201,000 for the similar period in 2011. The current period includes $60,000 in gains on the sale of $2.3 million of residential mortgage loans compared to $241,000 in similar gains on the sales of $6.5 million of mortgage loans in the 2011 period. Gains on the sale investment securities totaled $687,000 on sales of $18.3 million for the 2012 period compared to $224,000 of gains on sales of $10.3 million in the similar 2011 period. The proceeds from investment securities sales were reinvested to improve credit quality in the Company’s bond portfolio as well as to fund new loan growth.

Other Expense

Other expenses totaled $8,104,000 for the six months ended June 30, 2012 an increase of $634,000 compared to $7,470,000 for the similar period in 2011. The increase was due to costs related to the operation of five offices acquired from North Penn in 2011. Salary and benefit costs increased $665,000 due to the added staff while occupancy and equipment expenses rose $171,000. The majority of these increases were offset by a $737,000 decrease in merger related costs. The efficiency ratio for the 2012 period was 54.3% compared to 60.7% in the 2011 period due to the acquisition costs recorded in 2011.

Income Tax Expense

Income tax expense totaled $1,633,000 for an effective tax rate of 26.9% in the 2012 period compared to $1,036,000 and 24.8% in 2011. The increase in the effective tax rate reflects a 34% tax rate on $1,897,000 of additional pre-tax income.

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, 2012, the level of net interest income at risk in a 200 basis point 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 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, 2012, the Company had a positive 90 day interest sensitivity gap of $76.5 million or 11.1% of total assets, comparable to the $76.7 million or 11.5% of total assets as of December 31, 2011. Rate sensitive assets repricing within 90 days increased $7.2 million due to a $5.3 million increase in loans repricing within the period combined with a $2.8 million increase in interest bearing deposits. Time deposits repricing within 90 days increased $5.7 million, while non-maturity interest bearing balances and other borrowings increased slightly. 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.

June 30, 2012

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	$	15,261	$	-	$	-	$	-	$	15,261
Securities		9,739		27,455		49,910		57,788		144,892
Loans Receivable		126,744		95,598		159,818		97,261		479,421
Total RSA		151,744		123,053		209,728		155,049		639,574

Non-maturity interest-bearing deposits		37,834		42,986		113,510		42,697		237,027
Time Deposits		31,379		80,762		70,659		31,805		214,605
Other		6,080		19,784		11,900		17,007		54,771
Total RSL		75,293		143,532		196,069		91,509		506,403

Interest Sensitivity Gap	$	76,451		$	(20,479	)	$	13,659		$	63,540		$	133,171
Cumulative Gap		76,451			55,972			69,631			133,171
RSA/RSL-cumulative		201.5	%		125.6	%		116.8	%		126.3	%

December 31, 2011

Interest Sensitivity Gap	$	76,745		$	(21,350	)	$	(6,566	)	$	68,689		$	117,518
Cumulative Gap		76,745			55,395			48,829			117,518
RSA/RSL-cumulative		213.2	%		125.2	%		111.8	%		125.3	%

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

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, 2011.

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

None

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclsoures

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 (2)
10.2	Change in Control Severance Agreement with William S. Lance(2)
10.3	Norwood Financial Corp. Stock Option Plan (3)
10.4	Salary Continuation Agreement between the Bank and William W. Davis, Jr. (4)
10.5	Salary Continuation Agreement between the Bank and Lewis J. Critelli (4)
10.7	1999 Directors Stock Compensation Plan (3)
10.8	Salary Continuation Agreement between the Bank and Joseph A. Kneller (5)
10.9	Salary Continuation Agreement between the Bank and John H. Sanders (5)
10.10	2006 Stock Option Plan (6)
10.11	First and Second Amendments to Salary Continuation Agreement with William W. Davis, Jr. (7)
10.12	First and Second Amendments to Salary Continuation Agreement with Lewis J. Critelli (7)
10.14	First and Second Amendments to Salary Continuation Agreement with Joseph A. Kneller (7)
10.15	First and Second Amendments to Salary Continuation Agreement with John H. Sanders (7)
31	Rule 13a-14(a)/15d-14(a) Certification of CEO and 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 *

______________________

*	To be filed by amendment as permitted by Rule 405(a)(2)(iv) of Regulation S-T.

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

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

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

(4)	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.

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

(6)	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.

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

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 8, 2012	By:	/s/ Lewis J. Critelli
			Lewis J. Critelli
			President and Chief Executive Officer
			(Principal Executive Officer)

Date:	August 8, 2012	By:	/s/ William S. Lance
			William S. Lance
			Executive Vice President and Chief Financial Officer
			(Principal Financial Officer)

Attached files

Stock widget

Investing forum

NORWOOD FINANCIAL CORP Reports