EX-13 3 ex-13.txt ANNUAL REPORT 2002 ANNUAL REPORT FOSTERING GROWTH AND PROGRESS SUMMARY OF OPERATIONS Summary Of Selected Financial Data (Dollars In Thousands, Except Per Share Data)
FOR THE YEARS ENDED DECEMBER 31 ------------------------------------------------------------------------------------------------------------ 2002 2001 2000 1999 1998 ------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME $ 13,951 $ 13,554 $ 13,067 $ 12,134 $ 11,741 PROVISION FOR LOAN LOSSES 630 695 480 470 720 ------------------------------------------------------------------------------------------------------------ OTHER INCOME 3,004 2,802 2,489 1,954 1,697 OTHER EXPENSE 10,349 9,858 9,712 8,596 8,089 ------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 5,976 5,803 5,364 5,022 4,629 INCOME TAX EXPENSE 1,623 1,601 1,504 1,514 1,393 NET INCOME $ 4,353 $ 4,202 $ 3,860 $ 3,508 $ 3,236 ------------------------------------------------------------------------------------------------------------ NET INCOME PER SHARE-- BASIC $ 2.55 $ 2.50 $ 2.32 $ 2.09 $ 1.93 NET INCOME PER SHARE-- DILUTED $ 2.52 $ 2.48 $ 2.31 $ 2.08 $ 1.91 CASH DIVIDENDS DECLARED 0.90 0.82 0.71 0.59 0.50 ------------------------------------------------------------------------------------------------------------ RETURN ON AVERAGE ASSETS 1.21% 1.25% 1.21% 1.19% 1.21% RETURN ON AVERAGE EQUITY 11.60% 12.54% 13.75% 12.81% 12.38% ------------------------------------------------------------------------------------------------------------ BALANCES AT YEAR-END TOTAL ASSETS $367,468 $346,029 $326,731 $314,827 $279,017 LOANS RECEIVABLE 217,970 214,194 216,477 205,160 186,919 TOTAL DEPOSITS 291,852 274,923 252,959 243,507 233,767 STOCKHOLDERS' EQUITY 40,125 35,116 31,370 26,654 27,728 TRUST ASSETS UNDER MANAGEMENT 60,102 57,533 54,542 57,980 52,493 ------------------------------------------------------------------------------------------------------------ BOOK VALUE PER SHARE $ 22.64 $ 20.05 $ 17.99 $ 15.28 $ 15.56 TIER 1 CAPITAL TO RISK ADJUSTED ASSETS 15.06% 13.78% 12.78% 11.98% 12.30% TOTAL CAPITAL TO RISK ADJUSTED ASSETS 16.57% 15.30% 14.27% 13.50% 14.00% ALLOWANCE FOR LOAN LOSSES TO TOTAL LOANS 1.44% 1.50% 1.52% 1.63% 1.78% NON-PERFORMING ASSETS TO TOTAL ASSETS 0.07% 0.21% 0.22% 0.24% 0.30% ------------------------------------------------------------------------------------------------------------
[GRAPHICS OMITTED] 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) for the years ended December 31, 2002, 2001, and 2000. 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 interest rates, risks associated with the effect of opening a new branch, the ability to control costs and expenses, 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 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. The most significant estimate in the preparation of the Company's financial statements are for the allowance for loan losses and accounting for stock options. 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 below. The Company accounts for their stock option plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. The Company currently has no intentions of adopting the expense recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Results of Operations - Summary Net income for the Company for the year 2002 was $4,353,000 compared to $4,202,000 for the year 2001. This represents an increase of $151,000 or 3.6% over the prior year. Basic and diluted earnings per share for 2002 were $2.55 and $2.52 increasing from $2.50 and $2.48, respectively, in 2001. The return on average assets (ROAA) for the year ended December 31, 2002 was 1.21%, with a return on average equity (ROAE) of 11.60%. The increase in earnings was principally attributable to a higher level of net interest income and growth in other income. Net interest income, on a fully taxable equivalent basis (fte), totaled $14,479,000 in 2002, compared to $14,041,000 in 2001. The improvement in net interest income was due to $22.1 million growth in average earning assets during 2002, which offset a declining net interest margin. -15- [GRAPHICS OMITTED] Other income for 2002 was $3,004,000, an increase of $202,000 or 7.2% over 2001. Other income represented 17.2% of total revenues in 2002, improving from 16.6% in 2001. Other expenses totaled $10,349,000 in 2002 compared to $9,858,000 in 2001, an increase of $491,000 or 5.0%. The increase in expenses was principally due to a higher level of losses on lease residuals and increased cost of various employee benefit plans. Net income for the Company for the year 2001 was $4,202,000 compared to $3,860,000 for the year 2000. This represents an increase of $342,000 or 8.9% over the prior year. Basic and diluted earnings per share for 2001 were $2.50 and $2.48 increasing from $2.32 and $2.31, respectively, in 2000. The return on average assets (ROAA) for the year ended December 31, 2001 was 1.25% with a return on average equity (ROAE) of 12.54%. The increase in earnings was principally attributable to a higher level of net interest income and growth in other income. Net interest income, on a fully taxable equivalent basis (fte), totaled $14,041,000 in 2001, compared to $13,424,000 in 2000. The improvement in net interest income was due to a $17.2 million growth in average earning assets during 2001. Other income for 2001 was $2,802,000, an increase of $313,000 or 12.6% over 2000. Other income represented 16.6% of total revenues in 2001, improving from 15.6% in 2000. Operating expenses totaled $9,858,000 in 2001 compared to $9,712,000 in 2000, an increase of $146,000 or 1.5%. The increase in expenses was principally due to costs associated with investments in technology, including an expanded Internet banking customer base and implementation of a new on-line teller system. [GRAPHICS OMITTED] FINANCIAL CONDITION Total Assets Total assets at December 31, 2002, were $367.5 million compared to $346.0 million at year-end 2001, an increase of $21.5 million or 6.2%. Loans Receivable Loans receivable, which include automobile leases, represent the most significant percentage of the Company's assets, at 59.3% of total assets. At December 31, 2002, total loans receivable were $218.0 million compared to $214.2 million at year-end 2001, an increase of $3.8 million. Loan growth in commercial and residential real estate was partially offset by a net run-off in indirect automobile financing, included in consumer loans to individuals, and lease financing. Residential real estate, which includes home equity lending, totaled $69.0 million at December 31, 2002, compared to $64.6 million at year-end 2001. This increase of $4.4 million is net of prepayments and refinancing activity. In the low interest rate environment during 2002, fixed rate mortgage products were preferred by customers and accounted for the majority of the activity. The Company sells a portion of its longer-term fixed rate residential loan production for interest rate risk management, with $5.4 million sold into the secondary market during 2002. The Company's indirect lending portfolio (included in consumer loans to individuals) declined $8.6 million to $39.4 million at December 31, 2002. A portion of the net decrease may be attributable to the significant financing incentives offered by the automakers throughout 2002. In addition, the Company is focusing its efforts on increasing direct and real estate lending through its branch network. The Company stopped automobile lease originations during the third quarter of 1999. This was done to monitor experience in early terminations, amount of off-lease vehicles returned and the market values of vehicles returned -16- compared to residual values. As a result, total leases declined $4.5 million in 2002 to $1.6 million at December 31, 2002. Losses on lease residuals (included in other expense) totaled $870,000 for 2002. The Company maintains a reserve for residual losses (included in other liabilities), which totaled $213,000 at December 31, 2002, with a residual value in the remaining portfolio of $1.3 million compared to a $225,000 reserve, and $5.1 million of residual value at the prior year-end. The Company liquidates its returned off-lease vehicles through various used car dealers and automobile auction centers. At December 31, 2002, the Company had an inventory of automobiles to liquidate of $166,000 (included in other assets), decreasing significantly from $620,000 at December 31, 2001. Commercial loans consist principally of loans made to small businesses within the Company's market and are usually secured by real estate and other assets of the borrower. Commercial and commercial real estate loans totaled $94.7 million at December 31 2002, increasing from $81.1 million in 2001, an increase of $13.6 million or 16.8%. The growth in commercial lending was centered in the Pike and Monroe County market areas. [GRAPHICS OMITTED] Non-Performing Assets and Allowance for Loan Losses Non-performing assets consist of non-performing loans and real estate acquired through 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 income is reversed from current earnings. At December 31, 2002, non-performing loans totaled $221,000 and represented .10% of total loans receivable compared to $683,000 and .32% at year-end 2001. Total non-performing assets which includes foreclosed real estate totaled $242,000 and represented .07% of total assets, declining significantly from $737,000 and .21% at December 31, 2001. During 2002, the Company sold its two largest non-performing assets, which were loans secured by commercial properties. The allowance for loan losses totaled $3,146,000 at year-end 2002 and represented 1.44% of total loans receivable compared to $3,216,000 and 1.50% of total loans at year-end 2001. Net charge-offs for 2002 were $700,000, consisting principally of losses on the sale of repossessed automobiles, compared to net charge-offs of $779,000 in 2001. The provision for loan losses for 2002 was $630,000 compared to $695,000 in 2001 with the decrease due to a lower level of net charge-offs in 2002 and less non-performing loans. 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: concentration of credit in specific industries; economic and industry conditions; trends in delinquencies, large dollar exposures and growth. Management considers the allowance at December 31, 2002, adequate for the loan mix and classifications. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future. -17- The following table sets forth information with respect to the Company's allowance for loan losses at the dates indicated:
Year-ended December 31, ----------------------------------------------------------- (in thousands) 2002 2001 2000 1999 1998 ----------------------------------------------------------- Allowance balance as beginning of period $ 3,216 $ 3,300 $ 3,344 $ 3,333 $ 3,250 Charge-Offs: Commercial and all other (34) (12) - (12) (294) Real Estate (122) (11) (9) (17) (14) Consumer (608) (711) (589) (419) (366) Lease Financing (30) (152) (170) (184) (115) ----------------------------------------------------------- Total (794) (886) (768) (632) (789) Recoveries: Commercial and all other - 8 54 74 89 Real Estate 13 1 73 - 7 Consumer 72 85 88 83 50 Lease Financing 9 13 29 16 6 ----------------------------------------------------------- Total 94 107 244 173 152 Provision expense 630 695 480 470 720 ----------------------------------------------------------- Allowance balance at end of period $ 3,146 $ 3,216 $ 3,300 $ 3,344 $ 3,333 ===========================================================
Allowance for loan losses as a percent of total loans outstanding 1.44% 1.50% 1.52% 1.63% 1.78% Net loans charged off as a percent of average loans outstanding .33% .36% .25% .23% .34% Allowance for loan losses as a percent of non-performing loans 1,423.5% 470.9% 484.6% 508.9% 535.8%
The following table sets forth information regarding non-performing assets. The Bank had no troubled debt restructurings as defined in SFAS No. 114. As of December 31, 2002, there were no loans not previously discussed where known information about possible credit problems of borrowers cause management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms. Year-ended December 31, -------------------------------------- (in thousands) 2002 2001 2000 1999 1998 -------------------------------------- Non-accrual loans: Commercial and all other $ - $ 64 $ 64 $ 64 $ 65 Real estate 213 597 518 513 503 Consumer 3 11 - 19 20 -------------------------------------- Total 216 672 582 596 588 Accruing loans which are contractually past due 90 days or more 5 11 98 61 34 -------------------------------------- Total non-performing loans 221 683 680 657 622 Foreclosed real estate 21 54 27 110 204 -------------------------------------- Total non-performing assets $242 $737 $707 $767 $826 ====================================== Non-performing loans to total loans .10% .32% .31% .32% .33% Non-performing loans to total assets .06% .20% .21% .21% .22% Non-performing assets to total assets .07% .21% .22% .24% .30% -18- Securities The securities portfolio consists principally of issues of United States Government agencies, including mortgage-backed securities; municipal obligations, and corporate debt. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company classifies its investments into two categories: held to maturity (HTM) and available for sale (AFS). The Company does not have a trading account. Securities classified as HTM are those in which the Company has the ability and the intent to hold the security until contractual maturity. At December 31, 2002, the HTM portfolio totaled $6.2 million and consisted of longer-term municipal obligations. 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 as an adjustment to capital and reported in the equity section of the balance sheet as other comprehensive income. At December 31, 2002, $114.8 million in securities were so classified and carried at their fair value, with unrealized appreciation; net of tax, of $2,491,000, included in Accumulated other comprehensive income in stockholders' equity. At December 31, 2002, the average life of the portfolio was 2.3 years compared to 3.5 years at the prior year-end. The decrease was due to increased cash flow from the mortgage-backed securities, which were impacted by the low interest rate environment in 2002 and the purchase of short-term callable US Government Agency bonds. Total purchases for the year were $69.4 million with securities called, maturities and cash flow of $46.3 million and sales of $6.5 million. The purchases were funded principally by cash flow from the portfolio and deposit growth. At December 31, 2002, the Company's securities portfolio (HTM and AFS) totaled $121.0 million with the mix as follows: U.S. Government agencies 27.4%; mortgage-backed securities, 44.1%; municipal obligations, 17.7%; corporate obligations, 9.4% and equity securities of other financial institutions, 1.4%. The portfolio had $13.2 million of adjustable rate instruments at December 31, 2002. The portfolio contained no structured notes, step-up bonds and no off-balance sheet derivatives were in use. The portfolio totaled $102 million at year-end 2001. Deposits The Company, through the ten 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 (CD) 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. Total deposits at December 31, 2002, were $291.9 million increasing from $274.9 million at year-end 2001, an increase of $17.0 million or 6.2%. The increase was principally in core transaction accounts and retail time deposits. Interest bearing demand deposits, which are principally retail checking accounts, increased $5.5 million, or 15.6%, to $40.4 million. The Company's premium money market product, the Investor Account (included in money market deposit accounts), increased $3.8 million, or 33.4% to $15.3 million. In addition, savings deposit products increased $6.7 million, or 15%, to $51.6 million. Time deposits over $100,000, which consist principally of school district and other public funds, with maturities generally less than one year, were $29.5 million at December 31, 2002, compared to $27.4 million at year-end 2001. -19- These deposits are subject to competitive bid and the Company bases its bid on current interest rates, loan demand, investment portfolio structure and relative cost of other funding sources. As of December 31, 2002, non-interest bearing demand deposits totaled $33.5 million, increasing $1.7 million from the prior year-end. These are principally commercial deposits. In addition, the Company has $7.5 million of cash management accounts included in short-term borrowings. These balances represent commercial customers' excess funds invested in over-night securities, which the Company considers 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 ALCO is to maximize net interest income within acceptable levels of risk, which are established by policy. Interest rate risk is monitored and managed by using financial modeling techniques to measure the impact of changes in interest rates. Net interest income, which is the primary source of the Company's earnings, is impacted by changes in interest rates and the relationship of different interest rates. To manage the impact of the rate changes, the balance sheet must be structured so that repricing opportunities exist for both assets and liabilities at approximately the same time intervals. The Company uses net interest simulation to assist in interest rate risk management. The process includes simulating various interest rate environments and their impact on net interest income. At December 31, 2002, the level of net interest income at risk in a 200 basis points increase or decrease was within the Company's policy limits. Imbalance 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 indications of potential interest rate exposures over specific intervals. At December 31, 2002, the Bank had a positive 90 day interest sensitivity gap of $31.7 million or 8.6% of total assets. A positive gap means that rate-sensitive assets are greater than rate-sensitive liabilities at the time interval. This would indicate that in a declining rate environment, the yield on interest-earning assets would decrease faster than the cost of interest-bearing liabilities in the 90 day time frame. The repricing intervals are managed by ALCO strategies, including adjusting the average life of the investment portfolio, pricing of deposit liabilities to attract longer term time deposits, loan pricing to encourage variable rate products and evaluation of loan sales of longer term mortgages. The Company analyzes and measures the time periods in which rate sensitive assets (RSA) and rate sensitive liabilities (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. 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 -20- service their adjustable-rate debt may decrease in the event of an interest rate increase. The operating results of the Company are not subject to foreign currency exchange or commodity price risk. The following table displays interest-sensitivity as of December 31, 2002 (in thousands)
3 Months 3 through 1 through Greater Than or Less 12 Months 3 Years 3 Years Total --------------------------------------------------------- Federal Funds sold and Interest bearing deposits $ 6,665 $ - $ - $ - $ 6,665 Securities (1) 29,034 32,698 39,885 19,430 121,047 Loans Receivable (1) 71,019 35,145 50,141 61,665 217,970 --------------------------------------------------------- Total rate sensitive assets (RSA) $106,718 $ 67,843 $ 90,026 $ 81,095 $345,682 ========================================================= Non-maturity interest Bearing deposits(2) $ 22,872 $ 29,618 $ 78,454 $ -- $130,944 Time Deposits 31,258 63,693 20,239 12,265 127,455 Other 20,862 2,637 3,517 5,000 32,016 --------------------------------------------------------- Total rate sensitive liabilities (RSL) $ 74,992 $ 95,948 $102,210 $ 17,265 $290,415 ========================================================= Interest sensitivity gap $ 31,726 ($28,105) ($12,184) $ 63,830 $ 55,267 Cumulative gap 31,726 3,621 (8,563) 55,267 RSA/RSL-cumulative 142.3% 102.1% 96.9% 119.0%
(1) Included in the period in which interest rates are next scheduled to adjust or in which they are due. Prepayment speeds are based on historical experience and management judgment. (2) Non-maturity deposits are generally subject to immediate withdrawal. However, based on retention experience in various interest rate environments, management considers the deposits to have longer effective maturities. Liquidity Liquidity can be viewed as 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, cash flow from asset maturities, loan repayments and securities. At December 31, 2002, the Company had cash and cash equivalents of $16.2 million in the form of cash, due from banks, federal funds sold and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $114.8 million, which could be used for liquidity needs. This totals $131.0 million and represents 35.7% of total assets compared to $113.1 million and 32.7% of total assets at December 31, 2001. The Company also monitors other liquidity measures, all of which were within the Company's policy guidelines at December 31, 2002. The Company believes its liquidity position is adequate. The Company maintains established lines of credit with the Federal Home Loan Bank of Pittsburgh (FHLB) and other correspondent banks, which support liquidity needs. The approximate borrowing capacity from the FHLB was $120.4 million. At year-end 2002, the Company had $23 million in borrowings from the FHLB, decreasing from $25 million at December 31, 2001. 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, at -21- December 31, 2002 totaled $33,501,000. This consisted of $10,438,000 in commercial real estate, construction, and land development loans, $4,290,000 in home equity lines of credit, $1,298,000 in standby letters of credit and the remainder in other unused commitments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present 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 wtih 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 on and off balance sheet contractual obligations to make future payments. Contractual Obligations December 31, 2002 -------------------------------------------------------------- Less Than 1 Year 1-3 Years 4-5 Years Over 5 Years Total -------------------------------------------------------------- (In Thousands) Time Deposits $ 94,952 $ 20,239 $ 12,264 $ -- $ 127,455 Long Term Debt -- 5,000 5,000 13,000 23,000 Operating Leases 101 156 27 -- 284 -------------------------------------------------------------- $ 95,053 $ 25,395 $ 17,291 $ 13,000 $ 150,739 ============================================================== The Company is not aware of any known trends or any known demands, commitments, events or uncertainties, which would result in any material increase or decrease in liquidity. Results of Operations Net Interest Income Net interest income is the difference between income earned on loans and securities and interest paid on deposits and borrowings. For the year ended December 31, 2002, net interest income on a fully taxable basis (fte) was $14,479,000 an increase of $438,000 or 3.1%, over 2001. The resulting fte net interest spread and net interest margin for 2002 were 3.82% and 4.26%, respectively, compared to 3.76% and 4.42%, respectively, in 2001. Interest income (fte) for the year ended December 31, 2002 totaled $22,092,000 compared to $24,251,000 in 2001. The decrease was principally due to lower interest rates in 2002, with an average prime rate of 4.67% and Federal Funds target rate of 1.67%, compared to 6.86% and 3.86%, respectively, on average, for 2001. As a result of the lower interest rates, the yield on earning assets declined 113 basis points, to 6.51% in 2002. The earning asset yield was also unfavorably impacted by a change in the asset mix, as a result of deposits increasing more than loans. On average in 2002, loans represented 63.0% of earning assets compared to 67.7% in 2001. The offset was an increase in lower yielding Federal Funds sold, 4.6% of average earning assets compared to 2.6% in 2001, and AFS securities, 30.5% of average earning assets, increasing from 27.5%. Interest income earned on loans totaled $15,651,000 with a yield of 7.32% in 2002 decreasing from $17,934,000 with a yield of 8.35% in 2001. The decline in the yield was due in part to the lower interest rate environment with an average prime rate of 4.67% in 2002 compared to 6.86% in 2001. Loans averaged $213.8 million in 2002, compared to $214.9 million in 2001. -22- Securities available for sale averaged $103.6 million in 2002 with an fte interest income of $5,633,000 and a yield of 5.44% compared to $87.2 million, $5,450,000 and 6.25%, respectively, in 2001. The decrease in yield was principally due to the lower interest rate environment in 2002. During 2002, cash flows on mortgage-backed securities increased in the lower interest rate environment. These amounts were generally reinvested in lower coupon mortgage-backed securities, callable US Government agency securities and short-term tax-exempt municipal obligations. Interest expense for the year-end December 31, 2002 totaled $7,613,000, declining from $10,210,000 in 2001. The average cost of interest-bearing liabilities in 2002 was 2.69%, a decrease of 119 basis points from 3.88% in 2001. In the lower rate environment of 2002, the Company was able to reduce its cost of interest bearing deposits to 2.45% from 3.65% in 2001. Federal Funds sold, which represent overnight investments of liquidity, increased in 2002, as deposit growth exceeded loan activity. For 2002, Federal Funds averaged $15.6 million at a yield of 1.66% compared to $8.3 million and 3.15% in 2001. For the year ended December 31, 2001, net interest income on a fully taxable basis (fte) was $14,041,000, an increase of $617,000 or 4.6% over 2000. The resulting fte net interest spread and net interest margin for 2001 were 3.76% and 4.42%, respectively, compared to 3.84% and 4.47% over 2000. Total fte interest income for 2001 was $24,251,000, a decrease of $50,000 from the prior year. Interest rates declined significantly during 2001. At December 31, 2001, the prime rate was 4.75%, federal funds target rate was 1.75% and the Two Year Treasury Note was 3.02%, compared to 9.50%, 6.50% and 4.86%, respectively at year-end 2000. As a result, the earning asset yield decreased 45 basis points to 7.64% from 8.09% in 2000. This decline was partially offset by the earnings on $17.2 million growth in average earning assets. Interest expense totaled $10,210,000 for 2001, declining from $10,877,000 in 2000. With the generally lower interest rate environment in 2001, the Company's cost of interest-bearing liabilities decreased to 3.88% from 4.25% in the prior year. As a result of a 45 basis point decrease in the earning asset yield partially offset by a 37 basis point decrease in cost of interest-bearing liabilities, net interest spread declined 8 basis points to 3.76% compared to 3.84% in 2000. Net interest margin, which is the measurement of the net return on earning assets, also decreased 5 basis points to 4.42% in 2001 from 4.47%. The net interest margin was unfavorably impacted by the mix of earning asset growth, with 78% of the growth due to securities and short-term investments and 22% in loans, with the securities and short-term investments at a yield of 5.98%, which is lower than the 8.35% yield on loans. Interest income earned on loans totaled $17,934,000 with a yield of 8.35% in 2001 decreasing from $18,217,000 with a yield of 8.63% in 2000. The decline in the yield was due in part to the lower interest rate environment with an average prime rate of 6.86% in 2001 compared to 9.35% in 2000. Average loans increased $3.7 million to $214.9 million. Loans receivable represented 67.7% of average earning assets in 2001. Securities available for sale averaged $87.2 million in 2001 with an fte interest income of $5,450,000 and a yield of 6.25% compared to $80.8 million, $5,399,000 and 6.68%, respectively, in 2000. The decrease in yield was principally due to the lower interest rate environment in 2001. During 2001, cash flows on mortgage-backed securities increased in the lower interest rate environment. These amounts were generally reinvested in lower coupon mortgage-backed securities, short-term corporate bonds and tax-exempt municipal obligations. -23- Interest-bearing deposits averaged $230.9 million increasing $15.8 million from the average in 2000. The cost of interest bearing deposits for 2001 was 3.65% compared to 3.97% in 2000. Other borrowings, which consist of advances from the FHLB, decreased on average to $24.5 million in 2001, compared to $33.9 in 2000. The Company used deposit growth to pay-off the borrowings. Federal Funds sold, which represent overnight investments of liquidity increased in 2001, as deposit growth exceeded loan activity. For 2001, Federal Funds averaged $8.3 million at a yield of 3.15% compared to $521,000 and 5.95% in 2000. Other Income Other income totaled $3,004,000 in 2002, an increase of $202,000 or 7.2% over the $2,802,000 in 2001. Other income represented 17.2% of total revenues increasing from 16.6% in 2001. Service charges and fees were $1,788,000 in 2002 compared to $1,661,000 in 2001, an increase of $127,000. The increase is due in part to growth in fee-based retail deposit accounts, with service charges increasing $66,000, and debit card activity, which generated $166,000 in revenues, increasing from $134,000 in 2001. In addition, fees related to non-sufficient funds (nsf) in checking accounts increased $64,000, due to increased volume. Income from fiduciary activities was $236,000 in 2002 compared to $256,000 in 2001, with the decrease principally due to a lower level of estate fees in 2002. Commissions on sales of annuities and mutual funds were $136,000 on sales of $4.9 million in 2002, declining from revenues of $267,000 on sales of $9.2 million in 2001. In 2002, the Company sold $5.4 million of residential mortgages into the secondary market at a gain of $82,000 compared to $2.2 million of loans sold, at a gain of $48,000 in 2001. The loans sold were principally 30-year mortgages with coupons above the current market rate. The Company had net gains on sales of securities of $427,000 compared to $212,000 in 2001. The Company sold selected equity holdings of other financial institutions, which appeared attractively priced and corporate bonds. Other income totaled $2,802,000 in 2001, an increase of $313,000 or 12.6% over 2000. Other income represented 16.6% of total revenues increasing from 15.6% in 2000. Service charges and fees were $1,661,000 in 2001 compared to $1,486,000 in 2000, an increase of $175,000. The increase is due in part to growth in fee-based retail checking accounts, which increased by $52,000, and the Wayne Bank Visa Check Card which generated $134,000 in revenues, increasing from $97,000 in 2000. In addition, loan related fees, which include documentation charges and fees related to a loan promotion, increased $62,000. Commissions on sales of mutual funds, annuities and discount brokerage through Norwood Investment Corp totaled $267,000 on sales of $9.2 million compared to $201,000 in revenues on sales of $6.8 million in 2000. In 2000, the Company sold its portfolio of mortgage servicing rights (MSR) for a net gain of $105,000 with a total gain on MSR and residential mortgage loans sold of $231,000, compared to a $48,000 gain on loans sold in 2001. Earnings on the cash surrender value (CSV) of bank owned life insurance (BOLI), the proceeds of which were used to fund employee benefit plans, were $199,000 compared to $166,000 in 2000. Income on fiduciary activities totaled $256,000 for 2001, compared to $288,000 in 2000. The decrease was due in part to a lower level of estate income in 2001. -24- The Company had $212,000 in net realized gains on sales of securities in 2001, compared to $35,000 in 2000. The increase was due to gains on the sale of selected longer-term mortgage-backed securities, shorter-term corporate bonds and an equity holding of another bank. Other Income (dollars in thousands) For the year-ended December 31 2002 2001 2000 ------------------------- Service charges on Deposit Accounts $ 415 $ 358 $ 292 ATM Fees 187 167 144 NSF Fees 571 507 509 Merchant Card Processing 88 111 114 Loan related service fees 254 240 183 Debit Card 166 134 97 Fiduciary activities 236 256 288 Mutual Funds & Annuities 136 267 201 Gain on Sales of MSR & Loans 82 48 231 CSV on Life Insurance 203 199 166 Other Income 239 303 229 Net realized gains on sales of securities 427 212 35 ------------------------ Total $3,004 $2,802 $2,489 ======================== Other Expenses Other expenses totaled $10,349,000 in 2002, an increase of $491,000 or 5.0% over $9,858,000 in 2001. Salaries and employee benefit costs, which represented 46.8% of total other expense, were $4,847,000, for 2002, an increase of $205,000 or 4.4%. The increase was principally due to increasing costs of health insurance and other benefit plans. Losses on lease residuals were $870,000 in 2002 increasing from $630,000 in 2001. The increase was principally due to higher number of cars liquidated in 2002 and a soft used car market. The scheduled lease terminations for 2003 are 66, significantly less than the 259 scheduled in 2002. These losses were partially offset by lease termination fee income, included in other income, of $36,000 in 2002 and $64,000 in 2001. Professional fees were $186,000 in 2002 compared to $211,000 in 2001, with the decrease due to lower consulting and legal fees as a result of less expense related to problem loans. Other expenses totaled $9,858,000 in 2001, an increase of $146,000 or 1.5% over $9,712,000 in 2000. Salaries and employee benefit costs, which represented 47.1% of total other expense, were $4,642,000 for 2001, an increase of $287,000 or 6.6%. The increase was principally due to increasing costs of various employee benefit plans, incentive plans and higher staffing levels. Data processing related expense for 2001 was $521,000 compared to $432,000 in 2000. The increase was due to higher account charges from a third party provider, expanded customer activity in telephone and Internet banking and the installation of an on-line teller system. Losses on lease residuals were $630,000 in 2001 decreasing from $910,000 in 2000. The decrease was principally due to a lower reserve at year-end, as the leasing portfolio at December 31,2001, was $6.1 million compared to $13.6 million at prior year-end. These losses were partially offset by lease termination fee income, included in other income, of $64,000 in 2001 and $72,000 in 2000. Professional fees were $211,000 in 2001 compared to $248,000 in 2000, with the decrease due to lower legal fees as a result of litigation settled in 2000. -25- Income Taxes Income tax expense for the year 2002 was $1,623,000 for an effective tax rate of 27.2%, compared to an expense of $1,601,000 and an effective rate of 27.6% in 2001. The decrease in the effective tax rate is principally due to higher levels of interest income on municipal securities, which is not subject to Federal Income Tax. Income tax expense for the year 2001 was $1,601,000 for an effective tax rate of 27.6%, compared to an expense of $1,504,000 and an effective rate of 28.0% in 2000. The decrease in the effective tax rate is principally due to higher levels of interest income on municipal securities, which is not subject to Federal Income Tax. Capital and Dividends Total stockholders' equity at December 31, 2002, was $40.1 million, compared to $35.1 million at year-end 2001. The increase was principally due to retention of earnings of $2,817,000 after cash dividends declared of $1,536,000, and a $1,489,000 increase in accumulated other comprehensive income due to market value changes in the Company's AFS securities portfolio principally as a result of decreasing interest rates. At December 31, 2002 the Company had a leverage capital ratio of 10.13%, Tier 1 risk-based capital of 15.06% and total risk-based capital of 16.57% compared to 9.93%, 13.78% and 15.30%, respectively, in 2001. The following table sets forth the price range and cash dividends declared per share regarding common stock for the period indicated: Closing Price Range ----------------------- Cash dividend High Low paid per share ------------------------------------------- Year 2002 --------- First Quarter $ 27.00 $ 25.50 $ .22 Second Quarter 29.50 26.10 .22 Third Quarter 30.40 28.30 .22 Fourth Quarter 30.25 28.35 .24 Year 2001 --------- First Quarter $ 20.50 17.25 $ .20 Second Quarter 22.70 19.625 .20 Third Quarter 27.10 21.25 .20 Fourth Quarter 26.75 25.00 .22 The book value of the common stock was $22.64 per share at December 31, 2002 compared to $20.05 at prior year-end. At year-end 2002, the stock price was $29.79 per share, compared to $26.11 at December 31, 2001. -26- NORWOOD FINANCIAL CORP Summary of Quarterly Results (unaudited) (Dollars in thousands, except per share amounts)
2002 December 31 September 30 June 30 March 31 --------------------------------------------- Net interest income $3,479 $3,528 $3,494 $3,450 Provision for loan losses 150 150 150 180 Other income 620 755 931 698 Other expense 2,385 2,540 2,856 2,568 --------------------------------------------- Income before income taxes 1,564 1,593 1,419 1,400 Income tax expense 435 439 378 371 --------------------------------------------- NET INCOME $1,129 $1,154 $1,041 $1,029 ========================================== Basic earnings per share $ 0.66 $ 0.68 $ 0.61 $ 0.61 ========================================== Diluted earnings per share $ 0.65 $ 0.67 $ 0.60 $ 0.60 ==========================================
2001 December 31 September 30 June 30 March 31 --------------------------------------------- Net interest income $3,478 $3,429 $3,361 $3,286 Provision for loan losses 150 175 200 170 Other income 772 670 694 666 Other expense 2,523 2,421 2,464 2,450 --------------------------------------------- Income before income taxes 1,577 1,503 1,391 1,332 Income tax expense 454 409 375 363 --------------------------------------------- NET INCOME $1,123 $1,094 $1,016 $ 969 ========================================== Basic earnings per share $ 0.67 $ 0.65 $ 0.60 $ 0.58 ========================================== Diluted earnings per share $ 0.66 $ 0.64 $ 0.60 $ 0.58 ==========================================
-27- Norwood Financial Corp. Consolidated Average Balance Sheets with Resultant Interest and Rates (Tax-Equivalent Basis, dollars in thousands)
Year Ended December 31 ------------------------------------------------------------------------------------------ 2002 2001 2000 ------------------------------------------------------------------------------------------ Average Avg. Average Avg. Average Avg. Balance(2) Interest(1) Rate Balance(2) Interest(1) Rate Balance(2) Interest(1) Rate ------------------------------------------------------------------------------------------ ASSETS Interest Earning Assets Federal funds sold $ 15,573 $ 258 1.66% $ 8,322 $ 262 3.15% $ 521 $ 31 5.95% Interest bearing deposits with banks 346 5 1.45 162 6 3.70 210 6 2.86 Securities held to maturity 6,212 545 8.77 6,822 599 8.78 7,480 648 8.66 Securities available for sale Taxable 89,956 4,623 5.14 76,139 4,646 6.10 76,537 5,082 6.64 Tax-exempt 13,616 1,010 7.42 11,086 804 7.25 4,292 317 7.39 ---------------------- ------------------- -------------------- Total securities available for sale 103,572 5,633 5.44 87,225 5,450 6.25 80,829 5,399 6.68 Loans Receivable(3,4) 213,814 15,651 7.32 214,905 17,934 8.35 211,174 18,217 8.63 ---------------------- ------------------- -------------------- Total interest earnings assets 339,517 22,092 6.51 317,436 24,251 7.64 300,214 24,301 8.09 Non-interest earning assts Cash and due from banks 8,452 7,559 7,130 Allowance for loan losses (3,228) (3,268) (3,354) Other assets 14,093 14,264 15,245 -------- -------- -------- Total non-interest earning assets 19,317 18,555 19,021 -------- -------- -------- TOTAL ASSETS $358,834 $335,991 $319,235 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Interest- bearing liabilities: Interest-bearing demand and Money Market $ 74,696 730 0.98 $ 66,101 1,298 1.96 $ 60,822 1,515 2.49 Savings 48,361 648 1.34 42,631 792 1.86 42,492 933 2.20 Time 127,571 4,761 3.73 122,161 6,329 5.18 111,778 6,097 5.45 ---------------------- ------------------- -------------------- Total interest- bearing deposits 250,628 6,139 2.45 230,893 8,419 3.65 215,092 8,545 3.97 Short-term borrowings 9,550 176 1.84 7,781 295 3.79 6,914 303 4.38 Other borrowings 23,230 1,298 5.59 24,450 1,496 6.12 33,883 2,029 5.99 ---------------------- ------------------- -------------------- Total interest-bearing liabilities 283,408 7,613 2.69 263,124 10,210 3.88 255,889 10,877 4.25 Non-interest bearing demand 33,966 31,407 29,525 Other liabilities 3,949 7,942 5,746 -------- -------- -------- Total non-interest bearing liabilities 37,915 39,349 35,271 -------- -------- -------- Shareholders' equity 37,511 33,518 28,075 -------- -------- -------- TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $358,834 $335,991 $319,235 ======== ======== ======== Net interest income (tax-equivalent basis) 14,479 3.82% 14,041 3.76% $ 13,424 3.84% ==== ==== ==== Tax -equivalent basis adjustment (528) (487) (357) ------- ------- -------- Net interest income $13,951 $13,554 $ 13,067 ======= ======= ======== Net interest margin(tax-equivalent basis) 4.26% 4.42% 4.47% ==== ==== ====
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 deferred fees, net of costs. -28- RATE/VOLUME ANALYSIS The following table shows fully taxable equivalent effect of changes in volume and rate on interest income and interest expense.
Increase/(Decrease) -------------------------------------------------------------- 2002 Compared to 2001 2001 Compared to 2000 (dollars in thousands) Variance Due to Variance Due to ------------------------------ ----------------------------- INTEREST EARNING ASSETS: Volume Rate Net Volume Rate Net ------------------------------------------------------------------------------- ----------------------------- Federal funds sold $ 158 $ (162) $ (4) $ 252 $ (21) $ 231 Interest bearing deposits with banks 4 (5) (1) (2) 2 - Securities held to maturity (54) - (54) (58) 9 (49) Securities available for sale Taxable 772 (795) (23) (26) (410) (436) Tax-exempt 186 20 206 493 (6) 487 ----------------------------- ----------------------------- Total securities available for sale 958 (775) 183 467 (416) 51 Loans Receivable (91) (2,192) (2,283) 318 (601) (283) ----------------------------- ----------------------------- Total interest earning assets 976 (3,135) (2,159) 977 (1,027) (50) INTEREST BEARING LIABILITIES: ------------------------------------------------------------------------------- ----------------------------- Interest-bearing demand and money market 151 (719) (568) 123 (340) (217) Savings 97 (241) (144) 3 (144) (141) Time 270 (1,838) (1,568) 547 (315) 232 ----------------------------- ----------------------------- Total interest-bearing deposits 518 (2,798) (2,280) 673 (799) (126) Short-term borrowings 56 (175) (119) (76) 68 (8) Other borrowings (72) (126) (198) (399) (134) (533) ----------------------------- ----------------------------- Total interest bearing liabilities 502 (3,099) (2,597) 198 (865) (667) Net interest income (tax-equivalent basis) $ 474 $ (36) $ 438 $ 779 $ (162) $ 617 ============================= ==============================
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. -29- Beard Miller Company LLP -------------------------------------------- Certified Public Accountants and Consultants -------------------------------------------- INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders Norwood Financial Corp. Honesdale, Pennsylvania We have audited the accompanying consolidated balance sheets of Norwood Financial Corp. and its subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norwood Financial Corp. and its subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/Beard Miller Company LLP Harrisburg, Pennsylvania January 24, 2003 -30- CONSOLIDATED BALANCE SHEETS
December 31, ASSETS 2002 2001 ---------------------- (In Thousands) Cash and due from banks $ 9,579 $ 9,645 Interest bearing deposits with banks 230 111 Federal funds sold 6,435 7,580 ---------------------- Cash and Cash Equivalents 16,244 17,336 Securities available for sale 114,843 95,793 Securities held to maturity, fair value 2002 $6,504; 2001 $6,464 6,204 6,226 Loans receivable, net of allowance for loan losses 2002 $3,146; 2001 $3,216 214,824 210,978 Investment in FHLB stock, at cost 1,637 1,400 Bank premises and equipment, net 5,986 6,037 Accrued interest receivable 1,799 1,879 Other assets 5,931 6,380 ---------------------- Total Assets $ 367,468 $ 346,029 ====================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Non-interest bearing demand $ 33,453 $ 31,715 Interest-bearing demand 40,407 34,939 Money market deposit accounts 38,908 34,360 Savings 51,629 44,894 Time 127,455 129,015 ---------------------- Total Deposits 291,852 274,923 Short-term borrowings 9,016 6,641 Long-term debt 23,000 25,000 Accrued interest payable 1,654 2,326 Other liabilities 1,821 2,023 ---------------------- Total Liabilities 327,343 310,913 ---------------------- STOCKHOLDERS' EQUITY Common stock, par value $.10 per share; authorized 10,000,000 shares; issued 1,803,824 shares 180 180 Surplus 4,762 4,687 Retained earnings 34,082 31,265 Treasury stock, at cost 2002 31,506 shares; 2001 52,591 shares (640) (1,066) Accumulated other comprehensive income 2,491 1,002 Unearned Employee Stock Ownership Plan (ESOP) shares (750) (952) ---------------------- Total Stockholders' Equity 40,125 35,116 ---------------------- Total Liabilities and Stockholders' Equity $ 367,468 $ 346,029 ======================
-31- CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, --------------------------- 2002 2001 2000 --------------------------- (In Thousands, Except per Share Data) INTEREST INCOME Loans receivable, including fees $15,651 $17,924 $18,188 Securities: Taxable 4,623 4,646 5,082 Tax exempt 1,027 926 637 Other 263 268 37 --------------------------- Total Interest Income 21,564 23,764 23,944 --------------------------- INTEREST EXPENSE Deposits 6,139 8,419 8,545 Short-term borrowings 176 295 303 Long-term debt 1,298 1,496 2,029 --------------------------- Total Interest Expense 7,613 10,210 10,877 --------------------------- Net Interest Income 13,951 13,554 13,067 PROVISION FOR LOAN LOSSES 630 695 480 --------------------------- Net Interest Income after Provision for Loan Losses 13,321 12,859 12,587 --------------------------- OTHER INCOME Service charges and fees 1,788 1,661 1,486 Income from fiduciary activities 236 256 288 Net realized gains on sales of securities 427 212 35 Other 553 673 680 --------------------------- Total Other Income 3,004 2,802 2,489 --------------------------- OTHER EXPENSES Salaries and employee benefits 4,847 4,642 4,355 Occupancy 759 796 720 Furniture and equipment 517 525 514 Data processing related operations 556 521 432 Losses on lease residuals 870 630 910 Advertising 168 131 185 Professional fees 178 211 248 Taxes, other than income 222 287 271 Amortization of intangible assets 178 178 178 Other 2,054 1,937 1,899 --------------------------- Total Other Expenses 10,349 9,858 9,712 --------------------------- Income before Income Taxes 5,976 5,803 5,364 INCOME TAX EXPENSE 1,623 1,601 1,504 --------------------------- Net Income $ 4,353 $ 4,202 $ 3,860 =========================== EARNINGS PER SHARE Basic $ 2.55 $ 2.50 $ 2.32 =========================== Diluted $ 2.52 $ 2.48 $ 2.31 ===========================
-32- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Other Unearned Common Retained Treasury Comprehensive ESOP Stock Surplus Earnings Stock Income (Loss) Shares Total ------------------------------------------------------------------------- (In Thousands) BALANCE - DECEMBER 31, 1999 $ 180 $ 4,603 $ 25,763 $(1,214) $ (1,319) $ (1,359) $ 26,654 -------- Comprehensive income: Net income - - 3,860 - - - 3,860 Change in unrealized gains on securities available for sale, net of reclassification adjustment and tax effects - - - - 1,807 - 1,807 -------- Total Comprehensive Income 5,667 -------- Cash dividends declared, $.71 per share - - (1,182) - - - (1,182) Issuance of treasury stock - - - 1 - - 1 Release of earned ESOP shares, net - 26 - - - 204 230 ------------------------------------------------------------------------- BALANCE - DECEMBER 31, 2000 180 4,629 28,441 (1,213) 488 (1,155) 31,370 -------- Comprehensive income: Net income - - 4,202 - - - 4,202 Change in unrealized gains on securities available for sale, net of reclassification adjustment and tax effects - - - - 514 - 514 -------- Total Comprehensive Income 4,716 -------- Cash dividends declared, $.82 per share - - (1,378) - - - (1,378) Stock options exercised - (22) - 147 - - 125 Release of earned ESOP shares, net - 80 - - - 203 283 ------------------------------------------------------------------------- BALANCE - DECEMBER 31, 2001 180 4,687 31,265 (1,066) 1,002 (952) 35,116 -------- Comprehensive income: Net income - - 4,353 - - - 4,353 Change in unrealized gains on securities available for sale, net of reclassification adjustment and tax effects - - - - 1,489 - 1,489 -------- Total Comprehensive Income 5,842 -------- Cash dividends declared, $.90 per share - - (1,536) - - - (1,536) Stock options exercised - (78) - 434 - - 356 Tax benefit of stock options exercised - 5 - - - - 5 Acquisition of treasury stock - - - (8) - - (8) Release of earned ESOP shares, net - 148 - - - 202 350 ------------------------------------------------------------------------- BALANCE - DECEMBER 31, 2002 $ 180 $ 4,762 $ 34,082 $ (640) $ 2,491 $ (750) $ 40,125 =========================================================================
See notes to consolidated finanical statements. -33- START HERE CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, -------------------------------- 2002 2001 2000 -------------------------------- (In Thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 4,353 $ 4,202 $ 3,860 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 630 695 480 Depreciation 617 613 612 Amortization of intangible assets 178 178 178 Deferred income taxes (1,159) (1,485) (298) Net amortization of securities premiums and discounts 233 99 6 Net realized gains on sales of securities (427) (212) (35) Earnings on life insurance policy (183) (179) (166) Gain on sale of bank premises and equipment and foreclosed real estate (49) - (80) Gain on sale of mortgage loans (82) (48) (231) Mortgage loans originated for sale (5,409) (2,172) (1,415) Proceeds from sale of mortgage loans 5,491 2,220 1,646 Tax benefit of stock options exercised 5 - - Release of ESOP shares 350 283 230 Decrease in accrued interest receivable and other assets 1,183 1,813 1,597 Decrease in accrued interest payable and other liabilities (530) (1,010) (210) -------------------------------- Net Cash Provided by Operating Activities 5,201 4,997 6,174 -------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Securities available for sale: Proceeds from sales 6,455 14,632 13,811 Proceeds from maturities and principal reductions on mortgage-backed securities 46,336 31,302 7,832 Purchases (69,393) (63,787) (19,653) Securities held to maturity, proceeds from maturities 30 1,275 - (Increase) decrease in investment in FHLB stock (237) 1,181 - Net (increase) decrease in loans (5,660) 77 (12,940) Purchase of life insurance policy - (240) - Purchase of bank premises and equipment (572) (445) (351) Proceeds from sales of premises and equipment and foreclosed real estate 590 121 439 -------------------------------- Net Cash Used in Investing Activities (22,451) (15,884) (10,862) -------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 16,929 21,964 9,452 Net increase (decrease) in short-term borrowings 2,375 (1,219) (740) Repayments of long-term debt (2,000) (8,000) (15,000) Proceeds from long-term debt - 5,000 13,000 Stock options exercised 356 125 - Proceeds from (acquisition of) treasury stock (8) - 1 Cash dividends paid (1,494) (1,341) (1,129) -------------------------------- Net Cash Provided by Financing Activities 16,158 16,529 5,584 -------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents (1,092) 5,642 896 CASH AND CASH EQUIVALENTS - BEGINNING 17,336 11,694 10,798 -------------------------------- CASH AND CASH EQUIVALENTS - ENDING $ 16,244 $ 17,336 $ 11,694 ================================
-34- 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, commercial and consumer loans, as well as interest earnings on investment securities and 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. NOTE 2 - SUMMARY OF 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. and WTRO Properties. All 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. 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 period to maturity. 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 period to maturity. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Federal law requires a member institution of the Federal Home Loan Bank system to hold stock of its district Federal Home Loan Bank according to a predetermined formula. The stock is carried at cost. -35- NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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 Company has a portfolio of direct financing leases. These direct financing leases are carried at the Company's net investment, which includes the sum of aggregate rentals receivable and the estimated residual value of the leased automobiles less unearned income. Unearned income is amortized over the leases' terms by methods that approximate the interest method. 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 collectibility 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 collectibility 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 collectibility of the total contractual principal and interest is no longer in doubt. 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. 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 change, including the amounts and timing of future cash flows expected to be received on impaired loans. 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. -36- NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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. Premises and Equipment 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. 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. Foreclosed real estate is included in other assets. Intangible Assets Intangible assets are included in other assets and are being amortized over periods from seven to fifteen years. Annual assessments of the carrying values and remaining amortization periods of intangible assets are made to determine possible carrying value impairment and appropriate adjustments, as deemed necessary. 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 liabilities are adjusted through the provision for income taxes. The Company and its subsidiary file a consolidated federal income tax return. Advertising Costs The Company follows the policy of charging the costs of advertising to expense 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. 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. -37- NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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. Cash payments for interest for the years ended December 31, 2002, 2001 and 2000 were $8,285,000, $11,012,000 and $10,134,000, respectively. Cash payments for income taxes for the years ended December 31, 2002, 2001 and 2000 were $3,117,000, $3,225,000 and $2,200,000, respectively. Non-cash investing activities for 2002, 2001 and 2000 included foreclosed mortgage loans transferred to real estate owned and repossession of other assets of $1,183,000, $1,427,000 and $1,099,000, respectively. 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 in the balance sheets when they become receivable or payable. 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. 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. The components of other comprehensive income and related tax effects are as follows: Years Ended December 31, ------------------------ 2002 2001 2000 ------------------------ (In Thousands) Unrealized holding gains on available for sale securities $2,690 $ 976 $2,790 Reclassification adjustment for gains realized in income 427 212 35 ------------------------ Net Unrealized Gains 2,263 764 2,755 Income tax 774 250 948 ------------------------ Net of Tax Amount $1,489 $ 514 $1,807 ======================== Segment Reporting The Company acts as an independent community financial service provider and offers traditional banking and 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 -38- NOTE 2 - SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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. Reclassifications Certain items in the 2001 and 2000 financial statements have been reclassified to conform to the 2002 financial statement presentation format. These reclassifications had no effect on net income. New Accounting Standards In October 2002, the Financial Accounting Standards Board issued Statement No. 147, "Acquisitions of Certain Financial Institutions." This Statement provides guidance on accounting for the acquisition of a financial institution, including the acquisition of part of a financial institution. The Statement defines criteria for determining whether the acquired financial institution meets the conditions for a "business combination". If the acquisition meets the conditions of a "business combination", the specialized accounting guidance under Statement No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions" will not apply after September 30, 2002 and the amount of any unidentifiable intangible asset will be reclassified to goodwill upon adoption of Statement No. 147. The transition provisions were effective on October 1, 2002. At December 31, 2002, the Company had intangible assets with a net book value of $461,000, which will continue to be amortized under the new rules. Amortization expense related to these assets was $178,000 for each of the years ended December 31, 2002, 2001 and 2000. In July of 2001, the Financial Accounting Standards Board issued Statement 143, "Accounting for Asset Retirement Obligations," which addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement became effective for the Company on January 1, 2003 and did not have a significant impact on the Company's financial condition or results of operations. In July 2002, the Financial Accounting Standards Board issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This Statement delays recognition of these costs until liabilities are incurred, rather than at the date of commitment to the plan, and requires fair value measurement. It does not impact the recognition of liabilities incurred in connection with a business combination or the disposal of long-lived assets. The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002 and are not expected to have a significant impact on the Company's financial condition or results of operations. -39- NOTE 3 - SECURITIES The amortized cost and fair value of securities were as follows:
December 31, 2002 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------- (In Thousands) AVAILABLE FOR SALE: U.S. Government agencies $ 32,974 $ 223 $ - $ 33,197 States and political subdivisions 14,835 329 (4) 15,160 Corporate obligations 11,102 394 (93) 11,403 Mortgage-backed securities 51,836 1,526 (4) 53,358 ----------------------------------------------- 110,747 2,472 (101) 113,118 Equity securities 315 1,410 - 1,725 ----------------------------------------------- $ 111,062 $ 3,882 $ (101) $ 114,843 =============================================== HELD TO MATURITY: States and political subdivisions $ 6,204 $ 300 $ - $ 6,504 =============================================== December 31, 2001 ----------------------------------------------- AVAILABLE FOR SALE: U.S. Government agencies $ 15,462 $ 185 $ - $ 15,647 States and political subdivisions 12,791 108 (259) 12,640 Corporate obligations 14,140 360 (256) 14,244 Mortgage-backed securities 51,559 194 (294) 51,459 ----------------------------------------------- 93,952 847 (809) 93,990 Equity securities 323 1,480 - 1,803 ----------------------------------------------- $ 94,275 $ 2,327 (809) $ 95,793 =============================================== HELD TO MATURITY: States and political subdivisions $ 6,226 $ 238 $ - $ 6,464 ===============================================
Equity securities consist of stock in bank holding companies. The amortized cost and fair value of securities as of December 31, 2002 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
Available for Sale Held to Maturity ----------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ----------------------------------------- (In Thousands) Due in one year or less $ 2,504 $ 2,546 $ - $ - Due after one year through five years 41,714 42,275 926 953 Due after five years through ten years 1,678 1,698 - - Due after ten years 13,015 13,241 5,278 5,551 ----------------------------------------- 58,911 59,760 6,204 6,504 Mortgage-backed securities 51,836 53,358 - - Equity securities 315 1,725 - - ----------------------------------------- $111,062 $114,843 $ 6,204 $ 6,504 =========================================
Gross realized gains and gross realized losses on sales of securities available for sale were $432,000 and $5,000, respectively, in 2002, $216,000 and $4,000, respectively, in 2001, and $51,000 and $16,000, respectively, in 2000. Securities with a carrying value of $28,663,000 and $27,937,000 at December 31, 2002 and 2001, respectively, were pledged to secure public deposits, U.S. Treasury demand notes, securities sold under agreements to repurchase and for other purposes as required or permitted by law. -40- NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES The components of loans receivable at December 31 were as follows: 2002 2001 ---------------------- (In Thousands) Real estate: Residential $ 69,040 $ 64,635 Commercial 79,623 63,609 Construction 4,109 4,642 Commercial, financial and agricultural 15,074 17,442 Consumer loans to individuals 48,951 58,143 Lease financing, net of unearned income 1,592 6,126 ---------------------- 218,389 214,597 Unearned income and deferred fees (419) (403) Allowance for loan losses (3,146) (3,216) ---------------------- $ 214,824 $ 210,978 ====================== The Bank's net investment in direct financing leases at December 31 consists of: 2002 2001 ------------------ (In Thousands) Minimum lease payments receivable $ 325 $ 1,416 Estimated unguaranteed residual values 1,347 5,092 Unearned income (80) (382) ------------------ $ 1,592 $ 6,126 ================== The following table presents changes in the allowance for loan losses: Years Ended December 31, ----------------------------- 2002 2001 2000 ----------------------------- (In Thousands) Balance, beginning $ 3,216 $ 3,300 $ 3,344 Provision for loan losses 630 695 480 Recoveries 94 107 244 Loans charged off (794) (886) (768) ----------------------------- Balance, ending $ 3,146 $ 3,216 $ 3,300 ============================== The recorded investment in impaired loans, not requiring an allowance for loan losses was $256,000 and $618,000 at December 31, 2002 and 2001, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $-0- and $64,000 at December 31, 2002 and 2001, respectively. The related allowance for loan losses associated with these loans was $-0- and $7,000, respectively, at December 31, 2002 and 2001. For the years ended December 31, 2002, 2001 and 2000, the average recorded investment in these impaired loans was $262,000, $694,000 and $364,000 and the interest income recognized on these impaired loans was $23,000, $22,000 and $-0-, respectively. Loans on which the accrual of interest has been discontinued amounted to $216,000 and $672,000 at December 31, 2002 and 2001, respectively. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to $5,000 and $11,000 at December 31, 2002 and 2001, respectively. -41- NOTE 5 - PREMISES AND EQUIPMENT Components of premises and equipment at December 31 are as follows: 2002 2001 -------------------- (In Thousands) Land and improvements $ 924 $ 924 Buildings and improvements 6,957 6,938 Furniture and equipment 3,583 3,189 -------------------- 11,464 11,051 Accumulated depreciation (5,478) (5,014) -------------------- $ 5,986 $ 6,037 ==================== NOTE 6 - DEPOSITS Aggregate time deposits in denominations of $100,000 or more were $29,533,000 and $27,424,000 at December 31, 2002 and 2001, respectively. At December 31, 2002, the scheduled maturities of time deposits are as follows (in thousands): 2003 $ 94,952 2004 16,714 2005 3,525 2006 9,397 2007 2,867 --------- $ 127,455 ========= NOTE 7 - BORROWINGS Short-term borrowings at December 31 consist of the following: 2002 2001 --------------- (In Thousands) Securities sold under agreements to repurchase $8,016 $6,246 U.S. Treasury demand notes 1,000 395 --------------- $9,016 $6,641 ================ The outstanding balances and related information of short-term borrowings are summarized as follows: Years Ended December 31, ------------------------ 2002 2001 ------------------------ (Dollars In Thousands) Average balance during the year $ 9,552 $ 7,781 Average interest rate during the year 1.84% 3.80% Maximum month-end balance during the year $15,168 $ 9,411 Securities sold under agreements to repurchase generally mature within one day to one year from the transaction date. Securities with amortized cost and fair value of $10,303,000 and $10,388,000 at December 31, 2002 and $8,027,000 and $7,917,000 at December 31, 2001 were pledged as collateral for these agreements. The securities underlying the agreements were under the Company's control. The Company has a line of credit commitment available from the Federal Home Loan Bank (FHLB) of Pittsburgh for borrowings of up to $20,000,000 which expires in December 2003. There were no borrowings under this line of credit at December 31, 2002 and 2001. -42- NOTE 7 - BORROWINGS (CONTINUED) Long-term debt consisted of the following at December 31, 2002 and 2001: 2002 2001 ----------------- (In Thousands) Notes with the Federal Home Loan Bank (FHLB): Fixed note due February 2002 at 5.09% $ - $ 2,000 Convertible note due April 2005 at 6.13% 5,000 5,000 Convertible note due December 2006 at 6.19% 5,000 5,000 Convertible note due April 2009 at 4.83% 5,000 5,000 Convertible note due April 2009 at 5.07% 5,000 5,000 Convertible note due January 2011 at 5.24% 3,000 3,000 ----------------- $23,000 $25,000 ================= The convertible notes contain an option which allows the FHLB, at quarterly intervals, to change the note to an adjustable-rate advance at three-month LIBOR plus 11 to 16 basis points. If the notes are converted, the option allows the Bank to put the funds back to the FHLB at no charge. The Bank's maximum borrowing capacity with the Federal Home Loan Bank was $120,419,000 of which $23,000,000 was outstanding at December 31, 2002. Advances from the Federal Home Loan Bank 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. 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 after one year of employment. Employee contributions are vested at all times, and any Company contributions are fully vested after five years. The Company's contributions are expensed as the cost is incurred, funded currently, and amounted to $170,000, $166,000 and $145,000 for the years ended December 31, 2002, 2001 and 2000, respectively. The Company has a leveraged employee stock ownership plan ("ESOP") for the benefit of employees who meet the eligibility requirements which include having completed one year of service with the Company and having attained age twenty-one. The ESOP Trust purchased shares of the Company's common stock with proceeds from a loan from the Company. The Bank makes cash contributions to the ESOP on an annual basis sufficient to enable the ESOP to make the required loan payments. The loan bears interest at the prime rate adjusted annually. Interest is payable annually and principal payable in equal annual installments over ten years. The loan is secured by the shares of the stock purchased. As the debt is repaid, shares are released from collateral and allocated to qualified employees based on the proportion of debt service paid in the year. The Company accounts for its leveraged ESOP in accordance with Statement of Position 93-6. Accordingly, the shares pledged as collateral are reported as unallocated ESOP shares in the consolidated balance sheets. As shares are released from collateral, the Company reports compensation -43- NOTE 8 - EMPLOYEE BENEFIT PLANS (CONTINUED) expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings and dividends on unallocated ESOP shares are recorded as a reduction of debt. Compensation expense for the ESOP was $348,000, $269,000 and $214,000 for the years ended December 31, 2002, 2001 and 2000, respectively. The status of the ESOP shares at December 31 are as follows: 2002 2001 ----------------------- Allocated shares 68,607 60,141 Shares released from allocation 6,382 2,981 Unreleased shares 46,223 58,090 ----------------------- Total ESOP shares 121,212 121,212 ----------------------- Fair value of unreleased shares $1,377,000 $1,517,000 ======================= NOTE 9 - INCOME TAXES The components of the provision for federal income taxes are as follows: Years Ended December 31, ----------------------------- 2002 2001 2000 ----------------------------- (In Thousands) Current $ 2,782 $ 3,086 $ 1,802 Deferred (1,159) (1,485) (298) ----------------------------- $ 1,623 $ 1,601 $ 1,504 ============================= 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: Percentage of Income before Income Taxes ---------------------- Years Ended December 31, ---------------------- 2002 2001 2000 ---------------------- Tax at statutory rates 34.0% 34.0% 34.0% Tax exempt interest income, net of interest expense disallowance (5.8) (4.9) (4.1) Low-income housing tax credit (1.0) (1.0) (1.1) Earnings on life insurance (1.1) (1.2) (1.1) Other 1.1 0.7 0.3 ---------------------- 27.2% 27.6% 28.0% ====================== The income tax provision includes $145,000, $72,000 and $12,000 of income taxes relating to realized securities gains for the years ended December 31, 2002, 2001 and 2000, respectively. -44- NOTE 9 - INCOME TAXES (CONTINUED) The net deferred tax liability included in other liabilities in the accompanying balance sheets includes the following amounts of deferred tax assets and liabilities: 2002 2001 ------------------ (In Thousands) Deferred tax assets: Allowance for loan losses $ 847 $ 829 Deferred compensation 126 94 Intangible assets 187 170 Other 9 30 ------------------ Total Deferred Tax Assets 1,169 1,123 ------------------ Deferred tax liabilities: Net unrealized gain on securities 1,290 516 Premises and equipment 160 176 Lease financing 362 1,513 Other 93 39 ------------------ Total Deferred Tax Liabilities 1,905 2,244 ------------------ Net Deferred Tax Liability $ (736) $(1,121) ================== NOTE 10 - TRANSACTIONS WITH EXECUTIVE OFFICERS AND DIRECTORS Certain directors and executive officers of the Company, their families and their affiliates are customers of the Bank. Any transactions with such parties, including loans and commitments, were in the ordinary course of business at normal terms, including interest rates and collateralization, prevailing at the time and did not represent more than normal risks. At December 31, 2002 and 2001 such loans amounted to $1,693,000 and $3,522,000, respectively. During 2002, new loans to such related parties totaled $1,031,000 and repayments aggregated $2,860,000. NOTE 11 - 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 affect 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. 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 and 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, 2002, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2002, 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. -45- NOTE 11 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY (CONTINUED) 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, 2002 Total capital (to risk-weighted assets) $ 39,477 16.31% $ >19,358 >8.00% $>24,198 >10.00% - - - - Tier 1 capital (to risk-weighted assets) 35,891 14.83 > 9,679 >4.00 >14,519 > 6.00 - - - - Tier 1 capital (to average assets) 35,891 9.82 >14,614 >4.00 >18,268 > 5.00 - - - - As of December 31, 2001: Total capital (to risk-weighted assets) $ 36,440 15.22% $ >19,150 >8.00% $>23,937 >10.00% - - - - Tier 1 capital (to risk-weighted assets) 32,838 13.72 > 9,575 >4.00 >14,362 > 6.00 - - - - Tier 1 capital (to average assets) 32,838 9.56 >13,734 >4.00 >17,167 > 5.00 - - - -
The Company's ratios do not differ significantly from the Bank's ratios presented above. 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, 2002 and 2001 was approximately $3,845,000 and $3,021,000, 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, 2002 $31,283,000 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 12 - STOCK OPTION PLAN The Company adopted a Stock Option Plan for the officers and employees of the Company in 1995. An aggregate of 500,000 shares of authorized but unissued common stock of the Company were reserved for future issuance under the Plan. In 1999, the Company adopted the Directors Stock Compensation Plan, with an aggregate of 17,600 shares reserved for issuance under the Plan. The stock options typically have expiration terms ranging between one and ten years subject to certain extensions and early terminations. The per share exercise price of a stock option shall be, at a minimum, equal to the fair value of a share of common stock on the date the option is granted. -46- NOTE 12 - STOCK OPTION PLAN (CONTINUED) A summary of the Company's stock option activity and related information for the years ended December 31 follows:
2002 2001 2000 ------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------------------------------------------------------------------- Outstanding, beginning of year 103,590 $ 20.10 96,330 $ 18.79 80,330 $ 19.28 Granted 15,000 30.00 15,500 26.75 16,000 16.31 Exercised (21,370) 16.68 (7,240) 17.32 - N/A Forfeited - N/A (1,000) 16.31 - N/A -------------------------------------------------------------------- Outstanding, end of year 97,220 $ 22.38 103,590 $ 20.10 96,330 $ 18.79 ==================================================================== Exercisable, at end of year 82,220 $ 20.99 =====================
Exercise prices for options outstanding as of December 31, 2002 ranged from $16.31 to $30.00 per share. The weighted average remaining contractual life is 6.9 years. The Company accounts for the stock option plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation. Years Ended December 31, ----------------------------------- 2002 2001 2000 ----------------------------------- (In Thousands, Except Per Share Data) Net income, as reported $ 4,353 $ 4,202 $ 3,860 Total stock-based employee compensation expense determined under fair value based method for all awards, net of related taxes (74) (45) (64) ----------------------------------- Pro forma net income $ 4,279 $ 4,157 $ 3,796 =================================== Earnings per share (basic): As reported $ 2.55 $ 2.50 $ 2.32 Pro forma $ 2.51 $ 2.47 $ 2.28 Earnings per share (assuming dilution): As reported $ 2.52 $ 2.48 $ 2.31 Pro forma $ 2.47 $ 2.45 $ 2.27 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: Years Ended December 31, ------------------------------------ 2002 2001 2000 ------------------------------------ Dividend yield 3.13% 3.55% 3.54% Expected life 8 years 8 years 8 years Expected volatility 11.81% 19.39% 19.10% Risk-free interest rate 3.81% 4.97% 5.26% Weighted average fair value of options granted $3.66 $5.26 $3.29 -47- NOTE 13 - EARNINGS PER SHARE The following table sets forth the computations of basic and diluted earnings per share:
Years Ended December 31, ------------------------ 2002 2001 2000 ------------------------ (In Thousands, Except Per Share Data) Numerator, net income $4,353 $4,202 $3,860 ======================== Denominator: Denominator for basic earnings per share, weighted average shares 1,704 1,681 1,666 Effect of dilutive securities, employee stock options 27 14 6 ------------------------ Denominator for diluted earnings per share, adjusted weighted average shares and assumed conversions 1,731 1,695 1,672 ======================== Basic earnings per common share $ 2.55 $ 2.50 $ 2.32 ======================== Diluted earnings per common share $ 2.52 $ 2.48 $ 2.31 ========================
NOTE 14 - 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, ----------------- 2002 2001 ----------------- (In Thousands) Commitments to grant loans $10,438 $ 6,929 Unfunded commitments under lines of credit 21,765 17,312 Standby letters of credit 1,298 713 ----------------- $33,501 $24,954 ================= 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 credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral, when deemed necessary, supporting those commitments. -48- NOTE 15 - CONCENTRATIONS OF CREDIT RISK The Bank operates primarily in Wayne, Pike 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. NOTE 16 - DISCLOSURES ABOUT FAIR VALUE 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 sales 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 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, 2002 and 2001: o For cash and due from banks, interest-bearing deposits with banks and federal funds sold, the carrying amount is a reasonable estimate of fair value. o For securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. o The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Disclosure of the fair value of leases receivable is not required and has not been included in the following table. o The fair value of the investment in FHLB stock is the carrying amount. o The fair value of accrued interest receivable and accrued interest payable is the carrying amount. o The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits for similar remaining maturities. -49- NOTE 16 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) o The fair value of short-term borrowings approximate their carrying amount. o The fair value of long-term debt is estimated using discounted cash flow analyses based upon the Company's current borrowing rates for similar types of borrowing arrangements. o The fair value of commitments to extend credit and for outstanding letters of credit is estimated using the fees currently charged to enter into similar agreements. The estimated fair values of the Company's financial instruments are as follows:
December 31, 2002 December 31, 2001 ----------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ----------------------------------------- (In Thousands) Financial assets: Cash and due from banks, interest-bearing deposits with banks and federal funds sold $ 16,244 $ 16,244 $ 17,336 $ 17,336 Securities 121,047 121,347 102,019 102,257 Loans receivable, net 213,232 222,723 204,852 211,392 Investment in FHLB stock 1,637 1,637 1,400 1,400 Accrued interest receivable 1,799 1,799 1,879 1,879 Financial liabilities: Deposits 291,852 292,757 274,923 275,961 Short-term borrowings 9,016 9,016 6,641 6,641 Long-term debt 23,000 25,610 25,000 26,111 Accrued interest payable 1,654 1,654 2,326 2,326 Off-balance sheet financial instruments: Commitments to extend credit and outstanding letters of credit - - - -
-50- NOTE 17 - NORWOOD FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION December 31, ----------------- BALANCE SHEETS 2002 2001 ----------------- (In Thousands) ASSETS Cash on deposit in bank subsidiary $ 1,544 $ 943 Securities available for sale 370 280 Investment in bank subsidiary 38,739 34,394 Other assets 2 6 ----------------- $40,655 $35,623 ================= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 530 $ 507 Stockholders' equity 40,125 35,116 ----------------- $40,655 $35,623 ================= STATEMENTS OF INCOME Year Ended December 31, ---------------------------- 2002 2001 2000 ---------------------------- (In Thousands) Income: Dividends from bank subsidiary $ 1,536 $ 1,378 $ 1,182 Interest income from bank subsidiary 42 102 120 Other interest income 15 8 18 Net realized gains on sales of securities - - 15 ---------------------------- 1,593 1,488 1,335 Expenses 144 105 143 ---------------------------- 1,449 1,383 1,192 Income tax expense (benefit) (31) 10 2 ---------------------------- 1,480 1,373 1,190 Equity in undistributed earnings of subsidiary 2,873 2,829 2,670 ---------------------------- Net Income $ 4,353 $ 4,202 $ 3,860 ============================ STATEMENTS OF CASH FLOWS Year Ended December 31, ----------------------------- 2002 2001 2000 ----------------------------- (In Thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 4,353 $ 4,202 $ 3,860 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed earnings of bank subsidiary (2,873) (2,829) (2,670) Net realized gain on sale of securities - - (15) Release of ESOP shares 350 283 230 Tax benefit of stock options exercised 5 - - Other, net (33) 21 14 ----------------------------- Net Cash Provided by Operating Activities 1,802 1,677 1,419 ----------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in bank subsidiary - (200) (400) Purchase of securities available for sale (55) - (78) Proceeds from sale and maturity of securities available for sale - - 359 ----------------------------- Net Cash Used in Investing Activities (55) (200) (119) ----------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Stock options exercised 356 125 - (Acquisition) issuance of treasury stock (8) - 1 Cash dividends paid (1,494) (1,341) (1,129) ----------------------------- Net Cash Used in Financing Activities (1,146) (1,216) (1,128) ----------------------------- Increase in Cash and Cash Equivalents 601 261 172 CASH AND CASH EQUIVALENTS - BEGINNING 943 682 510 ----------------------------- CASH AND CASH EQUIVALENTS - ENDING $ 1,544 $ 943 $ 682 ============================= -51- INVESTOR INFORMATION Stock Listing Norwood Financial Corp stock is traded on the Nasdaq National Market under the symbol NWFL. The following firms are known to make a market in the Company's stock: Ferris Baker Watts F.J. Morrissey & Co, Inc. Baltimore, MD West Conshohocken, PA 410-659-4616 800-842-8928 Legg Mason Wood Walker, Inc. Janney Montgomery Scott, LLC Scranton, PA 18507 Scranton, PA 18503 570-346-9300 800-638-4417 Ryan Beck & Co. Boenning & Scattergood, Inc. Livingston, NJ West Conshohoken, PA 800-395-7926 800-496-1170 Transfer Agent Illinois Stock Transfer Company, 209 West Jackson Blvd., Suite 903, Chicago, IL 60606. Stockholders who may have questions regarding their stock ownership should contact the Transfer Agent at 312-427-2953 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. Shareholders do not incur brokerage commissions for the transactions. Please contact the transfer agent or Lewis J. Critelli for additional information. SEC Reports and Additional Information A copy of the Company's report on Form 10-K for its fiscal year ended December 31, 2002 including financial statements and schedules thereto, required to be filed with the Securities and Exchange Commission may be obtained upon written request of any stockholder, investor or analyst by contacting Lewis J. Critelli, Executive Vice President and Chief Financial Officer, Norwood Financial Corp, 717 Main Street, PO Box 269, Honesdale, PA 18431, 570-253-1455 -52-