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, 2011

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).  x 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

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 closing price of the registrant’s Common Stock as of June 30, 2011, $26.15 per share, was $80.5 million based on 3,078,792 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.

As of March 1, 2012, there were 3,286,120 shares outstanding 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, 2011. (Parts I, II, and IV)

2.Portions of the definitive Proxy Statement for the 2012 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.	Mine Safety Disclosures	32
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

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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.

• possible future impairment of intangible assets

• 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, 2011, the Company had total assets of $668.8 million, deposits of $525.8 million, and stockholders’ equity of $88.1 million. The Company’s ratio of average equity to average assets was 12.76%, 12.56% and 12.09% for fiscal years 2011, 2010 and 2009, respectively.

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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, five offices in Monroe County and three offices in Lackawanna 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, Monroe and Lackawanna and, to a much lesser extent, Susquehanna County. In addition, the Bank operates 16automated 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.

Acquisition of North Penn Bancorp, Inc.

On May 31, 2011, the Company completed its acquisition of North Penn Bancorp, Inc. (“North Penn”) and its wholly owned subsidiary, North Penn Bank, as contemplated by the Agreement and Plan of Merger, dated as of December 14, 2010, by and among the Company, Wayne Bank, North Penn and North Penn Bank (the “Agreement”). The Company acquired all of the outstanding shares of North Penn for an aggregate cash consideration of approximately $12.2 million and 532,000 shares of the Company’s common stock.  The cash and stock transaction was valued at approximately $26.9 million based on the closing price of the Company’s common stock on May 31, 2011.  In accordance with the Agreement, each outstanding share of North Penn common stock was converted, at the election of the holder, into either the right to receive $19.12 in cash or 0.6829 shares of the Company’s common stock, subject to the election and allocation procedures in the Agreement, including the requirement that $12,194,000 of the merger consideration (which included amounts paid in cancellation of existing stock options, for the unallocated shares held by the Employee Stock Ownership Plan (“ESOP”) and any shares as to which the holders exercised dissenters’ rights) be paid in cash and that the remainder be paid in the Company’s common stock.

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, Monroe and Lackawanna Counties, Pennsylvania. Based on data compiled by the FDIC as of June 30, 2011 (the latest date for which data is available), the Bank had the third largest share of FDIC-insured deposits in Wayne County with approximately 19.8%, third largest share in Pike County with 18.9%, ninth largest share in Monroe County with 3.0% and 10th largest share in Lackawanna County with 2.2%. 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

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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, 2011, the Bank had 140 full-time and 9 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 Bank’s loan 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 the 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, 2011, there were $7.4 million of indirect loans in the portfolio.  In connection with the acquisition of North Penn Bancorp, Inc., the Company acquired approximately $119.7 million in loans, including $36.2 million in residential real estate loans, $70.8 million in commercial real estate loans, $10.5 million in commercial, financial and agricultural loans, $1.8 million in consumer loans and $358,000 in construction loans.

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, 2011, the Bank had approximately $44.8 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

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 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. 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.

Commercial loans and leases are considered to have a higher degree of credit risk than secured real estate lending. The repayment of unsecured commercial business loans is wholly dependent of the success of the borrower’s business, while secured commercial business loans may be secured by collateral that may not be readily marketable in the event of default.

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

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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.

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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,
	2011				2010				2009				2008				2007
	$			%	$			%	$			%	$			%	$			%
	(dollars in thousands)
Commercial  loans	$	22,684		5.0	$	22,386		6.3	$	24,116		6.6	$	25,886		7.4	$	29,159		8.8
Real Estate-construction		11,087		2.4		12,638		3.5		14,405		4.0		14,856		4.2		20,404		6.2
Real Estate-residential and commercial		410,624		89.6		308,656		86.4		310,584		85.3		292,893		83.8		263,481		79.5
Consumer loans		13,934		3.0		13,668		3.8		14,850		4.1		16,087		4.6		18,526		5.5
		458,329		100.0		357,348		100.0		363,955		100.0		349,722		100.0		331,570		100.0
Deferred fees, net		(422	)			(493	)			(481	)			(318	)			(274	)
Allowance for loan losses		(5,458	)			(5,616	)			(5,453	)			(4,233	)			(4,081	)
Loans receivable, net	$	452,449			$	351,239			$	358,021			$	345,171			$	327,215

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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, 2011. 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 loans	$	3,845	$	6,258	$	12,581	$	22,684
Real Estate - Construction		6,141		4,055		891		11,087
Total	$	9,986	$	10,313	$	13,472	$	33,771
Loans with fixed rates	$	6,435	$	9,087	$	8,796	$	24,318
Loans with floating rates		8,558		895		-		9,453
Total	$	14,993	$	9,982	$	8,796	$	33,771

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. The increase in non-accrual loans during 2011 includes $1.9 million of such loans which were acquired from North Penn.  For the year ended December 31, 2011, interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of such loans was $535,000 of which $117,000 was collected.

	As of December 31,
	2011			2010			2009			2008			2007
	(dollars in thousands)
Non-accrual loans:
Commercial	$	404		$	513		$	—		$	—		$	—
Real estate – residential and commercial		7,411			3,527			4,916			2,087			109
Consumer		—			—			—			—			2
Total		7,815			4,040			4,916			2,087			111
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		7,815			4,079			5,015			2,087			163
Foreclosed real estate		2,910			748			392			660			—
Total non-performing assets	$	10,725		$	4,827		$	5,407		$	2,747		$	163
Total non-performing loans to total loans		1.71	%		1.14	%		1.38	%		0.60	%		0.05	%
Total non-performing loans to total assets		1.17	%		0.76	%		0.95	%		0.41	%		0.03	%
Total non-performing assets to total assets		1.60	%		0.90	%		1.02	%		0.54	%		0.03	%

The recorded investment in impaired loans, not requiring an allowance for loan losses was $6,807,000 (net of a charge-off against the allowance for loan losses of $698,000) and $6,111,000 (net of charge-offs against the allowance of $220,000) at December 31, 2011 and 2010, respectively. The

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recorded investment in impaired loans requiring an allowance for loan losses was $6,823,000 (net of charge-off against the allowance for loan losses of $0) and $8,641,000 (net of a charge-off against the allowance of $480,000) at December 31, 2011 and 2010. For the years ended December 31, 2011, 2010 and 2009, the average recorded investment in these impaired loans was $15,783,000, $10,096,000 and $3,585,000 and the interest income recognized on these impaired loans was $561,000, $385,000 and $139,000, respectively. In connection with the North Penn acquisition, the Company acquired loans with deteriorated credit quality with an unpaid balance of $1.9 million, which are being carried at their fair value of $1.3 million.

Potential Problem Loans. As of December 31, 2011, 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,
	2011			2010			2009			2008			2007
	(dollars in thousands)
Total loans receivable net of deferred fees	$	457,907		$	356,855		$	363,474		$	349,404		$	331,296
Average loans receivable	$	414,473		$	355,980		$	356,345		$	335,137		$	323,444
Allowance balance at beginning of period	$	5,616		$	5,453		$	4,233		$	4,081		$	3,828
Charge-offs:
Commercial		(2	)		(85	)		(17	)		(7	)		—
Real Estate – residential and commercial		(1,735	)		(699	)		(358	)		(465	)		(4	)
Consumer		(109	)		(82	)		(139	)		(171	)		(117	)
Total		(1,846	)		(866	)		(514	)		(643	)		(121	)
Recoveries:
Commercial		5			—			11			—			—
Real Estate – residential and commercial		51			2			4			1			2
Consumer		57			27			34			59			54
Leases		—			—			—			—			3
Total		113			29			49			60			59
Net Charge-offs		(1,733	)		(837	)		(465	)		(583	)		(62	)
Provision Expense		1,575			1,000			1,685			735			315
Allowance balance at end of period	$	5,458		$	5,616		$	5,453		$	4,233		$	4,081
Allowance for loan losses as a percent of total loans outstanding		1.19	%		1.57	%		1.50	%		1.21	%		1.23	%
Net loans charged off as a percent of average loans outstanding		0.42	%		0.24	%		0.13	%		0.17	%		0.02	%

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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,
	2011				2010				2009				2008				2007
			% of				% of				% of				% of				% of
			Loans				Loans				Loans				Loans				Loans
			to Total				to Total				to Total				to Total				to Total
	Amount		Loans		Amount		Loans		Amount		Loans		Amount		Loans		Amount		Loans
	(dollars in thousands)
Commercial	$	147	5.0	%	$	171	6.3	%	$	333	6.6	%	$	491	7.4	%	$	413	8.8	%
Real estate – construction		72	2.4			110	3.5			136	4.0			138	4.2			148	6.2
Real estate – residential and commercial		5,095	89.6			5,143	86.4			4,748	85.3			3,315	83.8			2,939	79.5
Consumer		144	3.0			192	3.8			236	4.1			289	4.6			362	5.5
Unallocated		—	—			—	—			—	—			—	—			219	—
Total	$	5,458	100.0	%	$	5,616	100.0	%	$	5,453	100.0	%	$	4,233	100.0	%	$	4,081	100.0	%

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Investment Activities

General. The Company maintains a portfolio of investment securities consisting 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,
	2011		2010		2009
	(dollars in thousands)
Securities: (carrying value)
U.S. Government agencies	$	13,398	$	30,268	$	39,772
State and political subdivisions		56,917		49,936		32,343
Corporate obligations		8,809		4,249		5,240
Mortgage-backed securities – government sponsored entities		70,965		60,928		53,154
Equity securities-financial services		345		604		776
Total Securities	$	150,434	$	145,985	$	131,285
Fair Value of Securities	$	150,440	$	145,994	$	131,299

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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, 2011. 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.”  The average yield on equity securities reflects actual income received during the period.

					After One				After Five								Total Investment
	One Year or Less				Through Five Years				Through Ten Years				After Ten Years				Securities
	Carrying		Average		Carrying		Average		Carrying		Average		Carrying		Average		Carrying		Value
	Value		Yield		Value		Yeild		Value		Yield		Value		Yield		Value		Yield
	(dollars in thousands)
U.S. Government agencies	$	—	—	%	$	13,398	1.86	%	$	—	—	%	$	—	—	%	$	13,398	1.86	%
State and political subdivision		466	5.13	%		3,515	4.43	%		19,223	5.31	%		33,713	5.55	%		56,917	5.40	%
Corporate obligations		1,518	1.23	%		6,157	3.60	%		1,134	4.20	%		—	—	%		8,809	3.27	%
Mortgage-backed securities- government sponsored entities		—	—	%		257	5.14	%		25,166	2.79	%		45,542	3.09	%		70,965	2.99	%
Equity securities-financial services		—	—	%		—	—	%		—	—	%		345	6.74	%		345	6.74	%
Total Investment Securities	$	1,984	2.15	%	$	23,327	2.74	%	$	45,523	3.89	%	$	79,600	4.15	%	$	150,434	3.83	%

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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 sixteen automated teller machines and is affiliated with the MoneyPass ATM network. 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 Deember 31,
	2011				2010				2009
	Average				Average				Average
	Balance		Rate Paid		Balance		Rate Paid		Balance		Rate Paid
	(dollars in thousands)
Non-interest bearing demand	$	69,721	—	%	$	61,966	—	%	$	59,224	—	%
Interest-bearing demand		46,960	0.13			38,150	0.11			35,808	0.10
Money Market		93,974	0.52			69,847	0.76			63,160	1.10
Savings		67,862	0.24			48,588	0.22			44,526	0.35
Time		196,253	1.60			177,761	2.03			174,201	2.80
Total	$	474,770			$	396,312			$	376,919

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, 2011.

	Amount
Maturity Period	(in thousands)
Within three months	$	9,334
Over three through six months		21,798
Over six through twelve months		17,343
Over twelve months		32,079
	$	80,554

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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,
	2011			2010			2009
	(dollars in thousands)
Short term borrowings:
Average balance during the year	$	28,521		$	26,100		$	26,402
Maximum month-end balance during the year	$	32,637		$	40,068		$	35,323
Average interest rate during the year		0.32	%		0.45	%		1.11	%
Total short-term borrowings at end of the year	$	21,794		$	33,309		$	25,803
Weighted average interest rate at the end of the year		0.25	%		0.37	%		0.56	%

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, 2011, the Bank had $107.7 million of assets under management compared to $113.7 million as of December 31, 2010. The decrease is partially due to 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 $140,000, compared to $116,000 in 2010 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, 2011 and 2010, the outstanding balance of foreclosed properties on which WTRO held title totaled $2,000,000 and $448,000, respectively.  The increase is due to the addition of a commercial property located in Luzerne 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 2011 totaled $27,000 and $33,000 in 2010.

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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 are likely to 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, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. 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 eliminated 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.  While the restrictions on interchange fees do not apply to banks that, together with their affiliates, have assets of less than $10 billion, the rule could affect the competitiveness of debit cards issued by smaller banks.

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

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provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination 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

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managing or controlling banks to be a proper incident thereto. These include any incidental activities 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 December 31, 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 nor 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 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 lieu of further special assessments, on November 12, 2009 the FDIC required 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 future assessments, an

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institution would assume 5% annual growth in the assessment base and a three basis point increase in the current assessment rate for 2011 and 2012.  The prepaid assessment would be applied against the actual assessment until exhausted.  Any funds remaining after June 30, 2013 would be returned to the institution.

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 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.

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 are reduced by goodwill and other intangibles.  Average tangible equity equals Tier 1 capital. For institutions with more than $1.0 billion in assets, average tangible equity is 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 ranges 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 may 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 2011.  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, 2011, 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 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.

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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, 2011.

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, 2011, loans-to-one-borrower limitation was $11.4 million and the Bank was in compliance with such limitation.

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.

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

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, 2011, 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 acquisition of North Penn Bancorp, Inc.

On May 31, 2011, we completed the acquisition of North Penn Bancorp, Inc. (“North Penn”) and its wholly owned subsidiary, North Penn Bank, pursuant to which North Penn merged with and into the Company and immediately thereafter, North Penn Bank merged 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 Lackawanna 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.

We hold certain intangible assets that could be classified as impaired in the future. If these assets are considered to be either partially or fully impaired in the future, our earnings would decrease.

At December 31, 2011, we had approximately $10.5 million in goodwill and identifiable intangible assets on our balance sheet. We are required to test our goodwill and identifiable intangible assets for impairment on a periodic basis. The impairment testing process considers a variety of factors, including the current market price of our common stock, the estimated net present value of our assets and liabilities, and information concerning the terminal valuation of similarly situated insured depository institutions. If an impairment determination is made in a future reporting period, our earnings and the book value of these intangible assets will be reduced by the amount of the impairment. If an impairment loss is recorded, it will have little or no impact on the tangible book value of our common stock or our regulatory capital levels, but such an impairment loss could significantly restrict the Bank’s ability to make dividend payments to us.

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

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the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.

As of December 31, 2011, our allowance for loan losses was $5,458,000 which represented 1.19% of outstanding loans. At such date, we had 48 nonperforming loans totaling $7.8 million and 22 impaired loans totaling $13.8 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, 2011, approximately 89.6% of our loans, had real estate as a primary, secondary or tertiary component of collateral. In addition, approximately 47.2% of our securities portfolio consisted of mortgage-backed securities issued by either Fannie Mae, Freddie Mac 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.

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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, 2011, we had approximately $7.6 million in investments, including mortgage-backed securities, on which we had unrealized losses of $59,000.  In addition, we had $3.6 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 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 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

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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:

·   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.

In response to this financial crisis affecting the banking system and financial markets, the United States Congress enacted the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009. Under these and other laws and government actions:

·   the U.S. Department of the Treasury, or “Treasury,” has provided capital to financial institutions and adopted programs to facilitate and finance the purchase of problem assets and finance asset-backed securities via the Troubled Assets Relief Program, or “TARP”;

·   the FDIC provided temporary liquidity guarantee, or “TLG”, of all FDIC-insured institutions and their affiliates’ debt, as well as deposits in noninterest-bearing transaction deposit accounts; and

·   the federal government has undertaken various forms of economic stimulus, including assistance to homeowners in restructuring mortgage payments on qualifying loans.

TARP and the TLG are winding down, and the effects of this wind-down cannot be predicted. In addition, the federal government is considering various proposals for a comprehensive overhauling reform of the financial services industry and markets and coordinating reforms with other countries. There can be no assurance that these various initiatives or any other future legislative or regulatory initiatives will be successful at improving economic conditions globally, nationally or in our markets, or that the measures adopted will not have adverse consequences.

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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.

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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 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, 2011, our lending limit per borrower was approximately $11.4 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.

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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.

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, 2011, our directors and executive officers beneficially owned approximately 279,468 shares, or approximately 8.2% of our common stock, including options to purchase 105,615 shares, in the aggregate, of our common stock at exercise prices ranging from $19.05 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 3,371,866 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 148,846 were issued as of December 31, 2011. As of December 31, 2011, options to purchase a total of 180,914 shares were exercisable and had exercise prices ranging from $19.05 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

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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 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

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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 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 15 additional branch offices. The Bank’s total investment in office property and equipment is $20.1 million with a net book value of $7.5 million as of December 31, 2011. The Bank currently operates automated teller machines at all 16 of its facilities. The Bank leases fiveof its locations with minimum lease commitments of $3.5 million through 2029.  Four 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.

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Item 4.  Mine Safety Disclosures

Not applicable.

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, 2011 (the “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

Not applicable.

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

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materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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 I -- Election of Directors” and “Corporate Governance” in the Proxy Statement for the 2012 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 I -- 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		39,412		$	26.26		—
2006 Stock Option Plan		168,100			29.05		75,300
Equity compensation plans not approved by security holders
1999 Directors Stock Compensation Plan		2,402			20.73		—
TOTAL		209,914		$	28.43		75,300

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 II -- Ratification of Appointment of Independent Registered Public Accounting Firm.”

34

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, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity and cash flows for the years in the three year period ended December 31, 2011, together with the related notes and the independent registered public accounting firm report of S.R. Snodgrass, A.C., independent registered public accounting firm.

2. Schedules omitted as they are not applicable.

3. Exhibits

No.	Description
3(i)	Articles of Incorporation of Norwood Financial Corp.(1)
3(ii)	Bylaws of Norwood Financial Corp. (2)
4.0	Specimen Stock Certificate of Norwood Financial Corp. (1)
10.1†	Employment Agreement with Lewis J. Critelli (2)
10.2†	Change in Control Severance Agreement with William S. Lance (2)
10.3†	Norwood Financial Corp. Stock Option Plan (3)
10.4†	Salary Continuation Agreement between the Bank and William W. Davis, Jr. (3)
10.5†	Salary Continuation Agreement between the Bank and Lewis J. Critelli (3)
10.6†	1999 Directors Stock Compensation Plan (3)
10.7†	Salary Continuation Agreement between the Bank and Joseph A. Kneller (5)
10.8†	Salary Continuation Agreement between the Bank and John H. Sanders (5)
10.9†	2006 Stock Option Plan (6)
10.10†	First and Second Amendments to Salary Continuation Agreement with William W. Davis, Jr. (7)
10.11†	First and Second Amendments to Salary Continuation Agreement with Lewis J. Critelli (7)
10.12†	First and Second Amendments to Salary Continuation Agreement with Joseph A. Kneller (7)
10.13†	First and Second Amendments to Salary Continuation Agreement with John H. Sanders (7)
13	Annual Report to Stockholders for the fiscal year ended December 31, 2011
21	Subsidiaries of Norwood Financial Corp. (see Item 1. Business, General and Subsidiary Activity)
23	Consent of S.R. Snodgrass, A.C.
31	Rule 13a-14(a)/15d-14(a) Certifications of CEO and CFO
32	Certification pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of Sarbanes Oxley Act of 2002
101.INS	XBRL Instance document *
101.SCH	XBRL Schema Document *
101.CAL	XBRL Calculation Linkbase Document *
101.LAB	XBRL Labels Linkbase Document *
101.PRE	XBRL Presentation Linkbase Document *
101.DEF	XBRL Definition Linkbase Document *

35

†	Management contract or compensatory plan arrangement.
*	Submitted as Exhibits 101 to this Form 10-K are documents formatted in XBRL (Extensible Business Reporting Language).  Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.
(1)	Incorporated herein by reference into this document from the Exhibits to Form 10, Registration Statement initially filed with the Commission on April 29, 1996, Registration No.0-28364.
(2)	Incorporated by reference into this document from the identically numbered exhibits to the Registrant’s Form 10-K filed with the Commission on March 15, 2010.
(3)	Incorporated herein by reference 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.
(4)	Incorporated by reference into this document from the Exhibits to Form S-8 filed with the Commission on August 14, 1998, File No. 333-61487.
(5)	Incorporated 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.
(6)	Incorporated by reference to this document from Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-134831) filed with the Commission on June 8, 2006.
(7)	Incorporated herein by reference from the Exhibits to the Registrant’s Current Report on Form 8-K filed April 4, 2006.

36

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 13, 2012	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 13, 2012 on behalf of the Registrant and in the capacities indicated.
/s/ Lewis J. Critelli
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/ Daniel J. O’Neill	/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/ Kevin M. Lamont
Kevin M. Lamont Director	Richard L. Snyder Director
/s/ William S. Lance
William S. Lance Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

EX-13

For the year ended December 31, 2011 net income totaled a record $7,356,000, an increase of $43,000 over the $7,313,000 earned in the prior year as an increase in net interest income offset significant one-time costs related to the acquisition. Earnings per share on a fully diluted basis were $2.39 for 2011, compared to $2.64 in 2010. The decrease in the earnings per share was principally due to one-time merger related costs of approximately $800,000 and the increased number of shares outstanding. The return on average assets for the year was 1.18% with a return on average equity of 9.26%.   consecutive year of increased cash dividends to our stockholders.       Total assets increased $131.8 million in 2011 due primarily to the acquisition of North Penn. Loans receivable grew $101 million from the prior year-end due primarily to the North Penn transaction. While retail lending increased $23.2 million, total commercial loans grew $77.8 million in 2011. We also utilized the Small Business Administration Loan programs to assist a number of our customers. As of December 31, 2011, total non-performing loans were $7,815,000 and represented 1.71% of total loans compared to $4,079,000, or 1.14% as of December 31, 2010.

     Total assets were $668.8 million as of December 31, 2011. Loans receivable totaled $457.9 million as of December 31, 2011, with total deposits of $525.8 million and stockholders’ equity of $88.1 million. The Company’s capital position remains “well-capitalized” in accordance with risk-based capital guidelines established by bank regulators. With our continued strong capital position, we declared cash dividends of $1.17 in 2011 compared to $1.13 in 2010. This marks the twentieth The increase was due in part to loans acquired from North Penn. We also saw an increase in charge-offs in 2011 due primarily to one credit which had been carried in non-accrual status and has since been transferred to Foreclosed Real Estate. Our market area is still feeling the impact of lower real estate values and high unemployment. We are working diligently to resolve our problem credits. Based on the increase in charge-offs, the Company determined that it would be appropriate

1

          to provide $1,575,000 for potential future losses for the year compared to $1,000,000 for the year 2010. As of December 31, 2011, the allowance for loan losses totaled $5,458,000 and 1.19% of total loans.      For the year, net interest income (fte) totaled $23,764,000, an increase of $3,102,000 or 15% over 2010. The net interest margin (fte) improved 4 basis points to 4.08% in 2011. Other income for the year totaled $4,735,000 compared to $4,064,000 in 2010, an increase of $671,000. Gains on the sale of investment securities increased $525,000 while earnings on bank owned life insurance policies improved $72,000 in 2011 compared to 2010. The 2011 period includes $271,000 in gains and servicing rights on the sale of $8.7 million of mortgage loans compared to $307,000 in similar gains on sales of $12.4 million of mortgage loans and servicing rights in the 2010 period. For the year ended December 31, 2011, other expense totaled $15,813,000 compared to $12,753,000 for the similar period in 2010, an increase of $3,060,000. Employment and occupancy costs rose $1,618,000 over the 2010 total due primarily to locations and staff added from the acquisition. One-time merger related costs approximated $800,000 and are included primarily in professional fees. Foreclosed real estate expenses also increased $537,000 in 2011 as several properties were acquired through foreclosures, resulting in valuation adjustments, payment of delinquent real estate taxes and on-going maintenance.      We encourage you to read the Financial Section of this report for a more detailed analysis of our performance.      The year 2011 holds much significance in the history of Norwood Financial Corp as we completed our merger and acquisition of North Penn Bank which was headquartered in Scranton, PA. The merger increased the Bank’s footprint adding three Community Offices in Lackawanna County and expanding our Monroe County presence. Most importantly, we added to our staff community bankers that are knowledgeable, know their customers, and are an asset to the Bank. We now operate sixteen Community Offices in four counties.

2

    The addition of Lackawanna County to the Bank’s footprint provides the Bank with the opportunity to increase our customer base, both for individuals and small business accounts. There is potential for growth since this is a new market for the Bank.  According to the U.S. Census Bureau the population of the county as of 2010 was 214,437 comprising approximately 86,000 households and home ownership as of 2009 of 66.1% which is a large market for the Bank to offer our competitive products to a new audience.     The Central Scranton office is on Adams Avenue across the street from the Lackawanna County Courthouse. It is conveniently located in the downtown business district and is easily accessible on foot or by car. This is a full-service location offering both consumer and commercial lenders on-site. Our Wealth Management and Trust Services Division also has an office in the Central Scranton facility.     In addition to the Central Scranton location, there is a Community Office in West Scranton which is located on Main Avenue as well as a Community Office in the Abington area, (Clarks Summit). Both of these Community Offices are located within business districts in their respective communities that consists of restaurants, real estate offices, law firms and a variety of small businesses which should provide opportunities for the Bank.     In Monroe County, the two offices that were added as a result of the merger are the Stroudsburg Community Office on Ninth Street and the Effort Office which is located in the western end of the county. The Effort Community Office is the newest branch location, constructed in 2006. The interior boasts a beautiful fireplace, columns surrounding a flat screen television and a bank lobby with an open floor plan. According to the 2009 U.S. Census Bureau’s statistics, Monroe County has experienced considerable population growth of 22.5% in the last 10 years. We anticipate additional growth as we build and expand our relationships in Monroe County.     The Bank has one of the top market shares in the combined areas of Wayne, Pike and Monroe Counties.  The five Community Offices  

3

in Wayne County, and the three offices in Pike County together with the three offices in Monroe County have made significant contributions to the Bank by increasing their customer base, adding to the bank’s loan volume and selling ancillary products for both consumers and businesses alike.  These Community Offices with their capable managers have established Wayne Bank as a strong community bank and a leader in the financial services industry. online. Customer response has been terrific and the Bank and its depositors should enjoy greater efficiencies, faster service and increased security due to the elimination of traditional paper statement delivery methods. Wayne Bank now offers its eCorp online banking tool which can be customized to meet the needs of more complex business enterprises. The Direct Link online banking system now includes the benefits of “CheckFree”, the nation’s leading

    In addition to the merger, Wayne Bank upgraded its operational systems to a new data processing services provider which affected virtually every record keeping process in the bank. We utilize systems provided by Fiserv which is a global leader in the financial services processing industry. This was a major and complex project in which our employees took ownership by learning the various new systems for their respective areas. The new technology was fully integrated first by Wayne Bank in May and then launched to the newly acquired Community Offices of the former North Penn Bank in August.   bill pay service provider. Our plans for 2012 also include mobile banking for even more customer convenience. We also plan to implement a new loan documentation platform which will enhance the turn-around time to finalize new loans for commercial and retail borrowers. The objective of all our investments in technology is to make it easier for customers to use Wayne Bank’s products and services.      During 2011 we welcomed Kevin Lamont to our Board of Directors. Kevin was Chairman of the former North Penn Bank. We truly appreciate his business insight and guidance.      A number of Bank Executives were promoted during the year:

     The upgraded system enabled Wayne Bank to introduce eStatements, which allows for delivery of checking and/or savings account statements William S. Lance to Executive Vice President, Chief Financial Officer and Secretary of Wayne Bank and Norwood Financial

4

5

Corp.  Bill joined Wayne Bank in March of 2010 and has over 30 years of financial banking experience; John Carmody to Senior Vice President and Senior Loan Officer and Executive of the Corporate Bank. John started with Wayne Bank in January 1996 and has held a variety of positions. Other promotions throughout the year include Vonnie A. Lewis to Community Office Manager of the Lakewood branch and Jill Hessling to Community Office Manager of the Waymart branch. will provide improved net interest income, while the new markets in Lackawanna County and Western Monroe County provide opportunities for expansion of our franchise.  We are pleased with our results in 2011, which included significant one-time costs related to our acquisition and expenses incurred to upgrade all of our information systems. As we continue to move through the current economic downturn, we will remain diligent in controlling and minimizing credit related

   During the past year we hired a number of new employees: Brian Mahlstedt was hired as a Senior Vice President of Commercial Lending and is located in the Central Scranton office. Richard Siarniak was hired as a Trust Associate and Vice President of the Wealth Management and Trust Services Division. Crystal Tompkins was hired as Community Office Manager of the West Scranton office. Maurice Dennis was hired as a Credit Analyst in the Commercial Lending Division and is based in Honesdale.        We had a number of employees attain milestones in their careers: Laurie Bishop, the Assistant Community Office Manager in the Hawley office attained 35 years of service which is outstanding! Three employees attained 25 years of service:   costs brought on us due to a fragile economy. Our core earnings have been strengthened, our net interest margin has improved, and our capital base continues to exceed peer and “well-capitalized” targets. We believe that we are well-positioned to take advantage of the opportunities available to us, and we look forward to serving our growing customer base as the economy rebounds from the recent difficulties.        Wayne Bank is proud to continue its 140 year tradition of being a symbol of strength, safety and security for the communities, customers and stockholders we serve. Please consider us for all you financial needs. We truly appreciate your support.

Ed Kasper, Toni Stenger and Myrna Draghi. Three employees attained 15 years of service: John Carmody, Jill Hessling and Jennifer Jaycox. In addition, five employees achieved ten years of service, and eight employees attained five years of service.        With our acquisition of North Penn now complete, we can look forward to the benefits which we expect to derive from the transaction. A solid loan base funded with core deposits               Lewis J. Critelli President and Chief Executive Officer

6

7

8

2011 CONSOLIDATED FINANCIAL REPORT
Management's Discussion & Analysis	10
Management's Report On Internal Control   Over Financial Reporting	29
Reports Of Independent Registered Public Accounting Firm	30
Consolidated Balance Sheets	32
Consolidated Statements Of Income	33
Consolidated Statements Of Stockholders' Equity	34
Consolidated Statements Of Cash Flows	35
Notes To Consolidated Financial Statements	37
Investor Information	74




9

NORWOOD FINANCIAL CORP - 2011 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, 2011 and 2010 and for the years ended December 31, 2011, 2010, and 2009. 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 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, the determination of goodwill impairment and the fair value of financial instruments. Please refer to the discussion of the allowance for loan losses calculation under “Non-performing Assets and Allowance for Loan Losses” in the “Financial Condition” section.

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

In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost and 2) the financial condition of the issuer. The Company does not have the intent to sell these securities and it is more likely than not that it will not sell the securities before recovery of their cost basis. The Company believes that the unrealized losses at December 31, 2011 and 2010 represent temporary impairment of the securities.

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

10

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

RESULTS OF OPERATIONS – SUMMARY

Net income for the Company for the year ended December 31, 2011 totaled $7,356,000, an increase of $43,000 over the $7,313,000 earned in 2010.  Basic and diluted earnings per share were $2.39 in 2011, decreasing from $2.65 basic and $2.64 diluted in 2010.  The return on average assets (ROA) for the year ended December 31, 2011 was 1.18% with a return on average equity (ROE) of 9.26% compared to an ROA of 1.37% and an ROE of 10.87% in the prior year.  The relatively flat earnings are due to significant one-time costs resulting from the acquisition of North Penn Bancorp, Inc. during 2011.  See Note 15 to the Consolidated Financial Statements for a more detailed analysis of the acquisition.  Net interest income on a fully taxable equivalent basis (fte) increased $3,102,000 in 2011 which offset the $3,060,000 increase in operating expenses.

Net interest income on a fully taxable equivalent basis (fte) totaled $23,764,000 in 2011, an increase of $3,102,000, or 15%, over 2010.  Average loans outstanding increased $58.5 million due primarily to loans acquired from North Penn and added $3,359,000 of interest income due to growth.  The net interest margin improved 4 basis points in 2011 to 4.08% as a 39 basis point reduction in the cost of funds exceeded the 25 basis point reduction on the yield earned.  The reduction in the cost of funds was due to the continued low interest rate environment and the downward repricing on deposits and borrowed funds, most notably certificates of deposit which mature and reinvest at current market rates.

Loans receivable increased $101 million in 2011 due primarily to the North Penn transaction.  Total commercial loans, primarily real estate related, grew $77.8 million while retail loans increased $23.2 million during the year. The low interest rate environment in place during the year led to sales of residential mortgage loans for purposes of interest rate risk management, and the Company sold $8.7 million of fixed rate loans.  As a result of the continued slow down in the local economy, the Company experienced an increase in non-performing loans from the $4,079,000 reported in 2010 to $7,815,000 as of December 31, 2011, which includes $1.9 million of loans acquired from North Penn.  As of year-end, non-performing loans represented 1.71% of total loans compared to 1.14% at December 31, 2010.  Net charge-offs totaled $1,733,000 in 2011, increasing from $837,000 in the prior year.  The increase was due primarily to one loan which had been carried in non-accrual status and has since been transferred to Foreclosed Real Estate.  Based on the increase in charge-offs and non-performing loans, the Company determined that it would be appropriate to allocate $1,575,000 to the allowance for loan losses for potential future losses.  As of December 31, 2011, the allowance for loan losses totaled $5,458,000 and 1.19% of total loans decreasing from $5,616,000 and 1.57% of total loans at December 31, 2010.  The decrease in the ratio of the allowance to total loans is a result of the accounting treatment for mergers whereby the loans are acquired at fair value and the sellers' allowance is eliminated.

Other income totaled $4,735,000 in 2011 compared to $4,064,000 in 2010.  Gains on the sale of investment securities increased $525,000 as the low rate environment created opportunities to reposition the portfolio.  Net gains of $973,000 on sales of $31.2 million of investment securities were recorded in 2011 compared to gains of $448,000 on sales of $23.5 million in 2010.  Earnings on bank owned life insurance policies improved $72,000

11

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

compared to 2010 due to the additional policies acquired in the North Penn transaction.  The 2011 period also includes $271,000 of gains on sales of $8.7 million of mortgage loans and servicing rights compared to $307,000 of net gains in 2010 on sales of $12.4 million of mortgage loans and servicing rights.

Other expenses were $15,813,000 in 2011 compared to $12,753,000 for 2010.  The majority of the increased costs recognized in 2011 were merger related, whether one-time costs for investment bankers, attorneys or consultants, or staffing and occupancy costs necessary to operate the five branch offices that were added in the acquisition.  Foreclosed real estate costs also increased $537,000 in 2011 as several properties were acquired through foreclosure, resulting in write-downs on the properties of $177,000 and other costs such as real estate taxes and maintenance of $400,000.  Additionally, the Company upgraded all of its information systems which led to increased costs in 2011.  Income tax expense for the year 2011 totaled $2,579,000 for an effective tax rate of 26.0% compared to $2,662,000 and 26.7% in the prior year due to an increased level of tax exempt income on loans, investments and bank owned life insurance policies.

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

Net income 2010	$	7,313
Net interest income		2,924
Provision for loan losses		(575	)
Net gains on sale of securities		525
Other income		146
Salaries and employee benefits		(1,341	)
Occupancy, furniture and equipment		(277	)
Foreclosed real estate owned		(537	)
Professional fees		(633	)
Other expenses		(272	)
Income tax expense		83
Net income for 2011	$	7,356

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 in 2009.  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

12

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

from 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

13

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

FINANCIAL CONDITION

TOTAL ASSETS

Total assets as of December 31, 2011, were $668.8 million compared to $537.0 million as of year-end 2010, an increase of $131.8 million or 24.5%. The increase in assets was primarily the result of the Company’s acquisition of North Penn Bancorp, Inc. on May 31, 2011.  See Note 15 to the Consolidated Financial Statements for a more detailed description of the acquisition.

LOANS RECEIVABLE

As of December 31, 2011, loans receivable totaled $457.9 million compared to $356.9 million as of year-end 2010, an increase of $101.0 million. Loan growth, principally due to the acquisition, was centered in commercial real estate loans and residential real estate loans.

Residential real estate loans, which includes home equity lending, totaled $148.1 million as of December 31, 2011, compared to $124.6 million as of year-end 2010, an increase of $23.5 million.  The growth includes $31.8 million of loans acquired from North Penn. Residential mortgage refinancing activity continued in 2011 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 $8.7 million of long term fixed rate loans sold into the secondary market during 2011.  In the current low interest rate environment, the Company expects to continue selling mortgage loans in 2012. The Company experienced a slow down and net decrease in home equity lending in 2011 exclusive of the $3.0 million increase due to the acquisition. 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 $262.5 million as of December 31, 2011, increasing from $184.1 million as of December 31, 2010.  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. The growth in commercial real estate lending in 2011 includes $67.8 million of loans acquired from North Penn located principally within the Bank’s primary market area. Commercial loans consisting principally of lines of credit and term loans secured by equipment or other assets increased $300,000 to $22.7 million as of December 31, 2011, but includes $5.4 million that was acquired from North Penn.

The Company’s indirect lending portfolio (included in consumer loans to individuals) declined $162,000 to $7.4 million as of December 31, 2011.  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 $5,458,000 as of December 31, 2011 and represented 1.19% of total loans receivable compared to $5,616,000 and 1.57% of total loans as of year-end 2010. Net charge-offs for 2011 totaled $1,733,000 and represented .42% of average loans compared to $837,000 and .24% of average loans in 2010.

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

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

condition is such that collection of interest is doubtful. Commercial and real estate related loans are generally placed on non-accrual when interest is 90 days delinquent. When loans are placed on non-accrual, accrued interest is reversed from current earnings.

As of December 31, 2011, non-performing loans totaled $7,815,000 and represented 1.71% of total loans compared to $4,079,000 or 1.14% as of December 31, 2010. Based on the level of non-performing loans, high unemployment, a soft real estate market and a slow economy, the Company added $1,575,000 to the allowance for loan losses for the year ended December 31, 2011 compared to $1,000,000 in 2010.

Foreclosed real estate owned totaled $2,910,000 as of December 31, 2011 and $748,000 as of December 31, 2010. The increase is principally due to the addition of a commercial property located in Luzerne County which is carried at $2,000,000 as of December 31, 2011.

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.  For loans acquired, including those that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts.

The Company has limited exposure to higher-risk loans. There are no option ARM products, interest only loans, sub-prime loans or loans with initial teaser rates in its residential real estate portfolio. The Company has $14.1 million of junior lien home equity loans. For 2011 net charge-offs for this portfolio totaled $80,000.

As of December 31, 2011, the Company considered its concentration of credit risk profile to be acceptable. The two highest concentrations are in the hospitality lodging industry and builders/contractors. In 2011, the Company recorded a charge-off of $948,000 on one motel loan that was considered impaired and subsequently obtained possession of the property and transferred the loan to Foreclosed Real Estate.

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

At December 31, 2011, the recorded investment in impaired loans, not requiring an allowance for loan losses was $6,807,000 (net of charge-offs against the allowance for loan losses of $698,000) and those impaired loans requiring an allowance totaled $6,823,000 (net of a charge-off against the allowance for loan losses of $0). The recorded investment in impaired loans not requiring an allowance for loan losses was $6,111,000 (net of $220,000) and $8,641,000 (net of $480,000) requiring an allowance for loan losses as of December 31, 2010.

As a result of its analysis, after applying these factors, management considers the allowance as of December 31, 2011, adequate. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses that might be incurred in the future.

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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)
	2011			2010			2009			2008			2007
Allowance balance at beginning of period	$	5,616		$	5,453		$	4,233		$	4,081		$	3,828
Charge-offs:
Commercial		(2	)		(85	)		(17	)		(7	)		—
Real Estate – residential and commercial		(1,735	)		(699	)		(358	)		(465	)		(4	)
Consumer		(109	)		(82	)		(139	)		(171	)		(117	)
Total		(1,846	)		(866	)		(514	)		(643	)		(121	)
Recoveries:
Commercial		5			—			11			—			—
Real Estate – residential and commercial		51			2			4			1			2
Consumer		57			27			34			59			54
Lease Financing		—			—			—			—			3
Total		113			29			49			60			59
Provision expense		1,575			1,000			1,685			735			315
Allowance balance at end of period	$	5,458		$	5,616		$	5,453		$	4,233		$	4,081
Allowance for loan losses as a percent
of total loans outstanding		1.19	%		1.57	%		1.50	%		1.21	%		1.23	%
Net loans charged off as a percent of   average loans outstanding		.42	%		.24	%		.13	%		.17	%		.02	%
Allowance coverage of non-performing loans		.7	x		1.4	x		1.1	x		2.0	x		25.0	x

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

	December 31,
	(dollars in thousands)
	2011			2010			2009			2008			2007
Non-accrual loans:
Commercial	$	404		$	513		$	—		$	—		$	—
Real estate – residential and commercial		7,411			3,527			4,916			2,087			109
Consumer		—			—			—			—			2
Total		7,815			4,040			4,916			2,087			111
Accruing loans which are contractually past due 90 days or more		—			39			99			—			52
Total non-performing loans		7,815			4,079			5,015			2,087			163
Foreclosed real estate		2,910			748			392			660			—
Total non-performing assets	$	10,725		$	4,827		$	5,407		$	2,747		$	163
Non-performing loans to total loans		1.71	%		1.14	%		1.38	%		.60	%		.05	%
Non-performing loans to total assets		1.17	%		.76	%		.95	%		.41	%		.03	%
Non-performing assets to total assets		1.60	%		.90	%		1.02	%		.54	%		.03	%

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

SECURITIES

The securities portfolio consists of issues of United States Government agencies, including mortgage-backed securities, municipal obligations, and corporate debt. The Company classifies its investments into two categories: held to maturity (HTM) and available for sale (AFS). The Company does not have trading securities. Securities classified as HTM are those in which the Company has the ability and the intent to hold the security until contractual maturity. As of December 31, 2011, the HTM portfolio totaled $171,000 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 Consolidated Balance Sheet as other comprehensive income. As of December 31, 2011, $150.3 million of securities were so classified and carried at their fair value, with unrealized appreciation, net of tax, of $3,315,000 included in accumulated other comprehensive income as a component of stockholder's equity.

As of December 31, 2011, the average life of the portfolio was 3.9 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 2011, 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.  The Company’s mortgage-backed securities holdings were also increased to generate a cash flow ladder of available liquidity.  Purchases for the year totaled $54.1 million with securities called, maturities and cash flow of $34.8 million and proceeds from sales of $32.1 million. The purchases were funded principally by cash flow generated from the portfolio.

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

	2011					2010
	(dollars in thousands)
	Carrying Value		% of portfolio			Carrying Value		% of portfolio
U.S. Government agencies	$	13,398		8.9	%	$	30,268		20.7	%
States and political subdivisions		56,917		37.8	%		49,936		34.2	%
Corporate obligations		8,809		5.9	%		4,249		2.9	%
Mortgage-backed securities -
government sponsored entities		70,965		47.2	%		60,928		41.8	%
Equity securities - financial services		345		0.2	%		604		0.4	%
Total	$	150,434		100.0	%	$	145,985		100.0	%

The portfolio had $5.1 million of adjustable rate instruments, which includes adjustable rate mortgage backed securities and corporate securities as of December 31, 2011 compared to $8.0 million at year end 2010. 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, 2011, the portfolio included $1.0 million of step-up bonds.  The mortgage backed securities include pass-through bonds and collateralized mortgage obligations with Fannie Mae, Freddie Mac and Government National Mortgage Association (GNMA). The Company has no exposure to common or preferred stock of Fannie Mae or Freddie Mac.

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, 2011 the Company held nine investment securities which had a combined unrealized loss of $56,000.

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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.  As of December 31, 2011, the Company held two equity securities which had a combined unrealized loss of $3,000.  No impairment charges have been recognized in 2011.

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

Approximately $150.3 million, which represents 22.5% of total assets at December 31, 2011,  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, 2011 and 2010.

The Company utilizes a third party provider to perform valuations of the investments. Methods used to perform the valuations include:  pricing models that vary based on asset class, available trade and bid information, actual transacted prices, and proprietary models for valuations of state and municipal obligations.

In addition, the Company has a sample of fixed-income securities valued by another independent source. The Company does not adjust values received from its providers, unless it is evident that fair value measurement is not consistent with the Company's policies.

The Company also utilizes a third party provider to provide the fair value of certain loan servicing rights.  Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation.  The fair value of mortgage servicing rights as of December 31, 2011 and 2010 was $308,000 and $274,000, respectively.

DEPOSITS

The Company, through the sixteen 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, 2011, totaled $525.8 million increasing $131.9 million from $393.9 million as of year-end 2010. The increase was principally due to growth from the acquisition.

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 $80.6 million as of December 31, 2011, compared to $60.0 million at year-end 2010. The increase was principally due to deposits acquired from North Penn and a higher 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, 2011, non-interest bearing demand deposits totaled $72.0 million compared to $62.2 million at year-end 2010. The increase is partially attributable to deposits acquired from North Penn. Cash management accounts in the form of securities sold under agreements to repurchase included in short-term

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

borrowings, totaled $21.8 million at year end 2011 compared to $33.1 million as of December 31, 2010. 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, 2011, 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 (12.0%) was outside the policy limit in a 200 basis point declining scenario.  The Company feels that the risk is minimal.

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, 2011, the Bank had a positive 90 day interest sensitivity gap of $76.7 million or 11.5% 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 2011 and 2010 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 - 2011 CONSOLIDATED FINANCIAL REPORT

The following table displays interest-sensitivity as of December 31, 2011 (in thousands):

	3 Months of Less			3-12 Months			1-3 Years			Over 3 Years			Total
Federal funds sold and
interest-bearing deposits	$	12,449		$	—		$	—		$	—		$	12,449
Securities		10,668			32,181			45,452			62,133			150,434
Loans Receivable		121,444			98,518			141,502			96,443			457,907
Total Rate Sensitive Assets (RSA)		144,561			130,699			186,954			158,576			620,790
Non-maturity interest-bearing deposits		37,032			41,755			110,856			42,391			232,034
Time Deposits		25,680			98,139			68,129			29,826			221,774
Borrowings		5,104			12,155			14,535			17,670			49,464
Total Rate Sensitive Liabilities (RSL)		67,816			152,049			193,520			89,887			503,272
Interest sensitivity gap	$	76,745		$	(21,350	)	$	(6,566	)	$	68,689		$	117,518
Cumulative gap		76,745			53,395			48,829			117,510
RSA/RSL-cumulative		213.2	%		125.2	%		111.8	%		125.3	%
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	%

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, 2011, the Company had cash and cash equivalents of $21.4 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 $150.3 million, which could be used for liquidity needs. This totals $171.7 million and represents 25.7% of total assets compared to $162.4 million and 30.2% of total assets as of December 31, 2010. The Company also monitors other liquidity measures, all of which were within the Company’s policy guidelines as of December 31, 2011. 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, 2011 and December 31, 2010. The maximum borrowing capacity from FHLB was $222.7 million. As of December 31, 2011, the Company had $27.7 million in term borrowings from the FHLB, compared to $38.0 million at December 31, 2010.

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NORWOOD FINANCIAL CORP - 2011 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, 2011 totaled $84.2 million. They consisted of $43.1 million of unfunded residential and commercial real estate, construction and land developments loans, $16.7 million in unused home equity lines of credit, $11.9 million in standby letters of credit and $12.5 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, 2011
	Total		Less than 1 year		1-3 years		4-5 years		Over 5 years
Time deposits	$	221,774	$	123,805	$	68,128	$	29,841	$	—
Long-term debt		27,760		5,000		5,000		7,670		10,000
Operating leases		3,504		312		620		536		2,036
	$	252,948	$	129,117	$	73,748	$	38,047	$	12,036

RESULTS OF OPERATIONS

NET INTEREST INCOME

Net interest income is the most significant source of revenue for the Company and represented 82.7% of total revenue for the year ended December 31, 2011.  Net interest income (fte) totaled $23,764,000 for the year ended December 31, 2011 compared to $20,662,000 for 2010, an increase of $3,102,000 or 15%.  The resulting fte net interest spread and net interest margin were 3.86% and 4.08% respectively in 2011 compared to 3.72% and 4.04%, respectively in 2010.

Interest income (fte) for the year ended December 31, 2011 totaled $28,946,000 compared to $26,685,000 in 2010.  The fte yield on average earning assets was 4.97%, decreasing 25 basis points from the 5.22% reported last year.  The continued low interest rate environment impacted the yield earned as new growth was added at historically low rates.  This most notably affected taxable securities which earned 2.61% in 2011 compared to 3.12% in 2010 as cash flow from the portfolio was reinvested at the lower rates.  Loan yields were also impacted by growth at lower than historical rates and earned 5.67% in 2011 compared to 5.98% in the prior year.  A $3.8 million increase in average interest bearing deposits with banks which yielded .26% in 2011 also contributed to the reduced yield.  The reduced yield was offset by a $71.5 million increase in average earning assets, resulting in the $2,261,000 increase in interest income (fte).

Interest expense was $5,182,000 in 2011 which resulted in an average cost of interest bearing liabilities of 1.11% compared to total interest expenses of $6,023,000 in 2010 with an average cost of 1.50%.  The continued low rate environment also impacted rates paid on deposits as the Company reduced rates paid on money market,

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

time and cash management accounts to market levels.  Total interest bearing deposits cost .95% in 2011 which was 33 basis points lower than the 1.28% cost in the prior year due primarily to a 43 basis point reduction in time deposits as certificates repriced to current market rates upon maturity and new growth was added at the reduced levels.  Short term borrowings (including cash management accounts) and long term debt also repriced downward in 2011.

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 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 (fte) totaled $20,662,000 in 2010 which was $790,000, or 4.0%, higher than the $19,872,000 recorded in the prior year.  The resulting fte net interest spread and margin were 3.72% and 4.04%, respectively, in 2010 compared to 3.60% and 4.03%, respectively in 2009.

OTHER INCOME

Other income totaled $4,735,000 for the year ended December 31, 2011 compared to $4,064,000 in 2010, an increase of $671,000 or 16.5%.  Net gains on the sales of securities provided $525,000 of the increase as the Company took advantage of opportunities in the credit markets to reposition the portfolio.  Earnings on bank owned life insurance policies increased $72,000 due to policies acquired from North Penn.

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

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

Other Income (dollars in thousands) For the year-ended December 31
	2011		2010		2009
Service charges on deposit accounts	$	159	$	151	$	165
ATM Fees		236		288		273
NSF Fees		996		1,058		1,281
Gain on sale of deposits		—		—		150
Safe deposit box rental		57		53		52
Loan related service fees		386		292		390
Debit card		474		413		373
Fiduciary activities		409		405		354
Commissions on mutual funds & annuities		140		116		112
Gain on sales of mortgage loans and servicing rights		271		307		481
Earnings on and proceeds from bank-owned life insurance		463		391		1,196
Other income		171		142		102
		3,762		3,616		4,929
Net realized gains on sales of securities		973		448		463
Total	$	4,735	$	4,064	$	5,392

OTHER EXPENSES

Other expenses totaled $15,813,000 for the year ended December 31, 2011 compared to $12,753,000 in 2010.  The $3,060,000, or 24.0%, increase in costs in 2011 includes approximately $800,000 of one-time merger related costs incurred pertaining to the North Penn acquisition, as well as over $600,000 of operating expenses related to the five new offices acquired in the transaction.  The majority of the one-time costs are included in professional fees while branch operating costs are included in employment and occupancy expenses.  Data processing costs increased $52,000 due partially to a system conversion completed in 2011, while foreclosed real estate costs increased $537,000 over the prior year as several properties were acquired through foreclosure, resulting in write-downs and other costs related to the properties.  The Company’s efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 55.5% in 2011 compared to 51.6% in 2010, reflecting the increased costs related to the acquisition.

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 the prior year, while professional fees increased $239,000 due primarily to merger related expenses incurred in connection with the 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.

INCOME TAXES

Income tax expense for the year ended December 31, 2011 was $2,579,000 for an effective tax rate of 26.0% compared to an expense of $2,662,000 and an effective tax rate of 26.7% in 2010.  The reduced rate reflects the increase in tax-exempt income earned in 2011 from loans, investment securities and bank owned life insurance.

23

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

Income tax expense for the year ended December 31, 2010 totaled $2,662,000 which resulted 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%.

CAPITAL AND DIVIDENDS

Total stockholders’ equity as of December 31, 2011, was $88.1 million, compared to $67.7 million as of year-end 2010. As a result of the North Penn acquisition, the Company added 530,994 shares of stock and $14.7 million of new capital.  The remaining increase was due primarily to retention of earnings of $3,660,000 after cash dividends declared of $3,696,000. Accumulated other comprehensive income increased $2,178,000 in 2011 due to a reduction in overall interest rates and the impact on fixed rate securities.  As of  December 31, 2011 the Company had a leverage capital ratio of 11.29%, Tier 1 risk-based capital of 15.86% and total risk-based capital of 17.04% compared to, 12.41%, 18.44% and 19.74%, respectively, in 2010. The reduced ratios reflect the impact of the acquisition.  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, 2011, there were approximately 1,700 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 2011
First Quarter	$	27.96	$	26.25		$	.29
Second Quarter		28.10		26.15			.29
Third Quarter		27.00		24.02			.29
Fourth Quarter		27.50		23.30			.30
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

The book value of the common stock was $26.81 as of December 31, 2011 compared to $24.45 as of December 31, 2010. As of year-end 2011, the stock price was $27.47, compared to $27.77 as of December 31, 2010.

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.

24

NORWOOD FINANCIAL CORP - 2011 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, 2006 and the reinvestment of dividends paid. The graph provides comparison at December 31, 2006 and each fiscal year through December 31, 2011.

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.

25

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP

SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

(Dollars in thousands, except per share amounts)

2011
	December 31		September 30		June 30		March 31
Interest income	$	7,470	$	7,655	$	6,619	$	6,026
Interest expense		1,244		1,392		1,301		1,245
Net interest income		6,226		6,263		5,318		4,781
Provision for loan losses		500		425		430		220
Other income		823		962		981		996
Net realized gains on sales of securities		205		544		12		212
Other expense		3,989		4,354		3,936		3,534
Income before income taxes		2,765		2,990		1,945		2,235
Income tax expense		768		775		461		575
NET INCOME	$	1,997	$	2,215	$	1,484	$	1,660
Basic earnings per share	$	.61	$	.67	$	.50	$	.60
Diluted earnings per share	$	.61	$	.67	$	.50	$	.60
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 gain 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

26

NORWOOD FINANCIAL CORP - 2011 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	2011									2010									2009
	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	$	551		$	1			0.18	%	$	3,000		$	10			0.33	%	$	2,031		$	5			0.25	%
Interest bearing deposits  with banks		20,258			52			0.26			16,415			47			0.29			4,552			14			0.31
Securities held to maturity		170			14			8.24			280			24			8.57			707			61			8.63
Securities available for sale
Taxable		96,891			2,528			2.61			95,121			2,969			3.12			100,120			4,131			4.13
Tax-exempt		50,245			2,865			5.70			40,332			2,340			5.80			29,283			1,699			5.80
Total securities     available for sale		147,136			5,393			3.67			135,453			5,309			3.92			129,403			5,830			4.51
Loans receivable (3,4)		414,473			23,486			5.67			355,980			21,295			5.98			356,345			21,688			6.09
Total interest     earning assets		582,588			26,946			4.97			511,128			26,685			5.22			493,038			27,598			5.60
Non-interest earning assets:
Cash and due from banks		8,394									7,402									6,935
Allowance for loan losses		(5,575	)								(5,476	)								(4,539	)
Other assets		37,018									22,638									17,309
Total non-interest     earning assets		39,837									24,564									19,705
TOTAL ASSETS	$	622,425								$	535,692								$	512,743
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest bearing demand and  money market	$	140,934			554			0.39		$	107,997			571			0.53		$	98,968			731			0.74
Savings		67,862			164			0.24			48,588			109			0.22			44,526			158			0.35
Time		196,253			3,133			1.60			177,761			3,603			2.03			174,201			4,876			2.80
Total interest-bearing      deposits		405,049			3,851			0.95			334,346			4,283			1.28			317,695			5,765			1.81
Short-term borrowings		28,521			92			0.32			25,932			117			0.45			26,233			292			1.11
Other borrowings		34,774			1,239			3.56			41,712			1,623			3.89			43,000			1,669			3.88
Total interest bearing      liabilities		468,344			5,182			1.11			401,990			6,023			1.50			386,928			7,726			2.00
Non-interest bearing liabilities:
Non-interest bearing demand  deposits		69,721									61,966									59,224
Other liabilities		4,941									4,433									4,615
Total non-interest     bearing liabilities		74,662									66,399									63,839
Stockholders' equity		79,.419									67,303									61,976
TOTAL LIABILITIES AND  STOCKHOLDERS' EQUITY	$	622,425								$	535,692								$	512,743
Net interest income
(tax-equivalent basis)					23,764			3.86	%					20,662			3.72	%					19,872			3.60	%
Tax-equivalent basis adjustment					(1,176	)								(998	)								(763	)
Net Interest Income				$	22,588								$	19,664								$	19,109
Net Interest margin
(tax-equivalent basis)								4.08	%								4.04	%								4.03	%

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.

27

NORWOOD FINANCIAL CORP - 2011 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)	2011 compared to 2010									2010 compared to 2009
	Variance due to									Variance due to
	Volume			Rate			Net			Volume			Rate			Net
INTEREST EARNING ASSETS:
Federal funds sold	$	(6	)	$	(3	)	$	(9	)	$	3		$	1		$	4
Interest bearing deposits		10			(5	)		5			34			(1	)		33
Securities held to maturity		(9	)		(1	)		(10	)		(37	)		0			(37	)
Securities available for sale:
Taxable		54			(495	)		(441	)		(198	)		(964	)		(1,162	)
Tax-exempt securities		566			(41	)		525			641			1			642
Total securities available for sale		620			(536	)		84			443			(963	)		(520	)
Loans receivable		3,359			(1,168	)		2,191			(22	)		(371	)		(393	)
Total interest earning assets		3,974			(1,713	)		2,261			421			(1,334	)		(913	)
INTEREST BEARING LIABILITIES:
Interest- bearing demand and money market		150			(167	)		(17	)		62			(222	)		(160	)
Savings		46			9			55			13			(62	)		(49	)
Time		349			(819	)		(470	)		98			(1,371	)		(1,273	)
Total interest- bearing deposits		545			(977	)		(432	)		173			(1,655	)		(1,482	)
Short-term borrowings		11			(36	)		(25	)		(3	)		(172	)		(175	)
Other borrowings		(255	)		(129	)		(384	)		(50	)		4			(46	)
Total interest bearing liabilities		301			(1,142	)		(841	)		120			(1,823	)		(1,703	)
Net interest income (tax-equivalent basis)	$	3,673		$	(571	)	$	3,102		$	301		$	489		$	790

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.

28

NORWOOD FINANCIAL CORP - 2011 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, 2011. 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, 2011.

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 31.

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

29

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Norwood Financial Corp.

Honesdale, Pennsylvania

We have audited the accompanying consolidated balance sheet of Norwood Financial Corp. and its subsidiary as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. 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.

We conducted our audits 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 audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norwood Financial Corp. and its subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 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, 2011, 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 13, 2012, expressed an unqualified opinion on the effectiveness of Norwood Financial Corp. and its subsidiary's internal control over financial reporting.

 

S.R. Snodgrass, A. C.

2100 Corporate Drive

Suite 400

Wexford, PA

March 13, 2012

30

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Norwood Financial Corp.

Honesdale, Pennsylvania

We have audited Norwood Financial Corp. (the "Company") and its subsidiary’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Norwood Financial Corp.'s 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 audits.

We conducted our audits 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 audits provide 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, 2011, 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 sheet of Norwood Financial Corp. and its subsidiary as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011, and our report dated March 13, 2012, expressed an unqualified opinion.

S.R. Snodgrass, A. C.

2100 Corporate Drive

Suite 400

Wexford, PA

March 13, 2012

31

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED BALANCE SHEETS

	December 31,
	2011			2010
	(In Thousands,
	Except Share Data)
ASSETS
Cash and due from banks	$	8,974		$	5,782
Interest bearing deposits with banks		12,449			7,843
Federal funds sold		—			3,000
Cash and cash equivalents		21,423			16,625
Securities available for sale		150,263			145,815
Securities held to maturity, fair value 2011: $177, 2010: $179		171			170
Loans receivable (net of allowance for loan losses 2011: $5,458; 2010: $5,616)		452,449			351,239
Investment in Federal Home Loan Bank Stock, at cost		3,593			3,361
Bank premises and equipment, net		7,479			4,904
Bank owned life insurance		11,887			8,249
Accrued interest receivable		2,468			2,166
Foreclosed real estate owned		2,910			748
Goodwill		9,715			—
Other intangibles		800			13
Other assets		5,656			3,715
Total Assets	$	668,814		$	537,005
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest bearing demand	$	71,959		$	62,238
Interest bearing demand		51,161			38,168
Money market deposit accounts		114,007			70,812
Savings		66,866			50,341
Time		221,774			172,306
Total Deposits		525,767			393,865
Short-term borrowings		21,794			33,309
Other borrowings		27,670			38,000
Accrued interest payable		1,321			1,536
Other liabilities		4,201			2,597
Total Liabilities		580,753			469,307
Stockholders’ Equity
Common stock, $.10 par value, authorized 10,000,000 shares,      issued:2011; 3,371,866 shares, 2010: 2,840,872 shares		337			284
Surplus		24,660			9,826
Retained earnings		62,308			58,648
Treasury stock at cost: 2011: 87,370 shares, 2010: 72,068 shares		(2,559	)		(2,197	)
Accumulated other comprehensive income		3,315			1,137
Total Stockholders’ Equity		88,061			67,698
Total Liabilities and Stockholders’ Equity	$	668,814		$	537,005

See notes to consolidated financial statements.

32

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF INCOME

	Years Ended December 31,
	2011		2010		2009
	(In Thousands, Except per Share Data)
INTEREST INCOME
Loans receivable, including fees	$	23,289	$	21,101	$	21,523
Securities:
Taxable		2,527		2,969		4,131
Tax exempt		1,901		1,560		1,162
Other		53		57		19
Total Interest Income		27,770		25,687		26,835
INTEREST EXPENSE
Deposits		3,851		4,283		5,765
Short-term borrowings		92		117		292
Other borrowings		1,239		1,623		1,669
Total Interest Expense		5,182		6,023		7,726
Net Interest Income		22,588		19,664		19,109
PROVISION FOR LOAN LOSSES		1,575		1,000		1,685
Net Interest Income after Provision for Loan Losses		21,013		18,664		17,424
OTHER INCOME
Service charges and fees		2,255		2,231		2,476
Income from fiduciary activities		409		405		354
Net realized gains (losses) on sales of securities		973		448		463
Gain on sales of loans and servicing rights		271		307		481
Earnings on life insurance policies		463		391		1,196
Gain on sale of deposits		—		—		150
Other		364		282		272
Total Other Income		4,735		4,064		5,392
OTHER EXPENSES
Salaries and employee benefits		7,848		6,507		6,829
Occupancy		1,402		1,136		1,133
Furniture and equipment		435		424		458
Data processing related operations		855		803		788
Federal Deposit Insurance Corporation insurance assessment		393		474		710
Advertising		205		187		186
Professional fees		1,283		650		411
Postage and telephone		510		484		487
Taxes, other than income		535		524		484
Foreclosed real estate owned		578		41		436
Amortization of intangible assets		108		52		52
Other		1,661		1,471		1,497
Total Other Expenses		15,813		12,753		13,471
Income before Income Taxes		9,935		9,975		9,345
INCOME TAX EXPENSE		2,579		2,662		2,282
Net Income	$	7,356	$	7,313	$	7,063
EARNINGS PER SHARE
Basic	$	2.39	$	2.65	$	2.57
Diluted	$	2.39	$	2.64	$	2.55

See notes to consolidated financial statements.

33

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

	Years Ended December 31, 2011, 2010 and 2009
																	Accumulated
																	Other
	Common Stock							Retained			Treasury Stock						Comprehensive
	Shares		Amount		Surplus			Earnings			Shares			Amount			Income (Loss)			Total
	(Dollars in Thousands, Except Per Share Data)
BALANCE – DECEMBER 31, 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
Comprehensive income:
Net income		-		-		-			7,356			-			-			-			7,356
Change in unrealized losses on    securities available for sale,    net of reclassification    adjustment and tax effects		-		-		-			-			-			-			2,178			2,178
Total Comprehensive Income		-		-		-			-			-			-			-			9,534
Cash dividends declared $1.17 per share		-		-		-			(3,696	)		-			-			-			(3,696	)
Acquisition of treasury stock		-		-		-			-			23,431			(602	)		-			(602	)
Stock options exercised		-		-		(26	)		-			(2,576	)		77			-			51
Tax benefit on stock options		-		-		5			-			-			-			-			5
Sale of treasury stock for ESOP		-		-		(10	)		-			(5,553	)		163			-			153
Compensation expense related to  stock options		-		-		170			-			-			-			-			170
North Penn acquisition		530,994		53		14,695			-			-			-			-			14,748
BALANCE – DECEMBER 31, 2011		3,371,866	$	337	$	24,660		$	62,308			87,370		$	(2,559	)	$	3,315		$	88,061

See notes to consolidated financial statements.

34

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2011			2010			2009
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	7,356		$	7,313		$	7,063
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,575			1,000			1,685
Depreciation		531			459			546
Amortization of intangible assets		108			52			52
Deferred income taxes		(104	)		(205	)		(749	)
Net amortization of securities premiums and discounts		811			462			156
Net realized gains on sales of securities		(973	)		(448	)		(463	)
Gain on sale of deposits		—			—			(150	)
Gain on life insurance policy		—			—			(816	)
Net increase in investment in life insurance		(463	)		(358	)		(351	)
Loss (gain) on sale of bank premises and equipment and foreclosed real estate		173			(3	)		360
Gain on sale of mortgage loans and servicing rights		(271	)		(307	)		(481	)
Mortgage loans originated for sale		(8,677	)		(12,488	)		(21,743	)
Proceeds from sale of mortgage loans originated for sale		8,948			12,795			22,224
Compensation expense related to stock options		170			163			134
Decrease (increase) in accrued interest receivable and other assets		2,272			989			(1,528	)
Increase (decrease) in accrued interest payable and other liabilities		(663	)		(843	)		65
Net Cash Provided by Operating Activities		10,793			8,581			6,004
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		32,146			23,944			15,449
Proceeds from maturities and principal reductions on mortgage-backed securities		34,752			66,102			44,047
Purchases		(54,107	)		(106,742	)		(58,409	)
Securities held to maturity, proceeds from maturities		—			540			—
Redemption of FHLB stock		716			177			—
Net decrease (increase) in loans		12,405			5,118			(14,912	)
Acquisition, net of cash acquired		4,544			—			—
Proceeds from life insurance policy		—			—			1,346
Purchase of bank premises and equipment		(175	)		(179	)		(248	)
Proceeds from sales of premises and equipment and foreclosed real estate		784			100			121
Net Cash Provided by (Used in) Investing Activities		31,065			(10,940	)		(12,606	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (decrease) increase in deposits		(3,532	)		2,392			35,594
Deposits sold		—			—			(3,606	)
Net (decrease) increase in short-term borrowings		(11,515	)		7,506			(12,323	)
Repayment of other borrowings		(18,106	)		(5,000	)		—
Stock options exercised		51			163			517
Tax benefit of stock options exercised		5			34			164
ESOP purchase of shares from treasury stock		153			156			166
Purchase of treasury stock		(602	)		(529	)		(68	)
Cash dividends paid		(3,514	)		(3,093	)		(2,967	)
Net Cash (Used In) Provided by Financing Activities		(37,060	)		1,629			17,477
Net Increase (Decrease) in Cash and Cash Equivalents		4,798			(730	)		10,875
CASH AND CASH EQUIVALENTS – BEGINNING		16,625			17,355			6,480
CASH AND CASH EQUIVALENTS – ENDING	$	21,423		$	16,625		$	17,355

35

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

	Years Ended December 31,
	2011		2010		2009
	(In Thousands)
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Income paid to depositors	$	5,398	$	6,544	$	7,916
Income taxes paid, net of refunds	$	2,363	$	2,742	$	2,441
Supplemental Schedule of Noncash Investing Activities
Investment purchase	$	1,067	$	-	$	-
Transfer of loans to foreclosed real estate	$	3,172	$	448	$	210
Merger with North Penn Bancorp, Inc.
Noncash assets acquired:
Securities available for sale	$	12,671
Restricted investment		985
Loans		118,336
Accrued interest receivable		566
Premises and equipment		2,931
Core deposit intangibles		895
Deferred tax assets		2,715
Other assets		9,715
Goodwill		154,217
Liabilities assumed:
Time deposits		51,936
Deposits other than time deposits		83,498
Borrowings		7,776
Accrued interest payable		203
Other liabilities		600
		144,013
Net Noncash Assets Acquired		10,204
Cash Acquired	$	15,192

See notes to consolidated financial statements.

36

NORWOOD FINANCIAL CORP - 2011 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, Lackawanna and Monroe Counties, Pennsylvania and, accordingly, has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy. These customers are also the primary depositors of the Bank. The Bank is limited in extending credit by legal lending limits to any single borrower or group of borrowers.

Securities

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

37

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

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

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

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

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

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary 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, 2011.

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

38

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

Troubled Debt Restructurings

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

Loans Acquired

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

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

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through

the sale of financial assets.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon a third party appraisal. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. The Company’s loan servicing assets at

39

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

December 31, 2011 and 2010, were not impaired. Total servicing assets included in other assets as of December 31, 2011 and 2010, were $302,000 and $250,000, 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.

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

40

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Transfers of Financial Assets

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

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.

Fair Value of Financial Instruments

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

Goodwill

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

Intangible Assets

At December 31, 2011, the Company had intangible assets of $800,000 as a result of the acquisition of North Penn Bancorp, Inc., which is net of accumulated amortization of $95,000 and is included in other assets.  These intangible assets will continue to be amortized using the sum-of-the-years digits method of amortization over ten years.  At December 31, 2010, the Company had intangible assets of $13,000 arising from the purchase of deposits in 1996, which is net of accumulated amortization of $767,000 which is included in other assets. These intangible assets were fully amortized during 2011. Amortization expense related to intangible assets was $108,000 in 2011 and $52,000 for each of the years ended December 31, 2010 and 2009.  The amortization expense will be $153,000 for the year ended December 31, 2012.

41

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

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, 2011 or 2010 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Treasury Stock

Common shares repurchased are recorded as treasury stock at cost.

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.

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.

42

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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,
	2011			2010			2009
	(In Thousands)
Unrealized holding gains (losses) on available for sale securities	$	4,275		$	(994	)	$	1,701
Reclassification adjustment for gains (losses) realized in income		(973	)		(448	)		(463	)
Net Unrealized Gains (Losses)		3,302			(1,442	)		1,238
Income tax expense (benefit)		1,124			(489	)		427
Net of Tax Amount	$	2,178		$	(953	)	$	811

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.

43

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

New Accounting Standards

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310):  A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The amendments in this Update provide additional guidance or clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring.  The amendments in this Update are effective for the first interim or annual reporting period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired.  For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011.  The Company has provided the necessary disclosures in Note 4.

In April 2011, the FASB issued ASU 2011-03, Transfers and Services (Topic 860): Reconsideration of Effective Control for Repurchase Agreements.  The main objective in developing this Update is to improve the accounting for repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the

financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion.  The amendments in this Update apply to all entities, both public and nonpublic.  The amendments affect all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity.  The guidance in this Update is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  This ASU is not expected to have a significant impact on the Company’s financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820):  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements.  The amendments in this Update are to be applied prospectively.  For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  Early application by public entities is not permitted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220):  Presentation of Comprehensive Income.  The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income.  To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  All entities

44

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

that report items of comprehensive income, in any period presented, will be affected by the changes in this Update.  For public entities, the amendments are effective for fiscal years, and interim periods within those  years, beginning after December 15, 2011.  The amendments in this Update should be applied retrospectively, and early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s  financial statements.

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

In September 2011, the FASB issued ASU 2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80):  Disclosures about an Employer’s Participation in a Multiemployer Plan.  The amendments in this Update will require additional disclosures about an employer’s participation in a multiemployer pension plan to enable users of financial statements to assess the potential cash flow implications relating to an employer’s participation in multiemployer pension plans.  The disclosures also will indicate the financial health of all of the significant plans in which the employer participates and assist a financial statement user to access additional information that is available outside the financial statements.  For public entities, the amendments in this Update are effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted.  The amendments should be applied retrospectively for all prior periods presented. The Company has provided the necessary disclosures in Note 8.

In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360):  Derecognition of in Substance Real Estate-a Scope Clarification.  The amendments in this Update affect entities that cease to have a  controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness.  That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real  estate, debt, and the results of the subsidiary’s operations in its consolidated financial statements until legal  title to the real estate is transferred to legally satisfy the debt.  The amendments in this Update should be

45

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

applied on a prospective basis to deconsolidation events occurring after the effective date.  Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities.  For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012.  This ASU is not expected to have a significant impact on the Company’s financial statements.

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

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

46

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 3 - SECURITIES

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

	December 31, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies	$	13,268	$	130	$	—		$	13,398
States and political subdivisions		54,106		2,640		—			56,746
Corporate obligations		8,733		130		(54	)		8,809
Mortgage-backed securities -
government sponsored entities		68,886		2,081		(2	)		70,965
Equity securities - financial services		239		109		(3	)		345
	$	145,232	$	5,090	$	(59	)	$	150,263
HELD TO MATURITY:
States and political subdivisions	$	171	$	6	$	—		$	177

	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

47

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

	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	)

The Company has 10 securities in the less than twelve month category and 1 security in the twelve months or more category as of December 31, 2011 compared to 61 securities in the less than twelve month category and no securities greater than twelve months as of December 31, 2010. In management’s opinion, the unrealized losses on debt securities reflect changes in interest rates subsequent to the acquisition of specific securities.  The Company holds a small amount of equity securities in other financial institutions. No other-than-temporary-impairment charges were recorded in 2011.  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, 2011 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(In Thousands)
Due in one year or less	$	1,977	$	1,984	$	—	$	—
Due after one year through five years		22,573		22,899		171		177
Due after five years through ten years		19,375		20,357		—		—
Due after ten years		32,182		33,713		—		—
		76,107		78,953		171		177
Mortgage-backed securities -
government sponsored entities		68,886		70,965		—		—
	$	144,993	$	149,918	$	171	$	177

48

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 3 - SECURITIES  (CONTINUED)

Gross realized gains and gross realized losses on sales of securities available for sale were $983,000 and $10,000, respectively, in 2011, compared to $450,000 and $2,000, respectively, in 2010, and $597,000 and $134,000, respectively, in 2009. The proceeds from the sales of securities totaled $32,146,000, $23,944,000 and $15,449,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

Securities with a carrying value of $71,245,000 and $71,412,000 at December 31, 2011 and 2010, 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 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Included in the 2011 balances are loans acquired from North Penn, as of the acquisition date, as follows

(in thousands):

Real Estate
Residential	$	36,221
Commercial		70,789
Construction		358
Commercial		10,499
Consumer		1,831
Total loans	$	119,698

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

	2011					2010
	(In Thousands)
Real Estate:
Residential	$	148,148		32.3	%	$	124,562		34.9	%
Commercial		262,476		57.3			184,094		51.5
Construction		11,087		2.4			12,638		3.5
Commercial		22,684		5.0			22,386		6.3
Consumer		13,934		3.0			13,668		3.8
Total Loans		458,329		100.0	%		357,348		100.0	%
Deferred fees, net		(422	)				(493	)
Allowance for loan losses		(5,458	)				(5,616	)
Loans receivable, net	$	452,449				$	351,239

Purchased loans acquired in a business combination are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality.  Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and December 31, 2011.  The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $1.3 million at December 31, 2011.

49

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the North Penn acquisition was $1.9 million and the estimated fair value of the loans was $1.5 million. Total contractually required payments on these loans, including interest, at the acquisition date was $3.6 million. However, the Company’s preliminary estimate of expected cash flows was $1.9 million. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $1.7 million relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $329,000 on the acquisition date relating to these impaired loans.

The carrying value of the loans acquired and accounted for in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, was determined by projecting discounted contractual cash flows. The table below presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired in the North Penn acquisition as of May 31, 2011:

(In thousands)
Unpaid principal balance	$	1,936
Interest		1,669
Contractual cash flows		3,605
Non-accretable discount		(1,724	)
Expected cash flows		1,881
Accretable discount		( 329	)
Estimated fair value	$	1,552

Changes in the accretable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31, 2011:

(In thousands)
Balance at beginning of period	$	329
Accretion		(67	)
Reclassification and other		(91	)
Balance at end of period	$	171

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

	May 31, 2011		December 31, 2011
	Acquired Loans with Specific Evidence of Deterioration in Credit Quality (ASC 310-30)		Acquired Loans with Specific Evidence of Deterioration in Credit Quality (ASC 310-30)
Outstanding Balance	$	1,936	$	1,412
Carrying Amount	$	1,552	$	1,241

50

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

There has been no allowance for loan losses recorded for acquired loans with or without specific evidence of deterioration in credit quality as of May 31, 2011 as well as those acquired without specific evidence of deterioration in credit quality as of December 31, 2011.  In addition, there has been no allowance for loan losses reversed.

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

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

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, deferments 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.

51

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

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

	Real Estate Loans
								Commercial		Consumer
	Residential		Commercial			Construction		Loans		Loans		Total
December 31, 2011						(In thousands)
Individually evaluated for impairment	$	-	$	11,786		$	-	$	598	$	-	$	12,384
Loans acquired with deteriorated credit quality		343		903			-		-		-		1,246
Collectively evaluated for impairment		147,805		249,787			11,087		22,086		13,934		444,699
Total Loans	$	148,148	$	262,476		$	11,087	$	22,684	$	13,934	$	458,329
	Real Estate Loans
								Commercial		Consumer
	Residential		Commercial		Construction			Loans		Loans		Total
December 31, 2010						(In thousands)
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
Total Loans	$	124,562	$	184,094		$	12,638	$	22,386	$	13,668	$	357,348

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

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

52

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

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

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.  As of December 31, 2011, troubled debt restructured loans totaled $7.2 million and resulted in specific reserves of $1.2 million.  During 2011, there were no new loans identified as troubled debt restructurings.  As of December 31, 2010, troubled debt restructured loans totaled $7.6 million and resulted in specific reserves of $1.5 million.  During 2011, there were no loan modifications classified as troubled debt restructurings.

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

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

53

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of  December 31, 2011 and December 31, 2010 (in thousands):

	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2011
Commercial real estate loans	$	237,407	$	11,009	$	14,060	$	-	$	-	$	262,476
Commercial loans		21,598		427		659		-		-		22,684
Total	$	259,005	$	11,436	$	14,719	$	-	$	-	$	285,160

	Pass		Special 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, 2011 and December 31, 2010 (in thousands):

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

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

54

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2011 and December 31, 2010 (in thousands):

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2011
Real Estate loans
Residential	$	143,550	$	160	$	1,351	$	-	$	3,087	$	4,598	$	148,148
Construction		10,532		-		555		-		-		555		11,087
Commercial		255,613		1,015		1,524		-		4,324		6,863		262,476
Commercial  loans		22,086		194		-		-		404		598		22,684
Consumer  loans		13,835		89		10		-		-		99		13,934
Total	$	445,616	$	1,458	$	3,440	$	-	$	7,815	$	12,713	$	458,329
	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2010
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,
	2011			2010			2009
	(In Thousands)
Allowance balance at beginning of period	$	5,616		$	5,453		$	4,233
Charge-offs:
Commercial		(2	)		(85	)		(17	)
Real Estate		(1,735	)		(699	)		(358	)
Consumer		(109	)		(82	)		(139	)
Total		(1,846	)		(866	)		(514	)
Recoveries:
Commercial		5			—			11
Real Estate		51			2			4
Consumer		57			27			34
Total		113			29			49
Provision expense		1,575			1,000			1,685
Allowance balance at end of period	$	5,458		$	5,616		$	5,453

55

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

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

(in thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial			Consumer			Total
Beginning balance, December 31, 2010	$	1,167		$	3,976		$	110		$	171		$	192		$	5,616
Charge Offs		(482	)		(1,253	)		-			(2	)		(109	)		(1,846	)
Recoveries		44			7			-			5			57			113
Provision Expense		528			1,108			(38	)		(27	)		4			1,575
Ending balance, December 31, 2011	$	1,257		$	3,838		$	72		$	147		$	144		$	5,458
Ending balance individually   evaluated for impairment	$	-		$	1,231		$	-		$	-		$	-		$	1,322
Ending balance collectively   evaluated for impairment	$	1,257		$	2,607		$	72		$	147		$	144		$	4,227

	Residential Real Estate		Commercial 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

The recorded investment in impaired loans, not requiring an allowance for loan losses was $6,807,000 (net of charge-offs against the allowance for loan losses of $698,000) and $6,111,000 (net of charge-offs against the allowance for loan losses of $220,000) at December 31, 2011 and 2010, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $6,823,000 (net of a charge-off against the allowance for loan losses of $0) and $8,641,000 (net of a charge-off against the allowance for loan losses of $480,000) at December 31, 2011 and 2010, respectively. The specific reserve related to impaired loans was $1,231,000 for 2011 and $1,648,000 for 2010. For the years ended December 31, 2011, 2010 and 2009, the average recorded investment in these impaired loans was $15,783,000, $10,096,000 and $3,585,000 and the interest income recognized on these impaired loans was $561,000, $385,000 and $139,000, respectively.

Loans on which the accrual of interest has been discontinued amounted to $7,815,000 and $4,040,000 at December 31, 2011 and 2010, 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 $0 and $39,000 at December 31, 2011 and 2010, 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 $535,000, $339,000 and $188,000 for 2011, 2010 and 2009, respectively.

56

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

The Company’s primary business activity is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy. The Company does not have any significant concentrations to any one customer.

As of December 31, 2011 and 2010, the Company considered its concentration of credit risk to be acceptable.  The two highest concentrations are in the hospitality lodging industry and builders/contractors, with loans outstanding of $44.8 million, or 51.2% of bank capital, to the hospitality lodging industry and $12.9 million, or 14.9% of bank capital to builders/contractors.  In 2011, the Company recorded a charge-off of $948,000 on one motel loan that was considered impaired and subsequently obtained possession of the property and transferred the loan to foreclosed real estate.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $241,000 and $21,000, respectively, in 2011 compared to $247,000 and $13,000, respectively, in 2010 and $309,000 and $6,000, respectively, in 2009.  The proceeds from the sales of residential mortgage loans totaled $8.9 million, $12.8 million and $21.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.

NOTE 5 - PREMISES AND EQUIPMENT

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

	2011			2010
	(In Thousands)
Land and improvements	$	2,228		$	925
Buildings and improvements		9,244			7,975
Furniture and equipment		3,801			5,253
		15,273			14,153
Accumulated depreciation		(7,794	)		(9,249	)
	$	7,479		$	4,904

Depreciation expense totaled $531,000, $459,000 and $546,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

Certain facilities are leased under various operating leases. Rental expense for these leases was $299,000, $254,000 and $284,000, respectively, for the years ended December 31, 2011, 2010 and 2009. Future minimum rental commitments under noncancellable leases as of December 31, 2011 were as follows (in thousands):

2012	$	312
2013		314
2014		306
2015		303
2016		233
Thereafter		2,036
	$	3,504

57

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 6 - DEPOSITS

Aggregate time deposits in denominations of $100,000 or more were $80,554,000 and $60,015,000 at December 31, 2011 and 2010, respectively.

At December 31, 2011, the scheduled maturities of time deposits are as follows (in thousands):

2012	$	123,805
2013		44,394
2014		23,734
2015		17,461
2016		12,380
	$	221,774

NOTE 7 - BORROWINGS

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

	2011		2010
	(In Thousands)
Securities sold under agreements to repurchase	$	21,794	$	33,110
U.S. Treasury demand notes		-		199
	$	21,794	$	33,309

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

	Years Ended December 31,
	2011			2010
	(Dollars In Thousands)
Average balance during the year	$	28,521		$	26,100
Average interest rate during the year		.32	%		.45	%
Maximum month-end balance during the year	$	32,637		$	40,068
Weighted average interest rate at the end of the year		.25	%		.37	%

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 $25,505,000 and $26,003,000 at December 31, 2011 and $34,502,000 and $34,494,000 at December 31, 2010 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 $0 and $199,000 at December 31, 2011 and 2010, respectively.

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 2016. There were no borrowings under this line at December 31, 2011 and 2010. The Company has a line of credit commitment available from Atlantic Central Bankers Bank for $7,000,000 which expires on June 30, 2012.  There were no borrowings under this line of credit at December 31, 2011 and 2010. 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, 2011 and December 31, 2010.

58

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 7 - BORROWINGS (CONTINUED)

Other borrowings consisted of the following at December 31, 2011 and 2010:

	2011		2010
	(In Thousands)
Notes with the FHLB:
Fixed rate note due January 2011 at 5.24%	$	—	$	3,000
Convertible note due August 2011 at 2.69%		—		10,000
Convertible note due September 2011 at 4.06%		—		5,000
Fixed rate 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 July 2015 at 4.34%		7,670		—
Convertible note due January 2017 at 4.71%		10,000		10,000
	$	27,670	$	38,000

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 16 to 22 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, 2011 are as follows (in thousands):

2012		5,000
2013		5,000
2014		—
2015		7,670
Thereafter		10,000
	$	27,670

The Bank’s maximum borrowing capacity with the FHLB was $222,721,000 of which $27,670,000 was outstanding at December 31, 2011. Advances from the FHLB are secured by qualifying assets of the Bank.

NOTE 8 - EMPLOYEE BENEFIT PLANS

The Company has a defined contributory profit-sharing plan which includes provisions of a 401(k) plan. The plan permits employees to make pre-tax contributions up to 15% of the employee’s compensation. 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 $398,000, $342,000 and $373,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

The Company has a non-qualified supplemental executive retirement plan for the benefit of certain executive officers. At December 31, 2011 and 2010, other liabilities include $1,472,000 and $1,445,000 accrued under the Plan.

Compensation expense includes approximately $116,000, $115,000 and $360,000 relating to the supplemental executive retirement plan for 2011, 2010 and 2009, 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, 2011 and 2010, the cash value of these policies was $11,887,000 and $8,249,000, respectively.

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

59

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 8 - EMPLOYEE BENEFIT PLANS (CONTINUED)

The net periodic post retirement benefit expense included in salaries and employee benefits was $44,000 and $135,000 for the years ended December 31, 2011 and 2010, respectively.

The Company participates in the Pentegra Mulitemployer Defined Benefit Pension Plan as a result of its acquisition of North Penn.  As of December 31, 2011, the Company’s Plan was 90.00% funded, and total contributions made are not more than 5% of the total contributions to the Plan.  The Company’s expense related to the Plan was $6,000 in 2011.

NOTE 9 - INCOME TAXES

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

	Years Ended December 31,
	2011			2010			2009
	(In Thousands)
Current	$	2,683		$	2,867		$	3,031
Deferred		(104	)		(205	)		(749	)
	$	2,579		$	2,662		$	2,282

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

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

	Percentage of Income
	before Income Taxes
	Years Ended December 31,
	2011			2010			2009
Tax at statutory rates		34.0	%		34.0	%		34.0	%
Tax exempt interest income, net of interest expense disallowance		(7.5	)		(6.2	)		(5.0	)
Incentive stock options		0.5			0.5			0.4
Earnings on life insurance		(1.2	)		(1.1	)		(4.1	)
Other		0.2			(0.5	)		(0.9	)
		26.0	%		26.7	%		24.4	%

The income tax provision includes $331,000, $152,000 and $157,000 of income taxes relating to realized securities gains for the years ended December 31, 2011, 2010 and 2009, respectively.

60

 

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 9 - INCOME TAXES (CONTINUED)

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

	2011		2010
	(In Thousands)
Deferred tax assets:
Allowance for loan losses	$	1,787	$	1,789
Deferred compensation		501		491
Purchase price adjustment		1,581		5
Other		277		191
Foreclosed real estate		183		123
Net operating loss carry forward		263		—
Total Deferred Tax Assets		4,592		2,599
Deferred tax liabilities:
Premises and equipment		282		276
Deferred loan fees		264		225
Net unrealized gains on securities		1,716		591
Total Deferred Tax Liabilities		2,262		1,092
Net Deferred Tax Asset	$	2,330	$	1,507

No valuation allowance was established at December 31, 2011 and 2010, 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 in the provision for income taxes in the Consolidated Statement of Income.

The Company recorded a deferred tax asset in the amount of $263,000 in 2011 related to a net operating loss carry forward resulting from its acquisition of North Penn Bancorp, Inc.  The carry forward will expire in 2030 but it is expected that the Company will realize the tax benefit before expiration based on the Company’s earning potential. The Company's federal and state income tax returns for taxable years through 2007 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue.

NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS’ EQUITY

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

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, 2011 and 2010, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

61

 

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

As of December 31, 2011, 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, 2011

Total capital (to risk-weighted assets)

$

75,846

16.13

%

$

≥37,611

≥8.00

%

$

≥47,014

≥10.00

%

Tier 1 capital (to risk-weighted assets)

70,381

14.97

≥18,806

≥4.00

≥28,208

≥6.00

Tier 1 capital (to average assets)

70,381

10.74

≥26,215

≥4.00

≥32,769

≥5.00

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

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, 2011 and 2010 was approximately $372,000 and $309,000, respectively.

Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2011, $49,700,000 of retained earnings were available for dividends without prior regulatory approval, subject to the regulatory capital requirements discussed above. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including the Company, unless such loans are collateralized by specific obligations.

NOTE 11 - STOCK 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 29,000 options, which included 4,500 options granted to outside directors in 2011, 28,000 options, which included 4,000 options granted to outside directors in 2010, and 24,000 options, which included 4,000 options granted to outside directors in 2009.

Total unrecognized compensation cost related to nonvested options under the Plan was $130,000 as of December 31, 2011, $165,000 as of December 31, 2010 and $158,000 as of December 31, 2009.  Salaries and employee benefits expense includes $170,000, $163,000 and $134,000 of compensation costs related to options for the years ended December 31, 2011, 2010 and 2009, respectively. Net income was reduced by $163,000, $153,000 and $127,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

62

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 11 - STOCK OPTION PLANS (CONTINUED)

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

31 follows:

				2011							2010							2009
				Weighted							Weighted							Weighted
				Average							Average							Average
				Exercise		Intrinsic					Exercise		Intrinsic					Exercise		Intrinsic
	Options			Price		Value		Options			Price		Value		Options			Price		Value
Outstanding,   beginning of year		189,639		$	28.52				170,915		$	28.07				176,443		$	25.78
Granted		29,000			27.43				28,000			27.74				27,000			28.60
Exercised		(2,575	)		19.69				(9,276	)		17.68				(32,528	)		15.83
Forfeited		(6,150	)		30.25				—			—				—			—
Outstanding,    end of year		209,914		$	28.43	$	113,352		189,639			28.52	$	146,361	$	170,915			28.07	$	286,464
Exercisable,    end of year		180,914		$	28.59	$	112,152		161,639			28.66		145,471		146,915		$	27.98	$	259,461

Exercise prices for options outstanding as of December 31, 2011 ranged from $19.05 to $31.50 per share. The weighted average remaining contractual life is 6.3 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,
	2011			2010			2009
Dividend yield		3.30	%		3.04	%		2.89	%
Expected life	7 years			7 years			7 years
Expected volatility		25.35	%		27.18	%		27.39	%
Risk-free interest rate		1.39	%		2.72	%		3.11	%
Weighted average fair value of options granted	$	4.70		$	6.12		$	6.77

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 $51,000 in 2011. 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 2011, all the shares issued in connection with stock option exercises, 2,575 shares in total, were issued from available treasury shares.

63

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 11 - STOCK OPTION PLANS (CONTINUED)

As of December 31, 2011, outstanding stock options consist of the following:

	Options Outstanding		Average Exercise Price		Remaining Life, Years		Options Exercisable		Average Exercise Price
		6,298	$	19.05		1.0		6,298	$	19.05
		16,616		23.95		2.0		16,616		23.95
		18,900		30.00		3.0		18,900		30.00
		23,100		30.38		4.3		23,100		30.38
		21,000		31.50		5.0		21,000		31.50
		21,000		31.25		6.0		21,000		31.25
		23,000		27.50		7.0		23,000		27.50
		1,000		28.90		7.3		1,000		28.90
		22,500		28.59		8.0		22,500		28.59
		1,000		26.88		8.2		1,000		26.88
		26,500		27.77		9.0		26,500		27.77
		1,000		26.27		9.5		—		—
		28,000		27.47		10.0		—		—
Total		209,914	$	28.43		6.3		180,914	$	28.59

NOTE 12 - EARNINGS PER SHARE

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

	Years Ended December 31,
	2011		2010		2009
	(In Thousands, Except per Share Data)
Numerator, net income	$	7,356	$	7,313	$	7,063
Denominator:
Denominator for basic earnings per share,  weighted average shares		3,073		2,762		2,750
Effect of dilutive securities, employee  stock options		3		4		16
Denominator for diluted earnings per share,  adjusted weighted average shares and  assumed conversions		3,076		2,766		2,766
Basic earnings per common share	$	2.39	$	2.65	$	2.57
Diluted earnings per common share	$	2.39	$	2.64	$	2.55

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 157,000, 140,150, and 109,821 for the years ended December 31, 2011, 2010 and 2009, respectively.

NOTE 13 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

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

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

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

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,
	2011		2010
	(In Thousands)
Unfunded availability under loan commitments	$	43,081	$	21,448
Unfunded commitments under lines of credit		29,255		30,311
Standby letters of credit		11,892		3,605
	$	84,228	$	55,364

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

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

NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS

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

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 14 - 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 orindirectly, 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 valuemeasurement 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.

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, 2011 and 2010 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, 2011
Available for Sale:
U.S. Government agencies	$	13,398	$	—	$	13,398	$	—
States and political subdivisions		56,746		—		56,746		—
Corporate obligations		8,809		—		8,809		—
Mortgage-backed securities -
government sponsored entities		70,965		—		70,965		—
Equity securities - financial services		345		345		—		—
Total available for sale	$	150,263	$	345	$	149,918	$	—
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	$	—

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 14 - 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, 2011 and 2010 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, 2011
Impaired Loans	$	12,399	$	—	$	—	$	12,399
Foreclosed real estate owned		2,910		—		—		2,910
	$	15,309	$	—	$	—	$	15,309
December 31, 2010
Impaired Loans	$	13,104	$	—	$	7,038	$	6,066
Foreclosed real estate owned		748		—		748		—
	$	13,852	$	—	$	7,786	$	6,066

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, 2011 and 2010.

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 - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 14 - 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, 2011, the fair value investment in impaired loans totaled $12,399,000 which included two loans for $6,823,000 for which a valuation allowance had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and twenty loans for $6,807,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of December 31, 2011, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $698,000 over the life of the loans.

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.

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 3 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.

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

Management evaluates the restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary 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

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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, 2011.

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, 2011 and December 31, 2010.

	December 31, 2011				December 31, 2010
	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	$	21,423	$	21,423	$	16,625	$	16,625
Securities		150,434		150,440		145,985		145,994
Loans receivable, net		452,449		463,118		351,239		358,873
Mortgage servicing rights		302		308		250		274
Investment in FHLB stock		3,593		3,593		3,361		3,361
Bank owned life insurance		11,887		11,887		8,249		8,249
Accrued interest receivable		2,468		2,468		2,166		2,166
Financial liabilities:
Deposits		525,767		527,707		393,865		395,157
Short-term borrowings		21,794		21,794		33,309		33,309
Other borrowings		27,670		30,002		38,000		40,413
Accrued interest payable		1,321		1,321		1,536		1,536
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding letters of credit		—		—		—		—

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 15 – ACQUISITION OF NORTH PENN BANCORP, INC.

On May 31, 2011, the Company closed on a merger transaction pursuant to which Norwood Financial Corp acquired North Penn Bancorp, Inc. in a stock and cash transaction.  The acquisition was an in-market transaction that expanded the Company’s existing footprint in Monroe County, Pennsylvania and extended its footprint into Lackawanna County, Pennsylvania.

North Penn Bancorp, Inc. was the holding company for North Penn Bank, a Pennsylvania savings bank that conducted its business from a main office in Scranton, Pennsylvania and four branch offices in the northeastern Pennsylvania counties of Lackawanna and Monroe.

Under the terms of the merger agreement, the Company acquired all of the outstanding shares of North Penn Bancorp, Inc. for a total purchase price of approximately $25.4 million.  As a result of the acquisition, the Company issued 530,994 common shares, or 15.75% of the total shares outstanding, to former shareholders of North Penn Bancorp, Inc.  North Penn Bank has been merged into Wayne Bank, with Wayne as the surviving entity.

The acquired assets and assumed liabilities were measured at estimated fair values. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management measured

loan fair values based on loan file reviews (including borrower financial statements or tax returns), appraised collateral values, expected cash flows and historical loss factors of North Penn Bank. Real estate acquired through foreclosure was primarily valued based on appraised collateral values. The Company also recorded an identifiable intangible asset representing the core deposit base of North Penn Bank based on management’s evaluation of the cost of such deposits relative to alternative funding sources. Management used significant estimates including the average lives of depository accounts, future interest rate levels and the cost of servicing various depository products. Management used market quotations to fair value investment securities and FHLB advances.

The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. North Penn Bank’s loans were deemed impaired at the acquisition date if the Company did not expect to receive all contractually required cash flows due to concerns about credit quality. Such loans were fair valued and the difference between contractually required payments at the acquisition date and cash flows expected to be collected was recorded as a nonaccretable difference. At the acquisition date, the Company recorded $1.9 million of purchased credit-impaired loans subject to a nonaccretable difference of $1.7 million. The method of measuring carrying value of purchased loans differs from loans originated by the Company (originated loans), and as such, the Company identifies purchased loans and purchased loans with a credit quality discount and originated loans at amortized cost.

North Penn Bank’s loans without evidence of credit deterioration were fair valued by discounting both expected principal and interest cash flows using an observable discount rate for similar instruments that a market participant would consider in determining fair value. Additionally, consideration was given to management’s best estimates of default rates and payment speeds. At acquisition, North Penn’s loan portfolio without evidence of deterioration totaled $119.8 million and was recorded at a fair value of $116.7 million.

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 15 – ACQUISITION OF NORTH PENN BANCORP, INC. (CONTINUED)

The following condensed statement reflects the values assigned to North Penn Bancorp’s net assets as of the acquisition date:

Total Purchase Price				$	25,396
Net Assets Acquired:
Cash	$	15,192
Securities available for sale		12,671
Restricted investments		985
Loans		118,336
Accrued interest receivable		566
Premises and equipment, net		2,931
Core deposit intangible		895
Deferred tax assets		2,715
Other assets		5,403
Time deposits		(51,936	)
Deposits other than time deposits		(83,498	)
Borrowings		(7,776	)
Accrued interest payable		(203	)
Other liabilities		(600	)
					15,681
Goodwill resulting from North Penn Merger				$	9,715

The Company recorded goodwill and other intangibles associated with the purchase of North Penn Bancorp, Inc. totaling $10.6 million. Goodwill is not amortized, but is periodically evaluated for impairment. The Company did not recognize any impairment during the year ended December 31, 2011. The carrying amount of the goodwill at December 31, 2011 was $9.7 million.

Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. Such lives are also periodically reassessed to determine if any amortization period adjustments are required. During the year ended December 31, 2011, no such adjustments were recorded. The identifiable intangible asset consists of a core deposit intangible which is being amortized on an accelerated basis over the useful life of such asset. The gross carrying amount of the core deposit intangible at December 31, 2011 was $895,000 with $95,000 accumulated amortization as of that date.

As of December 31, 2011, the current year and estimated future amortization expense for the core deposit intangible was:

2011	$	95,000
2012		153,000
2013		137,000
2014		121,000
2015		104,000
2016		88,000
2017		72,000
2018		56,000
2019		39,000
2020		23,000
2021		7,000
	$	895,000

Results of operations for North Penn prior to the acquisition date are not included in the Consolidated Statement of Income for the period ended December 31, 2011. Due to the significant amount of fair value adjustments historical results of North Penn are not relevant to the Company’s results of operations.

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NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 15 – ACQUISITION OF NORTH PENN BANCORP, INC. (CONTINUED)

The following table presents financial information regarding the former North Penn operations included in our Consolidated Statement of Income from the date of acquisition through December 31, 2011 under the column “Actual from acquisition date through December 31, 2011".  In addition, the following table presents unaudited pro forma information as if the acquisition of North Penn had occurred on January 1, 2010 under the “Pro forma” columns.  Merger and acquisition integration costs of $781,000 and $130,000 related to the North Penn merger that we incurred during the years ended December 31, 2011 and 2010, respectively, are not reflected in the unaudited pro forma amounts.  The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company merged with North Penn at the beginning of 2010.  Cost savings are also not reflected in the unaudited pro forma amounts for the years ended December 31, 2011 and 2010.

		Pro Forma
	Actual from acquisition date	year ended December 31,
	through December 31, 2011	2011	2010
Net interest income	$3,155	$24,715	$25,008
Noninterest income	180	5,030	4,536
Net income	536	8,419	8,113
Pro forma earnings per share:
Basic		$    2.56	$    1.98
Diluted		2.55	1.96

72

 

NORWOOD FINANCIAL CORP - 2011 CONSOLIDATED FINANCIAL REPORT

NOTE 16 - NORWOOD FINANCIAL CORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION

BALANCE SHEETS
				December 31,
				2011			2010
				(In Thousands)
ASSETS
Cash on deposit in bank subsidiary				$	1,230		$	346
Securities available for sale					238			212
Investment in bank subsidiary					84,187			66,163
Other assets					3,434			1,812
				$	89,089		$	68,533
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities				$	1,028		$	835
Stockholders’ equity					88,061			67,698
				$	89,089		$	68,533
STATEMENTS OF INCOME
	Years Ended December 31,
	2011			2010			2009
	(In Thousands)
Income:
Dividends from bank subsidiary	$	16,496		$	3,120		$	3,005
Other interest income		9			17			19
Net realized gain (loss) on sales of securities		—			66			(134	)
		16,505			3,203			2,890
Expenses		980			323			176
		15,525			2,880			2,714
Income tax benefit		(290	)		(82	)		(99	)
		15,815			2,962			2,813
Equity in undistributed earnings of subsidiary		(8,459	)		4,351			4,250
Net Income	$	7,356		$	7,313		$	7,063
STATEMENTS OF CASH FLOWS
	Years Ended December 31,
		2011		2010			2009
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	7,356		$	7,313		$	7,063
Adjustments to reconcile net income to    net cash provided by operating activities:
Undistributed earnings of bank subsidiary		8,459			(4,351	)		(4,250	)
Net (gains) losses on sales of securities		-			(66	)		134
Other, net		(506	)		(144	)		(300	)
Net Cash Provided by Operating Activities		15,309			2,752			2,647
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities		—			166			22
Outlays for business acquisitions		(10,518	)		—			—
Net Cash Provided by Investing Activities		(10,518	)		166			22
CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised		51			163			517
Tax benefit of stock options exercised		5			34			164
ESOP purchase of shares from treasury stock		153			156			166
Acquisition of treasury stock		(602	)		(529	)		(68	)
Cash dividends paid		(3,514	)		(3,093	)		(2,967	)
Net Cash Used in Financing Activities		(3,907	)		(3,269	)		(2,188	)
Net Increase (Decrease) in Cash and Cash Equivalents		884			(351	)		481
CASH AND CASH EQUIVALENTS - BEGINNING		346			697			216
CASH AND CASH EQUIVALENTS - ENDING	$	1,230		$	346		$	697

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NORWOOD FINANCIAL CORP - 2011 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.	RBC Capital Markets
West Conshohocken, PA	Philadelphia, PA  19103
800-496-1170	888-848-4677
Janney Montgomery Scott, LLC	Stifel Nicolaus
Scranton, PA  18503	St. Louis, MO
800-638-4417	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, 2011 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 William S. Lance, Executive Vice President, Chief Financial Officer and Secretary, Norwood Financial Corp., 717 Main Street, PO Box 269, Honesdale, PA  18431, 570-253-1455.

74

EX-23

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 Nos. 333-61487 and 333-134831 on Form S-8 of Norwood Financial Corp. of our report dated March 13, 2012, relating to the consolidated financial statements and the effectiveness of internal control over financial reporting, which appear in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K of Norwood Financial Corp. for the year ended December 31, 2011.

Wexford, Pennsylvania

March 13, 2012

S.R. Snodgrass, A.C.   *   2100 Corporate Drive, Suite 400   *    Wexford, Pennsylvania 15090-7647    *   Phone: (724) 934-0344   *    Facsmile: (724) 934-0345

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 14, 2012	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 14, 2012	By:	/s/ William S. Lance
		William S. Lance Executive 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, 2011 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, Executive 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	Executive Vice President and Chief Financial Officer

March 14, 2012

XML

Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies

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

Securities

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

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

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

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

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

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

Management evaluates the restricted stock for impairment. Management's determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary 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, 2011.

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.

Troubled Debt Restructurings

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

Loans Acquired

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

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

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through

the sale of financial assets.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon a third party appraisal. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. The Company's loan servicing assets at December 31, 2011 and 2010, were not impaired. Total servicing assets included in other assets as of December 31, 2011 and 2010, were $302,000 and $250,000, 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.

Premises and Equipment

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

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

Transfers of Financial Assets

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

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.

Fair Value of Financial Instruments

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

Goodwill

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

Intangible Assets

At December 31, 2011, the Company had intangible assets of $800,000 as a result of the acquisition of North Penn Bancorp, Inc., which is net of accumulated amortization of $95,000 and is included in other assets.  These intangible assets will continue to be amortized using the sum-of-the-years digits method of amortization over ten years.  At December 31, 2010, the Company had intangible assets of $13,000 arising from the purchase of deposits in 1996, which is net of accumulated amortization of $767,000 which is included in other assets. These intangible assets were fully amortized during 2011. Amortization expense related to intangible assets was $108,000 in 2011 and $52,000 for each of the years ended December 31, 2010 and 2009.  The amortization expense will be $153,000 for the year ended December 31, 2012.

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.

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, 2011 or 2010 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Treasury Stock

Common shares repurchased are recorded as treasury stock at cost.

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.

Cash Flow Information

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

Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, letters of credit and commitments to sell loans. Such financial instruments are recorded 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,
	2011			2010			2009
	(In Thousands)
Unrealized holding gains (losses) on available for sale securities	$	4,275		$	(994	)	$	1,701
Reclassification adjustment for gains (losses) realized in income		(973	)		(448	)		(463	)
Net Unrealized Gains (Losses)		3,302			(1,442	)		1,238
Income tax expense (benefit)		1,124			(489	)		427
Net of Tax Amount	$	2,178		$	(953	)	$	811

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.

New Accounting Standards

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310):  A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The amendments in this Update provide additional guidance or clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring.  The amendments in this Update are effective for the first interim or annual reporting period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired.  For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011.  The Company has provided the necessary disclosures in Note 4.

In April 2011, the FASB issued ASU 2011-03, Transfers and Services (Topic 860): Reconsideration of Effective Control for Repurchase Agreements.  The main objective in developing this Update is to improve the accounting for repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the

financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion.  The amendments in this Update apply to all entities, both public and nonpublic.  The amendments affect all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity.  The guidance in this Update is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  This ASU is not expected to have a significant impact on the Company's financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820):  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements.  The amendments in this Update are to be applied prospectively.  For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  Early application by public entities is not permitted. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220):  Presentation of Comprehensive Income.  The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income.  To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity was eliminated.  The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update.  For public entities, the amendments are effective for fiscal years, and interim periods within those  years, beginning after December 15, 2011.  The amendments in this Update should be applied retrospectively, and early adoption is permitted. This ASU is not expected to have a significant impact on the Company's  financial statements.

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

In September 2011, the FASB issued ASU 2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80):  Disclosures about an Employer's Participation in a Multiemployer Plan.  The amendments in this Update will require additional disclosures about an employer's participation in a multiemployer pension plan to enable users of financial statements to assess the potential cash flow implications relating to an employer's participation in multiemployer pension plans.  The disclosures also will indicate the financial health of all of the significant plans in which the employer participates and assist a financial statement user to access additional information that is available outside the financial statements.  For public entities, the amendments in this Update are effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted.  The amendments should be applied retrospectively for all prior periods presented. The Company has provided the necessary disclosures in Note 8.

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

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

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

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Nature of Operations

12 Months Ended

Dec. 31, 2011

Nature of Operations

NATURE OF OPERATIONS

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.

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Consolidated Balance Sheets (USD $) In Thousands, unless otherwise specified	Dec. 31, 2011	Dec. 31, 2010
ASSETS
Cash and due from banks	$ 8,974	$ 5,782
Interest bearing deposits with banks	12,449	7,843
Federal funds sold		3,000
Cash and cash equivalents	21,423	16,625
Securities available for sale	150,263	145,815
Securities held to maturity, fair value 2011: $177, 2010: $179	171	170
Loans receivable (net of allowance for loan losses 2011: $5,458; 2010: $5,616)	452,449	351,239
Investment in Federal Home Loan Bank Stock, at cost	3,593	3,361
Premises and equipment, net	7,479	4,904
Bank owned life insurance	11,887	8,249
Accrued interest receivable	2,468	2,166
Foreclosed real estate owned	2,910	748
Goodwill	9,715
Other intangibles	800	13
Other assets	5,656	3,715
Total Assets	668,814	537,005
LIABILITIES
Deposits: Non-interest bearing demand	71,959	62,238
Deposits: Interest-bearing demand	51,161	38,168
Deposits: Money market deposit accounts	114,007	70,812
Deposits: Savings	66,866	50,341
Deposits: Time	221,774	172,306
Total Deposits	525,767	393,865
Short-term borrowings	21,794	33,309
Other borrowings	27,670	38,000
Accrued interest payable	1,321	1,536
Other liabilities	4,201	2,597
Total Liabilities	580,753	469,307
STOCKHOLDERS' EQUITY
Common stock, $.10 par value per share, authorized 10,000,000; shares issued 2011: 3,371,866 shares, 2010: 2,840,872 shares	337	284
Surplus	24,660	9,826
Retained earnings	62,308	58,648
Treasury stock at cost: 2011: 87,370 shares, 2010: 72,068 shares	(2,559)	(2,197)
Accumulated other comprehensive income	3,315	1,137
Total Stockholders' Equity	88,061	67,698
Total Liabilities and Stockholders' Equity	$ 668,814	$ 537,005

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Consolidated Statements of Changes in Stockholders' Equity (parenthetical) (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Consolidated Statements of Changes in Stockholders' Equity
Common Stock, Dividends, Per Share, Declared	$ 1.17	$ 1.13	$ 1.09

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Acquisition of North Penn Bancorp, Inc.

12 Months Ended

Dec. 31, 2011

Acquisition of North Penn Bancorp, Inc.

ACQUISITION OF NORTH PENN BANCORP, INC.

NOTE 15 – ACQUISITION OF NORTH PENN BANCORP, INC.

On May 31, 2011, the Company closed on a merger transaction pursuant to which Norwood Financial Corp acquired North Penn Bancorp, Inc. in a stock and cash transaction.  The acquisition was an in-market transaction that expanded the Company's existing footprint in Monroe County, Pennsylvania and extended its footprint into Lackawanna County, Pennsylvania.

North Penn Bancorp, Inc. was the holding company for North Penn Bank, a Pennsylvania savings bank that conducted its business from a main office in Scranton, Pennsylvania and four branch offices in the northeastern Pennsylvania counties of Lackawanna and Monroe.

Under the terms of the merger agreement, the Company acquired all of the outstanding shares of North Penn Bancorp, Inc. for a total purchase price of approximately $25.4 million.  As a result of the acquisition, the Company issued 530,994 common shares, or 15.75% of the total shares outstanding, to former shareholders of North Penn Bancorp, Inc.  North Penn Bank has been merged into Wayne Bank, with Wayne as the surviving entity.

The acquired assets and assumed liabilities were measured at estimated fair values. Management made significant estimates and exercised significant judgment in accounting for the acquisition. Management measured

loan fair values based on loan file reviews (including borrower financial statements or tax returns), appraised collateral values, expected cash flows and historical loss factors of North Penn Bank. Real estate acquired through foreclosure was primarily valued based on appraised collateral values. The Company also recorded an identifiable intangible asset representing the core deposit base of North Penn Bank based on management's evaluation of the cost of such deposits relative to alternative funding sources. Management used significant estimates including the average lives of depository accounts, future interest rate levels and the cost of servicing various depository products. Management used market quotations to fair value investment securities and FHLB advances.

The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. North Penn Bank's loans were deemed impaired at the acquisition date if the Company did not expect to receive all contractually required cash flows due to concerns about credit quality. Such loans were fair valued and the difference between contractually required payments at the acquisition date and cash flows expected to be collected was recorded as a nonaccretable difference. At the acquisition date, the Company recorded $1.9 million of purchased credit-impaired loans subject to a nonaccretable difference of $1.7 million. The method of measuring carrying value of purchased loans differs from loans originated by the Company (originated loans), and as such, the Company identifies purchased loans and purchased loans with a credit quality discount and originated loans at amortized cost.

North Penn Bank's loans without evidence of credit deterioration were fair valued by discounting both expected principal and interest cash flows using an observable discount rate for similar instruments that a market participant would consider in determining fair value. Additionally, consideration was given to management's best estimates of default rates and payment speeds. At acquisition, North Penn's loan portfolio without evidence of deterioration totaled $119.8 million and was recorded at a fair value of $116.7 million.

The following condensed statement reflects the values assigned to North Penn Bancorp's net assets as of the acquisition date:

Total Purchase Price				$	25,396
Net Assets Acquired:
Cash	$	15,192
Securities available for sale		12,671
Restricted investments		985
Loans		118,336
Accrued interest receivable		566
Premises and equipment, net		2,931
Core deposit intangible		895
Deferred tax assets		2,715
Other assets		5,403
Time deposits		(51,936	)
Deposits other than time deposits		(83,498	)
Borrowings		(7,776	)
Accrued interest payable		(203	)
Other liabilities		(600	)
					15,681
Goodwill resulting from North Penn Merger				$	9,715

The Company recorded goodwill and other intangibles associated with the purchase of North Penn Bancorp, Inc. totaling $10.6 million. Goodwill is not amortized, but is periodically evaluated for impairment. The Company did not recognize any impairment during the year ended December 31, 2011. The carrying amount of the goodwill at December 31, 2011 was $9.7 million.

Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. Such lives are also periodically reassessed to determine if any amortization period adjustments are required. During the year ended December 31, 2011, no such adjustments were recorded. The identifiable intangible asset consists of a core deposit intangible which is being amortized on an accelerated basis over the useful life of such asset. The gross carrying amount of the core deposit intangible at December 31, 2011 was $895,000 with $95,000 accumulated amortization as of that date.

As of December 31, 2011, the current year and estimated future amortization expense for the core deposit intangible was:

2011	$	95,000
2012		153,000
2013		137,000
2014		121,000
2015		104,000
2016		88,000
2017		72,000
2018		56,000
2019		39,000
2020		23,000
2021		7,000
	$	895,000

Results of operations for North Penn prior to the acquisition date are not included in the Consolidated Statement of Income for the period ended December 31, 2011. Due to the significant amount of fair value adjustments historical results of North Penn are not relevant to the Company's results of operations.

The following table presents financial information regarding the former North Penn operations included in our Consolidated Statement of Income from the date of acquisition through December 31, 2011 under the column "Actual from acquisition date through December 31, 2011".  In addition, the following table presents unaudited pro forma information as if the acquisition of North Penn had occurred on January 1, 2010 under the "Pro forma" columns.  Merger and acquisition integration costs of $781,000 and $130,000 related to the North Penn merger that we incurred during the years ended December 31, 2011 and 2010, respectively, are not reflected in the unaudited pro forma amounts.  The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company merged with North Penn at the beginning of 2010.  Cost savings are also not reflected in the unaudited pro forma amounts for the years ended December 31, 2011 and 2010.

		Pro Forma
	Actual from acquisition date	year ended December 31,
	through December 31, 2011	2011	2010
Net interest income	$3,155	$24,715	$25,008
Noninterest income	180	5,030	4,536
Net income	536	8,419	8,113
Pro forma earnings per share:
Basic		$    2.56	$    1.98
Diluted		2.55	1.96

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Consolidated Statements of Cash Flows (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$ 7,356	$ 7,313	$ 7,063
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	1,575	1,000	1,685
Depreciation	531	459	546
Amortization of intangible assets	108	52	52
Deferred income taxes	(104)	(205)	(749)
Net amortization of securities premiums and discounts	811	462	156
Net realized gains on sales of securities	(973)	(448)	(463)
Gain on sale of deposits			(150)
Gain on life insurance policy			(816)
Net increase in investment in life insurance	(463)	(358)	(351)
Loss (gain) on sale of bank premises and equipment and foreclosed real estate	173	(3)	360
Gain on sale of mortgage loans and servicing rights	(271)	(307)	(481)
Mortgage loans originated for sale	(8,677)	(12,488)	(21,743)
Proceeds from sale of mortgage loans originated for sale	8,948	12,795	22,224
Compensation expense related to stock options	170	163	134
Decrease (increase) in accrued interest receivable and other assets	2,272	989	(1,528)
Increase (decrease) in accrued interest payable and other liabilities	(663)	(843)	65
Net Cash Provided by Operating Activities	10,793	8,581	6,004
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale: Proceeds from sales	32,146	23,944	15,449
Securities available for sale: Proceeds from maturities and principal reductions on mortgage-backed securities	34,752	66,102	44,047
Securities available for sale: Purchases	(54,107)	(106,742)	(58,409)
Securities held to maturity, proceeds from maturities		540
Redemption of FHLB stock	716	177
Net decrease (increase) in loans	12,405	5,118	(14,912)
Acquisition, net of cash and cash acquired	4,544
Proceeds from life insurance policy			1,346
Purchase of bank premises and equipment	(175)	(179)	(248)
Proceeds from sales of premises and equipment and foreclosed real estate	784	100	121
Net Cash Provided by (Used in) Investing Activities	31,065	(10,940)	(12,606)
CASH FLOWS FROM FINANCING ACTIVITIES
Net (decrease) increase in deposits	(3,532)	2,392	35,594
Deposits sold			(3,606)
Net (decrease) increase in short-term borrowings	(11,515)	7,506	(12,323)
Repayments of other borrowings	(18,106)	(5,000)
Stock options exercised	51	163	517
Tax benefit on stock options exercised	5	34	164
ESOP purchase of shares from treasury stock	153	156	166
Purchase of treasury stock	(602)	(529)	(68)
Cash dividends paid	(3,514)	(3,093)	(2,967)
Net Cash (Used in) Provided by Financing Activities	(37,060)	1,629	17,477
Net Increase (Decrease) in Cash and Cash Equivalents	4,798	(730)	10,875
CASH AND CASH EQUIVALENTS - BEGINNING	16,625	17,355	6,480
CASH AND CASH EQUIVALENTS - ENDING	21,423	16,625	17,355
Supplemental Disclosure of Cash Flow Information
Cash payments for: Income paid to depositors	5,398	6,544	7,916
Cash payments for: Income taxes paid, net of refunds	2,363	2,742	2,441
Supplemental Schedule of Noncash Investing Activities
Investment purchase	1,067
Transfer of loans to foreclosed real estate	3,172	448	210
Merger with North Penn Bancorp, Inc.
Noncash assets acquired: Securities available for sale	12,671
Noncash assets acquired: Restricted investment	985
Noncash assets acquired: Loans	118,336
Noncash assets acquired: Accrued interest receivable	566
Noncash assets acquired: Premises and equipment	2,931
Noncash assets acquired: Core deposit intangibles	895
Noncash assets acquired: Deferred tax assets	2,715
Noncash assets acquired: Other assets	5,403
Noncash assets acquired: Goodwill	9,715
Total Noncash assets acquired	154,217
Liabilities assumed:
Time deposits	51,936
Deposits other than time deposits	83,498
Borrowings	7,776
Accrued interest payable	203
Other liabilities	600
Total Liabilities assumed	144,013
Net Noncash Assets Acquired	10,204
Cash Acquired	$ 15,192

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Consolidated Balance Sheets (parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2011	Dec. 31, 2010
Consolidated Balance Sheets
Held-to-maturity Securities, Fair Value	$ 177	$ 179
Allowance for loan losses	$ 5,458	$ 5,616
Common Stock, Par or Stated Value Per Share	$ 0.1	$ 0.1
Common Stock, Shares Authorized	10,000,000	10,000,000
Common Stock, Shares, Issued	3,371,866	2,840,872
Treasury Stock, Shares	87,370	72,068

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Regulatory Matters and Stockholders' Equity

12 Months Ended

Dec. 31, 2011

Regulatory Matters and Stockholders' Equity

REGULATORY MATTERS AND STOCKHOLDERS' EQUITY

NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY

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

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, 2011 and 2010, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2011, 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, 2011

Total capital (to risk-weighted assets)

$

75,846

16.13

%

$

≥37,611

≥8.00

%

$

≥47,014

≥10.00

%

Tier 1 capital (to risk-weighted assets)

70,381

14.97

≥18,806

≥4.00

≥28,208

≥6.00

Tier 1 capital (to average assets)

70,381

10.74

≥26,215

≥4.00

≥32,769

≥5.00

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

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, 2011 and 2010 was approximately $372,000 and $309,000, respectively.

Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2011, $49,700,000 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.

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Document and Entity Information (USD $) In Millions, except Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Mar. 01, 2012	Jun. 30, 2011
Document and Entity Information
Document Type	10-K
Amendment Flag	false
Document Period End Date	Dec. 31, 2011
Entity Registrant Name	NORWOOD FINANCIAL CORP
Entity Central Index Key	0001013272
Current Fiscal Year End Date	--12-31
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		3,286,120
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	FY
Entity Current Reporting Status	Yes
Entity Public Float			$ 80.5
Entity Voluntary Filers	No
Entity Well-known Seasoned Issuer	Yes

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Stock Option Plans

12 Months Ended

Dec. 31, 2011

Stock Option Plans

STOCK OPTION PLANS

NOTE 11 - 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 29,000 options, which included 4,500 options granted to outside directors in 2011, 28,000 options, which included 4,000 options granted to outside directors in 2010, and 24,000 options, which included 4,000 options granted to outside directors in 2009.

Total unrecognized compensation cost related to nonvested options under the Plan was $130,000 as of December 31, 2011, $165,000 as of December 31, 2010 and $158,000 as of December 31, 2009.  Salaries and employee benefits expense includes $170,000, $163,000 and $134,000 of compensation costs related to options for the years ended December 31, 2011, 2010 and 2009, respectively. Net income was reduced by $163,000, $153,000 and $127,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

A summary of the Company's stock option activity and related information for the years ended December 

31 follows:

				2011							2010							2009
				Weighted							Weighted							Weighted
				Average							Average							Average
				Exercise		Intrinsic					Exercise		Intrinsic					Exercise		Intrinsic
	Options			Price		Value		Options			Price		Value		Options			Price		Value
Outstanding,   beginning of year		189,639		$	28.52				170,915		$	28.07				176,443		$	25.78
Granted		29,000			27.43				28,000			27.74				27,000			28.60
Exercised		(2,575	)		19.69				(9,276	)		17.68				(32,528	)		15.83
Forfeited		(6,150	)		30.25				—			—				—			—
Outstanding,    end of year		209,914		$	28.43	$	113,352		189,639			28.52	$	146,361	$	170,915			28.07	$	286,464
Exercisable,    end of year		180,914		$	28.59	$	112,152		161,639			28.66		145,471		146,915		$	27.98	$	259,461

Exercise prices for options outstanding as of December 31, 2011 ranged from $19.05 to $31.50 per share. The weighted average remaining contractual life is 6.3 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,
	2011			2010			2009
Dividend yield		3.30	%		3.04	%		2.89	%
Expected life	7 years			7 years			7 years
Expected volatility		25.35	%		27.18	%		27.39	%
Risk-free interest rate		1.39	%		2.72	%		3.11	%
Weighted average fair value of options granted	$	4.70		$	6.12		$	6.77

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 $51,000 in 2011. 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 2011, all the shares issued in connection with stock option exercises, 2,575 shares in total, were issued from available treasury shares.

As of December 31, 2011, outstanding stock options consist of the following:

	Options Outstanding		Average Exercise Price		Remaining Life, Years		Options Exercisable		Average Exercise Price
		6,298	$	19.05		1.0		6,298	$	19.05
		16,616		23.95		2.0		16,616		23.95
		18,900		30.00		3.0		18,900		30.00
		23,100		30.38		4.3		23,100		30.38
		21,000		31.50		5.0		21,000		31.50
		21,000		31.25		6.0		21,000		31.25
		23,000		27.50		7.0		23,000		27.50
		1,000		28.90		7.3		1,000		28.90
		22,500		28.59		8.0		22,500		28.59
		1,000		26.88		8.2		1,000		26.88
		26,500		27.77		9.0		26,500		27.77
		1,000		26.27		9.5		—		—
		28,000		27.47		10.0		—		—
Total		209,914	$	28.43		6.3		180,914	$	28.59

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Consolidated Statements of Income (USD $) In Thousands, except Per Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
INTEREST INCOME
Loans receivable, including fees	$ 23,289	$ 21,101	$ 21,523
Securities: Taxable	2,527	2,969	4,131
Securities: Tax exempt	1,901	1,560	1,162
Other	53	57	19
Total Interest Income	27,770	25,687	26,835
INTEREST EXPENSE
Deposits	3,851	4,283	5,765
Short-term borrowings	92	117	292
Other borrowings	1,239	1,623	1,669
Total Interest Expense	5,182	6,023	7,726
Net Interest Income	22,588	19,664	19,109
PROVISION FOR LOAN LOSSES	1,575	1,000	1,685
Net Interest Income after Provision for Loan Losses	21,013	18,664	17,424
OTHER INCOME
Service charges and fees	2,255	2,231	2,476
Income from fiduciary activities	409	405	354
Net realized gains (losses) on sales of securities	973	448	463
Gains on sale of loans and servicing rights	271	307	481
Earnings on life insurance policies	463	391	1,196
Gains on sale of deposits			150
Other	364	282	272
Total Other Income	4,735	4,064	5,392
OTHER EXPENSES
Salaries and employee benefits	7,848	6,507	6,829
Occupancy	1,402	1,136	1,133
Furniture and equipment	435	424	458
Data processing related operations	855	803	788
Federal Deposit Insurance Corporation insurance assessment	393	474	710
Advertising	205	187	186
Professional fees	1,283	650	411
Postage and telephone	510	484	487
Taxes, other than income	535	524	484
Foreclosed real estate owned	578	41	436
Amortization of intangible assets	108	52	52
Other	1,661	1,471	1,497
Total Other Expenses	15,813	12,753	13,471
Income before Income Taxes	9,935	9,975	9,345
INCOME TAX EXPENSE	2,579	2,662	2,282
Net Income	$ 7,356	$ 7,313	$ 7,063
EARNINGS PER SHARE
Basic	$ 2.39	$ 2.65	$ 2.57
Diluted	$ 2.39	$ 2.64	$ 2.55

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Premises and Equipment

12 Months Ended

Dec. 31, 2011

Premises and Equipment

PREMISES AND EQUIPMENT

NOTE 5 - PREMISES AND EQUIPMENT

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

	2011			2010
	(In Thousands)
Land and improvements	$	2,228		$	925
Buildings and improvements		9,244			7,975
Furniture and equipment		3,801			5,253
		15,273			14,153
Accumulated depreciation		(7,794	)		(9,249	)
	$	7,479		$	4,904

Depreciation expense totaled $531,000, $459,000 and $546,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

Certain facilities are leased under various operating leases. Rental expense for these leases was $299,000, $254,000 and $284,000, respectively, for the years ended December 31, 2011, 2010 and 2009. Future minimum rental commitments under noncancellable leases as of December 31, 2011 were as follows (in thousands):

2012	$	312
2013		314
2014		306
2015		303
2016		233
Thereafter		2,036
	$	3,504

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Loans Receivable and Allowance for Loan Losses

12 Months Ended

Dec. 31, 2011

Loans Receivable and Allowance for Loan Losses

LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Included in the 2011 balances are loans acquired from North Penn, as of the acquisition date, as follows

(in thousands):

Real Estate
Residential	$	36,221
Commercial		70,789
Construction		358
Commercial		10,499
Consumer		1,831
Total loans	$	119,698

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

	2011					2010
	(In Thousands)
Real Estate:
Residential	$	148,148		32.3	%	$	124,562		34.9	%
Commercial		262,476		57.3			184,094		51.5
Construction		11,087		2.4			12,638		3.5
Commercial		22,684		5.0			22,386		6.3
Consumer		13,934		3.0			13,668		3.8
Total Loans		458,329		100.0	%		357,348		100.0	%
Deferred fees, net		(422	)				(493	)
Allowance for loan losses		(5,458	)				5,616
Loans receivable, net	$	452,449				$	351,239

Purchased loans acquired in a business combination are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality.  Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the "acquisition date") and December 31, 2011.  The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $1.3 million at December 31, 2011.

On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the North Penn acquisition was $1.9 million and the estimated fair value of the loans was $1.5 million. Total contractually required payments on these loans, including interest, at the acquisition date was $3.6 million. However, the Company's preliminary estimate of expected cash flows was $1.9 million. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $1.7 million relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $329,000 on the acquisition date relating to these impaired loans.

The carrying value of the loans acquired and accounted for in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, was determined by projecting discounted contractual cash flows. The table below presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired in the North Penn acquisition as of May 31, 2011:

(In thousands)
Unpaid principal balance	$	1,936
Interest		1,669
Contractual cash flows		3,605
Non-accretable discount		(1,724	)
Expected cash flows		1,881
Accretable discount		( 329	)
Estimated fair value	$	1,552

Changes in the accretable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31, 2011:

(In thousands)
Balance at beginning of period	$	329
Accretion		(67	)
Reclassification and other		(91	)
Balance at end of period	$	171

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

	May 31, 2011		December 31, 2011
	Acquired Loans with Specific Evidence of Deterioration in Credit Quality (ASC 310-30)		Acquired Loans with Specific Evidence of Deterioration in Credit Quality (ASC 310-30)
Outstanding Balance	$	1,936	$	1,412
Carrying Amount	$	1,552	$	1,241

       There has been no allowance for loan losses recorded for acquired loans with or without specific evidence of deterioration in credit quality as of May 31, 2011 as well as those acquired without specific evidence of deterioration in credit quality as of December 31, 2011.  In addition, there has been no allowance for loan losses reversed.

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

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

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

	Real Estate Loans
								Commercial		Consumer
	Residential		Commercial			Construction		Loans		Loans		Total
December 31, 2011						(In thousands)
Individually evaluated for impairment	$	-	$	11,786		$	-	$	598	$	-	$	12,384
Loans acquired with deteriorated credit quality		343		903			-		-		-		1,246
Collectively evaluated for impairment		147,805		249,787			11,087		22,086		13,934		444,699
Total Loans	$	148,148	$	262,476		$	11,087	$	22,684	$	13,934	$	458,329
	Real Estate Loans
								Commercial		Consumer
	Residential		Commercial		Construction			Loans		Loans		Total
December 31, 2010						(In thousands)
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
Total Loans	$	124,562	$	184,094		$	12,638	$	22,386	$	13,668	$	357,348

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

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

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

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.  As of December 31, 2011, troubled debt restructured loans totaled $7.2 million and resulted in specific reserves of $1.2 million.  During 2011, there were no new loans identified as troubled debt restructurings.  As of December 31, 2010, troubled debt restructured loans totaled $7.6 million and resulted in specific reserves of $1.5 million.  During 2011, there were no loan modifications classified as troubled debt restructurings.

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

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event.  The Company's Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis.  Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration.  Loan Review also annually reviews relationships of $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, 2011 and December 31, 2010 (in thousands):

	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2011
Commercial real estate loans	$	237,407	$	11,009	$	14,060	$	-	$	-	$	262,476
Commercial loans		21,598		427		659		-		-		22,684
Total	$	259,005	$	11,436	$	14,719	$	-	$	-	$	285,160

	Pass		Special 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, 2011 and December 31, 2010 (in thousands):

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

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

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, 2011 and December 31, 2010 (in thousands):

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2011
Real Estate loans
Residential	$	143,550	$	160	$	1,351	$	-	$	3,087	$	4,598	$	148,148
Construction		10,532		-		555		-		-		555		11,087
Commercial		255,613		1,015		1,524		-		4,324		6,863		262,476
Commercial  loans		22,086		194		-		-		404		598		22,684
Consumer  loans		13,835		89		10		-		-		99		13,934
Total	$	445,616	$	1,458	$	3,440	$	-	$	7,815	$	12,713	$	458,329
	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2010
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,
	2011			2010			2009
	(In Thousands)
Allowance balance at beginning of period	$	5,616		$	5,453		$	4,233
Charge-offs:
Commercial		(2	)		(85	)		(17	)
Real Estate		(1,735	)		(699	)		(358	)
Consumer		(109	)		(82	)		(139	)
Total		(1,846	)		(866	)		(514	)
Recoveries:
Commercial		5			—			11
Real Estate		51			2			4
Consumer		57			27			34
Total		113			29			49
Provision expense		1,575			1,000			1,685
Allowance balance at end of period	$	5,458		$	5,616		$	5,453

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

(in thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial			Consumer			Total
Beginning balance, December 31, 2010	$	1,167		$	3,976		$	110		$	171		$	192		$	5,616
Charge Offs		(482	)		(1,253	)		-			(2	)		(109	)		(1,846	)
Recoveries		44			7			-			5			57			113
Provision Expense		528			1,108			(38	)		(27	)		4			1,575
Ending balance, December 31, 2011	$	1,257		$	3,838		$	72		$	147		$	144		$	5,458
Ending balance individually   evaluated for impairment	$	-		$	1,231		$	-		$	-		$	-		$	1,322
Ending balance collectively   evaluated for impairment	$	1,257		$	2,607		$	72		$	147		$	144		$	4,227

	Residential Real Estate		Commercial 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

The recorded investment in impaired loans, not requiring an allowance for loan losses was $6,807,000 (net of charge-offs against the allowance for loan losses of $698,000) and $6,111,000 (net of charge-offs against the allowance for loan losses of $220,000) at December 31, 2011 and 2010, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $6,823,000 (net of a charge-off against the allowance for loan losses of $0) and $8,641,000 (net of a charge-off against the allowance for loan losses of $480,000) at December 31, 2011 and 2010, respectively. The specific reserve related to impaired loans was $1,231,000 for 2011 and $1,648,000 for 2010. For the years ended December 31, 2011, 2010 and 2009, the average recorded investment in these impaired loans was $15,783,000, $10,096,000 and $3,585,000 and the interest income recognized on these impaired loans was $561,000, $385,000 and $139,000, respectively.

Loans on which the accrual of interest has been discontinued amounted to $7,815,000 and $4,040,000 at December 31, 2011 and 2010, 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 $0 and $39,000 at December 31, 2011 and 2010, 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 $535,000, $339,000 and $188,000 for 2011, 2010 and 2009, respectively.

The Company's primary business activity is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region's economy. The Company does not have any significant concentrations to any one customer.

As of December 31, 2011 and 2010, the Company considered its concentration of credit risk to be acceptable.  The two highest concentrations are in the hospitality lodging industry and builders/contractors, with loans outstanding of $44.8 million, or 51.2% of bank capital, to the hospitality lodging industry and $12.9 million, or 14.9% of bank capital to builders/contractors.  In 2011, the Company recorded a charge-off of $948,000 on one motel loan that was considered impaired and subsequently obtained possession of the property and transferred the loan to foreclosed real estate.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $241,000 and $21,000, respectively, in 2011 compared to $247,000 and $13,000, respectively, in 2010 and $309,000 and $6,000, respectively, in 2009.  The proceeds from the sales of residential mortgage loans totaled $8.9 million, $12.8 million and $21.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.

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Norwood Financial Corp (Parent Company Only) Financial Information

12 Months Ended

Dec. 31, 2011

Norwood Financial Corp (Parent Company Only) Financial Information

NORWOOD FINANCIAL CORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION

NOTE 16 - NORWOOD FINANCIAL CORP (PARENT COMPANY ONLY) FINANCIAL INFORMATION

BALANCE SHEETS
				December 31,
				2011			2010
				(In Thousands)
ASSETS
Cash on deposit in bank subsidiary				$	1,230		$	346
Securities available for sale					238			212
Investment in bank subsidiary					84,187			66,163
Other assets					3,434			1,812
				$	89,089		$	68,533
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities				$	1,028		$	835
Stockholders' equity					88,061			67,698
				$	89,089		$	68,533
STATEMENTS OF INCOME
	Years Ended December 31,
	2011			2010			2009
	(In Thousands)
Income:
Dividends from bank subsidiary	$	16,496		$	3,120		$	3,005
Other interest income		9			17			19
Net realized gain (loss) on sales of securities		—			66			(134	)
		16,505			3,203			2,890
Expenses		980			323			176
		15,525			2,880			2,714
Income tax benefit		(290	)		(82	)		(99	)
		15,815			2,962			2,813
Equity in undistributed earnings of subsidiary		(8,459	)		4,351			4,250
Net Income	$	7,356		$	7,313		$	7,063
STATEMENTS OF CASH FLOWS
	Years Ended December 31,
		2011		2010			2009
	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	7,356		$	7,313		$	7,063
Adjustments to reconcile net income to    net cash provided by operating activities:
Undistributed earnings of bank subsidiary		8,459			(4,351	)		(4,250	)
Net (gains) losses on sales of securities		-			(66	)		134
Other, net		(506	)		(144	)		(300	)
Net Cash Provided by Operating Activities		15,309			2,752			2,647
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities		—			166			22
Outlays for business acquisitions		(10,518	)		—			—
Net Cash Provided by Investing Activities		(10,518	)		166			22
CASH FLOWS FROM FINANCING ACTIVITIES
Stock options exercised		51			163			517
Tax benefit of stock options exercised		5			34			164
ESOP purchase of shares from treasury stock		153			156			166
Acquisition of treasury stock		(602	)		(529	)		(68	)
Cash dividends paid		(3,514	)		(3,093	)		(2,967	)
Net Cash Used in Financing Activities		(3,907	)		(3,269	)		(2,188	)
Net Increase (Decrease) in Cash and Cash Equivalents		884			(351	)		481
CASH AND CASH EQUIVALENTS - BEGINNING		346			697			216
CASH AND CASH EQUIVALENTS - ENDING	$	1,230		$	346		$	697

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Earnings Per Share

12 Months Ended

Dec. 31, 2011

Earnings Per Share

EARNINGS PER SHARE

NOTE 12 - EARNINGS PER SHARE

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

	Years Ended December 31,
	2011		2010		2009
	(In Thousands, Except per Share Data)
Numerator, net income	$	7,356	$	7,313	$	7,063
Denominator:
Denominator for basic earnings per share,  weighted average shares		3,073		2,762		2,750
Effect of dilutive securities, employee  stock options		3		4		16
Denominator for diluted earnings per share,  adjusted weighted average shares and  assumed conversions		3,076		2,766		2,766
Basic earnings per common share	$	2.39	$	2.65	$	2.57
Diluted earnings per common share	$	2.39	$	2.64	$	2.55

Stock options which had no intrinsic value because their effect would be anti-dilutive and therefore would not be included in the diluted EPScalculation were 157,000, 140,150, and 109,821 for the years ended December 31, 2011, 2010 and 2009, respectively.

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Employee Benefit Plans

12 Months Ended

Dec. 31, 2011

Employee Benefit Plans

EMPLOYEE BENEFIT PLANS

NOTE 8 - EMPLOYEE BENEFIT PLANS

The Company has a defined contributory profit-sharing plan which includes provisions of a 401(k) plan. The plan permits employees to make pre-tax contributions up to 15% of the employee's compensation. The amount of contributions to the plan, including matching contributions, is at the discretion of the Board of Directors. All employees over the age of 21 are eligible to participate in the plan after one year of employment. Employee contributions are vested at all times, and any Company contributions are fully vested after five years. The Company's contributions are expensed as the cost is incurred, funded currently, and amounted to $398,000, $342,000 and $373,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

The Company has a non-qualified supplemental executive retirement plan for the benefit of certain executive officers. At December 31, 2011 and 2010, other liabilities include $1,472,000 and $1,445,000 accrued under the Plan.

Compensation expense includes approximately $116,000, $115,000 and $360,000 relating to the supplemental executive retirement plan for 2011, 2010 and 2009, 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, 2011 and 2010, the cash value of these policies was $11,887,000 and $8,249,000, respectively.

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

The net periodic post retirement benefit expense included in salaries and employee benefits was $44,000 and $135,000 for the years ended December 31, 2011 and 2010, respectively.

The Company participates in the Pentegra Mulitemployer Defined Benefit Pension Plan as a result of its acquisition of North Penn.  As of December 31, 2011, the Company's Plan was 90.00% funded, and total contributions made are not more than 5% of the total contributions to the Plan.  The Company's expense related to the Plan was $6,000 in 2011.

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Deposits

12 Months Ended

Dec. 31, 2011

Deposits

DEPOSITS

NOTE 6 - DEPOSITS

Aggregate time deposits in denominations of $100,000 or more were $80,554,000 and $60,015,000 at December 31, 2011 and 2010, respectively.

At December 31, 2011, the scheduled maturities of time deposits are as follows (in thousands):

2012	$	123,805
2013		44,394
2014		23,734
2015		17,461
2016		12,380
	$	221,774

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Borrowings

12 Months Ended

Dec. 31, 2011

Borrowings

BORROWINGS

NOTE 7 - BORROWINGS

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

	2011		2010
	(In Thousands)
Securities sold under agreements to repurchase	$	21,794	$	33,110
U.S. Treasury demand notes		-		199
	$	21,794	$	33,309

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

	Years Ended December 31,
	2011			2010
	(Dollars In Thousands)
Average balance during the year	$	28,521		$	26,100
Average interest rate during the year		.32	%		.45	%
Maximum month-end balance during the year	$	32,637		$	40,068
Weighted average interest rate at the end of the year		.25	%		.37	%

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 $25,505,000 and $26,003,000 at December 31, 2011 and $34,502,000 and $34,494,000 at December 31, 2010 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 $0 and $199,000 at December 31, 2011 and 2010, respectively.

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 2016. There were no borrowings under this line at December 31, 2011 and 2010. The Company has a line of credit commitment available from Atlantic Central Bankers Bank for $7,000,000 which expires on June 30, 2012.  There were no borrowings under this line of credit at December 31, 2011 and 2010. 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, 2011 and December 31, 2010.

Other borrowings consisted of the following at December 31, 2011 and 2010:

	2011		2010
	(In Thousands)
Notes with the FHLB:
Fixed rate note due January 2011 at 5.24%	$	—	$	3,000
Convertible note due August 2011 at 2.69%		—		10,000
Convertible note due September 2011 at 4.06%		—		5,000
Fixed rate 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 July 2015 at 4.34%		7,670		—
Convertible note due January 2017 at 4.71%		10,000		10,000
	$	27,670	$	38,000

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 16 to 22 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, 2011 are as follows (in thousands):

2012		5,000
2013		5,000
2014		—
2015		7,670
Thereafter		10,000
	$	27,670

The Bank's maximum borrowing capacity with the FHLB was $222,721,000 of which $27,670,000 was outstanding at December 31, 2011. Advances from the FHLB are secured by qualifying assets of the Bank.

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Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

INCOME TAXES

NOTE 9 - INCOME TAXES

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

	Years Ended December 31,
	2011			2010			2009
	(In Thousands)
Current	$	2,683		$	2,867		$	3,031
Deferred		(104	)		(205	)		(749	)
	$	2,579		$	2,662		$	2,282

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

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

	Percentage of Income
	before Income Taxes
	Years Ended December 31,
	2011			2010			2009
Tax at statutory rates		34.0	%		34.0	%		34.0	%
Tax exempt interest income, net of interest expense disallowance		(7.5	)		(6.2	)		(5.0	)
Incentive stock options		0.5			0.5			0.4
Earnings on life insurance		(1.2	)		(1.1	)		(4.1	)
Other		0.2			(0.5	)		(0.9	)
		26.0	%		26.7	%		24.4	%

The income tax provision includes $331,000, $152,000 and $157,000 of income taxes relating to realized securities gains for the years ended December 31, 2011, 2010 and 2009, respectively.

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

	2011		2010
	(In Thousands)
Deferred tax assets:
Allowance for loan losses	$	1,787	$	1,789
Deferred compensation		501		491
Purchase price adjustment		1,581		5
Other		277		191
Foreclosed real estate		183		123
Net operating loss carry forward		263		—
Total Deferred Tax Assets		4,592		2,599
Deferred tax liabilities:
Premises and equipment		282		276
Deferred loan fees		264		225
Net unrealized gains on securities		1,716		591
Total Deferred Tax Liabilities		2,262		1,092
Net Deferred Tax Asset	$	2,330	$	1,507

No valuation allowance was established at December 31, 2011 and 2010, 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 in the provision for income taxes in the Consolidated Statement of Income.

The Company recorded a deferred tax asset in the amount of $263,000 in 2011 related to a net operating loss carry forward resulting from its acquisition of North Penn Bancorp, Inc.  The carry forward will expire in 2030 but it is expected that the Company will realize the tax benefit before expiration based on the Company's earning potential. The Company's federal and state income tax returns for taxable years through 2007 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue.

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Fair Values of Financial Instruments

12 Months Ended

Dec. 31, 2011

Fair Values of Financial Instruments

FAIR VALUES OF FINANCIAL INSTRUMENTS

NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS

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

The 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 orindirectly, 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 valuemeasurement 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.

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, 2011 and 2010 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, 2011
Available for Sale:
U.S. Government agencies	$	13,398	$	—	$	13,398	$	—
States and political subdivisions		56,746		—		56,746		—
Corporate obligations		8,809		—		8,809		—
Mortgage-backed securities -
government sponsored entities		70,965		—		70,965		—
Equity securities - financial services		345		345		—		—
Total available for sale	$	150,263	$	345	$	149,918	$	—
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	$	—

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, 2011 and 2010 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, 2011
Impaired Loans	$	12,399	$	—	$	—	$	12,399
Foreclosed real estate owned		2,910		—		—		2,910
	$	15,309	$	—	$	—	$	15,309
December 31, 2010
Impaired Loans	$	13,104	$	—	$	7,038	$	6,066
Foreclosed real estate owned		748		—		748		—
	$	13,852	$	—	$	7,786	$	6,066

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, 2011 and 2010.

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.

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, 2011, the fair value investment in impaired loans totaled $12,399,000 which included two loans for $6,823,000 for which a valuation allowance had been provided based on the estimated value of the collateral or the present value of estimated cash flows, and twenty loans for $6,807,000 which did not require a valuation allowance since the estimated realizable value of the collateral exceeded the recorded investment in the loan.  As of December 31, 2011, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $698,000 over the life of the loans.

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.

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 3 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.

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

Management evaluates the restricted stock for impairment. Management's determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary 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, 2011.

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, 2011 and December 31, 2010.

	December 31, 2011				December 31, 2010
	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	$	21,423	$	21,423	$	16,625	$	16,625
Securities		150,434		150,440		145,985		145,994
Loans receivable, net		452,449		463,118		351,239		358,873
Mortgage servicing rights		302		308		250		274
Investment in FHLB stock		3,593		3,593		3,361		3,361
Bank owned life insurance		11,887		11,887		8,249		8,249
Accrued interest receivable		2,468		2,468		2,166		2,166
Financial liabilities:
Deposits		525,767		527,707		393,865		395,157
Short-term borrowings		21,794		21,794		33,309		33,309
Other borrowings		27,670		30,002		38,000		40,413
Accrued interest payable		1,321		1,321		1,536		1,536
Off-balance sheet financial instruments:
Commitments to extend credit and outstanding letters of credit		—		—		—		—

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Consolidated Statements of Changes in Stockholders' Equity (USD $) In Thousands, except Share data, unless otherwise specified	Common Stock [Member]	Surplus [Member]	Retained Earnings [Member]	Treasury [Member]	Accumulated Other Comprehensive Income (Loss) [Member]	Total
Balance, at Dec. 31, 2008	$ 284	$ 9,972	$ 50,398	$ (3,243)	$ 1,279	$ 58,690
Shares, Issued, Beginning Balance at Dec. 31, 2008	2,840,872			104,310
Comprehensive income:
Net income			7,063			7,063
Change in unrealized gains (losses) on securities available for sale, net of reclassification adjustments and tax effects					811	811
Total Comprehensive Income						7,874
Cash dividends declared			(3,006)			(3,006)
Acquisition of treasury stock				(68)		(68)
Acquisition of treasury stock, shares				2,519
Stock options exercised		(492)		1,009		517
Stock options exercised, shares				(32,528)
Tax benefit on stock options exercised		164				164
Sale of treasury stock for ESOP		(14)		180		166
Sale of treasury stock for ESOP, shares				(5,865)
Compensation expense related to stock options		134				134
Balance, at Dec. 31, 2009	284	9,764	54,455	(2,122)	2,090	64,471
Shares, Issued, Ending Balance at Dec. 31, 2009	2,840,872			68,436
Comprehensive income:
Net income			7,313			7,313
Change in unrealized gains (losses) on securities available for sale, net of reclassification adjustments and tax effects					(953)	(953)
Total Comprehensive Income						6,360
Cash dividends declared			(3,120)			(3,120)
Acquisition of treasury stock				(529)		(529)
Acquisition of treasury stock, shares				18,571
Stock options exercised		(120)		283		163
Stock options exercised, shares				(9,276)
Tax benefit on stock options exercised		34				34
Sale of treasury stock for ESOP		(15)		171		156
Sale of treasury stock for ESOP, shares				(5,663)
Compensation expense related to stock options		163				163
Balance, at Dec. 31, 2010	284	9,826	58,648	(2,197)	1,137	67,698
Shares, Issued, Ending Balance at Dec. 31, 2010	2,840,872			72,068
Comprehensive income:
Net income			7,356			7,356
Change in unrealized gains (losses) on securities available for sale, net of reclassification adjustments and tax effects					2,178	2,178
Total Comprehensive Income						9,534
Cash dividends declared			(3,696)			(3,696)
Acquisition of treasury stock				(602)		(602)
Acquisition of treasury stock, shares				23,431
Stock options exercised		(26)		77		51
Stock options exercised, shares				(2,576)
Tax benefit on stock options exercised		5				5
Sale of treasury stock for ESOP		(10)		163		153
Sale of treasury stock for ESOP, shares				(5,553)
Compensation expense related to stock options		170				170
North Penn acquisition	53	14,695				14,748
North Penn acquisition, shares	530,994
Balance, at Dec. 31, 2011	$ 337	$ 24,660	$ 62,308	$ (2,559)	$ 3,315	$ 88,061
Shares, Issued, Ending Balance at Dec. 31, 2011	3,371,866			87,370

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Securities

12 Months Ended

Dec. 31, 2011

Securities

SECURITIES

NOTE 3 - SECURITIES

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

	December 31, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
AVAILABLE FOR SALE:
U.S. Government agencies	$	13,268	$	130	$	—		$	13,398
States and political subdivisions		54,106		2,640		—			56,746
Corporate obligations		8,733		130		(54	)		8,809
Mortgage-backed securities -
government sponsored entities		68,886		2,081		(2	)		70,965
Equity securities - financial services		239		109		(3	)		345
	$	145,232	$	5,090	$	(59	)	$	150,263
HELD TO MATURITY:
States and political subdivisions	$	171	$	6	$	—		$	177

	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

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

	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	)

The Company has 10 securities in the less than twelve month category and 1 security in the twelve months or more category as of December 31, 2011 compared to 61 securities in the less than twelve month category and no securities greater than twelve months as of December 31, 2010. In management's opinion, the unrealized losses on debt securities reflect changes in interest rates subsequent to the acquisition of specific securities.  The Company holds a small amount of equity securities in other financial institutions. No other-than-temporary-impairment charges were recorded in 2011.  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, 2011 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(In Thousands)
Due in one year or less	$	1,977	$	1,984	$	—	$	—
Due after one year through five years		22,573		22,899		171		177
Due after five years through ten years		19,375		20,357		—		—
Due after ten years		32,182		33,713		—		—
		76,107		78,953		171		177
Mortgage-backed securities -
government sponsored entities		68,886		70,965		—		—
	$	144,993	$	149,918	$	171	$	177

Gross realized gains and gross realized losses on sales of securities available for sale were $983,000 and $10,000, respectively, in 2011, compared to $450,000 and $2,000, respectively, in 2010, and $597,000 and $134,000, respectively, in 2009. The proceeds from the sales of securities totaled $32,146,000, $23,944,000 and $15,449,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

Securities with a carrying value of $71,245,000 and $71,412,000 at December 31, 2011 and 2010, 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.

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Off-Balance Sheet Financial Instruments

12 Months Ended

Dec. 31, 2011

Off-Balance Sheet Financial Instruments

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

NOTE 13 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

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

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

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

	December 31,
	2011		2010
	(In Thousands)
Unfunded availability under loan commitments	$	43,081	$	21,448
Unfunded commitments under lines of credit		29,255		30,311
Standby letters of credit		11,892		3,605
	$	84,228	$	55,364

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.