NORWOOD FINANCIAL CORP - FORM 10-K - EX-13 - EXHIBIT 13 - ANNUAL REPORT TO STOCKHOLDERS

Attached files

file	filename
EX-31.1 - EXHIBIT 31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF CEO - NORWOOD FINANCIAL CORP	ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF CFO - NORWOOD FINANCIAL CORP	ex31-2.htm
EX-32 - EXHIBIT 32 - CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 - NORWOOD FINANCIAL CORP	ex32.htm
EX-23 - EXHIBIT 23 - CONSENT OF S.R. SNODGRASS, P.C. - NORWOOD FINANCIAL CORP	ex23.htm
10-K - FORM 10-K YEAR ENDED 12/31/15 - NORWOOD FINANCIAL CORP. - NORWOOD FINANCIAL CORP	f10k_123115-0160.htm

2015 CONSOLIDATED FINANCIAL REPORT

Management's Discussion & Analysis	8
Management's Report On Internal Control Over Financial Reporting	27
Reports Of Independent Registered Publc Accounting Firm	28
Consolicated Balance Sheets	30
Consolidated Statements of Income	31
Consolidated Statements Of Comprehensive Income	32
Consolidated Statements Of Stockholders' Equity	33
Consolidated Statements Of Cash Flows	34
Notes To Consolidated Financial Statements	36
Investor Information	77

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS

Introduction

This Management’s Discussion and Analysis and related financial data are presented to assist in the understanding and evaluation of the financial condition and results of operations for Norwood Financial Corp (the Company) and its subsidiary Wayne Bank (the Bank) as of December 31, 2015 and 2014 and for the years ended December 31, 2015, 2014, and 2013. This section should be read in conjunction with the consolidated financial statements and related footnotes.

Forward-Looking Statements

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

Critical Accounting Policies

Note 2 to the Company’s consolidated financial statements (incorporated by reference in Item 8 of the Form 10-K) lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.

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

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

In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost and 2) the financial condition of the issuer. The Company does not have the intent to sell these securities and it is more likely than not that it will not sell the securities before recovery of their cost basis. The Company believes that any unrealized losses at December 31, 2015 and 2014 represent temporary impairment of the securities.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

The fair value of financial instruments is based upon quoted market prices, when available. For those instances where a quoted price is not available, fair values are based upon observable market based parameters as well as unobservable parameters. Any such valuation is applied consistently over time.

In connection with the acquisition of North Penn Bancorp, Inc. in 2011, we recorded goodwill in the amount of $9.7 million, representing the excess of amounts paid over the fair value of the net assets of the institution acquired at the date of acquisition. Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value.

Results of Operations – Summary

Net income for the Company for the year ended December 31, 2015 was $5,908,000 which was $1,749,000 lower than the $7,657,000 earned in 2014. Basic and diluted earnings per share were $1.60 in 2015 compared to $2.10 per share in 2014. The return on average assets (ROA) for the year ended December 31, 2015 was 0.80% and the return on average equity (ROE) was 5.83% compared to an ROA of 1.08% and an ROE of 7.92% in the prior year. The reduction in earnings from the prior year was the result of increased provision for loan losses and a decrease in net gains recognized on the sale of loans and securities which was partially offset by a decrease in expenses related to foreclosed properties.

Net interest income (fully taxable equivalent, or fte) totaled $25,882,000 which was an increase of $64,000 from the 2014 total. Average loans outstanding increased $29.0 million in 2015 but a 21 basis point decrease in the yield earned limited the increase in fte interest income to $288,000. The reduced yield was due to loan production at current market rates. Total average securities decreased $4.9 million in 2015 which contributed to a $178,000 decrease in fte interest income. Average interest-bearing deposits with banks were $3.5 million higher in 2015 and interest income in this area increased $9,000. Growth of the funding base led to a $50,000 increase in interest expense. A 2 basis point reduction in the cost of interest-bearing deposits lead to reduced interest expense on deposits of $42,000 despite a $19.1 million increase in average total deposits. The cost of borrowed funds increased $92,000 compared to the prior year due primarily to a $5.8 million increase in average long-term borrowings. The resulting fte net interest margin decreased 15 basis points to 3.75% in 2015 as a 16 basis point reduction in the yield earned was only partially offset by a 1 basis point decrease in the cost of funds.

Loans receivable increased $58.8 million from the prior year-end due primarily to a $28.6 million increase in commercial loans which includes a $21.3 million increase in municipal financing. Commercial real estate loans also increased $17.2 million in 2015. Residential mortgage loans and construction loans increased $3.4 million, net, after the sale of $4.3 million of fixed-rate residential mortgage loans for the purpose of interest rate risk management. Consumer loans increased $9.5 million in 2015 due primarily to a $9.2 million increase in indirect auto and marine financing. Total non-performing loans increased from $5.6 million and 1.12% of total loans at the end of 2014 to $7.1 million, or 1.27% of total loans on December 31, 2015. Net charge-offs totaled $3,157,000 in 2015 which was an increase from the $1,513,000 recorded in 2014. Based on the level of charge-offs and non-performing loans, the Company determined that it would be appropriate to allocate $4,580,000 to the allowance for loan losses to reserve for potential future losses which resulted in an increase in the ratio of the allowance for loan losses to total loans outstanding to 1.30% compared to 1.17% on December 31, 2014.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

Other income for the year ended December 31, 2015 totaled $4,699,000 compared to $5,110,000 in the prior year, a decrease of $411,000. Gains on the sale of loans and investment securities decreased $572,000 in the aggregate, while all other items of other income increased $161,000, net.

Other expenses were $17,100,000 in 2015 compared to $17,727,000 for the similar period in 2014, a decrease of $627,000. Salaries and benefits costs decreased $81,000 in 2015 due primarily to reduced incentive compensation. Occupancy and equipment costs decreased $35,000. Foreclosed real estate costs decreased $644,000 from the prior period. All other operating expenses increased $133,000, net. Income tax expense for the year totaled $1,632,000 which was a decrease of $974,000 from the prior year. The effective tax rate in 2015 was 21.6% compared to 25.4% in 2014 due primarily to a higher proportion of tax-exempt income.

The following table sets forth changes in net income (in thousands):

Net income 2014	$	7,657
Net interest income		(39	)
Provision for loan losses		(2,900	)
Net gains on sales of loans and securities		(572	)
Other income		161
Salaries and employee benefits		81
Occupancy, furniture and equipment		35
Foreclosed real estate owned		644
Other expenses		(133	)
Income tax expense		974
Net income for 2015	$	5,908

Net income for the Company for the year ended December 31, 2014 was $7,657,000 which was $808,000 lower than the $8,465,000 earned in 2013. Basic and diluted earnings per share were $2.10 in 2014 compared to $2.33 per share in 2013. The return on average assets (ROA) for the year ended December 31, 2014 was 1.08% and the return on average equity (ROE) was 7.92% compared to an ROA of 1.23% and an ROE of 9.13% in the prior year. The reduction in earnings from the prior year was the result of increased expenses related to foreclosed properties and a reduced level of proceeds from bank-owned life insurance policies which was partially offset by an increase in gains from the sale of loans and securities and a lower provision for loan losses.

Net interest income (fully taxable equivalent) totaled $25,818,000 which was a decrease of $39,000 from the 2013 total. Average loans outstanding increased $17.9 million in 2014 but a 30 basis point decrease in the yield earned resulted in a $618,000 reduction in interest income. The reduced yield was due to loan production at current market rates. Total average securities grew $5.2 million in 2014 which contributed to a $208,000 increase in interest income. Average interest-bearing deposits with banks were $7.2 million lower in 2014 and interest income in this area decreased $19,000. The mix of the funding base led to a reduction in interest expense as a 9 basis point reduction in the cost of interest-bearing deposits lead to reduced interest expense on deposits of $385,000 in spite of $1.8 million increase in average deposits. The cost of borrowed funds also decreased $5,000 compared to the prior year due to a reduced cost of long-term borrowings. As a result of the change in the mix and benefits derived from the downward repricing of deposits and borrowed funds, total interest expense was reduced by $390,000. The resulting net interest margin decreased 10 basis points to 3.90% in 2014 as a 17 basis point reduction in the yield earned was only partially offset by an 8 basis point decrease in the cost of funds.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

Loans receivable decreased $2.0 million from the prior year-end due primarily to an $11.2 million reduction in commercial real estate loans which was the result of several significant payoffs received in 2014 and the transfer of nonperforming loans to foreclosed real estate. Other commercial loans increased $6.8 million in 2014 due to growth in municipal financing, while consumer installment loans increased $4.4 million. Residential mortgage loans and construction loans decreased $2.0 million, but this decrease includes the sale of $4.3 million of fixed-rate residential mortgage loans for the purpose of interest rate risk management. Total non-performing loans were reduced from $9.5 million and 1.90% of total loans at the end of 2013 to $5.6 million, or 1.12% of total loans on December 31, 2014. Net charge-offs totaled $1,513,000 in 2014 which was a reduction from the $2,194,000 recorded in 2013. Based on the level of charge-offs and non-performing loans, the Company determined that it would be appropriate to allocate $1.7 million to the allowance for loan losses to reserve for potential future losses which resulted in an increase in the ratio of the allowance for loan losses to total loans outstanding to 1.17% compared to 1.13% on December 31, 2013.

Other income for the year ended December 31, 2014 totaled $5,110,000 compared to $5,615,000 in the prior year, a decrease of $505,000. Gains on the sale of loans and investment securities increased $309,000 in the aggregate but earnings and proceeds received on bank-owned life insurance policies decreased $701,000 while all other items of other income decreased $113,000, net. During 2013, the Company recorded a non-recurring gain of $770,000 from proceeds on a bank-owned life insurance policy.

Other expenses were $17,727,000 in 2014 compared to $16,705,000 for the similar period in 2013, an increase of $1,022,000. Salaries and benefits costs rose $169,000, or 2.0%, in 2014 due to merit increases. Occupancy and equipment costs decreased $19,000. Foreclosed real estate costs increased $988,000 over the prior period as several properties were acquired through foreclosure resulting in real estate taxes, write-downs or losses on sales as well as regular maintenance. All other operating expenses decreased $116,000, net. Income tax expense for the year totaled $2,606,000 which was a decrease of $100,000 from the prior year. The effective tax rate in 2014 was 25.4% compared to 24.2% in 2013 due primarily to the increase in earnings and proceeds received on bank owned life insurance policies in 2013.

The following table sets forth changes in net income (in thousands):

Net income 2013	$	8,465
Net interest income		(101	)
Provision for loan losses		720
Net gains on sales of loans and securities		309
Earnings and proceeds on bank owned life insurance		(701	)
Other income		(113	)
Salaries and employee benefits		(169	)
Occupancy, furniture and equipment		19
Foreclosed real estate owned		(988	)
Other expenses		116
Income tax expense		100
Net income for 2014	$	7,657

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

FINANCIAL CONDITION

Total Assets

Total assets as of December 31, 2015, were $750.5 million compared to $711.6 million as of year-end 2014, an increase of $38.9 million. Loans outstanding increased $58.8 million and total securities decreased $17.5 million.

Loans Receivable

As of December 31, 2015, loans receivable totaled $559.9 million compared to $501.1 million as of year-end 2014, an increase of $58.8 million. Commercial loans grew $45.8 million, while retail loans increased $13.0 million during the year.

Residential real estate loans, which includes home equity lending, totaled $161.8 million as of December 31, 2015, compared to $158.1 million as of year-end 2014, an increase of $3.7 million. The Company does not originate any non-traditional mortgage products such as interest-only loans or option adjustable rate mortgages and has no sub-prime mortgage exposure. The Company evaluates sales of its long-term, fixed-rate residential loan production for interest rate risk management, with $4.3 million of long-term, fixed-rate loans sold into the secondary market during 2015. In the current low interest rate environment, the Company expects to continue selling mortgage loans in 2016. The Company’s home equity loan portfolio, which is included in residential real estate loans, increased $529,000 in 2015.

Commercial loans consist principally of loans made to small businesses within the Company’s market and are usually secured by real estate or other assets of the borrower. Commercial real estate loans totaled $279.1 million as of December 31, 2015, increasing from $262.0 million as of December 31, 2014. The terms for commercial real estate loans are typically 15 to 20 years, with adjustable rates based on a spread to the prime rate or fixed for the initial three to five year period then adjusting to a spread to the prime rate. The majority of the Company’s commercial real estate portfolio is owner occupied and includes the personal guarantees of the principals. Commercial loans consisting principally of lines of credit and term loans secured by equipment or other assets increased $28.6 million to $71.1 million as of December 31, 2015 due to growth in municipal financing.

The Company’s indirect lending portfolio (included in consumer loans to individuals) increased $9.2 million to $23.5 million as of December 31, 2015.

Allowance for Loan Losses and Non-Performing Assets

The allowance for loan losses totaled $7,298,000 as of December 31, 2015 and represented 1.30% of total loans receivable compared to $5,875,000 and 1.17% of total loans as of year-end 2014. Net charge-offs for 2015 totaled $3,157,000 and represented 0.60% of average loans compared to $1,513,000 and 0.30% of average loans in 2014.

Non-performing assets consist of non-performing loans and real estate owned as a result of foreclosure, which is held for sale. Loans are placed on non-accrual status when management believes that a borrower’s financial condition is such that collection of interest is doubtful. Commercial and real estate related loans are generally placed on non-accrual when interest is 90 days delinquent. When loans are placed on non-accrual, accrued interest is reversed from current earnings.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

As of December 31, 2015, non-performing loans totaled $7,132,000 and represented 1.27% of total loans compared to $5,600,000 or 1.12% as of December 31, 2014. The increase in the level of non-performing loans is due primarily to one credit in the amount of $5.0 million that was transferred to nonaccrual status during the year based upon the borrower’s inability to meet the original terms of the credit. Based on the level of non-performing loans, actual charge-offs, a soft real estate market and a slow economy, the Company added $4,580,000 to the allowance for loan losses for the year ended December 31, 2015 compared to $1,680,000 in 2014.

Foreclosed real estate owned totaled $2,847,000 as of December 31, 2015 and $3,726,000 as of December 31, 2014. The decrease is due primarily to the sale of two commercial properties with a carrying value of $3.0 million as of December 31, 2014 which was partially offset by the addition of two commercial properties with a carrying value of $2.2 million as of December 31, 2015. During 2015, ten properties with a carrying value of $4,456,000 were disposed of through sales. The Company recorded a net loss of $154,000 from the sale of the properties.

The Company’s loan review process assesses the adequacy of the allowance for loan losses on a quarterly basis. The process includes a review of the risks inherent in the loan portfolio. It includes an analysis of impaired loans and a historical review of losses. Other factors considered in the analysis include: concentrations of credit in specific industries in the commercial portfolio; the local and regional economic condition; trends in delinquencies, internal risk rating classifications, large dollar loans of over $2 million and growth in the portfolio. For loans acquired, including those that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts.

The Company has limited exposure to higher-risk loans. The Company does not originate option ARM products, interest only loans, sub-prime loans or loans with initial teaser rates in its residential real estate portfolio. The Company has $9.0 million of junior lien home equity loans. For 2015, net charge-offs for this portfolio totaled $95,000.

As of December 31, 2015, the Company considered its concentration of credit risk profile to be acceptable. The highest concentrations are in the hospitality lodging industry and automobile dealers.

During 2015, the Company recognized a decrease in its adversely classified loans. The Company assesses a loss factor against the classified loans, which is based on prior experience. Classified loans which are considered impaired are measured on a loan by loan basis. The Company values such loans by either the present value of expected cash flows, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent.

At December 31, 2015, the recorded investment in impaired loans, not requiring an allowance for loan losses was $2,855,000 (net of charge-offs against the allowance for loan losses of $1,971,000) and those impaired loans requiring an allowance totaled $6,373,000. The recorded investment in impaired loans not requiring an allowance for loan losses was $8,632,000 (net of $158,000) and $2,973,000 for impaired loans requiring an allowance for loan losses as of December 31, 2014.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

As a result of its analysis, after applying these factors, management considers the allowance as of December 31, 2015, adequate. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, that might be incurred in the future.

The following table sets forth information with respect to the Company’s allowance for loan losses at the dates indicated:


	Year ended December 31,
	(dollars in thousands)
	2015			2014			2013			2012			2011

Allowance balance at beginning of period	$	5,875		$	5,708		$	5,502		$	5,458		$	5,616
Charge-offs:
Commercial loans		-			-			(4	)		(24	)		(2	)
Real Estate		(3,107	)		(1,466	)		(2,131	)		(2,354	)		(1,735	)
Consumer loans		(91	)		(80	)		(90	)		(59	)		(109	)
Total		(3,198	)		(1,546	)		(2,225	)		(2,437	)		(1,846	)
Recoveries:
Commercial loans		-			-			-			-			5
Real Estate		20			2			9			7			51
Consumer loans		21			31			22			24			57
Total		41			33			31			31			113
Provision expense		4,580			1,680			2,400			2,450			1,575
Allowance balance at end of period	$	7,298		$	5,875		$	5,708		$	5,502		$	5,458
Allowance for loan losses as a percent
of total loans outstanding		1.30	%		1.17	%		1.13	%		1.15	%		1.19	%
Net loans charged off as a percent of
average loans outstanding		0.60	%		0.30	%		0.45	%		0.50	%		0.42	%
Allowance coverage of non-performing loans		1.0	x		1.1	x		0.6	x		0.4	x		0.7	x

The following table sets forth information regarding non-performing assets.

	December 31,
	(dollars in thousands)
	2015			2014			2013			2012			2011
Non-accrual loans:
Commercial	$	43		$	-		$	-		$	328		$	404
Real estate		7,089			5,596			9,547			12,872			7,411
Consumer		-			4			-			-			-
Total		7,132			5,600			9,547			13,200			7,815

Accruing loans which are contractually
past due 90 days or more		-			-			-			-			-

Total non-performing loans		7,132			5,600			9,547			13,200			7,815
Foreclosed real estate		2,847			3,726			1,009			852			2,910
Total non-performing assets	$	9,979		$	9,326		$	10,556		$	14,052		$	10,725

Non-performing loans to total loans		1.27	%		1.12	%		1.90	%		2.77	%		1.71	%

Non-performing loans to total assets		0.95	%		0.79	%		1.34	%		1.96	%		1.17	%

Non-performing assets to total assets		1.33	%		1.31	%		1.48	%		2.09	%		1.60	%

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

Securities

The securities portfolio consists of issues of United States Government agencies, including mortgage-backed securities, municipal obligations, and corporate debt. The Company classifies its investments into two categories: held to maturity (HTM) and available for sale (AFS). The Company does not have trading securities. Securities classified as HTM are those in which the Company has the ability and the intent to hold the security until contractual maturity. As of December 31, 2015, there were no securities carried in the HTM portfolio. Securities classified as AFS are eligible to be sold due to liquidity needs or interest rate risk management. These securities are adjusted to and carried at their fair value with any unrealized gains or losses recorded net of deferred income taxes, as an adjustment to capital and reported in the equity section of the Consolidated Balance Sheet as other comprehensive income. As of December 31, 2015, $138.9 million of securities were so classified and carried at their fair value, with unrealized gains, net of tax, of $488,000 included in accumulated other comprehensive income as a component of stockholders’ equity.

As of December 31, 2015, the average life of the portfolio was 5.5 years. The Company has maintained a relatively short average life in the portfolio in order to generate cash flow to support loan growth and maintain liquidity levels. During 2015, a portion of cash flow generated from the portfolio through principal reductions, calls and security sales was utilized to fund loan growth. Purchases for the year totaled $50.6 million, while maturities and cash flow totaled $22.8 million and proceeds from sales were $45.0 million. The purchases were funded principally by cash flow generated from the portfolio and excess overnight liquidity.

The carrying value of the securities portfolio at December 31 is as follows:

	2015			2014
	(dollars in thousands)
	Carrying		% of	Carrying		% of
	Value		portfolio	Value		portfolio

U.S. Government agencies	$	9,169	6.6%	$	28,975	18.5%
States and political subdivisions		60,755	43.8%		54,332	34.7%
Corporate obligations		4,974	3.5%		6,486	4.2%
Mortgage-backed securities – government sponsored entities		63,569	45.8%		66,204	42.3%
Equity securities – financial services		384	0.3%		398	0.3%

Total	$	138,851	100.0%	$	156,395	100.0%

The portfolio had no adjustable-rate instruments as of December 31, 2015 and 2014. The portfolio contained no private label mortgage backed securities, collateralized debt obligations (CDOs), trust preferred securities, and no off-balance sheet derivatives were in use. The U.S. Government agency portfolio consists of both callable and non-callable notes with an average maturity of 3.9 years. As of December 31, 2015, the portfolio did not contain any step-up bonds. The mortgage backed securities includes pass-through bonds and collateralized mortgage obligations (CMO’s) with Fannie Mae, Freddie Mac and Government National Mortgage Association (GNMA).

The Company evaluates the securities in its portfolio for other-than-temporary-impairment (OTTI) as fair value declines below cost. In estimating OTTI management considers (1) the length of time and the extent of the decline in fair value and (2) the financial condition and near-term prospects of the issuer. As of December 31, 2015, the Company held 76 investment securities in a loss position which had a combined unrealized loss of $1.2 million. Management believes that these losses are principally due to changes in interest rates and represent temporary impairment as the Company does not have the intent to sell these 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 also holds a small

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

portfolio of equity securities of other financial institutions. As of December 31, 2015, none of these equity securities were in an unrealized loss position. No impairment charges have been recognized in 2015, 2014 and 2013.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company uses fair value measurements to record fair value adjustments to certain financial instruments and determine fair value disclosures (see Note 14 of Notes to the Consolidated Financial Statements).

Approximately $138.9 million, which represents 18.5% of total assets at December 31, 2015, consisted of financial instruments recorded at fair value on a recurring basis. This amount consists entirely of the Company’s available for sale securities portfolio. The Company uses valuation methodologies involving market-based or market derived information, collectively Level 1 and 2 measurements, to measure fair value. There were no transfers into or out of Level 3 for any instruments for the years ending December 31, 2015 and 2014.

The Company utilizes a third party provider to perform valuations of the investments. Methods used to perform the valuations include: pricing models that vary based on asset class, available trade and bid information, actual transacted prices, and proprietary models for valuations of state and municipal obligations. In addition, the Company has a sample of fixed-income securities valued by another independent source. The Company does not adjust values received from its providers, unless it is evident that fair value measurement is not consistent with the Company’s policies.

The Company also utilizes a third party provider to provide 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. The fair value of mortgage servicing rights as of December 31, 2015 and 2014 was $291,000 and $277,000, respectively.

DEPOSITS

The Company, through the fifteen branches of the Bank, provides a full range of deposit products to its retail and business customers. These products include interest-bearing and non-interest bearing transaction accounts, statement savings and money market accounts. Time deposits consist of certificates of deposit (CDs) with terms of up to five years and include Individual Retirement Accounts. The Bank participates in the Jumbo CD ($100,000 and over) markets with local municipalities and school districts, which are typically awarded on a competitive bid basis. The Company has no brokered deposits nor does it participate in the Certificate of Deposit Account Registry Service (CDARS).

Total deposits as of December 31, 2015, totaled $550.9 million, decreasing $9.0 million from year-end 2014. The decrease included a $25.1 million reduction in certificates of deposit as several local municipalities opted to maintain more liquid funds due to the Commonwealth of Pennsylvania’s budget impasse. Non-interest bearing demand balances increased $9.8 million in 2015, interest bearing demand balances increased $4.0 million and savings deposits increased $2.3 million during the year.

Time deposits of $250,000 or more, which consist principally of school district funds, other public funds and short-term deposits from large commercial customers with maturities generally less than one year, totaled $22.0 million as of December 31, 2015, compared to $42.0 million at year-end 2014. These deposits are subject to competitive bid and the Company bases its bid on current interest rates, loan demand, investment portfolio structure and the relative cost of other funding sources.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

As of December 31, 2015, non-interest bearing demand deposits totaled $107.8 million compared to $98.1 million at year-end 2014. Cash management accounts in the form of securities sold under agreements to repurchase included in short-term borrowings, totaled $33.6 million at year end 2015 compared to $25.7 million as of December 31, 2014. These balances represent commercial and municipal customers’ funds invested in overnight securities. The Company considers these accounts as a source of core funding.

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 the 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 should 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 December 31, 2015, the level of net interest income at risk in a ± 200 basis points increase was within the Company’s policy limit of a decline less than 8% of net interest income.

Imbalances in repricing opportunities at a given point in time reflect interest-sensitivity gaps measured as the difference between rate-sensitive assets and rate-sensitive liabilities. These are static gap measurements that do not take into account any future activity, and as such are principally used as early indicators of potential interest rate exposures over specific intervals.

At December 31, 2015, the Bank had a positive 90-day interest sensitivity gap of $38.8 million or 5.2% of total assets. A positive gap indicates that the balance sheet has a higher level of rate-sensitive assets (RSA) than rate-sensitive liabilities (RSL) at the specific time interval. This would indicate that in an increasing rate environment, the yield on interest-earning assets would increase faster than the cost of interest-bearing liabilities in the 90 day time frame. The level of RSA and RSL for an interval is managed by ALCO strategies, including adjusting the average life of the investment portfolio through purchases and sales, pricing of deposit liabilities to attract long or short term time deposits, utilizing borrowings to fund loan growth, loan pricing to encourage variable rate products and evaluation of loan sales of long term fixed rate mortgages.

The Company analyzes and measures the time periods in which RSA and RSL will mature or reprice in accordance with their contractual terms and assumptions. Management believes that the assumptions used are reasonable. The interest rate sensitivity of assets and liabilities could vary substantially if differing assumptions were used or if actual experience differs from the assumptions used in the analysis. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Interest rates may change at different rates changing the shape of the yield curve. The level of rates on the investment securities may also be affected by the spread relationship between different investments. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed. Finally, the ability of borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase. It should be noted that the operating results of the Company are not subject to foreign currency exchange or commodity price risk.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

The following table displays interest-sensitivity as of December 31, 2015 (in thousands):

	3 Months				3-12					Over
	Or Less			Months			1-3 Years			3 Years			Total
Federal funds sold and
interest-bearing deposits	$	266		$	-		$	-		$	-		$	266
Securities		3,983			9,088			23,672			102,108			138,851
Loans Receivable		129,418			128,652			153,528			148,327			559,925
Total Rate Sensitive Assets (RSA)	$	133,667		$	137,740		$	177,200		$	250,435		$	699,042

Non-maturity interest-bearing deposits	$	39,252		$	44,131		$	117,198		$	45,767		$	246,348
Time Deposits		26,352			63,715			78,289			28,391			196,747
Borrowings		29,246			18,280			38,827			8,008			94,361
Total Rate Sensitive Liabilities (RSL)	$	94,850		$	126,126		$	234,314		$	82,166		$	537,456

Interest sensitivity gap	$	38,817		$	11,614		$	(57,114	)	$	168,269		$	161,586
Cumulative gap		38,817			50,431			(6,683	)		161,586
RSA/RSL-cumulative		140.9	%		122.8	%		98.5	%		130.1	%

As of December 31, 2014
Interest sensitivity gap	$	64,389		$	(9,788	)	$	(40,674	)	$	138,122		$	152,049
Cumulative gap		64,389			54,601			13,927			152,049
RSA/RSL-cumulative		194.2	%		125.6	%		103.2	%		129.8	%

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

LIQUIDITY

Liquidity is the ability to fund customers’ borrowing needs and their deposit withdrawal requests while supporting asset growth. The Company’s primary sources of liquidity include deposit generation, asset maturities, cash flow from payments on loans and securities and access to borrowing from the Federal Home Loan Bank and other correspondent banks.

As of December 31, 2015, the Company had cash and cash equivalents of $10.0 million in the form of cash, due from banks, balances with the Federal Reserve Bank, and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $138.9 million, which could be used for liquidity needs. This totals $148.9 million and represents 19.8% of total assets compared to $168.8 million and 23.7% of total assets as of December 31, 2014. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of December 31, 2015. Based upon these measures, the Company believes its liquidity position is adequate.

The Company maintains established lines of credit with the Federal Home Loan Bank of Pittsburgh (FHLB), the Atlantic Community Bankers Bank (ACBB) and other correspondent banks, which support liquidity needs. The total available under all the lines was $321.5 million, with $19.7 million outstanding at December 31, 2015

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

and $0 outstanding at December 31, 2014. The maximum borrowing capacity from FHLB was $281.5 million. As of December 31, 2015, the Company had $41.1 million in term borrowings from the FHLB, compared to $22.2 million at December 31, 2014.

OFF-BALANCE SHEET ARRANGEMENTS

The Company’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments, as of December 31, 2015 totaled $73.7 million. They consisted of $19.7 million of commitments for residential and commercial real estate, construction and land developments loans, $18.5 million in unused home equity lines of credit, $5.4 million in performance and standby letters of credit and $30.1 million in other unused commitments, principally commercial lines of credit. Because these instruments have fixed maturity dates and many of them will expire without being drawn upon, they do not represent any significant liquidity risk.

Management believes that any amounts actually drawn upon can be funded in the normal course of operations. The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.

The following table represents the aggregate of on and off-balance sheet contractual obligations to make future payments (in thousands):

CONTRACTUAL OBLIGATIONS

	December 31, 2015
		Total		Less than 1 year		1-3 years		4-5 years		Over 5 years

Time deposits	$	196,747	$	90,197	$	78,295	$	28,255	$	-
Long-term debt		41,126		-		21,701		14,033		5,392
Operating leases		3,666		352		726		744		1,844

	$	241,539	$	90,549	$	100,722	$	43,032	$	7,236

RESULTS OF OPERATIONS

NET INTEREST INCOME

Net interest income is the most significant source of revenue for the Company and represented 83.9% of total revenue for the year ended December 31, 2015. Net interest income (fte) totaled $25,882,000 for the year ended December 31, 2015 compared to $25,818,000 for 2014, an increase of $64,000. The resulting fte net interest spread and net interest margin were 3.61% and 3.75%, respectively, in 2015 compared to 3.76% and 3.90%, respectively, in 2014.

Interest income (fte) for the year ended December 31, 2015 totaled $29,140,000 compared to $29,026,000 in 2014. The fte yield on average earning assets was 4.23%, decreasing 16 basis points from the 4.39% reported last year. The continued low interest rate environment impacted the yield earned as new loan production was added at historically low rates. This impacted loan yields which earned 4.61% in 2015 compared to 4.82% in the prior year. The reduced yield was partially offset by a $29.0 million increase in average loans outstanding, resulting in a $288,000 increase in loan income. The yield on securities decreased 2 basis points in 2015, and combined with a $4.8 million decrease in the average balance, resulted in a $178,000 decrease in interest income.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

Interest expense was $3,258,000 in 2015 which resulted in an average cost of interest-bearing liabilities of 0.62% compared to total interest expense of $3,208,000 in 2014 with an average cost of 0.63%. The continued low rate environment also impacted rates paid on deposits as the Company reduced rates paid on time deposits to market levels. Total interest-bearing deposits cost 0.52% in 2015 which was 2 basis points lower than the 0.54% cost in the prior year due primarily to a 14 basis point reduction in time deposits as certificates repriced to current market rates upon maturity and new growth was added at the reduced levels. Long term borrowings also repriced downward in 2015 reflecting a the impact from low cost borrowings originated in recent years.

Net interest income represented 82.8% of total revenue for the year ended December 31, 2014. Net interest income (fte) totaled $25,818,000 for the year ended December 31, 2014 compared to $25,857,000 for 2013, a decrease of $39,000. The resulting fte net interest spread and net interest margin were 3.76% and 3.90%, respectively, in 2014 compared to 3.85% and 4.00%, respectively, in 2013.

Interest income (fte) for the year ended December 31, 2014 totaled $29,026,000 compared to $29,455,000 in 2013. The fte yield on average earning assets was 4.39%, decreasing 17 basis points from the 4.56% reported last year. The continued low interest rate environment impacted the yield earned as new loan production was added at historically low rates. This impacted loan yields which earned 4.82% in 2014 compared to 5.12% in the prior year. The reduced yield was partially offset by a $17.9 million increase in average loans outstanding, resulting in a $618,000 decrease in loan income. The yield on securities improved 3 basis points in 2014, and combined with a $5.2 million increase in the average balance, added $208,000 of interest income.

Interest expense was $3,208,000 in 2014 which resulted in an average cost of interest-bearing liabilities of 0 .63% compared to total interest expense of $3,598,000 in 2013 with an average cost of 0.71%. The continued low rate environment also impacted rates paid on deposits as the Company reduced rates paid on money market and time accounts to market levels. Total interest-bearing deposits cost 0.54% in 2014 which was 9 basis points lower than the 0.63% cost in the prior year due primarily to a 12 basis point reduction in time deposits as certificates repriced to current market rates upon maturity and new growth was added at the reduced levels. Long term borrowings also repriced downward in 2014 reflecting a full year effect of low cost borrowings originated in 2013.

OTHER INCOME

Other income totaled $4,699,000 for the year ended December 31, 2015 compared to $5,110,000 in 2014, a decrease of $411,000. Gains from the sales of loans and securities decreased $572,000 from the prior year, while all other items of other income increased $161,000, net.

Other income totaled $5,110,000 for the year ended December 31, 2014 compared to $5,615,000 in 2013, a decrease of $505,000. Gains from the sales of loans and securities increased $309,000 from the prior year but earnings and proceeds received on bank-owned life insurance policies decreased $701,000 while all other items of other income decreased $113,000, net. During 2013, the Company recorded a non-recurring gain of $770,000 from proceeds on a bank-owned life insurance policy.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

Other Income (dollars in thousands)

For the year ended December 31

	2015		2014		2013
Service charges on deposit accounts	$	168	$	176	$	187
ATM Fees		220		206		196
NSF Fees		850		932		905
Safe deposit box rental		62		63		63
Loan related service fees		451		370		484
Debit card		660		620		635
Fiduciary activities		439		437		379
Commissions on mutual funds & annuities		143		94		187
Gain on sales of mortgage loans and servicing rights		104		132		112
Earnings on and proceeds from bank-owned life insurance		664		685		1,386
Other income		312		225		200
		4,073		3,940		4,734
Net realized gains on sales of securities		626		1,170		881

Total	$	4,699	$	5,110	$	5,615

OTHER EXPENSES

Other expenses totaled $17,100,000 for the year ended December 31, 2015 compared to $17,727,000 in the prior year. The $627,000 decrease in costs includes a $644,000 decrease in expenses related to foreclosed real estate owned. Salaries and benefits costs decreased $81,000 in 2015 while occupancy and equipment costs decreased $35,000. All other operating expenses increased $133,000, net. The Company’s efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 55.9% in 2015 compared to 57.3% in 2014.

Other expenses totaled $17,727,000 for the year ended December 31, 2014 compared to $16,705,000 in the prior year. The $1,022,000 increase in costs includes a $988,000 increase in expenses related to foreclosed real estate owned, including properties acquired through foreclosure in 2014. Salaries and benefits costs increased $169,000, or 2.0%, in 2014 while occupancy and equipment costs decreased $19,000. All other operating expenses decreased $116,000, net. The Company’s efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 57.3% in 2014 due to the increased costs of foreclosed real estate owned compared to 53.1% in 2013.

INCOME TAXES

Income tax expense for the year ended December 31, 2015 totaled $1,632,000 which resulted in an effective tax rate of 21.6% compared to $2,606,000 and 25.4% for 2014. The decrease in the effective rate reflects a higher proportion of tax-exempt income.

Income tax expense for the year ended December 31, 2014 totaled $2,606,000 which resulted in an effective tax rate of 25.4% compared to $2,706,000 and 24.2% for 2013. The increase in the effective rate reflects a decrease in tax-exempt income received from earnings and proceeds on bank-owned life insurance policies.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CAPITAL AND DIVIDENDS

Total stockholders’ equity as of December 31, 2015, was $101.0 million, compared to $99.0 million as of year-end 2014. The increase was due primarily to a $1.3 million increase from earnings retention after cash dividends declared of $4.6 million. As of December 31, 2015 the Company had a leverage capital ratio of 12.40%, common equity Tier 1 and Tier 1 risk-based capital ratio of 15.86% and total risk-based capital ratio of 17.09% compared to, 12.58%, 17.33% and 18.49%, respectively, at December 31, 2014.

The Company’s stock is traded on the Nasdaq Global Market under the symbol, NWFL. As of December 31, 2015, there were approximately 2,200 shareholders based on transfer agent mailings.

The following table sets forth the price range and cash dividends declared per share regarding common stock for the period indicated:

	Closing Price Range
	High		Low		Cash dividend
Year 2015					Declared per share
First Quarter	$	30.00	$	27.69	$	0.31
Second Quarter		30.90		27.88		0.31
Third Quarter		30.64		28.01		0.31
Fourth Quarter		29.30		27.69		0.31

Year 2014
First Quarter	$	29.88	$	27.25	$	0.30
Second Quarter		29.69		27.55		0.30
Third Quarter		29.46		27.55		0.30
Fourth Quarter		29.45		27.70		0.30

The book value of the common stock was $27.39 per share as of December 31, 2015 compared to $26.30 as of December 31, 2014. As of year-end 2015, the stock price was $28.75 per share, compared to $29.05 as of December 31, 2014.

NON-GAAP FINANCIAL MEASURES

This annual report contains or references tax-equivalent interest income and net interest income, which are non-GAAP financial measures. Tax-equivalent interest income and net interest income are derived from GAAP interest income and net interest income using an assumed tax rate of 34%. We believe the presentation of interest income and net interest income on a tax-equivalent basis ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Tax-equivalent net interest income is reconciled to GAAP net interest income on page 25. 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.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

STOCK PERFORMANCE GRAPH

Set forth below is a stock performance graph comparing the cumulative total shareholder return on the Common Stock with (a) the cumulative total stockholder return on stocks included in the Nasdaq Stock Market index and (b) the cumulative total stockholder return on stocks included in the Nasdaq Bank index, as prepared by Zack’s Investment Research, Inc. using data from the Center for Research in Securities Prices (CRSP) at the University of Chicago. All three investment comparisons assume the investment of $100 at the market close on December 31, 2010 and the reinvestment of dividends paid. The graph provides comparison at December 31, 2010 and each fiscal year through December 31, 2015.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP

SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

(Dollars in thousands, except per share amounts)

2015	December 31				September 30			June 30			March 31

Interest income		$	6,936			$	6,872		$	6,882		$	7,088
Interest expense			824				819			833			781
Net interest income			6,112				6,053			6,049			6,307
Provision for loan losses			2,820				720			420			620
Other income			1,098				1,008			99			968
Net realized gains on sales of securities			118				63			134			311
Other expense			4,674				4,070			4,168			4,187
Income (loss) before income taxes			(166	)			2,334			2,594			2,779
Income tax expense (benefit)			(294	)			557			631			738
NET INCOME		$	128			$	1,777		$	1,963		$	2,041

Basic earnings per share		$	0.04			$	0.48		$	0.53		$	0.55

Diluted earnings per share		$	0.04			$	0.48		$	0.53		$	0.55

2014
	December 31				September 30			June 30			March 31

Interest income		$	6,898			$	6,941		$	6,960		$	6,968
Interest expense			793				787			805			823
Net interest income			6,105				6,154			6,155			6,145
Provision for loan losses			420				420			420			420
Other income			1,062				961			959			958
Net realized gains on sales of securities			265				301			509			95
Other expense			4,997				4,124			4,473			4,132
Income before income taxes			2,015				2,872			2,730			2,646
Income tax expense			474				754			696			682
NET INCOME		$	1,541			$	2,118		$	2,034		$	1,964

Basic earnings per share		$	0.42			$	0.58		$	0.56		$	0.54

Diluted earnings per share		$	0.42			$	0.58		$	0.56		$	0.54

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP CONSOLIDATED AVERAGE BALANCE SHEETS WITH

RESULTANT INTEREST AND RATES

(Tax-Equivalent Basis, dollars in thousands)

Year Ended December 31	2015						2014									2013
		Average			Average			Average			Average			Average			Average
		Balance		Interest	Rate			Balance		Interest	Rate			Balance		Interest	Rate
		(2)		(1)				(2)		(1)				(2)		(1)

ASSETS
Interest-earning assets:
Interest bearing deposits with banks	$	6,392	$	16	0.25	%	$	2,910	$	7	0.24	%	$	10,128	$	26	0.26	%
Securities held-to-maturity		-		-	-			57		5	8.77			174		14	8.05
Securities available for sale:
Taxable		93,294		1,918	2.06			100,393		2,032	2.02			93,133		1,663	1.79
Tax-exempt		59,659		2,792	4.68			57,362		2,856	4.98			59,260		3,008	5.08
Total securities available for sale		152,953		4,710	3.08			157,755		4,888	3.10			152,393		4,671	3.07
Loans receivable (3)(4)		529,989		24,414	4.61			500,960		24,126	4.82			483,041		24,744	5.12
Total interest earning assets		689,334		29,140	4.23			661,682		29,026	4.39			645,736		29,455	4.56
Non-interest earning assets:
Cash and due from banks		8,638						8,606						9,018
Allowance for loan losses		(5,945)						(5,832)						(5,751)
Other assets		44,794						45,278						41,697
Total non-interest earning assets		47,487						48,052						44,964
TOTAL ASSETS	$	736,821					$	709,734					$	690,700
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest bearing liabilities:
Interest bearing demand and money market	$	177,104		301	0.17		$	174,558		304	0.17		$	172,448		395	0.23
Savings		74,753		37	0.05			71,612		35	0.05			69,282		44	0.06
Time		209,930		2,083	0.99			206,231		2,124	1.03			208,847		2,409	1.15
Total interest bearing deposits		461,787		2,421	0.52			452,401		2,463	0.54			450,577		2,848	0.63
Short-term borrowings		34,022		85	0.25			36,514		77	0.21			30,832		66	0.21
Other borrowings		28,742		752	2.62			22,987		668	2.91			22,076		684	3.10
Total interest bearing liabilities		524,551		3,258	0.62			511,902		3,208	0.63			503,485		3,598	0.71
Non-interest bearing liabilities:
Non-interest bearing demand deposits		106,601						96,870						90,331
Other liabilities		4,305						4,262						4,213
Total non-interest bearing liabilities		110,906						101,132						94,544
Stockholders’ equity		101,364						96,700						92,671
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	736,821					$	709,734					$	690,700


Net Interest Income
(tax equivalent basis)				25,882	3.61	%				25,818	3.76	%				25,857	3.85	%
Tax-equivalent basis adjustment				(1,361)						(1,258)						(1,196)
Net Interest Income			$	24,521					$	24,560					$	24,661
Net interest margin
(tax equivalent basis)					3.75	%					3.90	%					4.00	%

(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)	Loan balances include non-accrual loans and are net of unearned income.

(4)	Loan yields include the effect of amortization of purchased credit marks and deferred fees net of costs.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

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)
(dollars in thousands)	2015 compared to 2014						2014 compared to 2013
	Variance due to						Variance due to
	Volume		Rate		Net		Volume		Rate		Net
INTEREST EARNING ASSETS:
Interest bearing deposits	$	8	$	1	$	9	$	(17)	$	(2)	$	(19)
Securities held to maturity		-		-		-		(10)		1		(9)
Securities available for sale:
Taxable		(150)		36		(114)		136		233		369
Tax-exempt securities		109		(178)		(69)		(95)		(57)		(152)
Total securities available for sale		(41)		(142)		(183)		41		176		217
Loans receivable		1,372		(1,084)		288		897		(1,515)		(618)
Total interest earning assets		1,339		(1,225)		114		911		(1,340)		(429)

INTEREST BEARING LIABILITIES:
Interest-bearing demand and money market		(3)		-		(3)		5		(96)		(91)
Savings		2		-		2		1		(10)		(9)
Time		39		(80)		(41)		(30)		(255)		(285)
Total interest-bearing deposits		38		(80)		(42)		(24)		(361)		(385)
Short-term borrowings		(6)		14		8		12		(1)		11
Other borrowings		162		(78)		84		28		(44)		(16)
Total interest bearing liabilities		194		(144)		50		16		(406)		(390)

Net interest income (tax-equivalent basis)	$	1,145	$	(1,081)	$	64	$	895	$	(934)	$	(39)

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.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

REPORT ON MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING

TO THE STOCKHOLDERS OF NORWOOD FINANCIAL CORP

Management of Norwood Financial Corp and its subsidiary (Norwood) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Norwood’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Norwood’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Norwood; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of Norwood’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Norwood’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of Norwood’s internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria established in Internal Control – Integrated Framework as set forth by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Based upon its assessment, management has concluded that, as of December 31, 2015, the Company’s internal control over financial reporting, including controls over the preparation of regulatory financial statements in accordance with all federal and state laws and regulations, is effective based on the criteria established in Internal Control – Integrated Framework.

Norwood’s independent registered certified public accounting firm has audited the effectiveness of Norwood’s internal control over financial reporting. Their report appears on page 28.


Lewis J. Critelli		William S. Lance
President and Chief Executive Officer		Executive Vice President and Chief Financial Officer

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED BALANCE SHEETS

	December 31,
	2015			2014
	(In Thousands, Except Share and Per Share Data)
ASSETS
Cash and due from banks	$	9,744		$	8,081
Interest bearing deposits with banks		266			4,295

Cash and cash equivalents		10,010			12,376

Securities available for sale		138,851			156,395
Loans receivable (net of allowance for loan losses 2015: $7,298; 2014: $5,875)		552,627			495,260
Regulatory stock, at cost		3,412			1,714
Premises and equipment, net		6,472			6,734
Bank owned life insurance		18,820			18,284
Accrued interest receivable		2,363			2,339
Foreclosed real estate owned		2,847			3,726
Goodwill		9,715			9,715
Other intangibles		285			389
Deferred tax asset		3,669			3,285
Other assets		1,434			1,418

Total Assets	$	750,505		$	711,635

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing demand	$	107,814		$	98,064
Interest-bearing demand		52,040			46,441
Money market deposit accounts		119,028			120,603
Savings		75,280			73,004
Time		196,747			221,832

Total Deposits		550,909			559,944

Short-term borrowings		53,235			25,695
Other borrowings		41,126			22,200
Accrued interest payable		957			966
Other liabilities		3,280			3,789

Total Liabilities		649,507			612,594

STOCKHOLDERS’ EQUITY
Common stock, $.10 par value, authorized 10,000,000 shares,
issued: 2015: 3,724,668 shares, 2014: 3,718,018 shares		373			372
Surplus		35,351			35,206
Retained earnings		65,412			64,078
Treasury stock at cost: 2015: 23,311 shares, 2014: 40,576 shares		(626	)		(1,077	)
Accumulated other comprehensive income		488			462

Total Stockholders' Equity		100,998			99,041

Total Liabilities and Stockholders' Equity	$	750,505		$	711,635

See notes to consolidated financial statements

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF INCOME

	Years Ended December 31,
	2015		2014		2013
	(In Thousands, Except per Share Data)
INTEREST INCOME
Loans receivable, including fees	$	24,002	$	23,841	$	24,576
Securities
Taxable		1,918		2,032		1,662
Tax exempt		1,843		1,888		1,995
Other		16		7		26

Total Interest Income		27,779		27,768		28,259

INTEREST EXPENSE
Deposits		2,421		2,463		2,848
Short-term borrowings		85		77		66
Other borrowings		752		668		684

Total Interest Expense		3,258		3,208		3,598

Net Interest Income		24,521		24,560		24,661

PROVISION FOR LOAN LOSSES		4,580		1,680		2,400

Net Interest Income After
Provision for Loan Losses		19,941		22,880		22,261

OTHER INCOME
Service charges and fees		2,440		2,350		2,412
Income from fiduciary activities		439		437		379
Net realized gains on sales of securities		626		1,170		881
Net gain on sale of loans and servicing rights		104		132		112
Earnings and proceeds on life insurance policies		665		685		1,386
Other		425		336		445
Total Other Income		4,699		5,110		5,615

OTHER EXPENSES
Salaries and employee benefits		8,535		8,616		8,447
Occupancy		1,660		1,676		1,598
Furniture and equipment		422		441		538
Data processing related operations		943		929		891
Federal Deposit Insurance Corporation insurance assessment		411		420		444
Advertising		240		224		208
Professional fees		730		671		626
Postage and telephone		436		414		435
Taxes, other than income		711		649		710
Foreclosed real estate		911		1,555		567
Amortization of intangible assets		105		121		137
Other		1,996		2,011		2,104
Total Other Expenses		17,100		17,727		16,705

Income before Income Taxes		7,540		10,263		11,171

INCOME TAX EXPENSE		1,632		2,606		2,706
Net income	$	5,908	$	7,657	$	8,465

EARNINGS PER SHARE
BASIC	$	1.60	$	2.10	$	2.33
DILUTED	$	1.60	$	2.10	$	2.33

See notes to consolidated financial statements

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands)


	Years Ended December 31,
	2015			2014			2013

NET INCOME	$	5,908		$	7,657		$	8,465

Other comprehensive income (loss):
Investment securities available for sale:
Unrealized holding gains (losses)		656			5,820			(7,299	)
Tax Effect		(217	)		(1,984	)		2,481
Reclassification of gains from sale of securities		(626	)		(1,170	)		(881	)
Tax Effect		213			398			300
Net of tax amount		26			3,064			(5,399	)

COMPREHENSIVE INCOME	$	5,934		$	10,721		$	3,066

See notes to consolidated financial statements

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY



		Years Ended December 31, 2015, 2014 and 2013
													Accumulated
													Other
		Common Stock						Retained	Treasury Stock				Comprehensive
		Shares		Amount		Surplus		Earnings	Shares		Amount		Income (Loss)		Total
	(Dollars in Thousands, Except per Share Data)

BALANCE - DECEMBER 31, 2012		3,371,849	$	337	$	24,737	$	66,742	75,426	$	(2,192)	$	2,797	$	92,421
Net Income		-		-		-		8,465	-		-		-		8,465
Other comprehensive loss		-		-		-		-	-		-		(5,399)		(5,399)
Cash dividends declared ($1.16 per share)		-		-		-		(4,216)	-		-		-		(4,216)
Acquisition of treasury stock		-		-		-		-	10,712		(319)		-		(319)
Stock options exercised		-		-		(79)		-	(24,127)		654		-		575
Tax benefit on stock options exercised		-		-		39		-	-		-		-		39
Sale of treasury stock for ESOP		-		-		2		-	(5,426)		144		-		146
Compensation expense related to
stock options		-		-		162		-	-		-		-		162
Stock dividend declared-10%		336,869		34		10,149		(10,193)	8,043		-		-		(10)
BALANCE - DECEMBER 31, 2013		3,708,718		371		35,010		60,798	64,628		(1,713)		(2,602)		91,864
Net Income		-		-		-		7,657	-		-		-		7,657
Other comprehensive income		-		-		-		-	-		-		3,064		3,064
Cash dividends declared ($1.20 per share)		-		-		-		(4,377)	-		-		-		(4,377)
Acquisition of treasury stock		-		-		-		-	6,669		(179)		-		(179)
Stock options exercised		-		-		13		-	(25,577)		678		-		691
Tax benefit on stock options exercised		-		-		17		-	-		-		-		17
Sale of treasury stock for ESOP		-		-		13		-	(5,144)		137		-		150
Compensation expense related to
stock options		-		-		154		-	-		-		-		154
Restricted stock awards		9,300		1		(1)		-	-		-		-		-
BALANCE - DECEMBER 31, 2014		3,718,018		372		35,206		64,078	40,576		(1,077)		462		99,041
Net Income		-		-		-		5,908	-		-		-		5,908
Other comprehensive income		-		-		-		-	-		-		26		26
Cash dividends declared ($1.24 per share)		-		-		-		(4,574)	-		-		-		(4,574)
Acquisition of treasury stock		-		-		-		-	4,374		(127)		-		(127)
Stock options exercised		-		-		(9)		-	(16,859)		450		-		441
Tax benefit on stock options exercised		-		-		16		-	-		-		-		16
Sale of treasury stock for ESOP		-		-		10		-	(5,060)		136		-		146
Compensation expense related to
stock options		-		-		66		-	-		-		-		66
Restricted stock awards		6,650		1		62		-	280		(8)		-		55
BALANCE - DECEMBER 31, 2015		3,724,668	$	373	$	35,351	$	65,412	23,311	$	(626)	$	488	$	100,998

See notes to consolidated financial statements.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS



	Years Ended December 31,
		2015		2014		2013
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	5,908	$	7,657	$	8,465
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		4,580		1,680		2,400
Depreciation		551		572		594
Amortization of intangible assets		105		121		137
Deferred income taxes		(387)		(51)		140
Net amortization of securities premiums and discounts		936		860		1,057
Net realized gains on sales of securities		(626)		(1,170)		(881)
Earnings and proceeds on life insurance policies		(665)		(685)		(617)
Loss on sales of fixed assets and foreclosed real estate owned		427		920		347
Net gain on sale of mortgage loans		(113)		(150)		(112)
Mortgage loans originated for sale		(4,297)		(4,269)		(3,986)
Proceeds from sale of mortgage loans originated for sale		4,410		4,419		4,053
Compensation expense related to stock options		66		154		162
Compensation expense related to restricted stock		55		-		-
Decrease in accrued interest receivable and other assets		113		238		759
(Decrease) increase in accrued interest payable and other liabilities		(565)		235		173

Net Cash Provided by Operating Activities		10,498		10,531		12,691

CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		44,976		66,263		42,348
Proceeds from maturities and principal reductions on mortgage-backed securities		22,853		14,859		21,142
Purchases		(50,565)		(74,426)		(84,589)
Proceeds from maturities on securities held-to-maturity		-		175		-
Purchase of regulatory stock		(4,095)		(1,963)		(741)
Redemption of regulatory stock		2,397		3,126		494
Net increase in loans		(65,830)		(4,270)		(29,515)
Proceeds from bank-owned life insurance		-		75		1,089
Purchase of bank-owned life insurance		-		-		(3,000)
Purchase of premises and equipment		(290)		(193)		(393)
Proceeds from sales of foreclosed real estate owned and fixed assets		4,310		1,045		508

Net Cash (Used in) Provided by Investing Activities		(46,244)		4,691		(52,657)

CASH FLOWS FROM FINANCING ACTIVITIES
Net (decrease) increase in deposits		(9,035)		18,762		16,757
Net increase (decrease) in short-term borrowings		27,540		(24,219)		21,217
Repayments of other borrowings		(10,074)		(1,561)		(5,726)
Proceeds from other borrowings		29,000		-		7,000
Stock options exercised		441		691		575
Tax benefit of stock options exercised		16		17		39
ESOP purchase of shares from treasury stock		146		150		146
Purchase of treasury stock		(127)		(179)		(319)
Cash dividends paid		(4,527)		(4,370)		(4,155)

Net Cash Provided by (Used in) by Financing Activities		33,380		(10,709)		35,534

Net (Decrease) Increase in Cash and Cash Equivalents		(2,366)		4,513		(4,432)

CASH AND CASH EQUIVALENTS - BEGINNING		12,376		7,863		12,295
CASH AND CASH EQUIVALENTS - ENDING	$	10,010	$	12,376	$	7,863

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)



Years Ended December 31,
	2015	2014	2013
(In Thousands)

Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest paid	$	3,267	$	3,264	$	3,818
Income taxes paid, net of refunds	$	2,315	$	2,645	$	2,417
Supplemental Schedule of Noncash Investing Activities
Transfers of loans to foreclosed real estate owned and repossession of other assets	$	3,880	$	4,704	$	1,012
Dividends payable	$	1,147	$	1,100	$	1,093

See notes to consolidated financial statements

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS

Norwood Financial Corp (Company) is a one bank holding company. Wayne Bank (Bank) is a wholly-owned subsidiary of the Company. The Bank is a state-chartered bank located in Honesdale, Pennsylvania. The Company derives substantially all of its income from the bank related services which include interest earnings on commercial mortgages, residential real estate mortgages, commercial and consumer loans, as well as interest earnings on investment securities and fees from deposit services to its customers. The Company is subject to regulation and supervision by the Federal Reserve Board while the Bank is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, and the Bank’s wholly-owned subsidiaries, WCB Realty Corp., Norwood Investment Corp., Norwood Settlement Services, LLC and WTRO Properties. All significant intercompany accounts and transactions have been eliminated in consolidation.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the determination of other-than-temporary impairment on securities, the determination of goodwill impairment and the fair value of financial instruments.

Significant Group Concentrations of Credit Risk

Most of the Company’s activities are with customers located within northeastern Pennsylvania. Note 3 discusses the types of securities that the Company invests in. Note 4 discusses the types of lending that the Company engages in. The Company does not have any significant concentrations to any one industry or customer.

Concentrations of Credit Risk

The Bank operates primarily in Wayne, Pike, Lackawanna and Monroe Counties, Pennsylvania and, accordingly, 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. These customers are also the primary depositors of the Bank. The Bank is limited in extending credit by legal lending limits to any single borrower or group of borrowers.

Securities

Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Securities available for sale are carried at fair value. Unrealized gains and losses are reported in other comprehensive income, net of the related deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using a method which approximates the interest method over the term of the security.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

Management evaluates the regulatory stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management considers the FHLB’s regulatory capital ratios, liquidity, and the fact that new shares of FHLB stock continue to change hands at the $100 par value. Management believes no impairment charge is necessary related to FHLB stock as of December 31, 2015.

Loans Receivable

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees. Interest income is accrued on the unpaid principal balance. Loan origination fees are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Troubled Debt Restructurings

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

Loans Acquired

Loans acquired including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. Loans are evaluated individually to determine if there is evidence of deterioration of credit quality since origination. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as impairment. Any valuation allowances on these impaired loans reflect only losses incurred after the acquisition.

For purchased loans acquired that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon a third party appraisal. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. The Company’s loan servicing assets at December 31, 2015 and 2014, respectively, were not impaired. Total servicing assets included in other assets as of December 31, 2015 and 2014, were $261,000 and $271,000, respectively.

Allowance for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific and geneal components. The specific component relates to loans that are classified as substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either 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 real estate loans for impairment disclosures, unless such loans were acquired with impairment or are the subject of a restructuring agreement.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation expense is calculated principally on the straight-line method over the respective assets estimated useful lives as follows:



	Years
Buildings and improvements	10 - 40
Furniture and equipment	3 - 10

Transfers of Financial Assets

Transfers of financial assets, including loan and loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Foreclosed Real Estate

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of its carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses.

Bank Owned Life Insurance

The Company invests in bank owned life insurance (BOLI) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a select group of employees. The Company is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Income from the increase in cash surrender value of the policies or from death benefits realized is included in other income on the Consolidated Statements of Income.

Goodwill

In connection with an acquisition the Company recorded goodwill in the amount of $9.7 million, representing the excess of amounts paid over the fair value of net assets of the institutions acquired. Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value. The value of the goodwill can change in the future. We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Bank. If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss. No impairment was recognized for the years ended December 31, 2015, 2014 and 2013.

Intangible Assets

At December 31, 2015, the Company had intangible assets of $285,000 which is net of accumulated amortization of $610,000. These intangible assets will continue to be amortized using the sum-of-the-years digits method of amortization over ten years. At December 31, 2014, the Company had intangible assets of $389,000 which is net of accumulated amortization of $506,000. Amortization expense related to intangible assets was $105,000, $121,000 and $137,000 for the years ended December 31, 2015, 2014 and 2013.

As of December 31, 2015, the estimated future amortization expense for the core deposit intangible was:


2016	$	88,000
2017		72,000
2018		56,000
2019		39,000
2020		23,000
2021		7,000
	$	285,000

Income Taxes

Deferred income tax assets and liabilities are determined based on the differences between financial statement carrying amounts and the tax basis of existing assets and liabilities. These differences are measured at the enacted tax rates that will be in effect when these differences reverse. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. As changes in tax laws or rates are enacted, deferred tax assets and

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

liabilities are adjusted through the provision for income taxes. The Company and its subsidiary file a consolidated federal income tax return. The Company recognizes interest and penalties on income taxes as a component of income tax expense.

The Company analyzes each tax position taken in its tax returns and determines the likelihood that the position will be realized. Only tax positions that are “more-likely-than-not” to be realized can be recognized in an entity’s financial statements. For tax positions that do not meet this recognition threshold, an entity will record an unrecognized tax benefit for the difference between the position taken on the tax return and the amount recognized in the financial statements. The Company does not have any unrecognized tax benefits at December 31, 2015 or 2014 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Advertising Costs

Advertising costs are expensed as incurred.

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 less any unvested restricted shares. 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. Treasury shares are not deemed outstanding for earnings per share calculations.

Stock Option Plans

The Company recognizes the value of share-based payment transactions as compensation costs in the financial statements over the period that an employee provides service in exchange for the award. The fair value of the share-based payments for stock options is estimated using the Black-Scholes option-pricing model. The Company used the modified-prospective transition method to record compensation expense. Under the modified prospective method, companies are required to record compensation cost for new and modified awards over the related vesting period of such awards and record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method.

Restricted Stock

The Company recognizes compensation cost related to restricted stock based on the market price of the stock at the grant date over the vesting period. The product of the number of shares granted and the grant date market price of the Company’s common stock determines the fair value of restricted stock under the Company’s 2014 Equity Incentive Plan. The Company recognizes compensation expense for the fair value of the restricted stock on a straight-line basis over the requisite service period for the entire award.

Cash Flow Information

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

Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, letters of credit and commitments to sell loans. Such financial instruments are recorded on the balance sheets when they become receivable or payable.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Trust Assets

Assets held by the Company in a fiduciary capacity for customers are not included in the financial statements since such items are not assets of the Company. Trust income is reported on the accrual method.

Treasury Stock

Common shares repurchased are recorded as treasury stock at cost.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income as presented in the Consolidated Statement of Comprehensive Income.

Segment Reporting

The Company acts as an independent community financial service provider and offers traditional banking related financial services to individual, business and government customers. Through its branch and automated teller machine network, the Company offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of safe deposit services. The Company also performs personal, corporate, pension and fiduciary services through its Trust Department.

Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail, mortgage banking and trust operations of the Company. As such, discrete information is not available and segment reporting would not be meaningful.

New Accounting Standards

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

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method. The Company has included the disclosures related to this Update in Note 4.

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

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this Update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. For repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The amendments also require enhanced disclosures. The accounting changes in this Update are effective for the first interim or annual period beginning after December 15, 2014. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application is prohibited. The disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date. The Company has included the disclosures related to this Update in Note 7.

In June 2014, the FASB issued ASU 2014-12, Compensation – Stock Compensation (Topic 718): The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this Update as of the beginning of the earliest annual period presented in the

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Additionally, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. This Update is not expected to have a significant impact on the Company’s financial statements.

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

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40). The amendments in this Update provide guidance in accounting principles generally accepted in the United States of America about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

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

In November 2014, the FASB issued ASU 2014-17, Business Combinations (Topic 805): Pushdown Accounting. The amendments in this Update apply to the separate financial statements of an acquired entity and its subsidiaries that are a business or nonprofit activity (either public or nonpublic) upon the occurrence of an event in which an acquirer (an individual or an entity) obtains control of the acquired entity. An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs. If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity's most recent change-in-control event. The amendments in this Update are effective on November 18, 2014. After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event. This Update is not expected to have a significant impact on the Company’s financial statements.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In January 2015, the FASB issued ASU 2015-01, Income Statement – Extraordinary and Unusual Items, as part of its initiative to reduce complexity in accounting standards. This Update eliminates from U.S. GAAP the concept of extraordinary items. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity may also apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. This Update is not expected to have a significant impact on the Company’s financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810). The amendments in this Update affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related-party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The amendments in this Update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’s financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30), as part of its initiative to reduce complexity in accounting standards. To simplify presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016. An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. This Update is not expected to have a significant impact on the Company’s financial statements.

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

In June 2015, the FASB issued ASU 2015-10, Technical Corrections and Improvements. The amendments in this Update represent changes to clarify the FASB Accounting Standards Codification (“Codification”), correct unintended application of guidance, or make minor improvements to the Codification that are not expected to

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this Update. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this Update. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2015, the FASB issued ASU 2015-14, Revenue from Contract with Customers (Topic 606). The amendments in this Update defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. The Company is evaluating the effect of adopting this new accounting Update.

In August 2015, the FASB issued ASU 2015-15, Interest – Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. This Update adds SEC paragraphs pursuant to the SEC Staff Announcement at the June 18, 2015 Emerging Issues Task Force meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. This Update is not expected to have a significant impact on the Company’s financial statements.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805). The amendments in this Update require that an acquirer recognizes adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’s financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Update apply to all entities that present a classified statement of financial position. For public business entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Earlier application is permitted for all entities as of the

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

beginning of an interim or annual reporting period. The amendments in this Update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (g) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (h) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 3 - SECURITIES

The amortized cost, gross unrealized gains and losses, and fair value of securities were as follows:

	December 31, 2015
				Gross		Gross
		Amortized		Unrealized		Unrealized		Fair
		Cost		Gains		Losses		Value
	(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies	$	9,275	$	2	$	(108)	$	9,169
States and political subdivisions		59,120		1,747		(112)		60,755
Corporate obligations		4,933		45		(4)		4,974
Mortgage-backed securities-
government sponsored entities		64,491		23		(945)		63,569
Total debt securities		137,819		1,817		(1,169)		138,467
Equity securities-financial services		292		92		-		384
	$	138,111	$	1,909	$	(1,169)	$	138,851

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

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 3 - SECURITIES (CONTINUED)

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

	December 31, 2015
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
U.S. Government agencies	$	6,058	$	(71)	$	2,109	$	(37)	$	8,167	$	(108)
States and political subdivisions		9,086		(99)		1,417		(13)		10,503		(112)
Corporate obligations		2,221		(4)		-		-		2,221		(4)
Mortgage-backed securities-government sponsored entities		40,300		(432)		16,595		(513)		56,895		(945)
	$	57,665	$	(606)	$	20,121	$	(563)	$	77,786	$	(1,169)

	December 31, 2014
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In Thousands)
U.S. Government agencies	$	4,965	$	(17)	$	15,051	$	(339)	$	20,016	$	(356)
States and political subdivisions		3,195		(20)		4,633		(83)		7,828		(103)
Corporate obligations		-		-		1,144		(11)		1,144		(11)
Mortgage-backed securities-government sponsored entities		22,090		(189)		26,050		(748)		48,140		(937)
	$	30,250	$	(226)	$	46,878	$	(1,181)	$	77,128	$	(1,407)

The Company has 54 debt securities in the less than twelve month category and 22 debt securities in the twelve months or more category as of December 31, 2015. In management’s opinion, the unrealized losses on securities reflect changes in interest rates subsequent to the acquisition of specific securities. No other-than-temporary-impairment charges were recorded in 2015. Management believes that all other unrealized losses represent temporary impairment of 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 amortized cost and fair value of debt securities as of December 31, 2015 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
	(In Thousands)
Due in one year or less	$	640	$	647
Due after one year through five years		13,044		13,003
Due after five years through ten years		8,437		8,529
Due after ten years		51,207		52,719
		73,328		74,898

Mortgage-backed securities - government sponsored entities		64,491		63,569
	$	137,819	$	138,467

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 3 - SECURITIES (CONTINUED)

Gross realized gains and gross realized losses on sales of securities available for sale were $626,000 and $0, respectively, in 2015, compared to $1,199,000 and $29,000, respectively, in 2014, and $908,000 and $27,000, respectively, in 2013. The proceeds from the sales of securities totaled $44,976,000 $66,263,000 and $42,348,000 for the years ended December 31, 2015, 2014 and 2013, respectively.

Securities with a carrying value of $97,671,000 and $102,994,000 at December 31, 2015 and 2014, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law.

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Set forth below is selected data relating to the composition of the loan portfolio at December 31:

	Types of loans (dollars in thousands)
	December 31, 2015					December 31, 2014
Real Estate:
Residential	$	161,820		28.9	%	$	158,139		31.5	%
Commercial		279,123		49.8			261,956		52.2
Construction		18,987		3.4			19,221		3.9
Commercial, financial and agricultural		71,090		12.7			42,514		8.5
Consumer loans to individuals		29,231		5.2			19,704		3.9
Total loans		560,251		100.0	%		501,534		100.0	%

Deferred fees, net		(326	)				(399	)
Total loans receivable		559,925					501,135
Allowance for loan losses		(7,298	)				(5,875	)
Net loans receivable	$	552,627				$	495,260

Purchased loans acquired in a business combination are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses. The carrying value of purchased loans acquired with deteriorated credit quality was $498,000 at December 31, 2015.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

Changes in the accretable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31:

	2015		2014		2013
(In thousands)
Balance at beginning of period	$	8	$	20	$	76
Accretion		(1)		(12)		(56)
Reclassification and other		(7)		-		-
Balance at end of period	$	-	$	8	$	20

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

	December 31, 2015		December 31, 2014

Outstanding Balance	$	498	$	1,057
Carrying Amount	$	498	$	1,049

There were no material increases or decreases in the expected cash flows of these loans since the acquisition date. There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of May 31, 2011. In addition, there has been no allowance for loan losses on these loans reversed. As of December 31, 2015, for loans that were acquired with or without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation.

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. The 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. The Company does 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.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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

	Real Estate Loans									Commercial			Consumer
	Residential			Commercial			Construction			Loans			Loans			Total
	(In thousands)
December 31, 2015
Individually evaluated for impairment		$	28		$	8,660		$	-		$	42		$	-		$	8,730
Loans acquired with deteriorated credit quality			140			358			-			-			-			498
Collectively evaluated for impairment			161,652			270,105			18,987			71,048			29,231			551,023
Total Loans		$	161,820		$	279,123		$	18,987		$	71,090		$	29,231		$	560,251

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

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable.

			Unpaid
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2015	(In thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	168	$	173	$	-
Commercial		2,644		4,610		-
Commercial, financial and agricultural		43		43
Subtotal		2,855		4,826		-
With an allowance recorded:
Real Estate Loans
Commercial		6,373		6,446		1,613
Subtotal		6,373		6,446		1,613
Total:
Real Estate Loans
Residential		168		173		-
Commercial		9,017		11,056		1,613
Commercial, financial and agricultural		43		43		-
Total Impaired Loans	$	9,228	$	11,272	$	1,613

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

The following information for impaired loans is presented for the year ended December 31, 2015 and 2014:

	Average Recorded								Interest Income
	Investment								Recognized
	2015			2014			2013		2015			2014			2013
	(In thousands)
Total:
Real Estate Loans
Residential		$	159		$	233	$	252		$	4		$	5	$	5
Commercial			8,847			7,492		10,328			526			503		236
Commercial Loans			9			-		-			2			-		-
Total Loans		$	9,015		$	7,725	$	10,580		$	532		$	508	$	241

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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 December 31, 2015, troubled debt restructured loans totaled $6.8 million and resulted in specific reserves of $1,613,000. During 2015, there were two new loan relationships identified as troubled debt restructurings totaling $176,000 based on executed modification agreements, while one loan with a balance of $1.7 million as of December 31, 2014 was transferred to Foreclosed Real Estate Owned during 2015 as a result of foreclosure on the property. During 2015, the Company recognized charge-offs totaling $1.3 million on loans classified as troubled debt restructurings. Additionally, the Company recognized expenses of $322,000 in foreclosed real estate owned expense related to a property which was previously classified as a troubled debt restructuring.

As of December 31, 2014, troubled debt restructured loans totaled $8.8 million and resulted in specific reserves of $293,000. During 2014, there was one new loan relationship identified as troubled debt restructurings totaling $4.9 million based on extended deferrals of principal payments, while two loans with a balance of $4.7 million as of December 31, 2013 were transferred to Foreclosed Real Estate Owned during 2014 as a result of foreclosure on the properties. During 2014, the Company recognized charge-offs totaling $573,000 on loans classified as troubled debt restructurings in prior periods. No losses were recognized on loans identified as troubled debt restructurings in 2014. Additionally, the Company recognized a writedown of $680,000 in foreclosed real estate owned expense related to a property which was previously classified as a troubled debt restructuring.

Foreclosed assets acquired in settlement of loans are carried at fair value less estimated costs to sell and are included in foreclosed real estate owned on the Consolidated Balance Sheets. As of December 31, 2015 and 2014, foreclosed real estate owned totaled $2,847,000 and $3,726,000, respectively. As of December 31, 2015, included within foreclosed real estate owned is $267,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of December 31, 2015, the Company has initiated formal foreclosure proceedings on $110,000 of consumer residential mortgage loans.

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

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

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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 December 31, 2015 and December 31, 2014 (in thousands):



				Special
	Pass			Mention			Substandard			Doubtful			Loss			Total
December 31, 2015
Commercial real estate loans		$	267,892		$	1,837		$	9,394		$	-		$	-		$	279,123
Commercial			71,047			-			43			-			-			71,090
Total		$	338,939		$	1,837		$	9,437		$	-		$	-		$	350,213



				Special
	Pass			Mention			Substandard			Doubtful			Loss			Total
December 31, 2014
Commercial real estate loans		$	246,629		$	1,983		$	13,344		$	-		$	-		$	261,956
Commercial			42,514			-			-			-			-			42,514
Total		$	289,143		$	1,983		$	13,344		$	-		$	-		$	304,470

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 that have been placed on nonaccrual status and loans remaining in accrual status on which the contractual payment of principal and interest has become 90 days past due. The following table presents the recorded investment in the loan classes based on payment activity as of December 31, 2015 and December 31, 2014 (in thousands):



	Performing			Nonperforming			Total
December 31, 2015
Residential real estate loans		$	161,380		$	440		$	161,820
Construction			18,987			-			18,987
Consumer loans to individuals			29,231			-			29,231
Total		$	209,598		$	440		$	210,038



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

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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 December 31, 2015 and December 31, 2014 (in thousands):

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2015
Real Estate loans
Residential	$	160,683	$	646	$	51	$	-	$	440	$	1,137	$	161,820
Commercial		272,125		310		39		-		6,649		6,998		279,123
Construction		18,959		28		-		-		-		28		18,987
Commercial loans		71,043		4		-		-		43		47		71,090
Consumer loans		29,179		41		11		-		-		52		29,231
Total	$	551,989	$	1,029	$	101	$	-	$	7,132	$	8,262	$	560,251

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2014
Real Estate loans
Residential	$	156,242	$	222	$	-	$	-	$	1,675	$	1,897	$	158,139
Commercial		252,495		5,100		440		-		3,921		9,461		261,956
Construction		19,221		-		-		-		-		-		19,221
Commercial loans		42,500		14		-		-		-		14		42,514
Consumer loans		19,606		94		-		-		4		98		19,704
Total	$	490,064	$	5,430	$	440	$	-	$	5,600	$	11,470	$	501,534

The following table presents changes in the allowance for loan losses by class:

	Year ended December 31,
	2015		2014			2013
	(In Thouasands)

Allowance at beginning of period	$	5,875	$	5,708	$	5,502
Charge-offs:
Real Estate loans
Residential		(224)		(270)		(603)
Commercial		(2,883)		(1,196)		(1,488)
Construction		-		-		(40)
Commercial loans		-		-		(4)
Consumer loans		(91)		(80)		(90)
Total		(3,198)		(1,546)		(2,225)
Recoveries:
Real Estate loans
Residential		20		-		9
Commercial		-		2		-
Construction		-		-		-
Commercial loans		-		-		-
Consumer loans		21		31		22
Total		41		33		31
Provision for loan losses		4,580		1,680		2,400
Allowance at end of period	$	7,298	$	5,875	$	5,708

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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, 2014	$	1,323		$	3,890		$	222		$	256	$	184		$	5,875
Charge Offs		(224	)		(2,883	)		-			-		(91	)		(3,198	)
Recoveries		20			-			-			-		21			41
Provision for loan losses		(50	)		4,499			(132	)		141		122			4,580
Ending balance, December 31, 2015	$	1,069		$	5,506		$	90		$	397	$	236		$	7,298
Ending balance individually evaluated for impairment	$	-		$	1,613		$	-		$	-	$	-		$	1,613
Ending balance collectively evaluated for impairment	$	1,069		$	3,893		$	90		$	397	$	236		$	5,685

(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2013	$	1,441	$	3,025	$	898	$	184	$	160	$	5,708
Charge Offs		(270)		(1,196)		-		-		(80)		(1,546)
Recoveries		-		2		-		-		31		33
Provision for loan losses		152		2,059		(676)		72		73		1,680
Ending balance, December 31, 2014	$	1,323	$	3,890	$	222	$	256	$	184	$	5,875
Ending balance individually evaluated for impairment	$	-	$	293	$	-	$	-	$	-	$	293
Ending balance collectively evaluated for impairment	$	1,323	$	3,597	$	222	$	256	$	184	$	5,582

The recorded investment in impaired loans, not requiring an allowance for loan losses was $2,855,000 (net of charge-offs against the allowance for loan losses of $1,971,000) and $8,632,000 (net of charge-offs against the allowance for loan losses of $158,000) at December 31, 2015 and 2014, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $6,373,000 (net of a charge-off against the allowance for loan losses of $73,000) and $2,973,000 (net of a charge-off against the allowance for loan losses of $864,000) at December 31, 2015 and 2014, respectively. The specific reserve related to impaired loans was $1,613,000 for 2015 and $293,000 for 2014. For the years ended December 31, 2015 and 2014, the average recorded investment in these impaired loans was $9,015,000, and $7,725,000, respectively, and the interest income recognized on these impaired loans was $532,000 and $508,000, respectively.

During the period ended December 31, 2015, the allowance for residential real estate loans decreased from $1,323,000 to $1,069,000. This $254,000 decrease in the required allowance was due primarily to a decrease in the historical loss factor from 0.30% at December 31, 2014 to 0.23% on December 31, 2015. During the same period, the required allowance for commercial real estate loans increased from $3,890,000 at December 31, 2014

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

to $5,506,000 on December 31, 2015. This increase can be attributed to a $1,320,000 increase in the specific reserve component.

Interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of the loans was $515,000, $451,000 and $724,000 for 2015, 2014 and 2013, respectively.

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. The Company does not have any significant concentrations to any one customer.

As of December 31, 2015 and 2014, the Company considered its concentration of credit risk to be acceptable. As of December 31, 2015, the highest concentrations are in the hospitality lodging industry and automobile dealers, with loans outstanding of $52.6 million, or 56.8% of bank capital, to the hospitality lodging industry, and $27.5 million, or 29.7% of bank capital to the automobile dealer industry. Charge-offs on loans within these concentrations were $643,000, $422,000 and $0 for the years ended December 31, 2015, 2014 and 2013, respectively.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $113,000 and $0, respectively, in 2015 compared to $150,000 and $0, respectively, in 2014 and $74,000 and $7,000, respectively, in 2013. The proceeds from the sales of residential mortgage loans totaled $4.4 million, $4.4 million and $4.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.

NOTE 5 - PREMISES AND EQUIPMENT

Components of premises and equipment at December 31 are as follows:

	2015				2014
	(In Thousands)
Land and improvements		$	2,316			$	2,275
Buildings and improvements			9,857				9,723
Furniture and equipment			4,415				4,332
			16,588				16,330
Accumulated depreciation			(10,116	)			(9,596	)

		$	6,472			$	6,734

Depreciation expense totaled $551,000, $572,000 and $594,000 for the years ended December 31, 2015, 2014 and 2013, respectively.

Certain facilities are leased under various operating leases. Rental expense for these leases was $341,000, $338,000 and $325,000, respectively, for the years ended December 31, 2015, 2014 and 2013. Future minimum rental commitments under noncancellable leases as of December 31, 2015 were as follows (in thousands):



2016	$	352
2017		363
2018		363
2019		368
2020		376
Thereafter		1,844
	$	3,666

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 6 - DEPOSITS

Aggregate time deposits in denominations of $250,000 or more were $22,041,000 and $42,009,000 at December 31, 2015 and 2014, respectively. Included in deposit accounts are deposits of one customer relationship totaling $10,942,000 at December 31, 2015.

At December 31, 2015, the scheduled maturities of time deposits are as follows (in thousands):



2016	$	90,197
2017		54,846
2018		23,449
2019		20,926
2020		7,329
	$	196,747

NOTE 7 – BORROWINGS

Short-term borrowings at December 31 consist of the following:



	2015			2014
	(In Thousands)
Securities sold under agreements to repurchase		$	33,563		$	25,695
Federal Home Loan Bank short-term borrowings			19,672			-
		$	53,235		$	25,695

The outstanding balances and related information of short-term borrowings are summarized as follows:

	Years Ended December 31,
	2015			2014
	(Dollars In Thousands)
Average balance during the year	$	34,057		$	36,514
Average interest rate during the year		0.25	%		0.21	%
Maximum month-end balance during the year	$	55,183		$	49,634
Weighted average interest rate at the end of the year		0.36	%		0.20	%

Securities sold under agreements to repurchase generally mature within one day to one year from the transaction date. Securities with an amortized cost and fair value of $36,797,000 and $36,316,000 at December 31, 2015 and $28,914,000 and $28,437,000 at December 31, 2014, respectively, were pledged as collateral for these agreements. The securities underlying the agreements were under the Company’s control.

The collateral pledged for repurchase agreements that are classified as secured borrowings is summarized as follows (in thousands):

	As of December 31, 2015
	Remaining Contractual Maturity of the Agreements
	Overnight and continuous	Up to 30 days	30-90 days	Greater than 90 days	Total
Repurchase Agreements:
Obligations of U.S. Government agencies	$35,515	$139	$277	$385	$36,316

Total liability recognized for repurchase agreements					$33,563

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 7 – BORROWINGS (CONTINUED)

The Company has a line of credit commitment available from the FHLB of Pittsburgh for borrowings of up to $139,144,000 which expires in May, 2016. At December 31, 2015, there were $19,672,000 of borrowings outstanding on this line. There were no borrowings under this line of credit at December 31, 2014. The Company has a line of credit commitment available from Atlantic Community Bankers Bank for $7,000,000 which expires on June 30, 2016. There were no borrowings under this line of credit at December 31, 2015 and 2014. The Company has a line of credit commitment available from PNC Bank for $16,000,000 at December 31, 2015. There were no borrowings under this line of credit at December 31, 2015 and December 31, 2014. The Company also has a line of credit commitment from Zion’s Bank for $17,000,000. There were no borrowings under this line of credit at December 31, 2015 and December 31, 2014.

Other borrowings consisted of the following at December 31, 2015 and 2014:


	2015		2014
	(In Thousands)

Notes with the FHLB:
Convertible note due July 2015 at 4.34%	$	-	$	7,111
Convertible note due January 2017 at 4.71%		10,000		10,000
Amortizing fixed rate borrowing due December 2017 at 1.27%		8,000		-
Amortizing fixed rate borrowing due January 2018 at 0.91%		1,267		1,866
Amortizing fixed rate borrowing due December 2018 at 1.42%		2,434		3,223
Amortizing fixed rate borrowing due June 2020 at 1.49%		9,033		-
Amortizing fixed rate borrowing due December 2020 at 1.71%		5,000		-
Amortizing fixed rate borrowing due March 2022 at 1.75%		5,392		-
	$	41,126	$	22,200

The convertible note contains an option which allows the FHLB, at quarterly intervals, to change the note to an adjustable-rate advance at three-month LIBOR plus 17 basis points. If the note is converted, the option allows the Bank to put the funds back to the FHLB at no charge.

Contractual maturities of other borrowings at December 31, 2015 are as follows (in thousands):


2017	$	18,000
2018		3,701
2020		14,033
2022		5,392
	$	41,126

The Bank’s maximum borrowing capacity with the FHLB was $281,493,000 of which $60,798,000 was outstanding at December 31, 2015. Advances from the FHLB are secured by qualifying assets of the Bank.

NOTE 8 – EMPLOYEE BENEFIT PLANS

The Company has a defined contributory profit-sharing plan which includes provisions of a 401(k) plan. The plan permits employees to make pre-tax contributions up to 15% of the employee’s compensation, not to exceed the limits set by the Internal Revenue Service. The amount of contributions to the plan, including matching contributions, is at the discretion of the Board of Directors. All employees over the age of 21 are eligible to participate in the plan and receive Company contributions after one year of employment. Eligible employees are able to contribute to the Plan at the beginning of the first quarterly period after their date of employment. Employee contributions vest immediately, and any Company contributions are fully vested after five years. The

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)

Company’s contributions are expensed as the cost is incurred, funded currently, and amounted to $445,000, $445,000 and $440,000 for the years ended December 31, 2015, 2014 and 2013, respectively.

The Company has a non-qualified supplemental executive retirement plan for the benefit of certain executive officers. At December 31, 2015 and 2014, other liabilities include $1,427,000 and $1,443,000 accrued under the Plan. Compensation expense includes approximately $122,000, $124,000 and $126,000 relating to the supplemental executive retirement plan for 2015, 2014 and 2013, respectively. To fund the benefits under this plan, the Company is the owner of single premium life insurance policies on participants in the non-qualified retirement plan. At December 31, 2015 and 2014, the cash value of these policies was $18,820,000 and $18,284,000, respectively.

The Company provides post retirement benefits in the form of split-dollar life arrangements to employees who meet the eligibility requirements.

The net periodic post retirement benefit expense included in salaries and employee benefits was $89,000 and $87,000 for the years ended December 31, 2015 and 2014, respectively.

The Company participates in the Pentegra Mulitemployer Defined Benefit Pension Plan (EIN 13-5645888 and Plan # 001) as a result of its acquisition of North Penn. As of December 31, 2015 and 2014, the Company’s Plan was 79.9% and 98.9% funded, respectively, and total contributions made are not more than 5% of the total contributions to the Plan. The Company’s expense related to the Plan was $48,000 in 2015, $17,000 in 2014 and $22,000 in 2013. During the plan years ending December 31, 2015, 2014 and 2013, the Company made contributions of $48,000, $17,000 and $22,000, respectively.

NOTE 9 - INCOME TAXES

The components of the provision for federal income taxes are as follows:

	Years Ended December 31,
	2015				2014				2013
	(In Thousands)
Current		$	2,019			$	2,657			$	2,566
Deferred			(387	)			(51	)			140
		$	1,632			$	2,606			$	2,706

Deferred income taxes reflect temporary differences in the recognition of revenue and expenses for tax reporting and financial statement purposes, principally because certain items, such as, the allowance for loan losses and loan fees are recognized in different periods for financial reporting and tax return purposes. A valuation allowance has not been established for deferred tax assets. Realization of the deferred tax assets is dependent on generating sufficient taxable income. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. Deferred tax assets are recorded in other assets.

Income tax expense of the Company is less than the amounts computed by applying statutory federal income tax rates to income before income taxes because of the following:

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 9 - INCOME TAXES

	Percentage of Income
	before Income Taxes
	Years Ended December 31,
	2015		2014		2013
Tax at statutory rates	34.0	%	34.0	%	34.0	%
Tax exempt interest income, net of interest expense disallowance	(11.3)		(7.7)		(6.7)
Incentive stock options	0.3		0.4		0.4
Earnings and proceeds on life insurance	(1.8)		(1.5)		(3.7)
Other	0.4		0.2		0.2

	21.6	%	25.4	%	24.2	%

The net deferred tax asset included in other assets in the accompanying Consolidated Balance Sheets includes the following amounts of deferred tax assets and liabilities:

	2015		2014
	(In Thousands)
Deferred tax assets:
Allowance for loan losses	$	2,481	$	1,997
Deferred compensation		485		491
Purchase price adjustment		884		999
Other		182		201
Foreclosed real estate valuation allowance		305		280

Total Deferred Tax Assets		4,337		3,968

Deferred tax liabilities:
Premises and equipment		245		265
Deferred loan fees		172		170
Net unrealized gains on securities		251		248

Total Deferred Tax Liabilities		668		683

Net Deferred Tax Asset	$	3,669	$	3,285

The Company’s federal and state income tax returns for taxable years through 2011 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue.

NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY

The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY (CONTINUED)

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, Tier 1 and Common Equity Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2015 and 2014, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2015, the most recent notification from the regulators has categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The Bank’s actual capital amounts and ratios are presented in the table:

To be Well Capitalized

under Prompt

For Capital Adequacy

Corrective Action

Actual

Purposes

Provisions

Amount

Ratio

Amount

Ratio

Amount

Ratio

(Dollars in Thousands)

As of December 31, 2015:

Total capital (to risk-weighted assets)

92,777

16.25

≥$45,672

≥8.00

≥$7,090

≥10.00

Tier 1 capital (to risk-weighted assets)

85,638

15.00

≥34,254

≥6.00

≥45,672

≥8.00

Common Equity Tier 1 capital

(to risk-weighted assets)

85,638

15.00

≥25,690

≥4.50

≥37,108

≥6.50

Tier 1 capital (to average assets)

85,638

11.73

≥29,203

≥4.00

≥36,504

≥5.00

As of December 31, 2014:

Total capital (to risk-weighted assets)

89,613

17.59

≥$40,767

≥8.00

≥$50,959

≥10.00

Tier 1 capital (to risk-weighted assets)

83,738

16.43

≥20,383

≥4.00

≥30,575

≥6.00

Tier 1 capital (to average assets)

83,738

11.93

≥28,069

≥4.00

≥35,086

≥5.00

The Company’s ratios do not differ significantly from the Bank’s ratios presented above.

Effective January 1, 2015, the Company and the Bank became subject to new regulatory capital rules which, among other things, impose a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), set the minimum leverage ratio for all banking organizations at a uniform 4% of total assets, increased the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigned a higher risk-weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The new rules also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt out is exercised, which the Company and the Bank have done. The final rule limits a banking organization’s dividends, stock repurchases and other capital distributions, and certain discretionary bonus payments to executive officers, if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above regulatory minimum risk-based requirements. The capital conservation buffer requirements will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer will be effective. The Company and the Bank are in compliance with their respective new capital requirements, including the capital conservation buffer, as of December 31, 2015.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY (CONTINUED)

The Bank is required to maintain average cash reserve balances in vault cash or with the Federal Reserve Bank. The amount of these restricted cash reserve balances at December 31, 2015 and 2014 was approximately $437,000 and $368,000, respectively.

Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2015, $65,777,000 of retained earnings were available for dividends without prior regulatory approval, subject to the regulatory capital requirements discussed above. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including the Company, unless such loans are collateralized by specific obligations.

NOTE 11 - STOCK BASED COMPENSATION

The Company’s shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the Annual Meeting on April 26, 2006. An aggregate of 275,000 shares of authorized but unissued Common Stock of the Company were reserved for future issuance under the Plan. This includes up to 44,000 shares for awards to outside directors. Under this plan, the Company granted 7,423 options to employees in 2015, 12,500 options to employees in 2014, and 28,600 options, which included 4,000 options granted to outside directors in 2013. As of December 31, 2015, there were 4,057 shares available for stock option awards to outside directors.

At the Annual Meeting held on April 22, 2014, the Company’s shareholders approved the Norwood Financial Corp 2014 Equity Incentive Plan. An aggregate of 250,000 shares of authorized but unissued Common Stock of the Company were reserved for future issuance under the Plan. This includes up to 40,000 shares for awards to outside directors. The Plan also authorized the Company to award restricted stock to officers and outside directors, limited to 42,000 shares of restricted stock awards for officers and 8,000 shares of restricted stock awards for outside directors. Under this plan, the Company granted 13,727 shares in 2015 which included 7,077 options to employees, 4,250 shares of restricted stock to officers and 2,400 shares of restricted stock to directors. In 2014, the Company granted 9,300 shares, which included 2,800 shares to outside directors. All shares granted in 2014 were for restricted stock. The restricted shares vest over a five-year period. The product of the number of shares granted and the grant date market price of the Company’s common stock determine the fair value of restricted stock under the company’s restricted stock plan. Management recognizes compensation expense for the fair value of restricted stock on a straight-line basis over the requisite service period for the entire award. As of December 31, 2015, there were 226,973 shares available for future awards under this plan, which included 192,173 shares available for officer awards and 34,800 shares available for awards to outside directors. Included in these totals are 31,250 shares available for restricted stock awards to officers and 2,800 shares available for restricted stock awards to outside directors.

Total unrecognized compensation cost related to stock options was $71,000 as of December 31, 2015, $66,000 as of December 31, 2014, and $157,000 as of December 31, 2013. Salaries and employee benefits expense includes $66,000, $154,000 and $162,000 of compensation costs related to options for the years ended December 31, 2015, 2014 and 2013, respectively. Compensation costs related to restricted stock amounted to $55,000, $0 and $0 for the years ended December 31, 2015, 2014 and 2013, respectively. The expected future compensation expense relating to non-vested restricted stock outstanding as of December 31, 2015 and 2014 was $398,000 and $271,000 respectively. Net income was reduced by $92,000, $146,000 and $154,000 for the years ended December 31, 2015, 2014 and 2013, respectively.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 11 - STOCK BASED COMPENSATION (CONTINUED)

A summary of the Company’s stock option activity and related information for the years ended December 31 follows:

	2015					2014					2013
		Weighted					Weighted					Weighted
		Average		Average			Average		Average			Average		Aggregate
		Exercise		Intrinsic			Exercise		Intrinsic			Exercise		Intrinsic
	Options	Price		Value		Options	Price		Value		Options	Price		Value

Outstanding, beginning of year	206,463	$	26.74			219,540	$	26.64			225,670	$	26.27
Granted	14,500		28.55			12,500		29.08			28,600		27.07
Exercised	(16,859)		26.19			(25,577)		27.05			(24,127)		23.83
Forfeited	(9,583)		27.02			-		-			(10,603)		28.92

Outstanding, end of year	194,521	$	26.91	$	362,754	206,463	$	26.74	$	477,640	219,540	$	26.64	$	146,970

Exercisable, end of year	180,021	$	26.78	$	359,854	193,963	$	26.59	$	477,640	190,940	$	26.58	$	146,900

Exercise prices for options outstanding as of December 31, 2015 ranged from $24.44 to $29.08 per share. The weighted average remaining contractual life is 5.2 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing with the following weighted average assumptions:

	Years Ended December 31,
	2015		2014		2013
Dividend yield		3.77%		3.57%		3.49%
Expected life		10 years		10 years		10 years
Expected volatility		24.35%		24.97%		25.91%
Risk-free interest rate		2.28%		2.17%		3.01%
Weighted average fair value of options granted	$	4.89	$	5.30	$	5.72

The expected volatility is based on historical volatility. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on historical exercise experience. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.

Proceeds from stock option exercises totaled $441,000 in 2015. Shares issued in connection with stock option exercises are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. During 2015, all the shares issued in connection with stock option exercises, 16,859 shares in total, were issued from available treasury shares.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 11 - STOCK BASED COMPENSATION (CONTINUED)

All share and per share data have been adjusted to give retroactive effect to the 10% stock dividend declared in 2013.

As of December 31, 2015, outstanding stock options consist of the following:



		Average				Average
	Options	Exercise		Remaining	Options	Exercise
	Outstanding	Price		Life, Years	Exercisable	Price
	16,174	$	27.62	0.3	16,174	$	27.62
	15,400		28.64	1.0	15,400		28.64
	15,400		28.41	2.0	15,400		28.41
	15,400		25.00	3.0	15,400		25.00
	14,397		25.99	4.0	14,397		25.99
	1,100		24.44	4.2	1,100		24.44
	18,700		25.25	5.0	18,700		25.25
	22,200		24.97	6.0	22,000		24.97
	23,100		27.05	7.0	23,100		27.05
	1,100		27.55	7.0	1,100		27.55
	2,000		28.95	7.7	2,000		28.95
	23,250		26.90	8.0	23,250		26.90
	12,000		29.08	9.0	12,000		29.08
	14,500		28.55	10.0	-		-
Total	194,521				180,021

A summary of the Company’s restricted stock activity and related information for the years ended December 31 is as follows:


	2015					2014
				Weighted-Average				Weighted-Average
	Number of			Grant Date		Number of		Grant Date
	Shares			Fair Value		Shares		Fair Value

Non-vested, beginning of year		9,300		$	29.08		-	$	-
Granted		6,650			28.55		9,300		29.08
Vested		(1,860	)		29.08		-		-
Forfeited		(280	)		29.08		-		-
Non-vested at December 31		13,810		$	28.82		9,300	$	29.08

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 12 - EARNINGS PER SHARE

The following table sets forth the computations of basic and diluted earnings per share:

	Years Ended December 31,
	2015		2014		2013
	(In Thousands, Except Per Share Data)

Numerator, net income	$	5,908	$	7,657	$	8,465

Denominator:
Weighted average shares outstanding		3,682		3,645		3,627
Less: Weighted average unvested restricted shares		(9)		-		-
Denominator: Basic earnings per share		3,673		3,645		3,627

Weighted average shares outstanding		3,682		3,645		3,627
Add: Dilutive effect of stock options		9		12		5
Denominator: Diluted earnings per share		3,691		3,657		3,632

Basic earnings per common share	$	1.60	$	2.10	$	2.33

Diluted earnings per common share	$	1.60	$	2.10	$	2.33

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 14,000, 12,500, and 129,000 for the years ended December 31, 2015, 2014 and 2013, respectively. All share and per share data have been restated to give retroactive effect to the 10% stock dividend paid in 2013.

NOTE 13 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

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:



	December 31,
	2015		2014
	(In Thousands)
Commitments to grant loans	$	19,704	$	23,070
Unfunded commitments under lines of credit		48,641		45,269
Standby letters of credit		5,286		5,660
	$	73,631	$	73,999

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 13 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS (CONTINUED)

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.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit when deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.

The fair value hierarchy prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

Level 1:		Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2:		Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3:		Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable (i.e. supported with little or no market activity).

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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

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


	Fair Value Measurement Reporting Date using
Description	Total		Level 1		Level 2		Level 3
December 31, 2015
Available for Sale:
U.S. Government agencies	$	9,169	$	-	$	9,169	$	-
States and political subdivisions		60,755		-		60,755		-
Corporate obligations		4,974		-		4,974		-
Mortgage-backed securities-government
sponsored entities		63,569		-		63,569		-
Equity securities-financial services		384		384		-		-
Total available for sale	$	138,851	$	384	$	138,467	$	-

December 31, 2014
Available for Sale:
U.S. Government agencies	$	28,975	$	-	$	28,975	$	-
States and political subdivisions		54,332		-		54,332		-
Corporate obligations		6,486		-		6,486		-
Mortgage-backed securities-government
sponsored entities		66,204		-		66,204		-
Equity securities-financial services		398		398		-		-
Total available for sale	$	156,395	$	398	$	155,997	$	-

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

	Fair Value Measurement Reporting Date using
Description	Total		Level 1		Level 2		Level 3
December 31, 2015
Impaired Loans	$	7,615	$	-	$	-	$	7,615
Foreclosed real estate		2,847		-		-		2,847


December 31, 2014
Impaired Loans	$	11,312	$	-	$	-	$	11,312
Foreclosed real estate		3,726		-		-		3,726

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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

	Quantitative Information about Level 3 Fair Value Measurements
(dollars in thousands)	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
December 31, 2015

Impaired loans	$	2,574	Appraisal of collateral(1)	Appraisal adjustments(2)	10% (10%)

Impaired loans	$	5,041	Present value of future cash flows	Loan discount rate	4-7% (5.61%)
				Probability of default	0%

Foreclosed real estate owned	$	2,847	Appraisal of collateral(1)	Liquidation Expenses(2)	10%

December 31, 2014

Impaired loans	$	11,312	Appraisal of collateral(1)	Appraisal adjustments(2)	6 - 33% (23.35%)

Foreclosed real estate owned	$	3,726	Appraisal of collateral(1)	Liquidation Expenses(2)	10%

(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable, less any associated allowance.
(2)	Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

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

The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2015 and 2014.

Cash and cash equivalents (carried at cost):

The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities:

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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

Loans receivable (carried at cost):

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

Impaired loans (generally carried at fair value):

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

As of December 31, 2015, the fair value investment in impaired loans totaled $9,228,000 which included three loans for $6,373,000 for which a valuation allowance of $1,613,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and twenty loans for $2,855,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan. As of December 31, 2015, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $2,044,000 over the life of the loans.

As of December 31, 2014, the fair value investment in impaired loans totaled $11,605,000 which included three loans for $2,973,000 for which a valuation allowance of $293,000 had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and fourteen loans for $8,632,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan. As of December 31, 2014, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $1,022,000 over the life of the loans.

Mortgage servicing rights (generally carried at cost):

The Company utilizes a third party provider to estimate the fair value of certain loan servicing rights. Fair value for the purpose of this measurement is determined by estimating potential revenues and expenses of the various loan pools to arrive at a net cash flow stream, and then utilize present value methodologies on the cash flow stream at a current market yield.

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.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

Restricted investment in Federal Home Loan Bank stock (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 except certificates of deposit which are at fair value):

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.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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

	Fair Value Measurements at December 31, 2015

	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	10,010	$	10,010	$	10,010	$	-	$	-
Securities		138,851		138,851		384		138,467		-
Loans receivable, net		552,627		559,416		-		-		566,714
Mortgage servicing rights		261		291		-		-		291
Regulatory stock		3,412		3,412		3,412		-		-
Bank owned life insurance		18,820		18,820		18,820		-		-
Accrued interest receivable		2,363		2,363		2,363		-		-

Financial liabilities:
Deposits		550,909		551,175		354,162		-		197,013
Short-term borrowings		53,235		53,235		53,235		-		-
Other borrowings		41,126		41,260		-		-		41,260
Accrued interest payable		957		957		957		-		-

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

	Fair Value Measurements at December 31, 2014

	Carrying		Fair
	Amount		Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	12,376	$	12,376	$	12,376	$	-	$	-
Securities		156,395		156,395		398		155,997		-
Loans receivable, net		495,260		507,833		-		-		507,833
Mortgage servicing rights		271		277		-		-		277
Regulatory stock		1,714		1,714		1,714		-		-
Bank owned life insurance		18,284		18,284		18,284		-		-
Accrued interest receivable		2,339		2,339		2,339		-		-

Financial liabilities:
Deposits		559,944		560,243		338,112		-		222,131
Short-term borrowings		25,695		25,695		25,695		-		-
Other borrowings		22,200		23,228		-		-		23,228
Accrued interest payable		966		966		966		-		-

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

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 15 – ACCUMULATED OTHER COMPREHENSIVE INCOME

The following tables present the changes in accumulated other comprehensive income (loss) (in thousands) by component, net of tax, for the years ended December 31, 2015 and 2014:


	Unrealized gains on
	available for sale
	securities (a)
Balance as of December 31, 2014	$	462
Other comprehensive income before reclassification		439
Amount reclassified from accumulated other comprehensive income		(413)
Total other comprehensive income		26
Balance as of December 31, 2015	$	488



	Unrealized gains on
	available for sale
	securities (a)
Balance as of December 31, 2013	$	(2,602)
Other comprehensive income before reclassification		3,836
Amount reclassified from accumulated other comprehensive income		(772)
Total other comprehensive income		3,064
Balance as of December 31, 2014	$	462

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

The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) (in thousands) for the year ended December 31, 2015:


	Amount Reclassified
	From Accumulated				Affected Line Item in
	Other				Consolidated
	Comprehensive				Statement of
Details about other comprehensive income	Income (Loss) (a)				Income

		Twelve months		Twelve months
		ended		ended
		December 31,		December 31,
		2015		2014
Unrealized gains on available for sale securities	$	626	$	1,170	Net realized gains on sales of securities
		(213)		(398)	Income tax expense
	$	413	$	772	Net of tax

(a)	Amounts in parentheses indicate debits to net income.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 16 – PROPOSED ACQUISITION OF DELAWARE BANCSHARES, INC.

On March 10, 2016, Norwood Financial Corp. (“Norwood Financial”) and its wholly owned subsidiary, Wayne Bank, and Delaware Bancshares, Inc. (“Delaware Bancshares”), and its wholly owned subsidiary, The National Bank of Delaware County (“NBDC Bank”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which Delaware Bancshares will merge with and into Norwood Financial, with Norwood Financial as the surviving corporation. Concurrent with the merger, it is expected that NBDC Bank will merge with and into Wayne Bank.

Under the terms of the Merger Agreement, each outstanding share of Delaware Bancshares common stock will be converted into either the right to receive $16.68 in cash or 0.6221 shares of Norwood Financial common stock or a combination of both. Not more than 25% of the merger consideration shall be paid in cash and the remainder will be paid in Norwood Financial common stock. In the event of a greater than 20% decline in market value of Norwood Financial common stock, Delaware Bancshares may, in certain circumstances, be able to terminate the Merger Agreement unless Norwood Financial increases the number of shares into which Delaware Bancshares common stock may be converted.

The senior management of Norwood Financial and Wayne Bank will remain the same following the merger. The directors of NBDC Bank will be invited to join a newly formed regional advisory board. Within 18 months of the merger, Norwood Financial and Wayne Bank will invite one member of the advisory board to join their boards.

The transaction is subject to customary closing conditions, including the receipt of regulatory approvals and approval by the shareholders of Delaware Bancshares. The merger is currently expected to be completed in the third quarter of 2016.

Each of the directors and executive officers of Delaware Bancshares have agreed to vote their shares in favor of the approval of the Merger Agreement at the shareholders’ meeting to be held to vote on the proposed transaction. If the merger is not consummated under certain circumstances, Delaware Bancshares has agreed to pay Norwood Financial a termination fee of $615,000.

The Merger Agreement also contains usual and customary representations and warranties that Norwood Financial and Delaware Bancshares made to each other as of specific dates. The assertions embodied in those representations and warranties were made solely for purposes of the contract between Norwood Financial and Delaware Bancshares, and may be subject to important qualifications and limitations agreed to by the parties in connection with negotiating its terms. Moreover, the representations and warranties are subject to a contractual standard of materiality that may be different from what may be viewed as material to shareholders, and the representations and warranties may have been used to allocate risk between Norwood Financial and Delaware Bancshares rather than establishing matters as facts.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

NOTE 17 - NORWOOD FINANCIAL CORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION

BALANCE SHEETS

	December 31,
	2015		2014
	(In Thousands)
ASSETS
Cash on deposit in bank subsidiary	$	2,151	$	1,846
Securities available for sale		384		398
Investment in bank subsidiary		95,895		94,268
Other assets		4,113		3,900
Total assets	$	102,543	$	100,412

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities	$	1,545	$	1,371
Stockholders’ equity		100,998		99,041
Total liabilities and stockholders' equity	$	102,543	$	100,412

STATEMENTS OF INCOME

	Years Ended December 31,
	2015		2014		2013
Income:	(In Thousands)
Dividends from bank subsidiary	$	4,574	$	4,377	$	4,216
Other interest income		11		10		9
		4,585		4,387		4,225
Expenses		313		346		267
		4,272		4,041		3,958
Income tax benefit		(103)		(114)		(88)
		4,375		4,155		4,046
Equity in undistributed earnings of subsidiary		1,533		3,502		4,419
Net Income	$	5,908	$	7,657	$	8,465
Comprehensive Income	$	5,934	$	10,721	$	3,066

STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2015		2014		2013
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	5,908	$	7,657	$	8,465
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of bank subsidiary		(1,533)		(3,502)		(4,419)
Other, net		(19)		177		(247)
Net Cash Provided by Operating Activities		4,356		4,332		3,799

CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised		441		691		575
Tax benefit of stock options exercised		16		17		39
ESOP purchase of shares from treasury stock		146		150		146
Acquisition of treasury stock		(127)		(179)		(319)
Cash dividends paid		(4,527)		(4,370)		(4,155)
Net Cash Used in Financing Activities		(4,051)		(3,691)		(3,714)
Net Increase (Decrease) in Cash and Cash Equivalents		305		641		85

CASH AND CASH EQUIVALENTS - BEGINNING		1,846		1,205		1,120
CASH AND CASH EQUIVALENTS - ENDING	$	2,151	$	1,846	$	1,205

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

INVESTOR INFORMATION

STOCK LISTING

Norwood Financial Corp stock is traded on the Nasdaq Global Market under the symbol NWFL. The following firms are known to make a market in the Company’s stock:


Boenning & Scattergood, Inc. West Conshohocken, PA 19428 800-883-1212		RBC Capital Markets Philadelphia, PA 19103 888-848-4677

Janney Montgomery Scott, LLC Scranton, PA 18503 800-638-4417		Stifel Nicolaus St,. Louis, MO 63102 314-342-2000

TRANSFER AGENT

Computershare, P.O. Box 30170, College Station, TX 77842. Stockholders who may have questions regarding their stock ownership should contact the Transfer Agent at 800-662-7232.

DIVIDEND CALENDAR

Dividends on Norwood Financial Corp common stock, if approved by the Board of Directors are customarily paid on or about February 1, May 1, August 1 and November 1.

AUTOMATIC DIVIDEND REINVESTMENT PLAN

The Plan, open to all shareholders, provides the opportunity to have dividends automatically reinvested into Norwood stock. Participants in the Plan may also elect to make cash contributions to purchase additional shares of common stock. Please contact the transfer agent for additional information.

SEC REPORTS AND ADDITIONAL INFORMATION

A copy of the Company’s annual report on Form 10-K for its fiscal year ended December 31, 2015 including financial statements and schedules thereto, required to be filed with the Securities and Exchange Commission is available on the Company’s website at www.waynebank.com under the Stockholder Services tab. A copy of the report may be obtained upon written request of any stockholder, investor or analyst by contacting William S. Lance, Executive Vice President, Chief Financial Officer and Secretary, Norwood Financial Corp., 717 Main Street, PO Box 269, Honesdale, PA 18431, 570-253-1455.

NORWOOD FINANCIAL CORP - 2015 CONSOLIDATED FINANCIAL REPORT

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