10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One):

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

or

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

For the transition period from ________ to _________

Commission File No. 0-28364

NORWOOD FINANCIAL CORP.

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania	23-2828306
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

717 Main Street, Honesdale, Pennsylvania	18431
(Address of Principal Executive Offices)	(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $.10 par value	The Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o YES     x NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o YES     x NO

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x YES     o NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  o YES     o NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer x
Non-accelerated filer  o (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).o Yes     x No

As of March 4, 2011, there were 2,768,804 shares outstanding of the registrant’s Common Stock.

The Registrant’s voting stock trades on the NASDAQ Global Market under the symbol “NWFL.”  The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the last price the registrant’s Common Stock was sold as of June 30, 2010, $25.25 per share, was $66.8 million based on 2,644,740 shares of Common Stock outstanding.  For purposes of this calculation, the term “affiliate” refers to all directors and executive officers of the registrant, and all persons beneficially owning more than 5% of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

1.   Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 2010. (Parts I, II, and IV)

2.   Portions of the definitive Proxy Statement for the 2011 Annual Meeting of Stockholders. (Part III)

NORWOOD FINANCIAL CORP.

ANNUAL REPORT ON FORM 10-K

Table of Contents

Part I		Page
Item 1.	Business	2
Item 1A.	Risk Factors	22
Item 1B.	Unresolved Staff Comments	31
Item 2.	Properties	31
Item 3.	Legal Proceedings	31
Item 4.	[Removed and Reserved]	31
Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	32
Item 6.	Selected Financial Data	32
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	32
Item 8.	Financial Statements and Supplementary Data	32
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	32
Item 9A.	Controls and Procedures	32
Item 9B.	Other Information	33
Part III
Item 10.	Directors, Executive Officers and Corporate Governance	33
Item 11.	Executive Compensation	33
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	33
Item 13.	Certain Relationships and Related Transactions and Director Independence	34
Item 14.	Principal Accounting Fees and Services	34
Part IV
Item 15.	Exhibits, Financial Statement Schedules	35
SIGNATURES

1

PART I

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 as detailed in Item 1A include:

• our ability to realize the anticipated benefits from our acquisition of North Penn Bancorp, Inc.

• our ability to effectively manage future growth

• loan losses in excess of our allowance

• risks inherent in commercial lending

• real estate collateral which is subject to declines in value

• potential other-than-temporary impairments

• higher deposit insurance premiums

• soundness of other financial institutions

• increased compliance burden under new financial reform legislation

• risk of failure to stabilize the financial system

• current market volatility

• potential liquidity risk

• availability of capital

• regional economic factors

• loss of senior officers

• comparatively low legal lending limits

• limited market for the Company’s stock

• restrictions on ability to pay dividends

• common stock may lose value

• competitive environment

• issuing additional shares may dilute ownership

• extensive and complex governmental regulation and associated cost

• interest rate risks

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

Item 1. Business

General

Norwood Financial Corp. (the “Company”), a Pennsylvania corporation, is the holding company for Wayne Bank. On March 29, 1996, the Bank completed a holding company reorganization and became a wholly owned subsidiary of the Company. As of December 31, 2010, the Company had total assets of $537.0 million, deposits of $393.9 million, and stockholders’ equity of $67.7 million. The Company’s ratio of average equity to average assets was 12.56%, 12.09% and 11.57% for fiscal years 2010, 2009 and 2008, respectively.

2

Wayne Bank is a Pennsylvania chartered commercial bank headquartered in Honesdale, Pennsylvania. The Bank was originally chartered on February 17, 1870 as Wayne County Savings Bank. Wayne County Savings Bank changed its name to Wayne County Bank and Trust in December 1943. In September 1993, the Bank adopted the name Wayne Bank. The Bank’s deposits are currently insured to  applicable limits by the Deposit Insurance Fund (“DIF”) as administered by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is regulated by the Pennsylvania Department of Banking (“PDB”) and the FDIC.

The Bank is an independent community bank with five offices in Wayne County, three offices in Pike County and three offices in Monroe County. The Bank offers a wide variety of personal and business credit services and trust and investment products and real estate settlement services to the consumers, businesses, nonprofit organizations, and municipalities in each of the communities that the Bank serves. The Bank primarily serves the Pennsylvania counties of Wayne, Pike and Monroe, and to a much lesser extent, the counties of Lackawanna and Susquehanna. In addition, the Bank operates elevenautomated teller machines, one in each of its branch locations.

The Company’s main office is located at 717 Main Street, Honesdale, Pennsylvania and its telephone number is (570) 253-1455. The Company maintains a website at www.waynebank.com.  Information on our website should not be treated as part of this Annual Report on Form 10-K.  The Company makes copies of its SEC filings available free of charge as soon as reasonably practicable after they are filed, through a link on its website to the SEC’s website.

Pending Acquisition of North Penn Bancorp, Inc.

On December 14, 2010, Norwood Financial Corp. (“Norwood Financial”) and its wholly owned subsidiary, Wayne Bank, and North Penn Bancorp, Inc. (“North Penn”), and its wholly owned subsidiary, North Penn Bank, entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which North Penn will merge with and into Norwood Financial, with Norwood Financial as the surviving corporation. Concurrent with the merger, it is expected that North Penn Bank will merge with and into Wayne Bank.

Under the terms of the Merger Agreement, each outstanding share of North Penn common stock will be converted into either the right to receive $19.12 in cash or 0.6829 shares of Norwood Financial common stock. In addition, the elections of North Penn stockholders will be subject to the requirement that $12,194,000 of the merger consideration (which includes amounts paid in cancellation of existing stock options, for the unallocated shares held by the ESOP and any shares as to which the holders have exercised dissenters’ rights) be paid in cash and that the remainder be paid in Norwood common stock. All North Penn stock options, whether or not vested, will be canceled at the effective time of the merger in exchange for a cash payment equal to the difference between $19.12 and the exercise price of the stock option.  In the event of a greater than 20% decline in market value of Norwood Financial common stock, North Penn may, in certain circumstances, be able to terminate the Merger Agreement unless Norwood Financial increases the number of shares into which North Penn common stock may be converted.

The senior management of Wayne Bank will remain the same following the merger. At the closing of the merger, Norwood Financial and Wayne Bank will each expand the size of its board by one member and appoint one member of the North Penn board of directors to their boards.

The transaction is subject to customary closing conditions, including the receipt of regulatory approvals and approval by the shareholders of North Penn.  The merger is currently expected to be completed in the second quarter of 2011.

3

Each of the directors and executive officers of North Penn have agreed to vote their shares in favor of the approval of the Merger Agreement at the shareholders meeting to be held to vote on the proposed transaction. If the merger is not consummated under certain circumstances, North Penn has agreed to pay Norwood Financial a termination fee of $1,125,000.

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

The foregoing summary of the Agreement is not complete and is qualified in its entirety by reference to the complete text of such document, which is filed as Exhibit 2.1 to this Annual Report on Form 10-K and which is incorporated herein by reference in its entirety.

Competition

The competition for deposit products comes from other insured financial institutions such as commercial banks, thrift institutions, credit unions, and multi-state regional banks in the Company’s market area of Wayne, Pike and Monroe Counties, Pennsylvania. Based on data compiled by the FDIC as of June 30, 2010 (the latest date for which data is available), the Bank had the third largest share of FDIC-insured deposits in Wayne County with approximately 19.2%, third largest in Pike County with 18.6%, and 10th in Monroe County with 2.0%. This data does not reflect deposits held by credit unions with which the Bank also competes. Deposit competition also includes a number of insurance products sold by local agents and investment products such as mutual funds and other securities sold by local and regional brokers. Loan competition varies depending upon market conditions and comes from other insured financial institutions such as commercial banks, thrift institutions, credit unions, multi-state regional banks, and mortgage bankers.

Personnel

As of December 31, 2010, the Bank had 113 full-time and 5 part-time employees. None of the Bank’s employees are represented by a collective bargaining group.

Lending Activities

The Bank’s loan products include loans for personal and business use. Personal lending includes mortgage lending to finance principal residences and to a lesser extent second home dwellings. The products include fixed rate mortgage products with terms up to 30 years which may be sold, in the secondary market through the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Bank (FHLB) or held in the Bank’s portfolio subject to the extent consistent with our asset/liability management strategies. Fixed-rate home equity loans are originated on terms up to 180 months, as well as offering a home equity line of credit tied to prime rate. The Bank to a lesser extent also offers indirect dealer financing of automobiles (new and used), boats, and recreational vehicles through a limited network of dealers in Northeast Pennsylvania, but is allowing this portfolio to run-off. At December 31, 2010, there were $7.5 million of indirect loans in the portfolio.

4

Commercial loans and commercial mortgages are provided to local small and mid-sized businesses at a variety of terms and rate structures.  At December 31, 2010, the Bank had approximately $38.9 million in loans to the hospitality, lodging industry.  Commercial lending activities include lines of credit, revolving credit, term loans, mortgages, various forms of secured lending and a limited amount of letter of credit facilities. The rate structure may be fixed, immediately repricing tied to the prime rate or adjustable at set intervals.

The Bank’s construction lending has primarily involved lending for commercial construction projects and for single-family residences. All loans for the construction of speculative sale homes have a loan value ratio of not more than 80%. For both commercial and single-family projects loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion. Construction projects are inspected by contracted inspectors or bank personnel. Construction loans are underwritten on the basis of the estimated value of the property as completed. For commercial projects, the Bank typically also provides the permanent financing after the construction period, as a commercial mortgage.

The Bank also, from time to time originates loans secured by undeveloped land. Land loans granted to individuals have a term of up to 5 years. Land loans granted to developers may have an interest only period during development. The substantial majority of land loans have a loan-to-value ratio not exceeding 75%. The Bank has limited its exposure to land loans but may expand its lending on raw land, as market conditions allow, to qualified borrowers experienced in the development and sale of raw land.

Loans involving construction financing and loans on raw land have a higher level of risk than loans for the purchase of existing homes since collateral values, land values, development costs and construction costs can only be estimated at the time the loan is approved. The Bank has sought to minimize its risk in construction lending and in lending for the purchase of raw land by offering such financing primarily to builders and developers to whom the Bank has loaned funds in the past and to persons who have previous experience in such projects. The Bank also limits construction lending and loans on raw land to its market area, with which management is familiar.

Adjustable-rate loans decrease the risks associated with changes in interest rates by periodically repricing, but involve other risks because as interest rates increase, the underlying payments by the borrower increase, thus increasing the potential for payment default. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate may also be limited by the maximum periodic interest rate adjustment permitted in certain adjustable-rate mortgage loan documents, and, therefore is potentially limited in effectiveness during periods of rapidly rising interest rates. These risks have not had an adverse effect on the Bank.

Consumer lending, including indirect financing provides benefits to the Bank’s asset/liability management program by reducing the Bank’s exposure to interest rate changes, due to their generally shorter terms. Such loans may entail additional credit risks compared to owner-occupied residential mortgage lending especially when unsecured or secured by collateral such as automobiles that depreciate rapidly. As a result, the Bank has de-emphasized the indirect lending product line.

Commercial lending including real-estate related loans entail significant additional risks when compared with residential real estate and consumer lending. For example, commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the project and these risks can be significantly impacted by the cash flow of the borrowers and market conditions for commercial office, retail, and warehouse space. In periods of decreasing cash flows, the commercial borrower may permit a lapse in general maintenance of the property causing the value of the underlying collateral to deteriorate.

5

The liquidation of commercial property is often more costly and may involve more time to sell than residential real estate. The Bank offsets such factors with requiring more owner equity, a lower loan to value ratio and by obtaining the personal guaranties of the principals. In addition, a majority of the Bank’s commercial real estate portfolio is owner occupied property.

Due to the type and nature of the collateral, consumer lending generally involves more credit risk when compared with residential real estate lending. Consumer lending collections are typically dependent on the borrower’s continuing financial stability, and thus, are more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. In most cases, any repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance. The remaining deficiency is usually turned over to a collection agency.

There are additional risks associated with indirect automobile lending since we must rely on the automobile dealer to provide accurate information to us and accurate disclosures to the borrowers. These loans are principally done on a non-recourse basis. We seek to mitigate these risks by only dealing with dealers with whom we have a long-standing relationship.

Loan Solicitation and Processing

The Bank has established various lending limits for its officers and also maintains an Officer Loan Committee to approve higher loan amounts. The loan committee is comprised of the President and Chief Executive Officer, Senior Lending Officer and other Bank officers. The Loan Committee has the authority to approve all loans up to set limits based on the type of loan and the collateral. Requests in excess of these limits must be submitted to the Directors’ Loan Committee or Board of Directors for approval. Additionally, the President and Chief Executive Officer, and the Senior Lending Officer and other officers have the authority to approve secured and unsecured loans up to amounts approved by the Board of Directors and maintained in the Bank’s Loan Policy. Notwithstanding individual lending authority, certain loan policy exceptions must be submitted to the loan committee for approval.

Hazard insurance coverage is required on all properties securing loans made by the Bank. Flood insurance is also required, when applicable.

Loan applicants are notified of the credit decision by letter. If the loan is approved, the loan commitment specifies the terms and conditions of the proposed loan including the amount, interest rate, amortization term, a brief description of the required collateral, and the required insurance coverage. The borrower must provide proof of fire, flood (if applicable) and casualty insurance on the property serving as collateral and title insurance, and these applicable insurances must be maintained during the full term of the loan.

6

Loan Portfolio Composition. Set forth below is selected data relating to the composition of the Bank’s loan portfolio at the dates indicated.

	As of December 31,
	2010				2009				2008				2007				2006
	$			%	$			%	$			%	$			%	$			%
	(dollars in thousands)
Commercial, Financial and Agricultural	$	22,386		6.3	$	24,116		6.6	$	25,886		7.4	$	29,159		8.8	$	34,019		10.8
Real Estate-Construction		12,638		3.5		14,405		4.0		14,856		4.2		20,404		6.2		18,955		6.0
Real Estate-Mortgage		308,656		86.4		310,584		85.3		292,893		83.8		263,481		79.5		241,423		76.4
Consumer Loans to Individuals		13,668		3.8		14,850		4.1		16,087		4.6		18,526		5.5		21,520		6.8
		357,348		100.0		363,955		100.0		349,722		100.0		331,570		100.0		315,917		100.0
Unearned income and deferred fees		(493	)			(481	)			(318	)			(274	)			(350	)
Allowance for loan losses		(5,616	)			(5,453	)			(4,233	)			(4,081	)			(3,828	)
	$	351,239			$	358,021			$	345,171			$	327,215			$	311,739

7

Maturities and Sensitivities of Loans to Changes in Interest Rates. The following table sets forth maturities and interest rate sensitivity for selected categories of loans as of December 31, 2010. Scheduled repayments are reported in the maturity category in which payment is due.  Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less.

	One Year or Less		After One to Five Years		Over Five Years		Total
	(dollars in thousands)
Commercial, Financial and Agricultural	$	9,722	$	8,043	$	4,621	$	22,386
Real Estate - Construction		9,507		2,166		965		12,638
Total	$	19,229	$	2,166	$	5,586	$	35,024
Loans with fixed rates	$	14,546	$	7,706	$	5,586	$	27,838
Loans with floating rates		5,911		1,275		-		7,186
Total	$	20,457	$	8,981	$	5,586	$	35,024

Non-Performing Assets. The following table sets forth information regarding non-accrual loans, foreclosed real estate owned and loans that are 90 days or more delinquent but on which the Bank was accruing interest at the dates indicated. For the year ended December 31, 2010, interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of such loans was $390,000 of which $51,000 was collected.

	As of December 31,
	2010			2009			2008			2007			2006
	(dollars in thousands)
Non-accrual loans:
Commercial and all other	$	513		$	—		$	—		$	—		$	—
Real estate		3,527			4,916			2,087			109			392
Consumer		—			—			—			2			17
Total		4,040			4,916			2,087			111			409
Accruing loans which are contractually past-due 90 days or more:
Commercial and all other		—			9			—			—			—
Real estate		39			90			—			49			—
Consumer		—			—			—			3			—
Total		39			99			—			52			—
Total non-performing loans		4,079			5,015			2,087			163			409
Foreclosed real estate		748			392			660			—			—
Total non-performing assets	$	4,827		$	5,407		$	2,747		$	163		$	409
Total non-performing loans to total loans		1.14	%		1.38	%		0.60	%		0.05	%		0.13	%
Total non-performing loans to total assets		0.76	%		0.95	%		0.41	%		0.03	%		0.09	%
Total non-performing assets to total assets		0.90	%		1.02	%		0.54	%		0.03	%		0.09	%

8

The recorded investment in impaired loans, not requiring an allowance for loan losses was $6,111,000 (net of a charge-off against the allowance for loan losses of $220,000) and $6,962,000 (net of charge-offs against the allowance of $154,000) at December 31, 2010 and 2009, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $8,641,000 (net of charge-off against the allowance for loan losses of $480,000) and $1,065,000 (net of a charge-off against the allowance of $480,000) at December 31, 2010 and 2009. For the years ended December 31, 2010, 2009 and 2008, the average recorded investment in these impaired loans was $10,090,000, $3,585,000 and $3,331,000 and the interest income recognized on these impaired loans was $385,000, $139,000 and $143,000, respectively.

Potential Problem Loans. As of December 31, 2010, there were no loans not previously disclosed, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.

Analysis of the Allowance for Loan Losses. The following table sets forth information with respect to the Bank’s allowance for loan losses for the years indicated:

	As of December 31,
	2010			2009			2008			2007			2006
	(dollars in thousands)
Total loans receivable net of unearned income	$	356,855		$	363,474		$	349,404		$	331,296		$	315,567
Average loans receivable	$	355,980		$	356,345		$	335,137		$	323,444		$	301,533
Allowance balance at beginning of period	$	5,453		$	4,233		$	4,081		$	3,828		$	3,669
Charge-offs:
Commercial and all other		(85	)		(17	)		(7	)		—			—
Real Estate		(699	)		(358	)		(465	)		(4	)		—
Consumer		(82	)		(139	)		(171	)		(117	)		(150	)
Total		(866	)		(514	)		(643	)		(121	)		(150	)
Recoveries:
Commercial and all other		—			11			—			—			18
Real Estate		2			4			1			2			2
Consumer		27			34			59			54			65
Leases		—			—			—			3			4
Total		29			49			60			59			89
Net Charge-offs		(837	)		(465	)		(583	)		(62	)		(61	)
Provision Expense		1,000			1,685			735			315			220
Allowance balance at end of period	$	5,616		$	5,453		$	4,233		$	4,081		$	3,828
Allowance for loan losses as a percent of total loans outstanding		1.57	%		1.50	%		1.21	%		1.23	%		1.21	%
Net loans charged off as a percent of average loans outstanding		0.24	%		0.13	%		0.17	%		0.02	%		0.02	%

9

Allocation of the Allowance For Loan Losses. The following table sets forth the allocation of the Bank’s allowance for loan losses by loan category and the percent of loans in each category to total loans at the date indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which credit losses may occur. The total allowance is available to absorb losses from any type of loan.

	As of December 31,
	2010				2009				2008				2007				2006
	Amount				Amount		% of Loans to Total Loans		Loans		% of Loans to Total Loans		Amount		% of Loans to Total Loans		Amount		% of Loans to Total Loans
	(dollars in thousands)
Commercial, financial and agricultural	$	171	6.3	%	$	333	6.6	%	$	491	7.4	%	$	413	8.8	%	$	505	10.8	%
Real estate – construction		110	3.5			136	4.0			138	4.2			148	6.2			44	6.0
Real estate – mortgage		5,143	86.4			4,748	85.3			3,315	83.8			2,939	79.5			2,667	76.4
Consumer loans to individuals		192	3.8			236	4.1			289	4.6			362	5.5			388	6.8
General Risk Allocation		—	—			—	—			—	—			219	—			224	—
Total	$	5,616	100.0	%	$	5,453	100.0	%	$	4,233	100.0	%	$	4,081	100.0	%	$	3,828	100.0	%

10

Investment Activities

General. The Company maintains a portfolio of investment securities consisting principally of obligations of the U.S. Government and its agencies including mortgage-backed securities and obligations of states, counties and municipalities including school districts. To a lesser extent, the Company also has corporate debt obligations in the portfolio as well as a portfolio of equity instruments of other financial services companies. The Company considers its investment portfolio a source of earnings and liquidity. Investment securities may also be pledged to secure public deposits and customer repurchase agreements.

Securities Portfolio. Carrying values of securities at the dates indicated are as follows:

	As of December 31,
	2010		2009		2008
	(dollars in thousands)
Securities: (carrying value)
U.S. Government agencies	$	30,268	$	39,772	$	35,813
State and political subdivisions		49,936		32,343		25,916
Corporate obligations		4,249		5,240		5,625
Mortgage-backed securities –    government sponsored entities		60,928		53,154		62,318
Equity securities-financial services		604		776		1,155
Total Securities	$	145,985	$	131,285	$	130,827
Fair Value of Securities	$	145,994	$	131,299	$	130,840

11

Maturity Distribution of Securities. The following table sets forth certain information regarding carrying values, weighted average yields, and maturities of the Company’s securities portfolio as of December 31, 2010. Yields on tax-exempt securities are stated on a fully taxable equivalent basis using a Federal tax rate of 34%. Actual maturities may differ from contractual maturities as certain instruments have call features which allow prepayment of obligations. Maturity on the mortgage-backed securities is based upon contractual terms, the average life may differ as a result of changes in cash flow. Equity securities with no stated maturity are classified as “after ten years.”

	One Year or Less				After One Through Five Years				After Five Through Ten Years				After Ten Years				Total Investment Securities
	Carrying Value		Average Yield		Carrying Value		Average Yield		Carrying Value		Average Yield		Carrying Value		Average Yield		Carrying Value		Average Yield
	(dollars in thousands)
U.S. Government agencies	$	—	—	%	$	25,487	2.27	%	$	4,781	2.08	%	$	—	—	%	$	30,268	2.24	%
State and political subdivision		—	—	%		3,864	4.79	%		17,842	5.56	%		28,230	5.76	%		49,936	5.61	%
Corporate obligations		1,005	4.91	%		3,244	5.10	%		—	—	%		—	—	%		4,249	5.05	%
Mortgage-backed securities- government sponsored entities		311	3.72	%		425	5.12	%		21,247	3.08	%		38,945	3.54	%		60,928	3.39	%
Equity securities-financial services		—	—	%		—	—	%		—	—	%		604	—	%		604	—	%
Total Investment Securities	$	1,316	4.63	%	$	33,020	2.88	%	$	43,870	3.98	%	$	67,779	4.43	%	$	145,985	3.95	%

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Deposit Activities

General. The Bank provides a full range of deposit products to its retail and business customers. These include interest-bearing and noninterest bearing transaction accounts, statement savings and money market accounts. Certificate of deposit terms range up to 5 years for retail instruments. The Bank has no brokered deposits. The Bank participates in the Jumbo CD ($100,000 and over) markets with local municipalities and school districts which are typically priced on a competitive bid basis. Other services the Bank offers its customers on a limited basis include cash management, direct deposit, Remote Deposit Capture and Automated Clearing House (ACH) activity. The Bank operates elevenautomated teller machines and is affiliated with the STAR and MoneyPass ATM networks. Internet banking including bill-pay is offered through the website at www.waynebank.com.

The following table sets forth information regarding deposit categories of the Company.

	Years Ended December 31,
	2010				2009				2008
	Average				Average				Average
	Balance		Rate Paid		Balance		Rate Paid		Balance		Rate Paid
	(dollars in thousands)
Non-interest bearing demand	$	61,966	—	%	$	59,224	—	%	$	59,759	—	%
Interest-bearing demand		38,150	0.11			35,808	0.10			36,839	0.10
Money Market		69,847	0.76			63,160	1.10			65,519	2.15
Savings		48,588	0.22			44,526	0.35			44,510	0.47
Time		177,761	2.03			174,201	2.80			160,462	3.81
Total	$	396,312			$	376,919			$	367,089

Maturities of Time Deposits. The following table indicates the amount of the Bank’s time deposits of $100,000 or more by time remaining until maturity as of December 31, 2010.

	Amount
Maturity Period	(in thousands)
Within three months	$	9,497
Over three through six months		21,792
Over six through twelve months		12,277
Over twelve months		16,449
	$	60,015

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Short-Term Borrowings

The following table sets forth information concerning short-term borrowings (those maturing within one year) which consist principally of securities sold under agreements to repurchase, short-term Federal Home Loan Bank (FHLB) advances, federal funds purchased and U.S. Treasury demand notes that the Company had during the periods indicated.

	Years Ended December 31,
	2010			2009			2008
	(dollars in thousands)
Short term borrowings:
Average balance during the year	$	26,100		$	26,402		$	32,238
Maximum month-end balance during the year	$	40,068		$	35,323		$	42,061
Average interest rate during the year		0.45	%		1.11	%		2.14	%
Total short-term borrowings at end of the year	$	33,309		$	25,803		$	38,126
Weighted average interest rate at the end of the year		0.37	%		0.56	%		1.11	%

Trust Activities

The Bank operates a Wealth Management/Trust Department which provides estate planning, investment management and financial planning to customers for which it is generally compensated based on a percentage of assets under management. As of December 31, 2010, the Bank had $113.7 million of assets under management compared to $99.4 million as of December 31, 2009. The increase is partially due to improvement in stock market performance which can affect the value of a customer’s investment portfolio.

Subsidiary Activities

The Bank, a Pennsylvania chartered bank, is the only wholly owned subsidiary of the Company. Norwood Investment Corp. (NIC), a Pennsylvania Corporation incorporated in 1996 and a Pennsylvania licensed insurance agency, is a wholly-owned subsidiary of the Bank. NIC’s business is annuity and mutual fund sales and discount brokerage activities primarily to customers of the Bank. The annuities, mutual funds and other investment products are not insured by the FDIC or any other government agency. They are not deposits, obligations of or guaranteed by any bank. The securities are offered through Invest Financial a registered broker/dealer. NIC generated gross revenues for the Company of $116,000, compared to $112,000 in 2009 which is included in Other Income.

WCB Realty Corp., a Pennsylvania Corporation, is a wholly-owned real estate subsidiary of the Bank whose principal asset is the administrative offices of the Company, which also includes the Main Office of the Bank.

WTRO Properties Inc., a Pennsylvania Corporation, is a wholly-owned real estate subsidiary of the Bank established to hold title to certain real estate upon which the Bank has foreclosed.  As of December 31, 2010 and 2009, the outstanding balance of foreclosed properties on which WTRO held title totaled $448,000 and $0 respectively.  The increase is due to the addition of a commercial property located in Pike County.

Norwood Settlement Services, LLC, a Pennsylvania Limited Liability Company, was established in 2004 to provide title and settlement service to Bank customers and non-customers.  Gross revenues, included in other income, for 2010 totaled $33,000 and $93,000 in 2009.

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Regulation

Set forth below is a brief description of certain laws which relate to the regulation of the Registrant and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law.  The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation.  Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms.  The Dodd-Frank Act additionally creates a new independent federal regulator to administer federal consumer protection laws. The Dodd-Frank Act is expected to have a significant impact on our business operations as its provisions take effect.  Among the provisions that may affect us are the following:

Holding Company Capital Requirements.  The Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions.  Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

Deposit Insurance.  The Dodd-Frank Act permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2013. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective one year from the date of enactment, the Dodd-Frank Act eliminates the federal statutory prohibition against the payment of interest on business checking accounts.

Corporate Governance.The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The new legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not.  The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

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Prohibition Against Charter Conversions of Troubled Institutions.  Effective one year after enactment, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days.  The notice must include a plan to address the significant supervisory matter.  The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto.

Interstate Branching.  The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch.  Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state.  Accordingly, banks will be able to enter new markets more freely.

Limits on Derivatives.  Effective 18 months after enactment, the Dodd-Frank Act prohibits state-chartered banks from engaging in derivatives transactions unless the loans to one borrower limits of the state in which the bank is chartered takes into consideration credit exposure to derivatives transactions.  For this purpose, derivative transaction includes any contract, agreement, swap, warrant, note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure or the occurrence of any event  relating to, one or more commodities securities, currencies, interest or other rates, indices or other assets.

Transactions with Affiliates and Insiders.  Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates.  The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated.  The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the disinterested directors.

Debit Card Interchange Fees.  Effective July 21, 2011, the Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer.  Within nine months of enactment, the Federal Reserve Board is required to establish standards for reasonable and proportional fees which may take into account the costs of preventing fraud.  The restrictions on interchange fees, however, do not apply to banks that, together with their affiliates, have assets of less than $10 billion.

Consumer Financial Protection Bureau.  The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination

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and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products.  The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay.  In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

Regulation of the Company

General. The Company, as a bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”), is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and by the Pennsylvania Department of Banking (the “Department”).  The Company is required to file annually a report of its operations with, and is subject to examination by, the Federal Reserve and the Department. This regulation and oversight is generally intended to ensure that the Company limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of its subsidiary banks.

Under the BHCA, the Company must obtain the prior approval of the Federal Reserve before it may acquire control of another bank or bank holding company, merge or consolidate with another bank holding company, acquire all or substantially all of the assets of another bank or bank holding company, or acquire direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company would directly or indirectly own or control more than 5% of such shares.

Federal statutes impose restrictions on the ability of a bank holding company and its nonbank subsidiaries to obtain extensions of credit from its subsidiary bank, on the subsidiary bank’s investments in the stock or securities of the holding company, and on the subsidiary bank’s taking of the holding company’s stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services by the subsidiary bank.

A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the policy of the Federal Reserve that a bank holding company should stand ready to use available resources to provide adequate capital to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve regulations, or both.

Non-Banking Activities. The business activities of the Company, as a bank holding company, are restricted by the BHCA. Under the BHCA and the Federal Reserve’s bank holding company regulations, the Company may only engage in, or acquire or control voting securities or assets of a company engaged in, (1) banking or managing or controlling banks and other subsidiaries authorized under the BHCA and (2) any BHCA activity the Federal Reserve has determined to be so closely related to banking or managing or controlling banks to be a proper incident thereto. These include any incidental activities

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necessary to carry on those activities, as well as a lengthy list of activities that the Federal Reserve has determined to be so closely related to the business of banking as to be a proper incident thereto.

Financial Modernization. The Gramm-Leach-Bliley Act, permits greater affiliation among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a “financial holding company.”  A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including  securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The Act also permits the Federal Reserve and the Treasury Department to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” CRA rating. A financial holding company must provide notice to the Federal Reserve within 30 days after commencing activities previously determined by statute or by the Federal Reserve and Department of the Treasury to be permissible. The Company has not submitted notice to the Federal Reserve of its intent to be deemed a financial holding company.

Regulatory Capital Requirements. The Federal Reserve has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the BHCA. The Federal Reserve’s capital adequacy guidelines are similar to those imposed on the Bank by the Federal Deposit Insurance Corporation (“FDIC”). See “Regulation of the Bank-Regulatory Capital Requirements.”

Regulation of the Bank

General. As a Pennsylvania chartered, FDIC insured commercial bank, the Bank is subject to extensive regulation and examination by the Department and by the FDIC, which insures its deposits to the maximum extent permitted by law. The federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. The laws and regulations governing the Bank generally have been promulgated to protect depositors and not for the purpose of protecting stockholders. This regulatory structure also gives the federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Department, the FDIC or the United States Congress, could have a material impact on the Company, the Bank and their operations.

Pennsylvania  Banking Law. The Pennsylvania Banking Code (“Banking Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, and employees, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Banking Code delegates extensive rule-making power and administrative discretion to the Department so that the supervision and regulation of state chartered banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.

The Federal Deposit Insurance Corporation Act (“FDIA”), however, prohibits state chartered banks from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the bank meets

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all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the Banking Code is significantly restricted by the FDIA.

Federal Deposit Insurance. The Bank’s deposits are insured to applicable limits by the FDIC.  Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the maximum deposit insurance amount has been permanently increased from $100,000 to $250,000 and unlimited deposit insurance has been extended to non-interest-bearing transaction accounts until December 31, 2012.  Prior to the Dodd-Frank Act, the FDIC had established a Temporary Liquidity Guarantee Program under which, for the payment of an additional assessment by insured banks that did not opt out, the FDIC fully guaranteed all non-interest-bearing transaction accounts until June 30, 2010 (the “Transaction Account Guarantee Program”) and all senior unsecured debt of insured depository institutions or their qualified holding companies issued between October 14, 2008 and October 31, 2009, with the FDIC’s guarantee expiring by December 31, 2012 (the “Debt Guarantee Program”).  Neither the Company and the Bank opted out of the Debt Guarantee Program but neither issued any debt thereunder.  The Bank did not opt out of the Transaction Account Guarantee Program.

The FDIC has adopted a risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based on their examination ratings and capital ratios. Well-capitalized institutions with the CAMELS ratings of 1 or 2 are grouped in Risk Category I and, until 2009, were assessed for deposit insurance at an annual rate of between five and seven basis points of issued deposits with the assessment rate for an individual institution determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either five financial ratios or the average ratings of its long-term debt. Institutions in Risk Categories II, III and IV were assessed at annual rates of 10, 28 and 43 basis points, respectively.

Starting in 2009, the FDIC significantly raised the assessment rate in order to restore the reserve ratio of the Deposit Insurance Fund to the statutory minimum of 1.15%For the quarter beginning January 1, 2009, the FDIC raised the base annual assessment rate for institutions in Risk Category I to between 12 and 14 basis points while the base annual assessment rates for institutions in Risk Categories II, III and IV were increased to 17, 35 and 50 basis points, respectively.  For the quarter beginning April 1, 2009 the FDIC set the base annual assessment rate for institutions in Risk Category I to between 12 and 16 basis points and the base annual assessment rates for institutions in Risk Categories II, III and IV at 22, 32 and 45 basis points, respectively.  An institution’s assessment rate could be lowered by as much as five basis points based on the ratio of its long-term unsecured debt to deposits or, for smaller institutions based on the ratio of certain amounts of Tier 1 capital to adjusted assets.  The assessment rate may be adjusted for Risk Category I institutions that have a high level of brokered deposits and have experienced higher levels of asset growth (other than through acquisitions) and could be increased by as much as ten basis points for institutions in Risk Categories II, III and IV whose ratio of brokered deposits to deposits exceeds 10%.  Reciprocal deposit arrangements like CDARS® were treated as brokered deposits for Risk Category II, III and IV institutions but not for institutions in Risk Category I.  An institution’s base assessment rate would also be increased if an institution’s ratio of secured liabilities (including FHLB advances and repurchase agreements) to deposits exceeds 25%.  The maximum adjustment for secured liabilities for institutions in Risk Categories I, II, III and IV would be 8, 11, 16 and 22.5 basis points, respectively, provided that the adjustment may not increase an institution’s base assessment rate by more than 50%.

The FDIC imposed a special assessment equal to five basis points of assets less Tier 1 capital as of June 30, 2009, payable on September 30, 2009, and reserved the right to impose additional special assessments.  In November, 2009, instead of imposing additional special assessments, the FDIC amended the assessment regulations to require all insured depository institutions to prepay their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012 on December 30, 2009.  For purposes of estimating the future assessments, each institution’s base assessment rate in effect

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on September 30, 2009 was used, assuming a 5% annual growth rate in the assessment base and a 3 basis point increase in the assessment rate in 2011 and 2012.  The prepaid assessment will be applied against actual quarterly assessments until exhausted.  Any funds remaining after June 30, 2013 will be returned to the institution.  If the prepayment would impair an institution’s liquidity or otherwise create significant hardship, it may apply for an exemption.  Requiring this prepaid assessment does not preclude the FDIC from changing assessment rates or from further revising the risk-based assessment system.

The Dodd-Frank Act requires the FDIC to take such steps as necessary to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020.  In setting the assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also broadens the base for FDIC insurance assessments so that assessments will be based on the average consolidated total assets less average tangible equity capital of a financial institution rather than on its insured deposits.  The FDIC has adopted a new restoration plan to increase the reserve ratio to 1.15% by September 30, 2020 with additional rulemaking scheduled for 2011 regarding the method to be used to achieve a 1.35% reserve ratio by that date and offset the effect on institutions with assets less than $10 billion in assets.  Pursuant to the new restoration plan, the FDIC will forgo the 3 basis point increase in assessments scheduled to take effect on January 1, 2011.

  The FDIC has adopted new assessment regulations that redefine the assessment base as average consolidated assets less average tangible equity.  Insured banks with more than $1.0 billion in assets must calculate quarterly average assets based on daily balances while smaller banks and newly chartered banks may use weekly averages.  In the case of a merger, the average assets of the surviving bank for the quarter must include the average assets of the merged institution for the period in the quarter prior to the merger. Average assets would be reduced by goodwill and other intangibles.  Average tangible equity will equal Tier 1 capital. For institutions with more than $1.0 billion in assets average tangible equity will be calculated on a weekly basis while smaller institutions may use the quarter-end balance.  Beginning April 1, 2011, the base assessment rate for insured institutions in Risk Category I will range between 5 to 9 basis points and for institutions in Risk Categories II, III, and IV will be 14, 23 and 35 basis points.  An institution’s assessment rate will be reduced based on the amount of its outstanding unsecured long-term debt and for institutions in Risk Categories II, III and IV may be increased based on their brokered deposits. Risk Categories are eliminated for institutions with more than $10 billion in assets which will be assessed at a rate between 5 and 35 basis points.

In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the Federal Savings and Loan Insurance Corporation.  The FICO assessment rates, which are determined quarterly, averaged .01% of insured deposits on an annualized basis in fiscal year 2009.  These assessments will continue until the FICO bonds mature in 2017.

Regulatory Capital Requirements. The FDIC has promulgated capital adequacy requirements for state-chartered banks that, like the Bank, are not members of the Federal Reserve System. At December 31, 2010, the Bank exceeded all regulatory capital requirements and was classified as “well capitalized.”

The FDIC’s capital regulations establish a minimum 3% Tier I leverage capital requirement for the most highly-rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively increases the minimum Tier I leverage ratio for such other banks to 4% to 5%. Under the FDIC’s regulation, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset

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quality, high liquidity, good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System. Tier I or core capital is defined as the sum of common stockholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain servicing and purchased credit card relationships, and minus certain other listed assets.

The FDIC’s regulations also require that state-chartered, non-member banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier I capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier I capital for the risk-based standards are the same as those for the leverage capital requirement. The components of supplementary (Tier 2) capital include cumulative perpetual preferred stock, mandatory subordinated debt, perpetual subordinated debt, intermediate-term preferred stock, up to 45% of unrealized gains on equity securities and a bank’s allowance for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital that may be included in total capital is limited to 100% of Tier I capital.

A bank that has less than the minimum leverage capital requirement is subject to various capital plan and activities restriction requirements. The FDIC’s regulations also provide that any insured depository institution with a ratio of Tier I capital to total assets that is less than 2.0% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the FDIA and could be subject to potential termination of deposit insurance.

The Bank is also subject to minimum capital requirements imposed by the Department on Pennsylvania-chartered depository institutions. Under the Department’s capital regulations, a Pennsylvania bank or savings bank must maintain a minimum leverage ratio of Tier 1 capital (as defined under the FDIC’s capital regulations) to total assets of 4%. In addition, the Department has the supervisory discretion to require  higher leverage ratio for any institutions based on the institution’s substandard performance in any of a number of areas. The Bank was in compliance in both the FDIC and Pennsylvania capital requirements as of December 31, 2010.

Affiliate Transaction Restrictions. Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. In particular loans by a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are limited to 10% of a bank subsidiary’s capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary’s capital and surplus. Further, loans and other extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that all transactions between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.

Loans to One Borrower. Under Pennsylvania law, commercial banks have, subject to certain exemptions, lending limits to one borrower in an amount equal to 15% of the institution’s capital accounts. An institution’s capital account includes the aggregate of all capital, surplus, undivided profits, capital securities and general reserves for loan losses. Pursuant to the national bank parity provisions of the Pennsylvania Banking Code, the Bank may also lend up to the maximum amounts permissible for national banks, which are allowed to make loans to one borrower of up to 25% of capital and surplus in certain circumstances. As of December 31, 2010, loans-to-one-borrower limitation was $10.6 million and the Bank was in compliance with such limitation.

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Federal Home Loan Bank System. The Bank is a member of the FHLB of Pittsburgh, which is one of 12 regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Trustees of the FHLB.

As a member, the Bank is required to purchase and maintain restricted stock in the FHLB of Pittsburgh in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of the Bank’s outstanding advances from the FHLB. At December 31, 2010, the Bank was in compliance with this requirement. In December 2008, the FHLB of Pittsburgh notified member banks that is was suspending dividend payments and the repurchase of excess capital stock. Management evaluates the restricted stock for impairment in accordance with Statement of Position (SOP) 01-6, Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others. Management’s determination of whether these investments are impaired is based on the assessment of the ultimate recoverability of their costs rather than by recognizing temporary declines in value. Management believes no impairment charge is necessary related to FHLB stock as of December 31, 2010.

Federal Reserve System. The Federal Reserve requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking and NOW accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy the liquidity requirements that are imposed by the Department. At December 31, 2010, the Bank met its reserve requirements.

Restrictions on Dividends. The Pennsylvania Banking Code states, in part, that dividends may be declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital. The Bank has not declared or paid any dividends which cause the Bank’s retained earnings to be reduced below the amount required. Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due the FDIC.

The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. In a recent Supervisory Letter, the Federal Reserve staff has stated that, as a general matter, bank holding companies should eliminate cash dividends if net income available to shareholders for the past four quarters, net of dividends previously paid, is not sufficient to fully fund the dividend. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

Item 1A. Risk Factors

In determining whether to invest in our securities, investors should consider, among other factors, the following:

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Risks Related to Our Business

We may not realize the anticipated benefits from our proposed acquisition of North Penn Bancorp, Inc.

On December 14, 2010, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with North Penn Bancorp, Inc. (“North Penn”) and its wholly owned subsidiary, North Penn Bank, pursuant to which North Penn will merge with and into the Company and immediately thereafter, North Penn Bank will merge with and into the Bank.  The acquisition of North Penn is anticipated to strengthen our market position in Monroe County and allow us to better serve our customers in Luzerne County  The success of this transaction, however, will depend on, among other things, our ability to realize anticipated cost savings and to combine the businesses of the Bank and North Penn Bank in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of North Penn Bank nor result in decreased revenues resulting from any loss of customers. If we are not able to successfully achieve these objectives, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected.

Norwood Financial Corp. and North Penn have operated and, until the completion of the transactions, will continue to operate, independently. Certain North Penn employees may not be employed by us after the transaction.  In addition, North Penn employees that we wish to retain may elect to terminate their employment as a result of the acquisition, which could delay or disrupt the integration process. It is possible that the integration process could result in the disruption of North Penn’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers and employees or to achieve the anticipated benefits of the acquisition.

Our success will depend upon our ability to effectively manage our future growth.

We believe that we have in place the management and systems, including data processing systems, internal controls and a strong credit culture, to support continued growth. However, our continued growth and profitability depend on the ability of our officers and key employees to manage such growth effectively, to attract and retain skilled employees and to maintain adequate internal controls and a strong credit culture. Accordingly, there can be no assurance that we will be successful in managing our expansion, and the failure to do so would adversely affect our financial condition and results of operations.

If we experience loan losses in excess of our allowance, our earnings will be adversely affected.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.

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As of December 31, 2010, our allowance for loan losses was $5,616,000 which represented 1.57% of outstanding loans. At such date, we had seventeen nonperforming loans totaling $4.1 million and ten impaired loans totaling $14.7 million. We actively manage our nonperforming loans in an effort to minimize credit losses. Although management believes that its allowance for loan losses is adequate, there can be no assurance that the allowance will prove sufficient to cover future loan losses. Further, although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our non-performing or performing loans. Material additions to our allowance for loan losses would result in a decrease in our net income and capital, and could have a material adverse effect on our financial condition and results of operations.

Most of our loans are to commercial borrowers, which have a higher degree of risk than other types of loans.

Commercial loans are often larger and may involve greater risks than other types of lending. Because payments onsuch loans are often dependent on the successful operation of the property or business involved, repayment of such loans may be more sensitive than other types of loans due to adverse conditions in the real estate market or the economy. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself and the general economic environment. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired.

Most of our loans are secured, in whole or in part, with real estate collateral which is subject to declines in value.

In addition to the financial strength and cash flow characteristics of the borrower in each case, we often secure our loans with real estate collateral. As of December 31, 2010, approximately 86% of our loans, had real estate as a primary, secondary or tertiary component of collateral. In addition, approximately 42% of our securities portfolio consisted of mortgage-backed securities issued by either Fannie Mae (FNMA), Freddie Mac (FHLMC) or Government National Mortgage Association (GNMA). Real estate values and real estate markets are generally affected by, among other things, changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower. If real estate prices in our markets decline, the value of the real estate collateral securing our loans could be reduced. If we are required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.

We may be required to record other-than-temporary impairment charges in respect of our investment securities portfolio and restricted stock.

As of December 31, 2010, we had approximately $50.7 million in investments, including mortgage-backed securities on which we had unrealized losses of $1.2 million. In addition, we had $3.4 million of restricted stock in the FHLB of Pittsburgh, which has suspended the payment of dividends and repurchases of excess capital stock. We may be required to record impairment charges on our investments

24

and FHLB stock if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for resales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in the business climate, or adverse actions by regulators could have a negative effect on the value of our investments and mortgage backed securities. If an impairment charge is significant enough to result in a loss for the period, it could affect the ability of our bank subsidiary to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to stockholders and could also negatively impact our regulatory capital ratios and result in us not being classified as “well capitalized” for regulatory purposes.

Higher FDIC deposit insurance premiums and assessments could adversely affect our earnings and financial condition.

FDIC insurance premiums increased substantially in 2009 and we may be required to pay higher FDIC premiums in the future.  The large number of bank failures has significantly depleted the deposit insurance fund and reduced the ratio of reserves to insured deposits below the designated reserve ratio.  To restore the deposit insurance fund, the FDIC adopted a revised risk-based deposit insurance assessment schedule, which significantly raised deposit insurance premiums on all insured banks.  The FDIC also imposed a five basis point special assessment payable September 30, 2009 on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009.   In order to increase the funds available to the Deposit Insurance Fund, the FDIC required all insured depository institutions to prepay their federal deposit insurance assessments through 2012.  The prepayment was based on the institution’s assessment base and assessment rate as of September 30, 2009 assuming 5% annual growth in deposits and a three basis point increase in the assessment rate during years 2011 and 2012.  The prepayment was recorded on the balance sheet as a non-earning prepaid expense asset against which future quarterly assessments will be charged.  The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act requires the FDIC to achieve a higher reserve ratio for the Deposit Insurance Fund and significantly changes the methodology for calculating assessments.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions.  Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions.  There is no assurance that any such losses would not materially and adversely affect our results of operations.

Recently enacted financial reform legislation could substantially increase our compliance burden and costs and necessitate changes in the conduct of our business.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act will have a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. In particular, the following provisions of the Dodd-Frank Act, among others, are expected to impact our operations and activities, both currently and prospectively:

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·   The imposition of capital requirements on Norwood Financial Corp. that are no less stringent than those applicable to Wayne Bank, which may reduce our flexibility in raising capital;

·   Changes in methodologies for calculating deposit insurance premiums and increases in required deposit insurance fund reserve levels, which could increase our deposit insurance expense;

·   Elimination of restrictions on interstate branching, which could allow more competitors to enter our market area; and

·   Imposition of comprehensive, new consumer protection requirements, which could substantially increase our compliance burden and potentially expose us to new liabilities.

Further, we may be required to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements under the Dodd-Frank Act. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.

Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.

The Emergency Economic Stabilization Act of 2008 (the “EESA”) authorized Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under a troubled asset relief program, or “TARP.” The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury has allocated $250 billion towards the TARP Capital Purchase Program. Under the TARP Capital Purchase Program, Treasury is purchasing equity securities from participating institutions. The EESA also increased federal deposit insurance on most deposit accounts from $100,000 to $250,000. This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.

The EESA followed, and has been followed by, numerous actions by the Board of Governors of the Federal Reserve System, the U.S. Congress, Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. The EESA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.

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Recent levels of market volatility are unprecedented.

The capital and credit markets have recently experienced volatility and disruption which has reached unprecedented levels. In some cases, the markets produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If these levels of market disruption and volatility return, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and investments and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.

We may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. In that regard, a number of financial institutions have recently raised considerable amounts of capital in response to a deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors. Should we be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.

Our business is geographically concentrated and is subject to regional economic factors that could have an adverse impact on our business.

Substantially all of our business is with customers in our market area of Northeastern Pennsylvania. Most of our customers are consumers and small and medium-sized businesses which are dependent upon the regional economy. Adverse changes in economic and business conditions in our markets could adversely affect our borrowers, their ability to repay their loans and to borrow additional funds, and consequently our financial condition and performance.

Additionally, we often secure our loans with real estate collateral, most of which is located in Northeastern Pennsylvania. A decline in local economic conditions could adversely affect the values of

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such real estate. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

The loss of senior executive officers and certain other key personnel could hurt our business.

Our success depends, to a great extent, upon the services of Lewis J. Critelli, our President and Chief Executive Officer.  Although we have an employment agreement with non-compete provisions with Mr.  Critelli, the existence of such agreement does not assure that we will retain his services. The unexpected loss of Mr. Critelli could have a material adverse effect on our operations. From time to time, we also need to recruit personnel to fill vacant positions for experienced lending officers and branch managers. Competition for qualified personnel in the banking industry is intense, and there can be no assurance that we will continue to be successful in attracting, recruiting and retaining the necessary skilled managerial, marketing and technical personnel for the successful operation of our existing lending, operations, accounting and administrative functions or to support the expansion of the functions necessary for our future growth. Our inability to hire or retain key personnel could have a material adverse effect on our results of operations.

Our legal lending limits are relatively low and restrict our ability to compete for larger customers.

At December 31, 2010, our lending limit per borrower was approximately $10.6 million, or 15% of our capital plus allowance for loan losses. Accordingly, the size of loans that we can offer to potential borrowers is less than the size of loans that many of our competitors with larger capitalization are able to offer. We may engage in loan participations with other banks for loans in excess of our legal lending limits. However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and our customers.

Risks Related to Our Common Stock

There is a limited trading market for our common stock, which may adversely impact your ability to sell your shares and the price you receive for your shares.

Although our common stock is quoted on the Nasdaq Global Market, there has been limited trading activity in our stock and an active trading market is not expected to develop. This means that there may be limited liquidity for our common stock, which may make it difficult to buy or sell our common stock, may negatively affect the price of our common stock and may cause volatility in the price of our common stock.

There are restrictions on our ability to pay cash dividends.

Although we have paid cash dividends on a quarterly basis since 1996, and the Bank has paid dividends for many previous years, there is no assurance that we will continue to pay cash dividends. Future payment of cash dividends, if any, will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements and such other factors as the Board may deem relevant and will be subject to applicable federal and state laws that impose restrictions on our ability to pay dividends.

Our common stock is not insured and you could lose the value of your entire investment.

An investment in shares of our common stock is not a deposit and is not insured against loss by the government.

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Our management and significant shareholders control a substantial percentage of our stock and therefore have the ability to exercise substantial control over our affairs.

As of December 31, 2010, our directors and executive officers beneficially owned approximately 212,374 shares, or approximately 7.4% of our common stock, including options to purchase 98,578 shares, in the aggregate, of our common stock at exercise prices ranging from $16.98 to $31.50 per share. Because of the large percentage of stock held by our directors and executive officers and other significant shareholders, these persons could influence the outcome of any matter submitted to a vote of our shareholders.

We may issue additional shares of common or preferred stock, which may dilute the ownership and voting power of our shareholders and the book value of our common stock.

We are currently authorized to issue up to 10,000,000 shares of common stock of which 2,768,804 shares are currently outstanding and up to 5,000,000 shares of preferred stock of which no shares are outstanding. Our Board of Directors has authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares and to establish the terms of any series of preferred stock. These authorized but unissued shares could be issued on terms or in circumstances that could dilute the interests of other stockholders. In addition, a total of 250,000 shares of common stock have been reserved for issuance under the Norwood Financial Corp 2006 Stock Option Plan, of which 144,645 were issued as of December 31, 2010. As of December 31, 2010, options to purchase a total of 161,639 shares were exercisable and had exercise prices ranging from $16.98 to $31.50. Any such issuance will dilute the percentage ownership interest of shareholders and may further dilute the book value of our common stock.

Provisions of our Articles of Incorporation and the Pennsylvania Business Corporation Law could deter takeovers which are opposed by the Board of Directors.

Our articles of incorporation require the approval of 80% of our outstanding shares for any merger or consolidation unless the transaction meets certain fair price criteria or the business combination has been approved or authorized by the Board of Directors. In addition, our articles of incorporation may require the disgorgement of profits realized by any person who attempts to acquire control of the Company. As a Pennsylvania corporation with a class of securities registered with the Securities and Exchange Commission, the Company is governed by certain provisions of the Pennsylvania Business Corporation Law that, inter alia, permit the disparate treatment of certain shareholders; prohibit calls of special meetings of shareholders; require unanimous written consent for shareholder action in lieu of a meeting; require shareholder approval for certain transactions in which a shareholder has an interest; and impose additional requirements on business combinations with persons who are the beneficial owners of more than 20% of the Company’s stock.

Risks Related to Our Industry

We operate in a competitive market which could constrain our future growth and profitability.

We operate in a competitive environment, competing for deposits and loans with commercial banks, savings associations and other financial entities. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Many of the financial intermediaries operating in our market area offer certain services, such as international banking

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services, which we do not offer. Moreover, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers.

We are required to comply with extensive and complex governmental regulation which can adversely affect our business.

Our operations are and will be affected by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities. We are subject to supervision and periodic examination by the Federal Reserve Board (the “FRB”), “FDIC” and the Pennsylvania Department of Banking. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services. We are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any such changes may have on our future business and earnings prospects. Further, the cost of compliance with regulatory requirements may adversely affect our ability to operate profitability.

In addition, the monetary policies of the FRB have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. Among the instruments of monetary policy used by the FRB to implement its objectives are changes in the discount rate charged on bank borrowings and changes in the reserve requirements on bank deposits. It is not possible to predict what changes, if any, will be made to the monetary policies of the FRB or to existing federal and state legislation or the effect that such change may have on our future business and earnings prospects.

During the past several years, significant legislative attention has been focused on the regulation and deregulation of the financial services industry. Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, have been permitted to engage in activities which compete directly with traditional bank business.

We realize income primarily from the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and changes in interest rates may adversely affect our profitability and assets.

Changes in prevailing interest rates may hurt our business. We derive our income mainly from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the larger the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate. This can cause decreases in our spread and can adversely affect our income.

Interest rates affect how much money we can lend. For example, when interest rates rise, the cost of borrowing increases and loan originations tend to decrease. In addition, changes in interest rates can affect the average life of loans and investment securities. A reduction in interest rates generally results in increased prepayments of loans and mortgage-backed securities, as borrowers refinance their debt in order to reduce their borrowing cost. This causes reinvestment risk, because we generally are not able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Changes in market interest rates could also reduce the value of our financial assets. If we are unsuccessful

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in managing the effects of changes in interest rates, our financial condition and results of operations could suffer.

As a public company, we are subject to numerous reporting requirements that are currently evolving and could substantially increase our operating expenses and divert management’s attention from the operation of our business.

The Sarbanes-Oxley Act of 2002, which became law in July 2002, has required changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of that Act, the SEC has promulgated new rules covering a variety of subjects. Compliance with these new rules has significantly increased our legal and financial and accounting costs, and we expect these increased costs to continue. In addition, compliance with the requirements has taken a significant amount of management’s and the Board of Directors’ time and resources. Likewise, these developments may make it more difficult for us to attract and retain qualified members of our board of directors, particularly independent directors, or qualified executive officers.

As directed by Section 404 of the Sarbanes-Oxley Act, the SEC adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting. In addition, the independent registered public accounting firm auditing the company’s financial statements must report on the effectiveness of the company’s internal control over financial reporting. If we are ever unable to conclude that we have effective internal control over financial reporting or, if our independent auditors are unable to provide us with an unqualified report as to the effectiveness of our internal control over financial reporting for any future year-ends as required by Section 404, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our securities.

Item 1B. Unresolved Staff Comments

None.

Item  2. Properties

The Bank operates from its main office located at 717 Main Street, Honesdale, Pennsylvania and ten additional branch offices. The Bank’s total investment in office property and equipment is $14.2 million with a net book value of $4.9 million as of December 31, 2010. The Bank currently operates automated teller machines at all eleven of its facilities. The Bank leases fourof its locations with minimum lease commitments of $3.1 million through 2029. Three of the locations have various renewal options.

Item 3. Legal Proceedings

Neither the Company nor its subsidiaries are involved in any pending legal proceedings, other than routine legal matters occurring in the ordinary course of business, which in the aggregate involve amounts which are believed by management to be immaterial to the consolidated financial condition or results of operations of the Company.

Item 4.  [Removed and Reserved]

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Information relating to the market for Registrant’s common equity and related stockholder matters appears under “Capital and Dividends” in the Registrant’s Annual Report to Stockholders for the fiscal year ended December 31, 2010 (“Annual Report”) and is incorporated herein by reference.

Item 6. Selected Financial Data

The above-captioned information appears under “Summary of Selected Financial Data” in the Annual Report, and is incorporated herein by reference.

Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

The above-captioned information appears under “Management’s Discussion and Analysis” in the Annual Report and is incorporated herein by reference from the Annual Report.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

The above-captioned information appears under “Management’s Discussion and Analysis -- Market Risk” in the Annual Report and is incorporated herein by reference.

Item 8. Financial Statements and Supplementary Data

The Company’s consolidated financial statements listed in Item 15 and the Summary of Quarterly Results (unaudited) are incorporated herein by reference from the Annual Report.

Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

The above-captioned information appears under “Change in Auditors” in the Annual Report and is incorporated herein by reference.

Item 9A. Controls and Procedures

(a)  Disclosure Controls and Procedures. The Company’s management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

(b)  Internal Control over Financial Reporting. Management’s Report on Internal Control over Financial Reporting and the Report of the Company’s Independent Registered Public Accounting Firm are incorporated herein by reference from the Annual Report. There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Item 9B. Other Information

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information contained under the sections captioned “Section 16(a) Beneficial Ownership Reporting Compliance” and “Proposal 1 -- Election of Directors” and “Corporate Governance” in the Proxy Statement for the 2011 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated herein by reference.

The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial officer and principal accounting officer or controller. The Company undertakes to provide a copy of the Code of Ethics to any person without charge, upon request to Joseph A. Kneller, Senior Vice President, Norwood Financial Corp., 717 Main Street, Honesdale, PA  18431.

Item 11. Executive Compensation

The information contained under the section captioned “Director and Executive Compensation” in the Proxy Statement is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

(a)           Security Ownership of Certain Beneficial Owners

Information required by this item is incorporated herein by reference to the Section captioned  “Principal Holders of Our Common Stock” of the Proxy Statement.

(b)           Security Ownership of Management

Information required by this item is incorporated herein by reference to the sections captioned  “Proposal 1 -- Election of Directors” of the Proxy Statement.

(c)           Changes in Control

Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.

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(d)           Equity Compensation Plan Information

EQUITY COMPENSATION PLAN INFORMATION

	(a)		(b)			(c)
	Number of Securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans, (excluding securities reflected in column (a))
Equity compensation plans     approved by security holders
Stock Option Plan		41,986		$	26.35		—
2006 Stock Option Plan		143,675			29.42		104,300
Equity compensation plans not     approved by security holders
1999 Directors Stock Compensation Plan		3,978			19.25		—
TOTAL		189,639		$	28.52		104,300

The 1999 Directors Stock Compensation Plan provides for annual grants of options to non-employee directors as of the close of business on the day of the first regularly scheduled board meeting in December of each year. The amounts of such awards are determined by the board or a committee thereof. The exercise price for each option is equal to the fair market value of the stock as of the date of grant. Options generally have terms of ten years and one day from the date of grant and vest over periods ranging from six months to one year from the date of grant. Except in the event of death or disability, optionees may not sell shares acquired on exercise of options within six months of the date of grant. Options are not transferable except in the event of the death of the optionee.

Item 13. Certain Relationships and Related Transactions and Director Independence

The information required by this item is incorporated herein by reference to the section in the Proxy Statement captioned “Related Party Transactions” and “Corporate Governance”.

Item 14. Principal Accounting Fees and Services

The information required by this item is incorporated herein by reference to the section in the Proxy Statement captioned “Proposal 4 -- Ratification of Appointment of Independent Registered Public Accounting Firm.”

35

PART IV

Item 15. Exhibits, Financial Statement Schedules

(a) Listed below are all financial statements, schedules and exhibits filed as part of this report, and are incorporated by reference.

1. The consolidated balance sheets of Norwood Financial Corp. and subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity and cash flows for the years in the three year period ended December 31, 2010, together with the related notes and the independent registered public accounting firm reports of S.R. Snodgrass, A.C. and ParenteBeard LLC, independent registered public accounting firms.

2. Schedules omitted as they are not applicable.

3. Exhibits

No.	Description
2.1	Agreement and Plan of Merger, dated December 14, 2010, by and among Norwood Financial Corp., Wayne Bank, North Penn Bancorp, Inc. and North Penn Bank. (1)
3(i)	Articles of Incorporation of Norwood Financial Corp.(2)
3(ii)	Bylaws of Norwood Financial Corp. (3)
4.0	Specimen Stock Certificate of Norwood Financial Corp. (2)
10.1†	Employment Agreement with Lewis J. Critelli (3)
10.2†	Change in Control Severance Agreement with William S. Lance (3)
10.3†	Norwood Financial Corp. Stock Option Plan (5)
10.4†	Salary Continuation Agreement between the Bank and William W. Davis, Jr. (4)
10.5†	Salary Continuation Agreement between the Bank and Lewis J. Critelli (4)
10.6†	Salary Continuation Agreement between the Bank and Edward C. Kasper (4)
10.7†	1999 Directors Stock Compensation Plan (4)
10.8†	Salary Continuation Agreement between the Bank and Joseph A. Kneller (6)
10.9†	Salary Continuation Agreement between the Bank and John H. Sanders (6)
10.10†	2006 Stock Option Plan (7)
10.11†	First and Second Amendments to Salary Continuation Agreement with William W. Davis, Jr. (8)
10.12†	First and Second Amendments to Salary Continuation Agreement with Lewis J. Critelli (8)
10.13†	First and Second Amendments to Salary Continuation Agreement with Edward C. Kasper (8)
10.14†	First and Second Amendments to Salary Continuation Agreement with Joseph A. Kneller (8)
10.15†	First and Second Amendments to Salary Continuation Agreement with John H. Sanders (8)
13	Annual Report to Stockholders for the fiscal year ended December 31, 2010
16.1	Letter re Change in Certifying Accountant (9)
21	Subsidiaries of Norwood Financial Corp. (see Item 1. Business, General and Subsidiary Activity)
23.1	Consent of S.R. Snodgrass, A.C.
23.2	Consent of ParenteBeard, LLC
31	Rule 13a-14(a)/15d-14(a) Certification of CEO and CFO
32	Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of Sarbanes Oxley Act of 2002

36

†	Management contract or compensatory plan arrangement.
(1)	Incorporated by reference into this document from the identically numbered exhibit to the Registrant’s Current Report on Form 8-K filed with the Commission on December 17, 2010.
(2)	Incorporated herein by reference into this document from the Exhibits to Form 10, Registration Statement initially filed with the Commission on April 29, 1996, Registration No.0-28364.
(3)	Incorporated by reference into this document from the identically numbered exhibits to the Registrant’s Form 10-K filed with the Commission on March 15, 2010.
(4)	Incorporated herein by reference into this document from the Exhibits to the Registrant’s Form 10-K filed with the Commission on March 23, 2000, File No. 0-28364.
(5)	Incorporated by reference into this document from the Exhibits to Form S-8 filed with the Commission on August 14, 1998, File No. 333-61487.
(6)	Incorporated by reference into this document from the identically numbered exhibits to the Registrant’s Form 10-K filed with the Commission on March 22, 2004, File No. 0-28364.
(7)	Incorporated by reference to this document from Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-134831) filed with the Commission on June 8, 2006.
(8)	Incorporated herein by reference from the Exhibits to the Registrant’s Current Report on Form 8-K filed April 4, 2006.
(9)	Incorporated by reference into this document from the identically numbered exhibit to the Registrant’s Current Report on Form 8-K filed with the Commission on August 14, 2009.

37

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
	NORWOOD FINANCIAL CORP.
Dated: March 10, 2011	By:	/s/ Lewis J. Critelli
		Lewis J. Critelli President and Chief Executive Officer (Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on March 10, 2011 on behalf of the Registrant and in the capacities indicated.
/s/ Lewis J. Critelli	/s/ William W. Davis, Jr.
Lewis J. Critelli President, Chief Executive Officer and  Director (Principal Executive Officer )	William W. Davis, Jr. Director
/s/ Dr. Andrew A. Forte	/s/ Susan Gumble-Cottell
Dr. Andrew A. Forte Director	Susan Gumble-Cottell Director
	/s/ John E. Marshall
Daniel J. O’Neill Director	John E. Marshall Director
/s/ Ralph A. Matergia	/s/ Dr. Kenneth A. Phillips
Ralph A. Matergia Director	Dr. Kenneth A. Phillips Director
/s/ William S. Lance	/s/ Richard L. Snyder
William S. Lance Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	Richard L. Snyder Director

EX-13

Lewis J. Critelli President & Chief Executive Officer We strongly encourage you to read the financial section of this Annual Report for a more detailed analysis of our results.	We are truly pleased to report to you that your Company had a very solid financial performance in 2010 in what continues to be an inordinately challenging economic environment. Norwood Financial Corp had record earnings of $7,313,000 for the year ended December 31, 2010, an increase of $250,000 or 3.5% over the prior year. Earnings per share on a fully diluted basis were $2.64 in 2010 increasing from $2.55 in 2009. With the increase in earnings and our continued strong capital position, we declared cash dividends of $1.13 per share compared to $1.09 per share in 2009.  This marks the nineteenth consecutive year of increased cash dividends for our stockholders.  The return on average assets for the year was 1.37% with a return on average equity of 10.87%. Norwood ended the year with total assets of $537.0 million, loans receivable of $356.9 million, total deposits of $393.9 million and stockholders’ equity of $67.7 million. The Company’s capital position remains strong and is at the top level of its peer group in all measures of regulatory capital. Loans receivable totaled $356.9 million as of December 31, 2010, which is a slight decrease from 2009.  The decline was due to sales of residential mortgage	loans. During the year, the Company sold $12.4 million of fixed rate residential mortgages for purposes of interest rate risk management. This was partially offset by growth in commercial real estate loans.  As a result of the continuing slowdown in the local economy, high unemployment levels and a soft real estate market, we spent a great deal of effort addressing credit quality issues.  As of December 31, 2010, total non-performing loans were $4,079,000 and represented 1.14% of total loans compared to $5,015,000 or 1.38% as of December 31, 2009. Though our credit quality ratios remain strong, we still see the slow economic climate impacting our customers.  Net charge-offs for the year totaled $837,000 compared to $465,000 in 2009. As of December 31, 2010, the allowance for loan losses totaled $5,616,000 and 1.57% of total loans, compared to $5,453,000 and 1.50% of  total loans at December 31, 2009. For the year, net interest income (fully taxable equivalent) totaled $20,662,000, an increase of $790,000 or 4.0% over 2009.  The net interest margin (fte) remained strong throughout the year and increased 1 basis point to 4.04%.  We offset a decline in the yield on earning assets by reducing our cost of deposits and other borrowings.   Other income for 2010 totaled $4,064,000 compared to $5,392,000 in 2009. The decrease was principally due to a lower level of earnings and receipts of proceeds on bank owned life insurance policies which totaled $391,000 in 2010 compared to $1,196,000 in 2009.  The Company also had a $150,000 gain on the sale of deposits related to a branch closure in the 2009 period. The 2010 period includes $307,000 in gains on the sales of

$12.4 million of mortgage loans and the valuation of servicing rights compared to $481,000 in similar gains on $21.6 million of mortgage loan sales and servicing rights in the 2009 period. For the year ended December 31, 2010, other expense totaled $12,753,000 compared to $13,471,000 for the similar period in 2009, a decrease of $718,000.  The decrease was due in part to lower FDIC insurance assessments which totaled $474,000 in 2010 compared to $710,000 in 2009, including a $225,000 special assessment in 2009. There was also a lower level of foreclosed real estate costs which totaled $41,000 in the 2010 period and $436,000 in 2009. To perform consistently, even in a tough economic environment, Norwood Financial Corp and Wayne Bank have always relied on the following solid fundamentals of banking: Loan money to people you know using solid underwriting standards. Wayne Bank has never wavered from our high standards of lending to consumers and businesses alike, and we have money to lend to our customers.  In 2010, we originated over $33 million in commercial loan volume.  We helped to finance numerous projects that have helped our communities. Job creation in the small business sector will help lead the way for economic recovery. To assist with job creation, we have become more active in the Small Business Administration and USDA lending programs.  Both government agencies offer guarantees on certain loans made to qualifying small businesses.  We also originated over $37 million in residential mortgages and other types of consumer loans. With the current low interest rates many customers were able to refinance, shorten the term of their mortgage and/or lower their monthly payments. Fund your loans with local deposits while maintaining a strong liquidity position.  During 2010, we increased our percentage of checking and savings accounts to 60.0% from 50.7% in 2009.  This consistent customer deposit base allows us to continue to lend to our communities. We manage the Bank to ensure that we always have ample liquidity to maintain flexibility during challenging times. We strive to operate efficiently. This is directly related to the technology we offer our customers and the methods we utilize to process data.  The challenge is to serve our customers while maintaining operating efficiencies and the regulatory controls required.  Our approach, like many community banking organizations today, has been to partner with service providers having the resources to help us meet these challenges.  After a major study of alternatives, we concluded the “Fiserv Premier” system to be our best fit for the future.  We expect to implement this new system during the second quarter of 2011. This should provide opportunities to upgrade various systems we utilize for day-to-day operations, and will directly benefit our customers.   Additionally, we will seek improved capabilities for those customers who prefer self-service banking.  We plan to offer e-statements as we continue to go paperless.  The use of online banking continues to grow and we currently have almost 9,000 Internet banking customers.  As another option, we are evaluating a mobile banking product. Our Business Link Remote Deposit Capture service                  

      has 30 customers and will handle almost 250,000 items for those customers.  During 2011, we also plan to continue upgrading ATMs while adding self-service coin counters and automated currency handling equipment at select branches. Maintain a high level of capital. We have never aggressively leveraged our balance sheet. Our tier 1 capital is over 17% and is at the top end of our peer group.  We have always stressed “high quality” capital which among other things means conservative accounting, strong loan loss reserves and a high component of tangible common equity. The higher the quality of capital the more prepared one is for tough times. Wayne Bank contributed to almost 200 local causes ranging from fire companies, school athletics, art and musical events, builders’ associations and a variety of nonprofit groups.  Generous donations were also made through the Commonwealth of Pennsylvania, Department of Community and Economic Development’s Educational Improvement Tax Credit (EITC) program.  The Bank distributed almost $80,000 to six local organizations via the EITC guidelines.  We are pleased to be able to direct these funds to causes that support the local community, especially the children.  The Bank contributed to a variety of organizations, such as, The United Way of Lackawanna and Wayne Counties, the various Chambers of Commerce, the Greater Honesdale Partnership, the Wayne County YMCA, and the Pike County Builders’ Association. Management and employees serve on many boards of directors to assist in supporting them with their management and expertise.  Dorflinger-Suydam Wildlife sanctuary, the Wayne County Builders’ association, the Northeastern Pennsylvania alliance, the United Way of Lackawanna and Wayne Counties, and the Pike County Chamber of Commerce, are just a small sampling of the organizations where Wayne Bank’s employees participate on their board as members.  This is what sets a community bank apart from a regional or national bank. Teach Children to Save is a national campaign that raises awareness about the important role that banks and bankers play in helping young people develop lifelong savings habits.  It was the 14th anniversary of the organization and Wayne Bank’s employees presented interactive lessons on the importance of saving money to almost 400 students from the Delaware Valley School District in Northeastern Pennsylvania in honor of the Teach Children to Save program. Eight employees taught sixteen 3rd grade classes from Delaware Valley School District in Milford, Dingmans Ferry, and Shohola.  We firmly believe that the financial literacy of our young people is crucial to building a growing economy. Quality people build a quality organization.  We were very fortunate in 2010 to add a number of seasoned professionals to our staff.  William S. Lance was hired as senior Vice President and Chief Financial Officer of Norwood Financial Corp and Wayne Bank.  Bill has over 30 years of financial experience working with banks in Northeastern Pennsylvania and has an extensive and varied background in monitoring and overseeing the financial aspects of a bank. Terri A. Garringer filled the

    position of Community Office Manager in Lakewood.  Mark W. Ranzan was hired as Vice President, Commercial lender and is based in the Tannersville Community Office. Mark has twenty-four years of experience in commercial lending in Monroe County. There were a number of employees who received promotions during the year for their achievements. William Henigan, who has been with Wayne Bank since 1999 as a Commercial Lender, was elevated to Senior Vice President.  Bill primarily handles commercial loan customers in Monroe County. Ryan French was promoted to Vice President, Director of Human Resources, after joining Wayne Bank in 2009. Jessica Santiago, a Customer Service Representative in the Marshalls Creek office, was promoted to Assistant Branch Manager of our Marshalls Creek office.  Jessica has been with the Bank since 2004. We are pleased to note two employees recorded milestones in their careers with Wayne Bank:  Barbara Keesler celebrated thirty years with Wayne Bank and Rosemary Engvaldsen achieved twenty-five years of service.  We appreciate their years of commitment and dedication.  A significant group of employees also reached the fifteen year mark which included: John H. Sanders, Marianne Glamann, and Mary Ann Mansour. In addition 6 employees made the mark of 10 years, and 7 employees attained 5 years of service. In total, this group of employees has almost 200 years of Wayne Bank experience.  This level of experience truly helps us better serve our customers. A number of employees made 2010 the last of their working years.  Stepping into retirement was:  Bill Murray, Mortgage Loan Originator, who had worked for the Bank since 1994; Betty Rufano, who held the position of Head Teller in the Milford Community Office and worked for the Bank since 2003; and Sally Timko, who most recently held the position of Electronic Banking Specialist in Honesdale and had started with the Bank in 1982.  We wish them extended health and many years of happiness and leisure during their retirement years. Unfortunately, during the course of the year, Norwood Financial Corp and Wayne Bank mourned the loss of a long term member of the Board of Directors, Mr. Gary Rickard.  He had served on the Board since 1978.  Mr. Rickard was well-known throughout Wayne County as a partner of his family’s farm, Clearfield Farms. We will miss his contributions and presence on the board. On December 15, 2010, we were very excited to announce that we had entered into a definitive merger agreement pursuant to which Norwood Financial Corp will acquire North Penn Bancorp, Inc. in a stock and cash transaction. This transaction will expand our existing footprint in Monroe County and give us an entry into Lackawanna County.  Wayne Bank currently has three offices in Monroe County and with the addition of North Penn Bank’s two offices we will be better positioned to serve customers throughout the county. North Penn’s three offices in Lackawanna County will give Wayne Bank a solid base in a more densely populated market west of Wayne Bank’s existing franchise.  The addition of North Penn Bank will bring Norwood’s assets to just under $700 million with 16 branches serving four counties with the addition

of Lackawanna in Northeastern PA. The merger is expected to close pending regulatory approval in June of 2011.  The staff of both organizations are busy working to integrate the banks. We expect this larger version of Wayne Bank to offer expanded products and services throughout Northeastern Pennsylvania. We look forward to welcoming the North Penn customers, stockholders and employees. For almost 140 years Wayne Bank has been a symbol of strength, safety and security for the communities, customers and stockholders we serve. We are proud to continue that tradition. Bank with confidence. Please consider us for all your financial needs.  We truly appreciate your support.                   Lewis J. Critelli               President & Chief Executive Officer

2010 CONSOLIDATED FINANCIAL REPORT
Management's Discussion & Analysis	10
Management's Report On Internal Control Over   Financial Reporting	31
Reports Of Independent Registered Public Accounting Firm	32
Consolidated Balance Sheets	35
Consolidated Statements Of Income	36
Consolidated Statements Of Stockholders' Equity	37
Consolidated Statements Of Cash Flows	38
Notes To Consolidated Financial Statements	39
Investor Information	68




NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

MANAGEMENT’S DISCUSSION AND ANALYSIS

INTRODUCTION

This Management’s Discussion and Analysis and related financial data are presented to assist in the understanding and evaluation of the financial condition and results of operations for Norwood Financial Corp (the Company) and its subsidiary Wayne Bank (the Bank) as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009, and 2008. This section should be read in conjunction with the consolidated financial statements and related footnotes.

FORWARD-LOOKING STATEMENTS

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

CRITICAL ACCOUNTING POLICIES

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

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

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

In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost and 2) the financial condition of the issuer. The Company does not have the intent to sell these securities and it is more likely than not that it will not sell the securities before recovery of their cost basis. The Company believes that the unrealized losses at December 31, 2010 and 2009 represent temporary impairment of the securities.

EMERGENCY ECONOMIC STABILIZATION ACT OF 2008

In response to recent unprecedented market turmoil, the Emergency Economic Stabilization Act (“EESA”) was enacted on October 3, 2008. EESA authorizes the Secretary of the Treasury to purchase up to $700 billion in troubled assets from financial institutions under the Troubled Asset Relief Program or TARP.

10

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

Among many provisions, the EESA increased the maximum deposit insurance amount up to $250,000 until December 31, 2009, which had been extended to June 30, 2010 and subsequently made the increase permanent.  It also removed the statutory limits on the FDIC’s ability to borrow from the Treasury during this period.  The FDIC did not take the temporary increase in deposit insurance coverage into account when setting assessments. EESA allows financial institutions to treat any loss on the preferred stock of the Federal National Mortgage Association or Federal Home Loan Mortgage Corporation as an ordinary loss for tax purposes.

Pursuant to his authority under EESA, the Secretary of the Treasury created the TARP Capital Purchase Plan (CPP) under which the Treasury Department will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies. Qualifying financial institutions may issue senior preferred stock with a value equal to not less than 1% of risk-weighted assets and not more than the lesser of $25 billion or 3% of risk-weighted assets. The senior preferred stock will pay dividends at the rate of 5% per annum until the fifth anniversary of the investment and thereafter at the rate of 9% per annum. The senior preferred may be redeemed at any time in whole or in part by the financial institution. No dividends may be paid on common stock unless dividends have been paid on the senior preferred stock. Until the third anniversary of the issuance of the senior preferred, the consent of the U.S. Treasury will be required for any increase in the dividends on the common stock or for any stock repurchases unless the senior preferred has been redeemed in its entirety or the Treasury has transferred the senior preferred to third parties. The senior preferred will not have voting rights other than the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms or any merger, exchange or similar transaction that would adversely affect its rights. Prior to issuance, the financial institution and its senior executive officers must modify or terminate all benefit plans and arrangements to comply with EESA. Senior executives must also waive any claims against the Department of Treasury. In connection with the issuance of the senior preferred, participating institutions must issue the Secretary immediately exercisable 10-year warrants to purchase common stock with an aggregate market price equal to 15% of the amount of senior preferred.

Due to its strong capital position, the Company decided not to participate in the CPP.

RESULTS OF OPERATIONS – SUMMARY

Net income for the Company for the year-ended December 31, 2010 totaled $7,313,000, an increase of $250,000 or 3.5% over the $7,063,000 earned in 2009. The resulting basic and diluted earnings per share were $2.65 and $2.64, respectively, increasing from $2.57 and $2.55 respectively in 2009. The return on average assets (ROA) for the year ended December 31, 2010 was 1.37% with a return on average equity (ROE) of 10.87% compared to an ROA of 1.38% and an ROE of 11.40% for the prior year. The increase in earnings was attributable to an increase in net interest income on a fully taxable equivalent basis (fte) of $790,000 and a reduction in operating expenses of $718,000.  A $1,328,000 decrease in other income was partially offset by a $685,000 reduction in the provision for loan losses.

Net interest income on a fully taxable equivalent basis (fte) totaled $20,662,000 in 2010, which was $790,000 or 4.0%, higher than the $19,872,000 reported last year.  The improvement recorded in net interest income can be attributed to an $18.1 million increase in average earning assets which exceeded the $15.1 million of growth in average interest bearing liabilities.  Effective asset/liability management strategies also contributed to the improved earnings as a thirty-eight basis point reduction in the yield on earning assets was offset by a fifty basis point decrease in the cost of interest bearing liabilities.

Average loans outstanding remained relatively stable in 2010 as the current economic downturn impacted the Company’s ability to extend credit to qualifying borrowers. The Company also sold $12.4 million of fixed-rate residential mortgage loans in 2010 to reduce its risk to rising interest rates. As a result of negative growth and an eleven basis point reduction in the yield earned, income generated by the loan portfolio decreased $393,000 from

11

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

the prior year total.  Income from the securities portfolio also declined $520,000 as new taxable securities were added at historically low interest rate levels to replace proceeds received from sales, maturities or calls.  Income from tax free securities improved $642,000 as the Company took advantage of historically wide spreads in the municipal markets to increase the outstanding balance of these securities by $11.0 million on average.  Average interest bearing liabilities grew $15.1 million but a fifty basis point reduction in the cost of these funds resulted in a decrease in total interest expense of $1,703,000 compared to 2009.  The majority of the reduced cost can be attributed to time deposits which matured and were replaced at current market rates.  The Company’s provision for loan losses decreased $685,000 based upon management’s evaluation of the adequacy of the allowance for loan losses.

Other income for the year ended 2010 totaled $4,064,000 compared to $5,392,000 in 2009, a decrease of $1,328,000.  The earnings and proceeds on bank owned life insurance policies totaled $391,000 in 2010 compared to $1,196,000 in 2009, while service charges and fees declined $245,000 related to service charges on deposits.  Gains on the sales of investment securities totaled $448,000 on sales of $23.9 million for the 2010 period compared to $463,000 on sales of $15.4 million for the 2009 period.  The Company also had a $150,000 gain on the sale of deposits related to a branch closure in the 2009 period.  The 2010 period includes $307,000 in gains and servicing rights on the sale of $12.4 million of mortgage loans compared to $481,000 in similar gains on sales of $21.6 million of mortgage loans and servicing rights in the 2009 period.

For the year ended December 31, 2010, other expense totaled $12,753,000 compared to $13,471,000 for the similar period in 2009, a decrease of $718,000.  The decrease was due in part to a reduction in FDIC insurance assessments which decreased $236,000 from the 2009 total and a lower level of foreclosed real estate costs which totaled $41,000 in the 2010 period and $436,000 in 2009.  The 2009 period also included $267,000 related to the funding of an employee benefit plan.

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

Net income 2009	$	7,063
Net interest income		555
Provision for loan losses		685
Earnings and proceeds on BOLI		(805	)
Gains on sales of mortgage loans and servicing rights		(174	)
Gain on sale of deposits		(150	)
Other income		(199	)
Salaries and employee benefits		322
FDIC insurance assessments		236
Foreclosed real estate owned		395
Professional fees		(239	)
Other expenses		4
Income tax expense		(380	)
Net income for 2010	$	7,313

Net income for the Company for the year-ended December 31, 2009 totaled $7,063,000, an increase of $386,000 or 5.8% over the $6,677,000 earned in 2008.  The resulting basic and diluted earnings per share were $2.57 and $2.55, respectively, increasing from $2.44 and $2.41 respectively in 2008.  The return on average

12

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

assets (ROA) for the year ended December 31, 2009 was 1.38% with a return on average equity (ROE) of 11.40% compared to an ROA of 1.36% and an ROE of 11.79% for the prior year.  The increase in earnings was attributable to an increase in net interest income on a fully taxable equivalent basis (fte) of $842,000 and $816,000 of tax-exempt proceeds from a bank-owned life insurance (BOLI) policy which is $1,371,000 net of tax.  This was partially offset by a $950,000 increase in the provision for loan losses and $620,000 in higher FDIC insurance assessments, the net of which is $1,036,000 after tax.

Net interest income on a fully taxable equivalent basis (fte) totaled $19,872,000 in 2009, an increase of $842,000 as compared to the prior year.  Net interest income was favorably impacted by a $25.1 million increase in average earning assets for 2009 compared to average earning assets in 2008.  The net interest margin decreased 4 basis points to 4.03% for 2009.  The decrease in margin was due to the low interest rate environment in 2009 with an average prime rate of 3.25% and federal funds rate of .25% compared to 5.09% and 1.84%, respectively in 2008.  As a result, the yield on earning assets (fte) for 2009 was 5.60% compared to 6.14% in 2008.  This impact on the yield on earning assets was partially offset by a 63 basis point decrease in the cost of interest-bearing liabilities.

Loans receivable increased $14.1 million or 4.0% from the prior year-end. The increase in loans was centered in commercial real estate. The Company experienced a significant volume of residential mortgage refinancing activity in 2009. During the year, the Company sold $21.7 million of fixed rate residential mortgages for purposes of interest rate risk management. As a result of the general slow down in the local economy, higher unemployment and a softer real estate market, the Company did experience an increase in non-performing loans in 2009. As of December 31, 2009, total non-performing loans were $5,015,000 and represented 1.38% of total loans compared to $2,087,000 or .60% as of December 31, 2008. The increase was principally due to one commercial real estate loan and a home equity loan in which the Bank is in a first lien position. For the year ended December 31, 2009, net charge-offs totaled $465,000 compared to $583,000 in 2008. With the increase in non-performing loans, higher unemployment, soft real estate market and slow economy, the Company increased its provision for loan losses to $1,685,000 for the year 2009 compared to $735,000 for the year 2008. As of December 31, 2009, the allowance for loan losses totaled $5,453,000 and 1.50% of total loans increasing from $4,233,000 and 1.21% of loans at December 31, 2008.

Other income for 2009 totaled $5,392,000 compared to $4,087,000 in 2008, an increase of $1,305,000. The earnings and proceeds on bank owned life insurance policies totaled $1,196,000 in 2009 compared to $344,000 in 2008. Gains on the sales of investment securities totaled $463,000 on sales of $15.4 million for the 2009 period compared to $18,000 in losses in the 2008 period. The Company also had a $150,000 gain on the sale of deposits related to a branch closure in the 2009 period. The 2009 period includes $481,000 in gains on the sales of $21.6 million of mortgage loans and servicing rights compared to $499,000 in similar gains on sales of $14.4 million of mortgage loans and servicing rights in the 2008 period.

For the year ended December 31, 2009, other expense totaled $13,471,000 compared to $12,240,000 for the similar period in 2008, an increase of $1,231,000. The increase was due in part to higher FDIC insurance assessments which increased $620,000 including the special assessment of $225,000. This was partially offset by a lower level of foreclosed real estate costs which totaled $436,000 in the 2009 period and $582,000 in 2008. Income tax expense for the year 2009 totaled $2,282,000 for an effective tax rate of 24.4% compared to $2,836,000 of federal income tax expense and an effective tax rate of 29.8% for the prior year. The reduction in the effective tax rate is principally due to the receipt of $816,000 in tax exempt BOLI proceeds in 2009.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

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

Net income 2008	$	6,677
Net interest income		708
Provision for loan losses		(950	)
Earnings and proceeds on BOLI		852
Net realized gains on sales of securities		481
Other income		(28	)
Salaries and employee benefits		(783	)
FDIC insurance assessments		(620	)
Other expenses		172
Income tax expense		554
Net income for 2009	$	7,063

FINANCIAL CONDITION

TOTAL ASSETS

Total assets as of December 31, 2010, were $537.0 million compared to $529.7 million as of year-end 2009, an increase of $7.3 million or 1.3%. The increase in assets was limited by the Company’s ability to increase loans outstanding in the current economic environment combined with limited opportunities available to increase the securities portfolio.

LOANS RECEIVABLE

As of December 31, 2010, loans receivable totaled $356.9 million compared to $363.5 million as of year-end 2009, a decrease of $6.6 million. Loan growth, principally in commercial real estate was offset by a lower level of home equity loans, sales of residential real estate loans and a net run-off in indirect automobile financing, which is included in consumer loans to individuals.

Residential real estate, which includes home equity lending, totaled $124.6 million as of December 31, 2010, compared to $130.3 million as of year-end 2009, a decrease of $5.7 million. The Company experienced a significant amount of residential mortgage refinancing activity in 2010 as customers took advantage of the low interest rate environment. The Company does not originate any non-traditional mortgage products such as interest-only loans or option adjustable rate mortgages and has no sub-prime mortgage exposure.  The Company evaluates sales of its long-term fixed rate residential loan production for interest rate risk management, with $12.4 million of long term fixed rate loans sold into the secondary market during 2010.  In the current low interest rate environment, the Company expects to continue selling mortgage loans in 2011. The Company experienced a slow down and net decrease in home equity lending of $2.1 million to $45.1 million as of December 31, 2010. The decrease was due in part to consumers paying off home equity loans with proceeds from mortgage refinancing. The slow down in home equity lending is also indicative of lower real estate values.

Commercial loans consist principally of loans made to small businesses within the Company’s market and are usually secured by real estate or other assets of the borrower. Commercial real estate loans totaled $184.1 million as of December 31, 2010, increasing from $180.3 million as of December 31, 2009. The terms for commercial real estate loans are typically 15 to 20 years, with adjustable rates based on a spread to the prime rate or fixed for the initial three to five year period then adjusting to a spread to the prime rate. The majority of the Company’s commercial real estate portfolio is owner occupied and includes the personal guarantees of the principals.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

The growth in commercial real estate lending in 2010 was centered in loans to the hospitality lodging industry and summer camps all within the Bank’s primary market area. Commercial loans consisting principally of lines of credit and term loans secured by equipment or other assets decreased $1.7 million to $22.4 million as of December 31, 2010. The decrease was principally due to pay-offs in equipment loans and lower usage on lines of credit.

The Company’s indirect lending portfolio (included in consumer loans to individuals) declined  $900,000 to $7.5 million as of December 31, 2010.  The Company has de-emphasized indirect automobile lending and as a result of the soft economy has also experienced a general slow down in other indirect financing.

ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING ASSETS

The allowance for loan losses totaled $5,616,000 as of December 31, 2010 and represented 1.57% of total loans receivable compared to $5,453,000 and 1.50% of total loans as of year-end 2009. Net charge-offs for 2010 totaled $837,000 and represented .24% of average loans compared to $465,000 and .14% of average loans in 2009.

As of December 31, 2010, non-performing loans totaled $4,079,000 and represented 1.14% of total loans compared to $5,015,000 or 1.38% as of December 31, 2009. Based on the level of non-performing loans, high unemployment, soft real estate market and a slow economy the Company added $1,000,000 to the provision for loan losses for the year ended December 31, 2010 compared to $1,685,000 in 2009.

The Company’s loan review process assesses the adequacy of the allowance for loan losses on a quarterly basis. The process includes a review of the risks inherent in the loan portfolio. It includes an analysis of impaired loans and a historical review of losses. Other factors considered in the analysis include; concentrations of credit in specific industries in the commercial portfolio; the local and regional economic condition; trends in delinquencies, internal risk rating classification, large dollar loans of over $2 million and growth in the portfolio.

The Company has limited exposure to higher-risk loans. There are no option ARM products, interest only loans, subprime loans or loans with initial teaser rates in its residential real estate portfolio. The Company has $14.7 million of junior lien home equity loans. For 2010 net charge-offs for this portfolio totaled $118,000.

As of December 31, 2010, the Company considered its concentration of credit risk profile to be acceptable. The two highest concentrations are in the hospitality lodging industry and summer camps. In 2010 there were no losses in either portfolio while one motel loan was delinquent and considered impaired.

Due to weaker economic conditions the Company has seen an increase in its internally adversely classified loans. The Company assesses a loss factor against the classified loans, which is based on prior experience. Classified loans which are considered impaired are measured on a loan by loan basis. The Company values such loans by either the present value of expected cash flows, the loans obtainable market price or the fair value of collateral if the loan is collateral dependent.

At December 31, 2010, the recorded investment in impaired loans, not requiring an allowance for loan losses was $6,111,000 (net of charge-offs against the allowance for loan losses of $220,000) and those impaired loans requiring an allowance totaled $8,641,000 (net of a charge-off against the allowance for loan losses of $480,000). The recorded investment in impaired loans not requiring an allowance for loan losses was $6,962,000 (net of $154,000) and $1,065,000 (net of $480,000) requiring an allowance for loan losses as of December 31, 2009.

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

15

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

placed on non-accrual when interest is 90 days delinquent. When loans are placed on non-accrual, accrued interest is reversed from current earnings.

As of December 31, 2010, non-performing loans totaled $4,079,000 and represented 1.14% of total loans decreasing from $5,015,000 and 1.38% of total loans as of December 31, 2009. The decrease was principally due to the resolution and payment on one loan that was included in non-performing loans as of December 31, 2009. Foreclosed real estate owned totaled $748,000 as of December 31, 2010 and $392,000 as of December 31, 2009. The increase is principally due to the addition of a commercial property located in Pike County which is carried at $448,000 as of December 31, 2010.

As a result of its analysis, after applying these factors, management considers the allowance as of December 31, 2010, adequate. 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.

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

dates indicated:

	Year-ended December 31,
	(dollars in thousands)
	2010			2009			2008			2007			2006
Allowance balance at beginning of period	$	5,453		$	4,233		$	4,081		$	3,828		$	3,669
Charge-offs:
Commercial and all other		(85	)		(17	)		(7	)		—			—
Real Estate		(699	)		(358	)		(465	)		(4	)		—
Consumer		(82	)		(139	)		(171	)		(117	)		(150	)
Total		(866	)		(514	)		(643	)		(121	)		(150	)
Recoveries:
Commercial and all other		—			11			—			—			18
Real Estate		2			4			1			2			2
Consumer		27			34			59			54			65
Lease Financing		—			—			—			3			4
Total		29			49			60			59			89
Provision expense		1,000			1,685			735			315			220
Allowance balance at end of period	$	5,616		$	5,453		$	4,233		$	4,081		$	3,828
Allowance for loan losses as a percent
of total loans outstanding		1.57	%		1.50	%		1.21	%		1.23	%		1.21	%
Net loans charged off as a percent of average loans outstanding		.24	%		.13	%		.17	%		.02	%		.02	%
Allowance coverage of non-performing loans		1.4	x		1.1	x		2.0	x		5.0	x		9.4	x

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

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

	December 31,
	(dollars in thousands)
	2010			2009			2008			2007			2006
Non-accrual loans:
Commercial and all other	$	513		$	—		$	—		$	—		$	—
Real estate		3,527			4,916			2,087			109			392
Consumer		—			—			—			2			17
Total		4,040			4,916			2,087			111			409
Accruing loans which are contractually past due 90 days or more		39			99			—			52			—
Total non-performing loans		4,079			5,015			2,087			163			409
Foreclosed real estate		748			392			660			—			—
Total non-performing assets	$	4,827		$	5,407		$	2,747		$	163		$	409
Non-performing loans to total loans		1.14	%		1.38	%		.60	%		.05	%		.13	%
Non-performing loans to total assets		.76	%		.95	%		.41	%		.03	%		.09	%
Non-performing assets to total assets		.90	%		1.02	%		.54	%		.03	%		.09	%

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 generally accepted accounting principles in the United States, 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. As of December 31, 2010, the HTM portfolio totaled $170,000 and consisted of one municipal obligation. Securities classified as AFS are eligible to be sold due to liquidity needs or interest rate risk management. These securities are adjusted to and carried at their fair value with any unrealized gains or losses recorded net of deferred income taxes, as an adjustment to capital and reported in the equity section of the balance sheet as other comprehensive income. As of December 31, 2010, $145.8 million of securities were so classified and carried at their fair value, with unrealized appreciation net of tax, of $1,137,000, included in accumulated other comprehensive income as a component of stockholders’ equity.

As of December 31, 2010, the average life of the portfolio was 4.5 years. The Company has maintained  a relatively short average life in the portfolio in order to generate cash flow to support loan growth and maintain liquidity levels. During 2010, a significant portion of cash flow generated from the proceeds of called U.S. agency securities were reinvested in tax-free municipal bonds to take advantage of historically wide spreads in the municipal bond market and to reduce the Company’s federal income tax liability. Purchases for the year totaled $106.7 million with securities called, maturities and cash flow of $66.1 million and proceeds from sales of $23.9 million. The purchases were funded principally by cash flow generated from the portfolio. The carrying value of the securities portfolio is as follows:

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

	2010					2009
	(dollars in thousands)
	Carrying Value		% of portfolio			Carry Value		% of portfolio
U.S. Government agencies	$	30,268		20.7	%	$	39,772		30.3	%
States and political subdivisions		49,936		34.2	%		32,343		24.6	%
Corporate obligations		4,249		2.9	%		5,240		4.0	%
Mortgage-backed securities -
government sponsored entities		60,928		41.8	%		53,154		40.5	%
Equity securities - financial services		604		0.4	%		776		0.6	%
Total	$	145,985		100.0	%	$	131,285		100.0	%

The portfolio had $8.0 million of adjustable rate instruments, principally adjustable rate mortgage backed securities as of December 31, 2010 compared to $19.5 million at year end 2009. The portfolio contained no private label mortgage backed securities, collateralized debt obligations (CDOs), trust preferreds, and no off-balance sheet derivatives were in use. The U.S. Government agency portfolio consists principally of callable notes with final maturities of generally less than five years.  As of December 31, 2010, the portfolio included $8.0 million of step-up bonds.  The mortgage backed securities are pass-through bonds with Fannie Mae (FNMA), Freddie Mac (FHLMC), and Government National Mortgage Association (GNMA). The Company has no exposure to common or preferred stock of FNMA or FHLMC.

The Company evaluates the securities in its portfolio for other-than-temporary-impairment (OTTI) as fair value declines below cost. In estimating OTTI management considers (1) the length of time and the extent of the decline in fair value and (2) the financial condition and near-term prospects of the issuer. As of December 31, 2010 the Company held 61 securities which had a combined unrealized loss of $1.2 million. Management believes that these losses are principally due to changes in interest rates and represent temporary impairment as the Company does not have the intent to sell these securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis. The Company holds a small portfolio of equity securities of other financial institutions the value of which has been impacted by weakened conditions of the financial market. In 2009, the Company recorded an OTTI charge on two equity holdings totaling $31,000.  No additional impairment charges have been recognized.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company uses fair value measurements to record fair value adjustments to certain financial instruments and determine fair value disclosures (see Note 16 of Notes to the Consolidated Financial Statements).

Approximately $145.8 million, which represents 27.2% of total assets at December 31, 2010, consisted of financial instruments recorded at fair value on a recurring basis. This amount consists entirely of the Company’s available for sale securities portfolio. The Company uses valuation methodologies involving market-based or market derived information, collectively Level 1 and 2 measurements, to measure fair value. There were no transfers into or out of Level 3 for any instruments for the years ending December 31, 2010 and 2009.

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

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

The Company also utilizes a third party provider to provide an estimated fair value of certain loan servicing rights.  Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation.  The estimated fair value of mortgage servicing rights as of December 31, 2010 and 2009 was $274,000 and $179,000, respectively.

DEPOSITS

The Company, through the eleven branches of the Bank, provides a full range of deposit products to its retail and business customers. These products include interest-bearing and non-interest bearing transaction accounts, statement savings and money market accounts. Time deposits consist of certificates of deposit (CDs) with terms of up to five years and include Individual Retirement Accounts. The Bank participates in the Jumbo CD ($100,000 and over) markets with local municipalities and school districts, which are typically awarded on a competitive bid basis. The Company has no brokered deposits.

Total deposits as of December 31, 2010, totaled $393.9 million increasing $2.4 million from $391.5 million as of year-end 2009. The increase was principally due to a higher level of money market and savings deposits which increased by $16.7 million.

Time deposits over $100,000, which consist principally of school district funds, other public funds and short-term deposits from large commercial customers with maturities generally less than one year, totaled $60.0 million as of December 31, 2010, compared to $66.6 million at year-end 2009. The decrease was principally due to a lower level of CDs with local school districts. These deposits are subject to competitive bid and the Company bases its bid on current interest rates, loan demand, investment portfolio structure and the relative cost of other funding sources.

As of December 31, 2010, non-interest bearing demand deposits totaled $62.2 million compared to $59.8 million at year-end 2009. The increase is partially attributable to a higher level of commercial deposits, as a result of growth in the commercial loan portfolio. Cash management accounts in the form of securities sold under agreements to repurchase included in short-term borrowings, totaled $33.1 million at year end 2010 compared to $25.6 million as of December 31, 2009. These balances represent commercial and municipal customers’ funds invested in overnight securities. The Company considers these accounts as a source of core funding.

MARKET RISK

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

Net interest income, which is the primary source of the Company’s earnings, is impacted by changes in interest rates and the relationship of different interest rates. To manage the impact of the rate changes, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities at approximately the same time intervals.  The Company uses net interest simulation to assist in interest rate risk management. The process includes simulating various interest rate environments and their impact on net interest income. As of December 31, 2010, the level of net interest income at risk in a 200 basis points increase was within the Company’s policy limit of a decline less than 8% of net interest income.  Due to the inability to reduce many deposit rates by the full 200 basis points, the Company’s net interest income at risk was slightly (8.74%) outside the policy limit in a 200 basis point declining scenario.  The Company feels that the risk is minimal.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

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

At December 31, 2010, the Bank had a positive 90 day interest sensitivity gap of $41.3 million or 7.7% of total assets.  A positive gap indicates that the balance sheet has a higher level of rate-sensitive assets (RSA) than rate-sensitive liabilities (RSL) at the specific time interval. This would indicate that in an increasing rate environment, the yield on interest-earning assets would increase faster than the cost of interest-bearing liabilities in the 90 day time frame. The level of RSA and RSL for an interval is managed by ALCO strategies, including adjusting the average life of the investment portfolio through purchase and sales, pricing of deposit liabilities to attract long or short term time deposits, utilizing borrowings to fund loan growth, loan pricing to encourage variable rate products and evaluation of loan sales of long term fixed rate mortgages.

The Company analyzes and measures the time periods in which RSA and RSL will mature or reprice in accordance with their contractual terms and assumptions. Management believes that the assumptions used are reasonable. The interest rate sensitivity of assets and liabilities could vary substantially if differing assumptions were used or if actual experience differs from the assumptions used in the analysis. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Interest rates may change at different rates changing the shape of the yield curve. The level of rates on the investment securities may also be affected by the spread relationship between different investments. This was evident in 2010 and 2009 as the spread between certain asset classes were at historical highs in relation to treasuries due to market liquidity and credit concerns. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed. Finally, the ability of borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase. It should be noted that the operating results of the Company are not subject to foreign currency exchange or commodity price risk.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

The following table displays interest-sensitivity as of December 31, 2010 (in thousands):

	3 Months of Less			3-12 Months			1-3 Years			Over 3 Years			Total
Federal funds sold and
interest-bearing deposits	$	10,593		$	250		$	—		$	—		$	10,843
Securities		10,916			31,003			48,110			55,956			145,985
Loans Receivable		85,565			67,052			108,295			95,943			356,855
Total Rate Sensitive Assets (RSA)		107,074			98,305			156,405			151,899			513,683
Non-maturity interest-bearing deposits		25,197			28,014			74,303			31,807			159,321
Time Deposits		30,009			77,797			46,458			18,042			172,306
Borrowings		10,527			26,107			24,675			10,000			71,309
Total Rate Sensitive Liabilities (RSL)		65,733			131,918			145,436			59,849			402,936
As of December 31, 2010
Interest sensitivity gap	$	41,341		$	(33,613	)	$	10,969		$	92,050		$	110,747
Cumulative gap		41,341			7,728			18,697			110,747
RSA/RSL-cumulative		162.9	%		103.9	%		105.5	%		127.5	%
As of December 31, 2009
Interest sensitivity gap	$	26,256		$	(35,423	)	$	(20,986	)	$	135,313		$	105,160
Cumulative gap		26,256			(9,167	)		(30,153	)		105,160
RSA/RSL-cumulative		128.9	%		95.5	%		91.2	%		126.3	%

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

LIQUIDITY

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

As of December 31, 2010, the Company had cash and cash equivalents of $16.6 million in the form of cash, due from banks, balances with the Federal Reserve Bank, short-term deposits with other institutions and Federal Funds sold. In addition, the Company had total securities available for sale of $145.8 million, which could be used for liquidity needs. This totals $162.4 million and represents 30.2% of total assets compared to $148.0 million and 27.9% of total assets as of December 31, 2009. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of December 31, 2010. Based upon these measures, the Company believes its liquidity position is adequate.

The Company maintains established lines of credit with the Federal Home Loan Bank of Pittsburgh (FHLB), the Atlantic Central Bankers Bank (ACBB) and other correspondent banks, which support liquidity needs. The total available under all the lines was $43 million, with $-0- outstanding at December 31, 2010 and December 31, 2009. The maximum borrowing capacity from FHLB was $182.7 million. As of December 31, 2010, the Company had $38 million in term borrowings from the FHLB, compared to $43 million at December 31, 2009.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

OFF-BALANCE SHEET ARRANGEMENTS

The Company’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Unused commitments, as of December 31, 2010 totaled $55.4 million. They consisted of $21.4 million in commercial real estate, construction and land developments loans, $15.1 million in home equity lines of credit, $3.6 million in standby letters of credit and $15.3 million in other unused commitments, principally commercial lines of credit. Because these instruments have fixed maturity dates and because many of them will expire without being drawn upon, they do not represent any significant liquidity risk.

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

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

Contractual Obligations

	December 31, 2010
	Total		Less than 1 year		1-3 years		4-5 years		Over 5 years
Time deposits	$	172,306	$	107,806	$	46,458	$	18,042	$	—
Long-term debt		38,000		18,000		10,000		—		10,000
Operating leases		3,105		259		536		514		1,796
	$	213,411	$	126,065	$	56,994	$	18,556	$	11,796

RESULTS OF OPERATIONS

NET INTEREST INCOME

Net interest income is the most significant source of revenue for the Company and represented 82.9% of total revenue for the year ended December 31, 2010.  Net interest income (fte) totaled $20,662,000 for the year ended December 31, 2010 compared to $19,872,000 for 2009, an increase of $790,000 or 4.0%.  The resulting fte net interest spread and net interest margin were 3.72% and 4.04% respectively in 2010 compared to 3.60% and 4.03%, respectively in 2009.

Interest income (fte) for the year ended December 31, 2010 totaled $26,685,000 compared to $27,598,000 in 2009.  The fte yield on average earning assets was 5.22% in 2010 which was 38 basis points lower than the 5.60% recorded in 2009.  Interest income was negatively impacted by the continued period of historically low interest rates, most notably in the area of taxable securities where the yield decreased 101 basis points compared to the prior year.  As securities matured or were called prior to maturity, new securities were added at current market levels resulting in the decreased yield.  Also contributing to the reduced yield was an $11.9 million increase in average interest bearing deposits with banks which earned .29% in 2010.  The yield on average loans outstanding decreased only 11 basis points in 2010 as the Federal Reserve maintained a prime rate of 3.25% throughout 2010 and a significant portion of floating rate loans were affected by floor rates.  The decrease in yield was partially offset by an $18.1 million increase in average earning assets compared to 2009.

Interest expense for the year ended December 31, 2010 totaled $6,023,000 which resulted in an average cost of interest bearing liabilities of 1.50% compared to interest expense of $7,726,000 and an average cost of 2.00% in 2009.  The extended period of low interest rates impacted all deposit categories as the Company continued to

22

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

reduce the rates paid to current market levels.  Time deposits, which represent the Company’s largest category of deposits, were the most significantly impacted as higher costing deposits matured and were reinvested at lower rates.  The cost of time deposits decreased 77 basis points during the year from 2.80% to 2.03%.  Average short-term borrowings, which totaled $25.9 million in 2010, repriced downward by 66 basis points in 2010 to .45%.

Net interest income represented 78.0% of total revenue for the year ended December 31, 2009.  Net interest income (fte) totaled $19,872,000 for the year ended December 31, 2009 compared to $19,030,000 for 2008, an increase of $842,000 or 4.4%.  The resulting fte net interest spread and net interest margin were 3.60% and 4.03% respectively in 2009 compared to 3.51% and 4.07%, respectively in 2008.

Interest income (fte) for the year ended December 31, 2009 totaled $27,598,000 compared to $28,724,000 for 2008. The fte yield on average earning assets for 2009 was 5.60%, decreasing 54 basis points from 6.14% in 2008. Interest income was unfavorably impacted by the significant decrease in short-term interest rates. During 2009, the prime interest rate averaged 3.25% compared to 5.09% during 2008. The Federal Funds rate and other short-term market rates showed a similar lower trend. This decline in short-term rates impacts the Company’s floating rate loans principally commercial real estate, lines of credit and home equity lines of credit which are based on a spread to the prime rate. As of December 31, 2009, $58.1 million of loans were immediately repriceable. The decrease in yield was partially offset by a $25.1 million increase in average earning assets for the year 2009 compared to 2008.

Interest income (fte) earned on loans totaled $21,688,000 for the year ended December 31, 2009 with a resulting fte yield of 6.09% compared to $22,161,000 with an fte yield of 6.61% in 2008. The decrease was due to the lower prime interest rate in 2009, partially offset by growth of $21.2 million in average loans. The Company also established interest rate floors on lines of credit to offset the decrease in the prime rate. The securities available-for-sale portfolio averaged $129.4 million in 2009 with interest income (fte) of $5,830,000 and a yield (fte) of 4.51% compared to $130.9 million with interest income (fte) of $6,473,000 and yield (fte) of 4.94% in 2008. The decrease in yield in 2009 was principally due to higher yielding investments maturing and reinvested at the current lower interest rates.

Federal Funds sold and interest-bearing deposits with banks averaged $6.6 million at a yield of .29% compared to $1.1 million at a yield of 2.53% in 2008. The increase in Fed Funds at the current low yield had a negative impact on the margin in 2009.

Interest expense for the year-ended December 31, 2009 totaled $7,726,000 with an average cost of interest-bearing liabilities of 2.00% compared to interest expense of $9,694,000 with an average cost of 2.63% in 2008. The decrease was principally due to a lower level of short-term interest rates. In the lower rate environment, the Company reduced rates paid on money market accounts, time deposits and cash management accounts (included in short-term borrowings). The cost of time deposits decreased 101 basis points to 2.80% in 2009 from 3.81% in 2008, as higher costing time deposits matured and were replaced at lower rates. The rate on short-term borrowings principally cash management accounts declined 103 basis points to 1.11% in 2009 from 2.14% in 2008.

OTHER INCOME

Other income totaled $4,064,000 for the year ended December 31, 2010 which was $1,328,000 lower than the 2009 total.  The decrease was due primarily to several non-recurring items recorded in 2009 including the receipt of $816,000 of proceeds from an insurance claim on bank-owned life insurance and a $150,000 gain on the sale of deposits related to a branch closure.  Gains from the sale of mortgage loans also decreased $174,000 from the prior period.  Additionally, fees recognized from non-sufficient funds (NSF) decreased $223,000

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

compared to 2009 as customers more efficiently managed their accounts and amendments to banking regulations reduced the volume of customers impacted by these fees.

Other income for the year-ended December 31, 2009 totaled $5,392,000 compared to $4,087,000 in 2008, an increase of $1,305,000.  The increase is partially due to the receipt of $816,000 in proceeds from a death claim on a bank-owned life insurance policy.  The Company took advantage of the low interest rate environment and sold $15.4 million of investment securities at a gain of $463,000 compared to $18,000 in losses in 2008.  The Company also had a $150,000 gain on the sale of deposits related to a branch closure in the 2009 period.  Service charges and fees decreased $124,000 principally due to a lower volume of NSF fees.  The decline in NSF fees was also related to the branch closure.

Other Income (dollars in thousands) For the year-ended December 31
	2010		2009		2008
Service charges on deposit accounts	$	151	$	165	$	194
ATM Fees		288		273		280
NSF Fees		1,058		1,281		1,424
Gain on sale of deposits		—		150		—
Safe deposit box rental		53		52		55
Loan related service fees		292		390		281
Debit card		413		373		376
Fiduciary activities		405		354		404
Commissions on mutual funds & annuities		116		112		105
Gain on sales of mortgage loans and servicing rights		307		481		499
Earnings on and proceeds from bank-owned life insurance		391		1,196		344
Other income		142		102		143
		3,616		4,929		4,105
Net realized gains (losses) on sales of securities		448		463		(18	)
Total	$	4,064	$	5,392	$	4,087

OTHER EXPENSES

Other expenses totaled $12,753,000 for the year ended December 31, 2010 which represents a decrease of $718,000, or 5.3%, from the $13,471,000 recorded in 2009.  Salaries and employee benefits costs, which represent 51.0% of total other expense, decreased $322,000 in 2010.  This decrease includes the $267,000 cost incurred in 2009 related to a retirement plan, which was funded by proceeds from a bank-owned life insurance policy included in other income. In 2010, the Company also incurred a $91,000 expense to pay out a portion of its post-retirement life insurance obligation which was offset by a corresponding reduction in federal income tax expense.  FDIC insurance expense decreased $236,000 compared to the prior period due to the $225,000 special assessment paid in 2009.  Costs related to foreclosed real estate properties also decreased $395,000 from last year, while professional fees increased $239,000 due primarily to merger related expenses incurred in connection with the proposed acquisition of North Penn Bancorp.  The Company’s efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 51.6% in 2010 compared to 53.3% in 2009.

Other expenses totaled $13,471,000 in 2009 compared to $12,240,000 for 2008, an increase of $1,231,000. Salaries and employee benefit costs increased $783,000. The increase included $267,000 related to a retirement plan which was funded by proceeds from a BOLI policy included in other income.

24

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

The Company also paid out a portion of its post-retirement life insurance obligation, $136,000, which was offset by a reduction to federal income tax. FDIC insurance assessments totaled $710,000, an increase of $620,000 over the prior year. The increase included a special assessment of $225,000 which was based on five basis points of assets less Tier 1 capital as of June 30, 2009. Instead of imposing an additional special assessment, the FDIC required all banks to prepay their estimated risk-based assessment for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on December 30, 2009. The bank pre-paid $1,711,000 which is included in other assets and will be amortized over 36 months. The efficiency ratio, which is total other expenses as a percentage of net interest income (fte) plus other income for the year ended December 31, 2009 was 53.3%.

INCOME TAXES

Income tax expense for the year ended December 31, 2010 totaled $2,662,000 which results in an effective tax rate of 26.7% compared to $2,282,000 and 24.4% for 2009.  The reduced rate in 2009 reflected the benefit from $816,000 of insurance proceeds which were exempt from federal income taxes.  Excluding this item, the effective rate in 2009 would have been 26.8%.

Income tax expense for the year ended December 31, 2009 totaled $2,282,000 for an effective tax rate of 24.4% compared to an expense of $2,836,000 and an effective tax rate of 29.8% for 2008. The decrease in the effective tax rate was due to the receipt of $816,000 in proceeds from a BOLI policy which is exempt from federal income taxes and a $136,000 reduction to tax related to post-retirement life insurance benefits. Excluding these two items the effective tax rate for 2009 was 27.8%.

CAPITAL AND DIVIDENDS

Total stockholders’ equity as of December 31, 2010, was $67.7 million, compared to $64.5 million as of year-end 2009. The increase was principally due to retention of earnings of $4,193,000 after cash dividends declared of $3,120,000. Accumulated other comprehensive income decreased $953,000 in 2010 due to an increase in overall interest rates and the impact on fixed rate securities.  As of  December 31, 2010 the Company had a leverage capital ratio of 12.41%, Tier 1 risk-based capital of 18.44% and total risk-based capital of 19.74% compared to, 11.87%, 16.97% and 18.27%, respectively, in 2009.  The Company did not participate in the Treasury Department’s TARP Capital Purchase Program.

The Company’s stock is traded on the Nasdaq Global market under the symbol, NWFL. As of December 31, 2010, there were approximately 1,500 shareholders based on transfer agent mailings.

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

	Closing Price Range				Cash dividends
	High		Low		declared per share
Year 2010
First Quarter	$	29.18	$	25.22	$	.28
Second Quarter		28.06		24.18		.28
Third Quarter		28.75		25.00		.28
Fourth Quarter		29.75		26.38		.29
Year 2009
First Quarter	$	29.45	$	22.95	$	.27
Second Quarter		32.00		24.10		.27
Third Quarter		33.25		30.57		.27
Fourth Quarter		31.10		25.50		.28

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

The book value of the common stock was $24.45 as of December 31, 2010 compared to $23.25 as of December 31, 2009. As of year-end 2010, the stock price was $27.77, compared to $28.59 as of December 31, 2009.

NON-GAAP FINANCIAL MEASURES

This annual report contains or references tax-equivalent interest income and net interest income, which are non-GAAP financial measures. Tax-equivalent interest income and net interest income are derived from GAAP interest income and net interest income using an assumed tax rate of 34%. We believe the presentation of interest income and net interest income on a tax-equivalent basis ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Tax-equivalent net interest income is reconciled to GAAP net interest income on page 29. Although the Company believes that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP measures.

CHANGE IN AUDITORS

On August 11, 2009, the Company dismissed Beard Miller Company LLP (“BMC”) as the Company’s independent public accountants, and engaged S.R. Snodgrass, A.C. to serve as the Company’s independent public accountants. The appointment of Snodgrass and the dismissal of BMC were approved by the Audit Committee of the Company’s Board of Directors. BMC audited the Company’s consolidated financial statements for the year ended December 31, 2008. BMC’s report did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. During the year ended December 31, 2008 and from December 31, 2008 through August 11, 2009, there were no disagreements or reportable events between the Company and BMC on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of BMC, would have caused them to make a reference to the subject matter of the disagreements or reportable events in connection with their reports. BMC subsequently became known as ParenteBeard LLC.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

STOCK PERFORMANCE GRAPH

Set forth below is a stock performance graph comparing the cumulative total shareholder return on the Common Stock with (a) the cumulative total stockholder return on stocks included in the Nasdaq Stock Market index and (b) the cumulative total stockholder return on stocks included in the Nasdaq Bank index, as prepared by the Center for Research in Securities Prices (“CRSP”) at the University of Chicago. All three investment comparisons assume the investment of $100 at the market close on December 31, 2005 and the reinvestment of dividends paid. The graph provides comparison at December 31, 2005 and each fiscal year through December 31, 2010.

There can be no assurance that the Company’s future stock performance will be the same or similar to the historical performance shown in the above graph. The Company neither makes nor endorses any predictions as to stock performance.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP

SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

(Dollars in thousands, except per share amounts)

2010
	December 31		September 30		June 30		March 31
Interest income	$	6,273	$	6,395	$	6,377	$	6,642
Interest expense		1,357		1,476		1,545		1,645
Net interest income		4,916		4,919		4,832		4,997
Provision for loan losses		270		250		150		330
Other income		943		874		952		847
Net realized gains on sales of securities		68		161		64		155
Other expense		3,305		3,112		3,176		3,160
Income before income taxes		2,352		2,592		2,522		2,509
Income tax expense		544		702		704		712
NET INCOME	$	1,808	$	1,890	$	1,818	$	1,797
Basic earnings per share	$	.65	$	.68	$	.66	$	.65
Diluted earnings per share	$	.65	$	.68	$	.66	$	.65
2009
	December 31		September 30		June 30		March 31
Interest income	$	6,722	$	6,680	$	6,743	$	6,690
Interest expense		1,895		1,914		1,908		2,009
Net interest income		4,827		4,766		4,835		4,681
Provision for loan losses		1,100		140		220		225
Other income		1,885		928		996		1,120
Net realized gain on sales of securities		40		90		172		161
Other expense		3,702		3,174		3,320		3,275
Income before income taxes		1,950		2,470		2,463		2,462
Income tax expense		148		695		714		725
NET INCOME	$	1,802	$	1,775	$	1,749	$	1,737
Basic earnings per share	$	0.65	$	0.64	$	0.64	$	0.64
Diluted earnings per share	$	0.65	$	0.64	$	0.62	$	0.63

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP CONSOLIDATED AVERAGE BALANCE SHEETS WITH RESULTANT INTEREST AND RATES

(Tax-Equivalent Basis, dollars in thousands)

Year Ended December 31	2010									2009									2008
	Average Balance(2)			Interest(1)			Avg Rate			Average Balance(2)			Interest(1)			Avg Rate			Average Balance(2)			Interest(1)			Avg Rate
ASSETS
Interest Earning Assets:
Federal funds sold	$	3,000		$	10			.33	%	$	2,031		$	5			0.25	%	$	1,082		$	28			2.59	%
Interest bearing deposits with banks		16,415			47			.29			4,552			14			0.31			66			1			1.52
Securities held to maturity		280			24			8.57			707			61			8.63			706			61			8.64
Securities available for sale
Taxable		95,121			2,969			3.12			100,120			4,131			4.13			108,809			5,207			4.79
Tax-exempt		40,332			2,340			5.80			29,283			1,699			5.80			22,108			1,266			5.73
Total  securities available for sale		135,453			5,309			3.92			129,403			5,830			4.51			130,917			6,473			4.94
Loans receivable (3,4)		355,980			21,295			5.98			356,345			21,688			6.09			335,137			22,161			6.61
Total interest earning assets		511,128			26,685			5.22			493,038			27,598			5.60			467,908			28,724			6.14
Non-interest earning assets:
Cash and due from banks		7,402									6,935									8,102
Allowance for loan losses		(5,476	)								(4,539	)								(4,013	)
Other assets		22,638									17,309									17,687
Total non-interest earning assets		24,564									19,705									21,776
TOTAL ASSETS	$	535,692								$	512,743								$	489,684
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest bearing demand and money market	$	107,997			571			.53		$	98,968			731			0.74		$	102,358			1,449			1.42
Savings		48,588			109			.22			44,526			158			0.35			44,510			208			0.47
Time		177,761			3,603			2.03			174,201			4,876			2.80			160,462			6,116			3.81
Total interest-bearing deposits		334,346			4,283			1.28			317,695			5,765			1.81			307,330			7,773			2.53
Short-term borrowings		25,932			117			.45			26,233			292			1.11			32,328			693			2.14
Other borrowings		41,712			1,623			3.89			43,000			1,669			3.88			28,710			1,228			4.28
Total interest bearing liabilities		401,990			6,023			1.50			386,928			7,726			2.00			368,368			9,694			2.63
Non-interest bearing liabilities:
Non-interest bearing demand deposits		61,966									59,224									59,759
Other liabilities		4,433									4,615									4,908
Total non-interest bearing liabilities		66,399									63,839									64,667
Stockholders' equity		67,303									61,976									56,649
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	535,692								$	512,743								$	489,684
Net interest income
(tax-equivalent basis)					20,662			3.72	%					19,872			3.60	%					19,030			3.51	%
Tax-equivalent basis adjustment					(998	)								(763	)								(629	)
Net Interest Income				$	19,664								$	19,109								$	18,401
Net Interest margin
(tax-equivalent basis)								4.04	%								4.03	%								4.07	%

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.

29

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

RATE/VOLUME ANALYSIS

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

	Increase/(Decrease)
(dollars in thousands)	2010 compared to 2009									2009 compared to 2008
	Variance due to									Variance due to
	Volume			Rate			Net			Volume			Rate			Net
INTEREST EARNING ASSETS:
Federal funds sold	$	3		$	1		$	4		$	14		$	(37	)	$	(23	)
Interest bearing deposits with banks		34			(1	)		33			14			(1	)		13
Securities held to maturity		(37	)		0			(37	)		0			0			0
Securities available for sale
Taxable		(198	)		(964	)		(1,162	)		(395	)		(681	)		(1,076	)
Tax-exempt		641			1			642			416			17			433
Total securities available for sale		443			(963	)		(520	)		21			(664	)		(643	)
Loans receivable		(22	)		(371	)		(393	)		1,353			(1,826	)		(473	)
Total interest earning assets		421			(1,334	)		(913	)		1,402			(2,528	)		(1,126	)
INTEREST BEARING LIABILITIES:
Interest- bearing demand and money market		62			(222	)		(160	)		(47	)		(671	)		(718	)
Savings		13			(62	)		(49	)		0			(50	)		(50	)
Time		98			(1,371	)		(1,273	)		490			(1,730	)		(1,240	)
Total interest- bearing deposits		173			(1,655	)		(1,482	)		443			(2,451	)		(2,008	)
Short-term borrowings		(3	)		(172	)		(175	)		(113	)		(288	)		(401	)
Long term debt		(50	)		4			(46	)		564			(123	)		441
Total interest bearing liabilities		120			(1,823	)		(1,703	)		894			(2,862	)		(1,968	)
Net interest income
(tax-equivalent basis)	$	301		$	489		$	790		$	508		$	334		$	842

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.

30

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

TO THE STOCKHOLDERS OF NORWOOD FINANCIAL CORP

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

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

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

Management assessed the effectiveness of Norwood’s internal control over financial reporting as of December 31, 2010.  In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control – Integrated Framework.”  Based on our assessment and those criteria, management determined that Norwood maintained effective internal control over financial reporting as of December 31, 2010.

Norwood’s Independent registered certified public accounting firm has audited the effectiveness of Norwood’s internal control over financial reporting. Their report appears on page 32.

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

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Norwood Financial Corp.

Honesdale, Pennsylvania

We have audited the accompanying consolidated balance sheet of Norwood Financial Corp. and its subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of Norwood Financial Corp. and its subsidiary’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Norwood Financial Corp. and its subsidiary for the year ended December 31, 2008 were audited by other auditors whose report, dated March 10, 2009, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides 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, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), Norwood Financial Corp. and its subsidiary’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 8, 2011, expressed an unqualified opinion on the effectiveness of Norwood Financial Corp.’s internal control over financial reporting.

S.R. Snodgrass, A. C.

2100 Corporate Drive

Suite 400

Wexford, PA

March 8, 2011

32

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Norwood Financial Corp.

Honesdale, Pennsylvania

We have audited Norwood Financial Corp. and its subsidiary’s internal control over financial reporting as of December 31, 2010 and 2009, based on criteria established in Internal Control – Integrated Framework issued by the  Committee of Sponsoring Organizations of the Treadway Commission. Norwood Financial Corp. and its subsidiary’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

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

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

In our opinion, Norwood Financial Corp. and its subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Norwood Financial Corp. and its subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for the years then ended and our report dated March 8, 2011, expressed an unqualified opinion.

S.R. Snodgrass, A. C.

2100 Corporate Drive

Suite 400

Wexford, PA

March 8, 2011

33

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Norwood Financial Corp.

Honesdale, Pennsylvania

We have audited the accompanying consolidated statements of income, stockholders’ equity, and cash flows of Norwood Financial Corp. and its subsidiary for the year ended December 31, 2008. Norwood Financial Corp. and its subsidiary’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Norwood Financial Corp. and its subsidiary for the year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

Parente Beard LLC

Lancaster, Pennsylvania

March 8, 2011

34

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED BALANCE SHEETS

	December 31,
	2010			2009
	(In Thousands,
	Except Share Data)
ASSETS
Cash and due from banks	$	5,782		$	6,498
Interest bearing deposits with banks		7,843			7,857
Federal funds sold		3,000			3,000
Cash and cash equivalents		16,625			17,355
Securities available for sale		145,815			130,577
Securities held to maturity, fair value 2010: $179, 2009: $722		170			708
Loans receivable (net of allowance for loan losses 2010: $5,616; 2009: $5,453)		351,239			358,021
Investment in Federal Home Loan Bank Stock, at cost		3,361			3,538
Bank premises and equipment, net		4,904			5,189
Bank owned life insurance		8,249			7,889
Accrued interest receivable		2,166			2,200
Foreclosed real estate owned		748			392
Other assets		3,728			3,827
Total Assets	$	537,005		$	529,696
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits:
Non-interest bearing demand	$	62,238		$	59,820
Interest bearing demand		38,168			34,410
Money market deposit accounts		70,812			60,035
Savings		50,341			44,423
Time		172,306			192,785
Total Deposits		393,865			391,473
Short-term borrowings		33,309			25,803
Other borrowings		38,000			43,000
Accrued interest payable		1,536			2,057
Other liabilities		2,597			2,892
Total Liabilities		469,307			465,225
Stockholders’ Equity
Common stock, $.10 par value, authorized 10,000,000 shares, issued: 2,840,872		284			284
Surplus		9,826			9,764
Retained earnings		58,648			54,455
Treasury stock at cost: 2010: 72,068 shares, 2009: 68,436 shares		(2,197	)		(2,122	)
Accumulated other comprehensive income		1,137			2,090
Total Stockholders’ Equity		67,698			64,471
Total Liabilities and Stockholders’ Equity	$	537,005		$	529,696

See notes to consolidated financial statements.

35

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF INCOME

	Years Ended December 31,
	2010		2009		2008
	(In Thousands, Except per Share Data)
INTEREST INCOME
Loans receivable, including fees	$	21,101	$	21,523	$	21,983
Securities:
Taxable		2,969		4,131		5,207
Tax exempt		1,560		1,162		876
Other		57		19		29
Total Interest Income		25,687		26,835		28,095
INTEREST EXPENSE
Deposits		4,283		5,765		7,773
Short-term borrowings		117		292		693
Other borrowings		1,623		1,669		1,228
Total Interest Expense		6,023		7,726		9,694
Net Interest Income		19,664		19,109		18,401
PROVISION FOR LOAN LOSSES		1,000		1,685		735
Net Interest Income after Provision for Loan Losses		18,664		17,424		17,666
OTHER INCOME
Service charges and fees		2,231		2,476		2,600
Income from fiduciary activities		405		354		404
Net realized gains (losses) on sales of securities		448		463		(18	)
Gain on sales of loans and servicing rights		307		481		499
Earnings on life insurance policies		391		1,196		344
Gain on sale of deposits		—		150		—
Other		282		272		258
Total Other Income		4,064		5,392		4,087
OTHER EXPENSES
Salaries and employee benefits		6,507		6,829		6,046
Occupancy		1,136		1,133		1,118
Furniture and equipment		424		458		507
Data processing related operations		803		788		753
Federal Deposit Insurance Corporation insurance assessment		474		710		90
Advertising		187		186		213
Professional fees		650		411		331
Postage and telephone		484		487		521
Taxes, other than income		524		484		504
Foreclosed real estate owned		41		436		582
Amortization of intangible assets		52		52		52
Other		1,471		1,497		1,523
Total Other Expenses		12,753		13,471		12,240
Income before Income Taxes		9,975		9,345		9,513
INCOME TAX EXPENSE		2,662		2,282		2,836
Net Income	$	7,313	$	7,063	$	6,677
EARNINGS PER SHARE
Basic	$	2.65	$	2.57	$	2.44
Diluted	$	2.64	$	2.55	$	2.41

See notes to consolidated financial statements.

36

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

	Years Ended December 31, 2010, 2009 and 2008
																	Accumulated
																	Other
	Common Stock							Retained			Treasury						Comprehensive
	Shares		Amount		Surplus			Earnings			Shares			Amount			Income (Loss)			Total
	(Dollars in Thousands, Except Per Share Data)
BALANCE – DECEMBER 31, 2007		2,840,872	$	284	$	10,159		$	47,030			87,256		$	(2,708	)	$	1,054		$	55,819
Comprehensive Income:
Net Income		-		-		-			6,677			-			-			-			6,677
Change in unrealized gains on securities available for sale, net of reclassification adjustment and tax effects		-		-		-			-			-			-			225			225
Total Comprehensive  Income		-		-		-			-			-			-			-			6,902
Cash dividends declared, $1.02 per share		-		-		-			(2,789	)		-			-			-			(2,789	)
Acquisition of treasury stock		-		-		-			-			50,632			(1,583	)		-			(1,583	)
Stock options exercised		-		-		(455	)		-			(27,979	)		875			-			420
Tax benefit of stock options exercised		-		-		134			-			-			-			-			134
Sale of treasury stock for ESOP		-		-		(20	)		-			(5,599	)		173			-			153
Compensation expense related to stock options		-		-		154			-			-			-			-			154
Cumulative effect of net periodic postretirement benefit		-		-		-			(520	)		-			-			-			(520	)
BALANCE – DECEMBER 31, 2008		2,840,872		284		9,972			50,398			104,310			(3,243	)		1,279			58,690
Comprehensive income:
Net income		-		-		-			7,063			-			-			-			7,063
Change in unrealized gains on securities available for sale, net of reclassification adjustment and tax effects		-		-		-			-			-			-			811			811
Total Comprehensive  Income		-		-		-			-			-			-			-			7,874
Cash dividends declared, $1.09 per share		-		-		-			(3,006	)		-			-			-			(3,006	)
Acquisition of treasury stock		-		-		-			-			2,519			(68	)		-			(68	)
Stock options exercised		-		-		(492	)		-			(32,528	)		1,009			-			517
Tax benefit of stock options exercised		-		-		164			-			-			-			-			164
Sale of treasury stock for ESOP		-		-		(14	)		-			(5,865	)		180			-			166
Compensation expense related to stock options		-		-		134			-			-			-			-			134
BALANCE – DECEMBER 31, 2009		2,840,872		284		9,764			54,455			68,436			(2,122	)		2,090			64,471
Comprehensive income:
Net income		-		-		-			7,313			-			-			-			7,313
Change in unrealized losses on securities available for sale, net of reclassification adjustment and tax effects		-		-		-			-			-			-			(953	)		(953	)
Total Comprehensive Income		-		-		-			-			-			-			-			6,360
Cash dividends declared $1.13 per share		-		-		-			(3,120	)		-			-			-			(3,120	)
Acquisition of treasury stock		-		-		-			-			18,571			(529	)		-			(529	)
Stock options exercised		-		-		(120	)		-			(9,276	)		283			-			163
Tax benefit on stock options		-		-		34			-			-			-			-			34
Sale of treasury stock for ESOP		-		-		(15	)		-			(5,663	)		171			-			156
Compensation expense related to stock options		-		-		163			-			-			-			-			163
BALANCE – DECEMBER 31, 2010		2,840,872	$	284	$	9,826		$	58,648			72,068		$	(2,197	)	$	1,137		$	67,698

See notes to consolidated financial statements.

37

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	7,313		$	7,063		$	6,677
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,000			1,685			735
Depreciation		459			546			577
Amortization of intangible assets		52			52			52
Deferred income taxes		(205	)		(749	)		36
Net amortization of securities premiums and discounts		462			156			44
Net realized (gains) losses on sales of securities		(448	)		(463	)		18
Gain on sale of deposits		—			(150	)		—
Gain on life insurance policy		—			(816	)		—
Net increase in investment in life insurance		(358	)		(351	)		(301	)
Loss (gain) on sale of bank premises and equipment and foreclosed real estate		(3	)		360			540
Gain on sale of mortgage loans and servicing rights		(307	)		(481	)		(499	)
Mortgage loans originated for sale		(12,488	)		(21,743	)		(866	)
Proceeds from sale of mortgage loans originated for sale		12,795			22,224			881
Compensation expense related to stock options		163			134			154
Decrease (increase) in accrued interest receivable and other assets		989			(1,528	)		(68	)
Increase (decrease) in accrued interest payable and other liabilities		(843	)		65			(829	)
Net Cash Provided by Operating Activities		8,581			6,004			7,151
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		23,944			15,449			67
Proceeds from maturities and principal reductions on mortgage-backed securities		66,102			44,047			39,319
Purchases		(106,742	)		(58,409	)		(45,254	)
Securities held to maturity, proceeds from maturities		540			—			—
Purchase of FHLB stock		—			—			(2,386	)
Redemption of FHLB stock		177			—			920
Net (increase) decrease in loans		5,118			(14,912	)		(33,523	)
Proceeds from sale of mortgage loans		—			—			13,988
Proceeds from life insurance policy		—			1,346			—
Purchase of bank premises and equipment		(179	)		(248	)		(325	)
Proceeds from sales of premises and equipment and foreclosed real estate		100			121			—
Net Cash Used in Investing Activities		(10,940	)		(12,606	)		(27,194	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits		2,392			35,594			(10,365	)
Deposits sold		—			(3,606	)		—
Net increase (decrease) in short-term borrowings		7,506			(12,323	)		11,440
Proceeds from other borrowings		—			—			25,000
Repayments of other borrowings		(5,000	)		—			(5,000	)
Stock options exercised		163			517			420
Tax benefit of stock options exercised		34			164			134
ESOP purchase of shares from treasury stock		156			166			153
Purchase of treasury stock		(529	)		(68	)		(1,583	)
Cash dividends paid		(3,093	)		(2,967	)		(2,740	)
Net Cash Provided by Financing Activities		1,629			17,477			17,459
Net Increase (Decrease) in Cash and Cash Equivalents		(730	)		10,875			(2,584	)
CASH AND CASH EQUIVALENTS – BEGINNING		17,355			6,480			9,064
CASH AND CASH EQUIVALENTS – ENDING	$	16,625		$	17,355		$	6,480

See notes to consolidated financial statements.

38

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - NATURE OF OPERATIONS

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

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

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

Estimates

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

Significant Group Concentrations of Credit Risk

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

Concentrations of Credit Risk

The Bank operates primarily in Wayne, Pike and Monroe Counties, Pennsylvania and, accordingly, has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy. These customers are also the primary depositors of the Bank. The Bank is limited in extending credit by legal lending limits to any single borrower or group of borrowers.

Securities

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

39

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

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

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis.

The Company, as a member of the Federal Home Loan Bank (FHLB) system is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula. This restricted stock has no quoted market value and is carried at cost.

In December 2008, the FHLB of Pittsburgh notified member banks that it was suspending dividend payments and the repurchase of excess capital stock.  In October, 2010, the FHLB of Pittsburgh repurchased a portion of member bank’s excess stock, but notified member banks that decisions regarding future capital stock repurchases will be made on a quarterly basis.

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to FHLB stock as of December 31, 2010.

Loans Receivable

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

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

40

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon a third party appraisal. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. The Company’s loan servicing assets at December 31, 2010 and 2009, were not impaired. Total servicing assets included in other assets as of December 31, 2010 and 2009, were $250,000 and $179,000, respectively.

Allowance for Loan Losses

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

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

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

41

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Premises and Equipment

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

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

Transfers of Financial Assets

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

Foreclosed Real Estate

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

Bank Owned Life Insurance

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

Intangible Assets

At December 31, 2010 and 2009, the Company had intangible assets of $13,000 and $65,000 arising from the purchase of deposits in 1996, which is net of accumulated amortization of $767,000 and $715,000 which are included in other assets. These intangible assets will continue to be amortized on a straight-line basis over fifteen years. Amortization expense related to intangible assets was $52,000 for each of the years ended December 31, 2010, 2009 and 2008. The amortization expense will be $13,000 for the year ended December 31, 2011.

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. The Company recognizes interest and penalties on income taxes as a component of income tax expense.

42

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The Company analyzes each tax position taken in its tax returns and determine the likelihood that the position will be realized. Only tax positions that are “more-likely-than-not” to be realized can be recognized in an entity’s financial statements. For tax positions that do not meet this recognition threshold, an entity will record an unrecognized tax benefit for the difference between the position taken on the tax return and the amount recognized in the financial statements. The Company does not have any unrecognized tax benefits at December 31, 2010 or 2009 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Advertising Costs

Advertising costs are expensed as incurred.

Earnings per Share

Basic earnings per share represents income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. Treasury shares are not deemed outstanding for earnings per share calculations.

Stock Option Plans

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

Fair Value Measurements

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

Level 1:	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable (i.e. supported with little or no market activity).

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

43

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT 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 period December 31, 2010, 2009 and 2008 were $6,544,000, $7,916,000 and $10,645,000, respectively. Cash payments for income taxes in 2010 were $2,742,000 compared to $2,441,000 in 2009 and $3,138,000 in 2008. Non-cash investing activity for 2010, 2009, and 2008 included foreclosed mortgage loans transferred to real estate owned and repossession of other assets of $589,000, $296,000 and $1,328,000, 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,
	2010			2009		2008
	(In Thousands)
Unrealized holding gains (losses) on available for sale securities	$	(994	)	$	1,701	$	311
Reclassification adjustment for gains (losses) realized in income		448			463		(18	)
Net Unrealized Gains (Losses)		(1,442	)		1,238		329
Income tax expense (benefit)		(489	)		427		104
Net of Tax Amount	$	(953	)	$	811	$	225

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 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.

44

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

New Accounting Standards

In January 2010, the FASB issued ASU 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that for certain shareholders escrowed share arrangements represent compensation.  ASU 2010-05 is effective January 15, 2010.  The adoption of this guidance did not have a material impact on the Company’s financial position.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The Company has presented the necessary disclosures in the Note 8 herein.

In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In March 2010, the FASB issued ASU 2010-11, Derivatives and Hedging.  ASU 2010-11 provides clarification and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in ASC 815-15-15-8.  ASU 2010-11 is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. The adoption of this guidance did not have a significant impact on the Company’s financial statements.

In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310):  Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force.  ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets.  Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said.  The amendment will be effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15, 2010.  The adoption of this guidance did not have a significant impact on the Company’s financial statements.

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption.  The Company has presented the necessary disclosures in Note 5 herein.

45

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In September, 2010, the FASB issued ASU 2010-25, Plan Accounting – Defined Contribution Pension Plans.  The amendments in this ASU require that participant loans be classified as notes receivable from participants, which are segregated from plan investments and measured at their unpaid principal balance plus any accrued but unpaid interest.  The amendments in this update are effective for fiscal years ending after December 15, 2010 and are not expected to have a significant impact on the Company’s financial statements.

In October, 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.  This ASU addresses the diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The amendments are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2011 and are not expected to have a significant impact on the Company’s financial statements.

In December, 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.  This ASU modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist.  The qualitative factors are consistent with the existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  For public entities, the amendments in this update are effective for fiscal year, and interim periods within those years, beginning after December 15, 2010.  Early adoption is not permitted.  For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Nonpublic entities may early adopt the amendments using the effective date for public entities.  This ASU is not expected to have a significant impact on the Company’s financial statements.

In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations.  The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  The amendments also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.   The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted.  This ASU is not expected to have a significant impact on the Company’s financial statements.

NOTE 3 – CHANGE IN ACCOUNTING PRINCIPLE

Generally accepted accounting principles in the United States require the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee’s benefit during his or her retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Alternatively, if the policyholder has

46

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 3 – CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED)

agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized. For transition, an entity can choose to apply the guidance using either of the following approaches: (a) a change in accounting principle through retrospective application to all periods presented or (b) a change in accounting principle through a cumulative-effect adjustment to the balance in retained earnings at the beginning of the year of adoption. The Company has chosen approach (b) and recorded a cumulative effect adjustment as of January 1, 2008 to the balance of retained earnings of $520,000.  Net Periodic Postretirement Benefit expense included in salaries and employee benefits was $135,000 and $166,000 for the years ended December 31, 2010 and 2009, respectively.

NOTE 4 - SECURITIES

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

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies	$	30,194	$	392	$	(318	)	$	30,268
States and political subdivisions		49,880		510		(624	)		49,766
Corporate obligations		4,018		231		—			4,249
Mortgage-backed securities -
government sponsored entities		59,770		1,398		(240	)		60,928
Equity securities - financial services		224		381		(1	)		604
	$	144,086	$	2,912	$	(1,183	)	$	145,815
HELD TO MATURITY:
States and political subdivisions	$	170	$	9	$	—		$	179
	December 31, 2009
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies	$	39,607	$	295	$	(130	)	$	39,772
States and political subdivisions		30,872		780		(17	)		31,635
Corporate obligations		5,043		200		(3	)		5,240
Mortgage-backed securities -
government sponsored entities		51,554		1,618		(18	)		53,154
		127,076		2,893		(168	)		129,801
Equity securities - financial services		330		451		(5	)		776
	$	127,406	$	3,344	$	(173	)	$	130,577
HELD TO MATURITY:
States and political subdivisions	$	708	$	14	$	—		$	722

47

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - SECURITIES  (CONTINUED)

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

	December 31, 2010
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(In Thousands)
U.S. Government agencies	$	8,696	$	(318	)	$	—	$	—		$	8,696	$	(318	)
States and political subdivisions		21,829		(624	)		—		—			21,829		(624	)
Mortgage-backed securities -
government sponsored entities		20,113		(240	)		—		—			20,113		(240	)
Equity securities - financial services		15		(1	)		—		—			15		(1	)
	$	50,653	$	(1,183	)	$	—	$	—		$	50,653	$	(1,183	)
	December 31, 2009
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(In Thousands)
U.S. Government agencies	$	15,366	$	(130	)	$	—	$	—		$	15,366	$	(130	)
States and political subdivisions		1,413		(17	)		—		—			1,413		(17	)
Corporate obligations		997		(3	)		—		—			997		(3	)
Mortgage-backed securities -
government sponsored entities		3,655		(18	)		—		—			3,655		(18	)
Equity Securities - financial services		49		(3	)		5		(2	)		54		(5	)
	$	21,480	$	(171	)	$	5	$	(2	)	$	21,485	$	(173	)

The Company has 61 securities in the less than twelve month category and no securities in the twelve months or more category as of December 31, 2010 compared to 24 securities in the less than twelve month category and 1 security greater than twelve months as of December 31, 2009. In management’s opinion, the unrealized losses in the U.S. Government agencies and the mortgage-backed securities reflect changes in interest rates subsequent to the acquisition of specific securities. The unrealized losses in the States and Political Subdivisions also reflect a widening of spreads due to liquidity and credit concerns in the municipal debt markets. The Company holds a small amount of equity securities in other financial institutions, the value of which has been impacted by weakened conditions of the financial market. In 2009, the Company recorded an other-than-temporary-impairment charge on two equity holdings totaling $31,000.  No additional other-than-temporary-impairment charges were recorded in 2010.  Management believes that all other unrealized losses represent temporary impairment of the securities, as it is the intent of the Company to not sell the securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis.

The amortized cost and fair value of securities as of December 31, 2010 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.

48

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 4 - SECURITIES  (CONTINUED)

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(In Thousands)
Due in one year or less	$	1,001	$	1,005	$	—	$	—
Due after one year through five years		31,803		32,425		170		179
Due after five years through ten years		22,604		22,623		—		—
Due after ten years		28,684		28,230		—		—
		84,092		84,283		170		179
Mortgage-backed securities -
government sponsored entities		59,770		60,928		—		—
	$	143,862	$	145,211	$	170	$	179

Gross realized gains and gross realized losses on sales of securities available for sale were $450,000 and $2,000, respectively, in 2010, compared to $597,000 and $134,000, respectively, in 2009, and $44,000 and $62,000, respectively, in 2008. The proceeds from the sales of securities totaled $23,944,000, $15,449,000 and $67,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Securities with a carrying value of $71,412,000 and $65,438,000 at December 31, 2010 and 2009, 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.

NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The components of loans receivable at December 31 were as follows:

	2010			2009
	(In Thousands)
Real estate:
Residential	$	124,562		$	130,318
Commercial		184,094			180,266
Construction		12,638			14,405
Commercial, financial and agricultural		22,386			24,116
Consumer loans to individuals		13,668			14,850
		357,348			363,955
Unearned income and deferred fees		(493	)		(481	)
Allowance for loan losses		(5,616	)		(5,453	)
	$	351,239		$	358,021

	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
December 31, 2010
Total Loans	$	124,562	$	184,094	$	12,638	$	22,386	$	13,668	$	357,348
Individually evaluated for impairment	$	—	$	14,239	$	—	$	513	$	—	$	14,752
Collectively evaluated for impairment	$	124,562	$	169,855	$	12,638	$	21,873	$	13,668	$	342,596

49

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans.  Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers.  Specific loan loss allowances are established for identified losses based on a review of such information.  A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probably that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  All loans identified as impaired are evaluated independently.  We do not aggregate such loans for evaluation purposes.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

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

A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider.  Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk.  TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after a period of performance.

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

			Unpaid				Average		Interest
	Recorded		Principal		Associated		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
December 31, 2010
With no related allowance recorded:
Real Estate Loans
Residential	$	—	$	—	$	—	$	—	$	—
Construction		—		—		—		—		—
Commercial		5,598		5,598		—		5,088		266
Commercial Loans		513		513		—		115		—
Consumer Loans		—		—		—		—		—
Total		6,111		6,111		—		5,203		266
With an allowance recorded:
Real Estate Loans
Residential		—		—		—		—		—
Construction		—		—		—		—		—
Commercial		8,641		8,548		1,648		4,734		119
Commercial Loans		—		—		—		159		—
Consumer Loans		—		—		—		—		—
Total		8,641		8,548		1,648		4,893		119
Total:
Real Estate loans
Residential		—		—		—		—		—
Construction		—		—		—		—		—
Commercial		14,239		14,146		1,648		9,822		385
Commercial Loans		513		513		—		274		—
Consumer Loans		—		—		—		—		—
Total Impaired Loans	$	14,752	$	14,659	$	1,618	$	10,096	$	385

50

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

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

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event.  The Bank’s Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis.  Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration.  Loan Review also annually reviews relationships of $500,000 and over to assign or re-affirm risk ratings.  Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of December 31, 2010 (in thousands):

			Special
	Pass		Mention		Substandard		Doubtful		Loss		Total
December 31, 2010
Commercial real estate loans	$	165,226	$	1,780	$	17,088	$	—	$	—	$	184,094
Commercial loans		21,759		75		552		—		—		22,386
Total	$	186,985	$	1,855	$	17,640	$	—	$	—	$	206,480

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits.  The following table presents the recorded investment in the loan classes based on payment activity as of December 31, 2010 (in thousands):

December 31, 2010	Performing		Nonperforming		Total
Residential real estate loans	$	123,623	$	939	$	124,562
Construction		12,638		—	$	12,638
Consumer loans		13,668		—	$	13,668
Total	$	149,929	$	939	$	150,868

51

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2010 (in thousands):

							Greater than
							90 Days				Total Past
							Past Due				Due and
			31-60 Days		61-90 Days		and still		Non-		Non-		Total
December 31, 2010	Current		Past Due		Past Due		accruing		Accrual		Accrual		Loans
Real Estate loans
Residential	$	123,177	$	407	$	—	$	39	$	939	$	1,385	$	124,562
Construction		12,622		16		—		—		—		16		12,638
Commercial		176,981		3,047		1,478		—		2,588		7,113		184,094
Commercial loans		21,858		15		—		—		513		528		22,386
Consumer  loans		13,642		24		2		—		—		26		13,668
Total	$	348,280	$	3,509	$	1,480	$	39	$	4,040	$	9,068	$	357,348

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

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Allowance balance at beginning of period	$	5,453		$	4,233		$	4,081
Charge-offs:
Commercial and all other		(85	)		(17	)		(7	)
Real Estate		(699	)		(358	)		(465	)
Consumer		(82	)		(139	)		(171	)
Total		(866	)		(514	)		(643	)
Recoveries:
Commercial and all other		—			11			—
Real Estate		2			4			1
Consumer		27			34			59
Total		29			49			60
Provision expense		1,000			1,685			735
Allowance balance at end of period	$	5,616		$	5,453		$	4,233

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

(In thousands)
	Residential		Commercial
	Real Estate		Real Estate		Construction		Commercial		Consumer		Total
December 31, 2010
Allowance for loan losses:
Ending balance	$	1,167	$	3,976	$	110	$	171	$	192	$	5,616
Ending balance individually evaluated for impairment	$	—	$	1,648	$	—	$	—	$	—	$	1,648
Ending balance collectively evaluated for impairment	$	1,167	$	2,328	$	110	$	171	$	192	$	3,968
Total loans:
Ending balance	$	124,562	$	184,094	$	12,638	$	22,386	$	13,668	$	357,348
Ending balance individually evaluated for impairment	$	—	$	14,239	$	—	$	513	$	—	$	14,752
Ending balance collectively evaluated for impairment	$	124,562	$	169,855	$	12,638	$	21,873	$	13,668	$	342,596

52

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

The recorded investment in impaired loans, not requiring an allowance for loan losses was $6,111,000 (net of charge-offs against the allowance for loan losses of $220,000) and $6,962,000 (net of charge-offs against the allowance for loan losses of $154,000) at December 31, 2010 and 2009, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $8,641,000 (net of a charge-off against the allowance for loan losses of $480,000) and $1,065,000 (net of a charge-off against the allowance for loan losses of $480,000) at December 31, 2010 and 2009, respectively. The specific reserve related to impaired loans was $1,648,000 for 2010 and $36,000 for 2009. For the years ended December 31, 2010, 2009 and 2008, the average recorded investment in these impaired loans was $10,096,000, $3,585,000 and $3,331,000 and the interest income recognized on these impaired loans was $385,000, $139,000 and $143,000, respectively.

Loans on which the accrual of interest has been discontinued amounted to $4,040,000 and $4,916,000 at December 31, 2010 and 2009, 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 $39,000 and $99,000  at December 31, 2010 and 2009, respectively. Interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of the loans was $339,000, $188,000 and $31,000 for 2010, 2009 and 2008, respectively.

The Company’s primary business activity is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy.

As of December 31, 2010, the Company considered its concentration of credit risk to be acceptable.  The two highest concentrations are in the hospitality lodging industry and summer camps, with loans outstanding of $38.9 million, or 55.1% of capital, to the hospitality lodging industry and $22.2 million, or 31.5% of capital, to summer camps.  In 2010, there were no losses in either portfolio.  As of December 31, 2010, one motel loan with an outstanding balance of $3,047,000 was delinquent and considered impaired.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $247,000 and $13,000, respectively, in 2010 compared to $309,000 and $6,000, respectively, in 2009 and $410,000 and $0, respectively, in 2008.  The proceeds from the sales of residential mortgage loans totaled $12.4 million, $21.8 million and $14.4 million for the years ended December 31, 2010, 2009 and 2008, respectively.

NOTE 6 - PREMISES AND EQUIPMENT

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

	2010			2009
	(In Thousands)
Land and improvements	$	925		$	925
Buildings and improvements		7,975			7,933
Furniture and equipment		5,253			5,158
		14,153			14,016
Accumulated depreciation		(9,249	)		(8,827	)
	$	4,904		$	5,189

Depreciation expense totaled $459,000, $546,000 and $577,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

53

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 6 - PREMISES AND EQUIPMENT (CONTINUED)

Certain facilities are leased under various operating leases. Rental expense for these leases was $254,000, $284,000 and $280,000, for the years ended December 31, 2010, 2009 and 2008. Future minimum rental commitments under noncancellable leases as of December 31, 2010 were as follows (in thousands):

2011	$	259
2012		267
2013		269
2014		259
2015		255
Thereafter		1,796
	$	3,105

NOTE 7 - DEPOSITS

Aggregate time deposits in denominations of $100,000 or more were $60,015,000 and $66,631,000 at December 31, 2010 and 2009, respectively.

At December 31, 2010, the scheduled maturities of time deposits are as follows (in thousands):

2011	$	107,806
2012		32,063
2013		14,395
2014		13,872
2015		4,170
	$	172,306

NOTE 8 - BORROWINGS

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

	2010		2009
	(In Thousands)
Securities sold under agreements to repurchase	$	33,110	$	25,606
U.S. Treasury demand notes		199		197
	$	33,309	$	25,803

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

	Years Ended December 31,
	2010			2009
	(Dollars In Thousands)
Average balance during the year	$	26,100		$	26,402
Average interest rate during the year		.45	%		1.11	%
Maximum month-end balance during the year	$	40,068		$	35,323
Weighted average interest rate at the end of the year		.37	%		.56	%

Securities sold under agreements to repurchase generally mature within one day to one year from the transaction date. Securities with an amortized cost and fair value of  $34,502,000 and $34,494,000 at December 31, 2010 and $26,910,000 and $27,240,000 at December 31, 2009 were pledged as collateral for these agreements. The securities underlying the agreements were under the Company’s control.

The Bank maintains a U. S. Treasury tax and loan note option account for the deposit of withholding taxes, corporate income taxes and certain other payments to the federal government. Deposits are subject to withdrawal and are evidenced by an open-ended interest-bearing note. Borrowings under this note option account were $199,000 and $197,000 at December 31, 2010 and 2009, respectively.

54

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 8 - BORROWINGS (CONTINUED)

The Company has a line of credit commitment available from the FHLB of Pittsburgh for borrowings of up to $20,000,000 which expires in December 2011. There were no borrowings under this line at December 31, 2010 and 2009. The Company has a line of credit commitment available from Atlantic Central Bankers Bank for $7,000,000 which expires on June 30, 2011.  There were no borrowings under this line of credit at December 31, 2010 and 2009. The Company has a line of credit commitment available which has no expiration date from PNC Bank for $16,000,000. There were no borrowings under this line of credit at December 31, 2010 and December 31, 2009.

Other borrowings consisted of the following at December 31, 2010 and 2009:

	2010		2009
	(In Thousands)
Notes with the FHLB:
Fixed rate note due September 2010 at 3.53%	$	—	$	5,000
Convertible note due January 2011 at 5.24%		3,000		3,000
Convertible note due August 2011 at 2.69%		10,000		10,000
Fixed rate note due September 2011 at 4.06%		5,000		5,000
Convertible note due October 2012 at 4.37%		5,000		5,000
Convertible note due May 2013 at 3.015%		5,000		5,000
Convertible note due January 2017 at 4.71%		10,000		10,000
	$	38,000	$	43,000

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 19 basis points. If the notes are converted, the option allows the Bank to put the funds back to the FHLB at no charge.

Contractual maturities of other borrowings at December 31, 2010 are as follows (in thousands):

2011		18,000
2012		5,000
2013		5,000
2014		—
Thereafter		10,000
	$	38,000

The Bank’s maximum borrowing capacity with the FHLB was $182,707,000 of which $38,000,000 was outstanding at December 31, 2010. Advances from the FHLB are secured by qualifying assets of the Bank.

NOTE 9 - 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 $342,000, $373,000 and $317,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

The Company has a non-qualified supplemental executive retirement plan for the benefit of certain executive officers. At December 31, 2010 and 2009, other liabilities include $1,445,000 and $1,419,000 accrued under the Plan. Compensation expense includes approximately $115,000, $360,000 and $96,000 relating to the

55

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED)

supplemental executive retirement plan for 2010, 2009 and 2008, respectively. To fund the benefits under this plan, the Company is the owner of single premium life insurance policies on participants in the non-qualified retirement plan. At December 31, 2010 and 2009, the cash value of these policies was $8,249,000 and $7,889,000, 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 made 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 was secured by the shares of the stock purchased and was paid off in 2006.

As the debt was repaid, shares were released from collateral and allocated to qualified employees based on the proportion of debt service paid in the year. 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 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 $-0- for the years ended December 31, 2010, 2009 and 2008, respectively. 

The status of the ESOP shares at December 31 are as follows:

	2010		2009
Allocated shares		138,556		158,903
Shares released from allocation		52,353		32,006
Total ESOP shares		190,909		190,909

NOTE 10 - INCOME TAXES

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

	Years Ended December 31,
	2010			2009			2008
	(In Thousands)
Current	$	2,867		$	3,031		$	2,800
Deferred		(205	)		(749	)		36
	$	2,662		$	2,282		$	2,836

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

56

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 10 - INCOME TAXES (CONTINUED)

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,
	2010			2009			2008
Tax at statutory rates		34.0	%		34.0	%		34.0	%
Tax exempt interest income, net of interest expense disallowance		(6.2	)		(5.0	)		(3.9	)
Incentive stock options		0.5			0.4			0.5
Earnings on life insurance		(1.1	)		(4.1	)		(0.7	)
Other		(0.5	)		(0.9	)		(0.1	)
		26.7	%		24.4	%		29.8	%

The income tax provision includes $152,000 and $157,000 of income taxes relating to realized securities gains for the years ended December 31, 2010 and 2009, respectively, and $6,000 of income tax credit relating to realized securities losses for the year ended December 31, 2008.

The net deferred tax asset included in other assets in the accompanying balance sheets includes the following amounts of deferred tax assets and liabilities:

	2010		2009
	(In Thousands)
Deferred tax assets:
Allowance for loan losses	$	1,789	$	1,682
Deferred compensation		491		482
Intangible assets		5		26
Other		191		122
Foreclosed real estate valuation allowance		123		126
Total Deferred Tax Assets		2,599		2,438
Deferred tax liabilities:
Premises and equipment		276		268
Deferred loan fees		225		277
Net unrealized gains on securities		591		1,080
Total Deferred Tax Liabilities		1,092		1,625
Net Deferred Tax Asset	$	1,507	$	813

No valuation was established at December 31, 2010 and 2009, due to the Company’s ability to carry back taxes paid in prior years and anticipated future taxable income as evidenced by the Company’s earnings potential. There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Statement of Income. The Company’s federal and state income tax returns for taxable years through 2006 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue.

57

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 11 - 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, 2010 and 2009 such loans amounted to $3,345,000 and $3,530,000, respectively. During 2010, new loans to such related parties totaled $1,370,000 and repayments and other reductions aggregated $1,555,000.

NOTE 12 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY

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

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, 2010 and 2009, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2010, the most recent notification from the regulators has categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.

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

Actual

For Capital Adequacy Purposes

To Be Well Capitalized under Prompt Corrective Action

Amount

Ratio

Amount

Ratio

Amount

Ratio

As of December 31, 2010:

Total capital (to risk-weighted assets)

$

69,713

19.23

%

$

≥28,995

≥8.00

%

$

≥36,243

≥10.00

%

Tier 1 capital (to risk-weighted assets)

65,027

17.94

≥14,497

≥4.00

≥21,746

≥6.00

Tier 1 capital (to average assets)

65,027

12.14

≥21,432

≥4.00

≥26,790

≥5.00

As of December 31, 2009:

Total capital (to risk-weighted assets)

$

65,197

17.85

%

$

≥29,227

≥8 .00

%

$

≥36,534

≥10.00

%

Tier 1 capital (to risk-weighted assets)

60,469

16.55

≥14,614

≥4.00

≥21,920

≥6.00

Tier 1 capital (to average assets)

60,469

11.53

≥20,974

≥4.00

≥26,217

≥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, 2010 and 2009 was approximately $309,000 and $229,000, respectively.

58

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 12 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY (CONTINUED)

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, 2010, $58,159,000 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 13 - STOCK OPTION PLANS

The Company’s shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the Annual Meeting on April 26, 2006. An aggregate of 250,000 shares of authorized but unissued Common Stock of the Company were reserved for future issuance under the Plan. This includes up to 40,000 shares for awards to outside directors. Under this plan, the Company granted 28,000 options, which included 4,000 options granted to outside directors in 2010, 24,000 options, which included 4,000 options granted to outside directors in 2009 and 24,000 options in 2008 which included 4,000 options granted to outside directors.

Total unrecognized compensation cost related to nonvested options under the Plan was $165,000 as of December 31, 2010, $158,000 as of December 31, 2009 and $130,000 as of December 31, 2008.  Salaries and employee benefits expense includes $162,000, $134,000 and $154,000 of compensation costs related to options for the years ended December 31, 2010, 2009 and 2008, respectively. Net income was reduced by $153,000, $127,000 and $144,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

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

				2010							2009							2008
				Weighted							Weighted							Weighted
				Average		Average					Average		Average					Average		Average
				Exercise		Intrinsic					Exercise		Intrinsic					Exercise		Intrinsic
	Options			Price		Value		Options			Price		Value		Options			Price		Value
Outstanding, beginning of year		170,915		$	28.07				176,443		$	25.78				180,422		$	24.04
Granted		28,000			27.74				27,000			28.60				24,000			27.50
Exercised		(9,276	)		17.68				(32,528	)		15.83				(27,979	)		14.98
Forfeited		—			—				—			—				—			—
Outstanding, end of year		189,639		$	28.52	$	146,361		170,915		$	28.07	$	286,464		176,443		$	25.95	$	273,487
Exercisable, end of year		161,639		$	28.66	$	145,471		146,915			27.98		259,461

Exercise prices for options outstanding as of December 31, 2010 ranged from $16.98 to $31.50 per share. The weighted average remaining contractual life is 6.6 years.

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

	Years Ended December 31,
	2010			2009			2008
Dividend yield		3.04	%		2.89	%		2.79	%
Expected life	7 years			7 years			7 years
Expected volatility		27.18	%		27.39	%		25.08	%
Risk-free interest rate		2.72	%		3.11	%		2.01	%
Weighted average fair value of options granted	$	6.12		$	6.77		$	5.43

59

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 13 - STOCK OPTION PLANS (CONTINUED)

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

Proceeds from stock option exercises totaled $163,000 in 2010. Shares issued in connection with stock options exercises are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. During 2010, all the shares issued in connection with stock option exercises, 9,276 shares in total, were issued from available treasury shares.

As of December 31, 2010, outstanding stock options consist of the following:

	Options Outstanding		Average Exercise Price		Remaining Life, Years		Options Exercisable		Average Exercise Price
		1,575	$	16.98		1.0		1,575	$	16.98
		6,298		19.05		2.0		6,298		19.05
		17,616		23.95		3.0		17,616		23.95
		20,475		30.00		4.0		20,475		30.00
		24,675		30.38		5.3		24,675		30.38
		22,000		31.50		6.0		22,000		31.50
		22,000		31.25		7.0		22,000		31.25
		23,000		27.50		8.0		23,000		27.50
		1,000		28.90		8.3		1,000		28.90
		23,000		28.59		9.0		23,000		28.59
		1,000		26.88		9.2		—		—
		27,000		27.77		10.0		—		—
Total		189,639	$	28.52		6.6		161,639	$	28.66

NOTE 14 - EARNINGS PER SHARE

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

	Years Ended December 31,
	2010		2009		2008
	(In Thousands, Except per Share Data)
Numerator, net income	$	7,313	$	7,063	$	6,677
Denominator:
Denominator for basic earnings per share, weighted average shares		2,762		2,750		2,740
Effect of dilutive securities, employee stock options		4		16		29
Denominator for diluted earnings per share, adjusted weighted average shares and assumed conversions		2,766		2,766		2,769
Basic earnings per common share	$	2.65	$	2.57	$	2.44
Diluted earnings per common share	$	2.64	$	2.55	$	2.41

Stock options which had no intrinsic value because their effect would be anti-dilutive and therefore would not be included in the diluted EPS calculation were 140,150, 109,821 and 89,150 for the years ended December 31, 2010, 2009 and 2008, respectively.

60

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 15 - 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,
	2010		2009
	(In Thousands)
Commitments to grant loans	$	21,448	$	17,713
Unfunded commitments under lines of credit		30,311		36,809
Standby letters of credit		3,605		3,679
	$	55,364	$	58,201

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the customer and generally consists of real estate.

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

NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a 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.

61

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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

Level 1:	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

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

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2010 and 2009 are as follows:

	Fair Value Measurement Reporting Date using
Description	Total		(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Unobservable Inputs
December 31, 2010
Available for Sale:
U.S. Government agencies	$	30,268	$	—	$	30,268	$	—
States and political subdivisions		49,766		—		49,766		—
Corporate obligations		4,249		—		4,249		—
Mortgage-backed securities -
government sponsored entities		60,928		—		60,928		—
Equity securities - financial services		604		604		—		—
Total available for sale	$	145,815	$	604	$	145,211	$	—
December 31, 2009
Available for Sale:
U.S. Government agencies	$	39,772	$	—	$	39,772	$	—
States and political subdivisions		31,635		—		31,635		—
Corporate obligations		5,240		—		5,240		—
Mortgage-backed securities -
government sponsored entities		53,154		—		53,154		—
Equity securities - financial services		776		776		—		—
Total available for sale	$	130,577	$	776	$	129,801	$	—

62

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2010 and 2009 are as follows:

	Fair Value Measurement Reporting Date using
Description	Total		(Level 1) Quoted Prices in Active Markets for Identical Assets		(Level 2) Significant Other Observable Inputs		(Level 3) Significant Unobservable Inputs
December 31, 2010
Impaired Loans	$	13,104	$	—	$	7,038	$	6,066
Foreclosed real estate owned		748		—		748		—
	$	13,852	$	—	$	7,786	$	6,066
December 31, 2009
Impaired Loans	$	7,991	$	—	$	3,797	$	4,194
Foreclosed real estate owned		392		—		392		—
	$	8,383	$	—	$	4,189	$	4,194

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, 2010 and 2009.

Cash and cash equivalents (carried at cost):

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

Securities:

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) are used to support fair values of certain Level 3 investments, if applicable.

Loans receivable (carried at cost):

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

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

Impaired loans (generally carried at fair value):

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

As of December 31, 2010, the fair value investment in impaired loans totaled $13,104,000 which includes three loans for $8.6 million for which a valuation allowance has been provided based on current collateral values and seven loans for $6.1 million which do not require a valuation allowance since the current collateral value exceeds the loan value.  As of December 31, 2010, the Company has recognized charge-offs against the allowance for loan losses on impaired loans in the amount of $700,000 over the life of the loans.

As of December 31, 2009, the fair value investment in impaired loans was $7,991,000 which included two loans for $1.0 million for which a valuation allowance had been provided based on the estimated value of the collateral and five loans for $7.0 million which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of December 31, 2009, the Company had recognized a cumulative charge-off against the allowance for loan losses in the amount of $634,000 on impaired loans.

Mortgage Servicing Rights (generally carried at cost):

The Company utilizes a third party provider to estimate the fair value of certain loan servicing rights. Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation.

Foreclosed real estate owned (carried at fair value):

Real estate properties acquired through, or in lieu of loan foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. These assets are included in Level 2 fair value based upon the lowest level of input that is significant to the fair value measurement.

Restricted investment in Federal Home Loan Bank stock (carried at cost):

The Company, as a member of the Federal Home Loan Bank (FHLB) system is required to maintain an investment in capital stock of its district FHLB according to a predetermined formula. This restricted stock has no quoted market value and is carried at cost.

In December 2008, the FHLB of Pittsburgh notified member banks that it was suspending dividend payments and the repurchase of excess capital stock.  In October, 2010, the FHLB of Pittsburgh repurchased a portion of member bank’s excess stock, but notified member banks that decisions regarding future capital stock repurchases will be made on a quarterly basis.

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to FHLB stock as of December 31, 2010.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

Accrued interest receivable and payable (carried at cost):

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

Deposit liabilities (carried at cost):

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

Short-term borrowings (carried at cost):

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

Other borrowings (carried at cost):

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

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

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

The estimated fair values of the Bank’s financial instruments were as follows at December 31, 2010 and December 31, 2009.

	December 31, 2010				December 31, 2009
	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	$	16,625	$	16,625	$	17,355	$	17,355
Securities		145,985		145,994		131,285		131,299
Loans receivable, net		351,239		358,873		358,021		368,180
Mortgage servicing rights		250		274		179		179
Investment in FHLB stock		3,361		3,361		3,538		3,538
Accrued interest receivable		2,166		2,166		2,200		2,200
Financial liabilities:
Deposits		393,865		395,157		391,473		392,445
Short-term borrowings		33,309		33,309		25,803		25,803
Other borrowings		38,000		40,413		43,000		45,591
Accrued interest payable		1,536		1,536		2,057		2,057
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding letters of credit		—		—		—		—

65

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 17 – PROPOSED ACQUISITION OF NORTH PENN BANCORP, INC.

On December 15, 2010, the Company announced the signing of a definitive merger agreement pursuant to which Norwood Financial Corp would acquire North Penn Bancorp, Inc. in a stock and cash transaction.  The proposed acquisition is an in-market transaction that will expand the Company’s existing footprint in Monroe County, Pennsylvania and extends its footprint into Lackawanna County, Pennsylvania.

North Penn Bancorp, Inc. is the holding company for North Penn Bank, a Pennsylvania savings bank that conducts its business from its main office in Scranton, Pennsylvania and four branch offices, in the northeastern Pennsylvania counties of Lackawanna and Monroe.  As of September 30, 2010, North Penn Bancorp, Inc. had total assets of $164.5 million, total net loans of $119.7 million, total deposits of $136.5 million and total stockholders’ equity of $19.9 million.

Under the terms of the agreement, the Company will acquire all of the outstanding shares of North Penn Bancorp, Inc. for a total purchase price of approximately $27.1 million.  North Penn Bank will be merged into Wayne Bank, with Wayne as the surviving entity.  It is expected that the merger will be consummated in the second quarter of 2011 subject to certain conditions, including regulatory and North Penn stockholder approvals.

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NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

NOTE 18 - NORWOOD FINANCIAL CORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION

BALANCE SHEETS
				December 31,
				2010			2009
				(In Thousands)
ASSETS
Cash on deposit in bank subsidiary				$	346		$	697
Securities available for sale					212			359
Investment in bank subsidiary					66,163			62,571
Other assets					1,812			1,620
				$	68,533		$	65,247
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities				$	835		$	776
Stockholders’ equity					67,698			64,471
				$	68,533		$	65,247
STATEMENTS OF INCOME
	Years Ended December 31,
	2010				2009			2008
	(In Thousands)
Income:
Dividends from bank subsidiary	$	3,120		$	3,005		$	3,990
Other interest income		17			19			25
Net realized gain (loss) on sales of securities		66			(134	)		(62	)
		3,203			2,890			3,953
Expenses		323			176			164
		2,880			2,714			3,789
Income tax benefit		(82	)		(99	)		(68	)
		2,962			2,813			3,857
Equity in undistributed earnings of subsidiary		4,351			4,250			2,820
Net Income	$	7,313		$	7,063		$	6,677
STATEMENTS OF CASH FLOWS
	Years Ended December 31,
		2010			2009			2008
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	7,313		$	7,063		$	6,677
Adjustments to reconcile net income to net cash provided by operating activities:
Undistributed earnings of bank subsidiary		(4,351	)		(4,250	)		(2,820	)
Net (gains) losses on sales of securities		(66	)		134			—
Other, net		(144	)		(300	)		(190	)
Net Cash Provided by Operating Activities		2,752			2,647			3,667
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities		166			22			17
Net Cash Provided by Investing Activities		166			22			17
CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised		163			517			420
Tax benefit of stock options exercised		34			164			134
ESOP purchase of shares from treasury stock		156			166			153
Acquisition of treasury stock		(529	)		(68	)		(1,583	)
Cash dividends paid		(3,093	)		(2,967	)		(2,740	)
Net Cash Used in Financing Activities		(3,269	)		(2,188	)		(3,616	)
Net Increase (Decrease) in Cash and Cash Equivalents		(351	)		481			68
Cash and Cash Equivalents - Beginning		697			216			148
Cash and Cash Equivalents - Ending	$	346		$	697		$	216

67

NORWOOD FINANCIAL CORP - 2010 CONSOLIDATED FINANCIAL REPORT

INVESTOR INFORMATION

STOCK LISTING

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

Boenning & Scattergood, Inc.	Janney Montgomery Scott, LLC
West Conshohocken, PA	Scranton, PA  18503
800-496-1170	800-638-4417
RBC Capital Markets	Stifel Nicolaus
Philadelphia, PA  19103	St. Louis, MO
888-848-4677	314-342-2000

TRANSFER AGENT

IST Shareholder Services, 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 for additional information.

SEC REPORTS AND ADDITIONAL INFORMATION

A copy of the Company’s annual report on Form 10-K for its fiscal year ended December 31, 2010 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 Edward C. Kasper, Executive Vice President and Secretary, Norwood Financial Corp., 717 Main Street, PO Box 269, Honesdale, PA  18431, 570-253-1455.

68

EX-23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors of Norwood Financial Corp.

We consent to the incorporation by reference in Registration Statement os. 333-61487 and 333-134831 on Form S-8 of Norwood Financial Corp. of our report dated March 8, 2011, relating to the consolidated financial statements and the effectiveness of internal control over financial reporting, which appear in the Annual Report toShareholders, which is incorporated in this Annual Report on Form 10-K of Norwood Financial Corp. for the year ended December 31, 2010.

Wexford, Pennsylvania

March 10, 2011

EX-23.2

Consent of Independent Registered Public Accounting Firm

Norwood Financial Corp.

Honesdale, Pennsylvania

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-61487 and 333-134831) of Norwood Finanical Corp. of our report dated March 10, 2009, with respect to the consolidated statements of income, stockholders' equity, and cash flows for the year ended December 31, 2008, which appear in the 2010 Annual Report to Shareholders, which appears in this Annual Report on Form 10-K.

Lancaster, Pennsylvania

March 10, 2011

EX-31

CERTIFICATION

I, Lewis J. Critelli, certify that:

1. I have reviewed this annual report on Form 10-K of Norwood Financial Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(e) and 15d-14(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting  that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  March 10, 2011	By:	/s/ Lewis J. Critelli
		Lewis J. Critelli President and Chief Executive Officer

CERTIFICATION

I, William S. Lance, certify that:

1. I have reviewed this annual report on Form 10-K of Norwood Financial Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(e) and 15d-14(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting  that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  March 10, 2011	By:	/s/ William S. Lance
		William S. Lance Senior Vice President & Chief Financial Officer

EX-32

Exhibit 32

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Norwood Financial Corp. (the Company) on Form 10-K for the year ending December 31, 2010 as filed with the Securities and Exchange Commission on the date hereof (the Report), We, Lewis J. Critelli, President and Chief Executive Officer and William S. Lance, Senior Vice President and Chief Financial Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

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

March 10, 2011