EX-13 2 ex-13.htm 2017 ANNUAL REPORT
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 

   
 
2017 CONSOLIDATED FINANCIAL REPORT
 
 
Management's Discussion & Analisis
10
Management's Report On Internal Control Over Financial Reporting
30
Reports Of  Independent Registered Public Accounting Firm
31
Consolidated Balance Sheets
33
Consolidated Statements Of Income
34
Consolidated Statements Of Comprehensive Income
35
Consolidated Statements Of  Stockholders' Equity
36
Consolidated Statements Of Cash Flows
37
Notes To Consolidated Financial Statements
39
Investor Information
89





NORWOOD FINANICAL CORP - 2017 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, 2017 and 2016, and for the years ended December 31, 2017, 2016, and 2015. 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 Delaware Bancshares, Inc., the ability to control costs and expenses, demand for real estate, government fiscal policies, cybersecurity and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

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

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the determination of other-than-temporary impairment on securities, the determination of goodwill impairment and the fair value of financial instruments. Please refer to the discussion of the allowance for loan losses calculation under "Allowance for Loan Losses and Non-performing Assets" 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. Prior to the enactment of the Tax Cuts and Jobs Act (the "Act") on December 22, 2017, the Company had a net deferred tax asset totaling $7.6 million, based on the pre-Act federal tax rate of 35%.  As a result of the Act's reduction in the corporate income tax rate to 21%, the Company revalued its net deferred tax asset as of December 31, 2017, which resulted in a $3,060,000 reduction in its value.  The reduction in the value of the net deferred tax asset has been recorded as additional income tax expense in 2017.

In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost and 2) the financial condition of the issuer. The Company does not have the intent to sell these securities and it is more likely than not that it will not sell the securities before recovery of their cost basis. The Company believes that any unrealized losses at December 31, 2017 and 2016 represent temporary impairment of the securities.
10
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

The fair value of financial instruments is based upon quoted market prices, when available.  For those instances where a quoted price is not available, fair values are based upon observable market based parameters as well as unobservable parameters.  Any such valuation is applied consistently over time.
 
In connection with the acquisition of North Penn Bancorp, Inc. in 2011, we recorded goodwill in the amount of $9.7 million, representing the excess of amounts paid over the fair value of the net assets of the institution acquired at the date of acquisition.  In connection with the acquisition of Delaware Bancshares, Inc. in 2016, we recorded goodwill in the amount of $1.6 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 annually 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, 2017 was $8,198,000 which was $1,487,000 higher than the $6,711,000 earned in 2016.  On December 22, 2017, the President signed the Tax Cut and Jobs Act (the "Act") into law.  Among other things, the Act reduced the corporate tax rate from a maximum of 35% to a flat 21% rate effective January 1, 2018.  Prior to December 22, 2017, the Company had a net deferred tax asset totaling $7.6 million, based on the pre-Act federal tax rate of 35%.  As a result of the reduction in the corporate income tax rate to 21%, the Company revalued its net deferred tax asset as of December 31, 2017, which resulted in a $3,060,000 reduction in its value.  The reduction in the value of the net deferred tax asset has been recorded as additional income tax expense in 2017.  The Company's core operating results (which excludes the non-recurring tax expense related to the revaluation of the deferred tax asset) increased $4,547,000 to $11,258,000.  Earnings per share on a fully diluted basis were $1.31 for 2017 ($1.80 core operating results per diluted share) compared to $1.15 in 2016, after adjusting for the 50% stock dividend declared in 2017.  The return on average assets for the year was 0.73% with a return on average equity of 7.04% compared to 0.74% and 6.17%, respectively, in 2016.  Core operating results reflected a return on average assets of 1.02% for 2017 and a return on average equity of 10.39%.  Net interest income increased $6,318,000 and other income improved $1,732,000 to offset the $1,746,000 increase in other expenses and the $4,667,000 increase in income tax expense.

Net interest income (fully taxable equivalent, or fte) totaled $37,090,000 which was an increase of $6,751,000 from the 2016 total.  Average loans outstanding increased $110.9 million in 2017 which resulted in an increase in fte interest income of $5,011,000.  The increase in average loan balances was impacted by growth and the $112.1 million of loans acquired from Delaware in 2016.  Total average securities increased $91.5 million in 2017 due primarily to the Delaware acquisition which contributed to a $2,160,000 increase in fte interest income.  Average interest-bearing deposits with banks were $4.7 million in 2017 and interest income in this area increased $6,000.  Average interest-bearing deposits increased $160.6 million due primarily to the acquisition and resulted in a $774,000 increase in interest expense.  The cost of borrowed funds decreased $348,000 compared to the prior year due primarily to a $5.2 million decrease in average long-term borrowings and a 79 basis point decrease in the cost of the borrowings resulting from the maturity of higher costing borrowings.  The resulting fte net interest spread decreased 2 basis points to 3.44% in 2017 as an 8 basis point reduction in the yield earned was only partially offset by a 6 basis point decrease in the cost of funds.

Loans receivable increased $50.2 million from the prior year-end.  Loan growth included a $34.7 million increase in commercial loans due primarily to a $22.7 million increase in commercial real estate loans.  Retail loans increased $15.5 million in 2017 due to a $19.4 million increase in indirect auto and marine financing.  Residential mortgage loans and construction loans decreased $3.9 million.  Total non-performing loans increased from $1.9 million and 0.27% of total loans at the end of 2016 to $2.5 million, or 0.32% of total loans on December 31, 2017.  Net charge-offs totaled $1,029,000 in 2017 which was a decrease from the $2,885,000 recorded in 2016.  Based on management's analysis, the Company determined that it would be appropriate to allocate $2,200,000 to the
 
 
11
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

allowance for loan losses in 2017 which resulted in an increase in the ratio of the allowance for loan losses to total loans outstanding to 1.00% compared to 0.91% on December 31, 2016.  The allowance for loan losses represented 308% of total non-performing loans on December 31, 2017 compared to 335% as of December 31, 2016.

Other income for the year ended December 31, 2017 totaled $6,911,000 compared to $5,179,000 in the prior year, an increase of $1,732,000.  Gains on the sale of loans and investment securities increased $77,000 in the aggregate, while all other items of other income increased $1,655,000, net. Service charges and fees collected from the expanded customer base contributed to this increase.
 
Other expenses were $24,870,000 in 2017 compared to $23,124,000 for the similar period in 2016, an increase of $1,746,000.  Salaries and benefits costs increased $1,922,000 in 2017, while occupancy and furniture and equipment costs increased $736,000 due to costs related to the operation of twelve new Community Offices.  Foreclosed real estate expense increased $484,000 in 2017, while all other operating expenses decreased $1,396,000, net. Included in the decreased expenses are $1.8 million of merger related expenses recognized in 2016.  Income tax expense for the year totaled $6,551,000 which was an increase of $4,667,000 from the prior year.  The increase includes a non-recurring charge of $3,060,000 related to the revaluation of deferred tax assets.  The effective tax rate in 2017 was 44.4% compared to 21.9% in 2016.  Excluding the revaluation charge, the effective tax rate in 2017 would have been 23.7%.
 
The following table sets forth changes in net income (in thousands):
     
     
Net income 2016
$
 6,711
Net interest income
  
 6,318
Provision for loan losses
  
 (150)
Net gains on sales of loans and securities
  
 77
Other income
  
 1,655
Salaries and employee benefits
  
 (1,922)
Occupancy, furniture and equipment
  
 (736)
Foreclosed real estate owned
  
 (484)
Merger related
  
 1,806
Other expenses
  
 (410)
Income tax expense - ordinary income
  
 (1,607)
Income tax expense - net deferred tax asset revaluation
  
 (3,060)
Net income for 2017
$
 8,198


Net income for the Company for the year ended December 31, 2016 was $6,711,000 which was $803,000 higher than the $5,908,000 earned in 2015.  Basic and diluted earnings per share were $1.16 and $1.15, respectively, in 2016 after adjusting for the 50% stock dividend declared in 2017, compared to the adjusted $1.07 per share for basic and diluted in 2015.  The return on average assets (ROA) for the year ended December 31, 2016 was 0.74% and the return on average equity (ROE) was 6.17% compared to an ROA of 0.80% and an ROE of 5.83% in the prior year.  The improvement in earnings over the prior year was the result of the benefits realized from the acquisition of Delaware on July 31, 2016.  Net interest income increased $4,069,000 and the provision for loan losses decreased $2,530,000 in 2016 which offset increased expenses related to the acquisition, including $1,806,000 of merger costs.

Net interest income (fully taxable equivalent, or fte) for 2016 totaled $30,339,000 which was an increase of $4,457,000 from the 2015 total.  Average loans outstanding increased $96.9 million in 2016 which resulted in an increase in fte interest income of $4,476,000, while an 11 basis point decrease in the yield earned impacted earnings negatively by $672,000.  The reduced yield was due to loan production at current market rates.  Average loan balances and loan yields were also impacted by the $112.1 million of loans acquired from Delaware.  Total average securities increased $55.6 million in 2016 due primarily to the Delaware acquisition which contributed
 
 
12
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

 
to a $1,023,000 increase in fte interest income.  Average interest-bearing deposits with banks were $8.2 million in 2016 and interest income in this area increased $26,000.  Average interest-bearing deposits increased $106.5 million due to the acquisition and resulted in a $182,000 increase in interest expense.  The cost of borrowed funds increased $214,000 compared to the prior year due primarily to a $7.8 million increase in average long-term borrowings.  The resulting fte net interest margin decreased 15 basis points to 3.60% in 2016 as a 20 basis point reduction in the yield earned was only partially offset by a 5 basis point decrease in the cost of funds.

Loans receivable increased $154.0 million in 2016 from the prior year-end due primarily to the $112.1 million of loans acquired from Delaware.  Organic growth included a $22.8 million increase in commercial loans due primarily to an $18.6 million increase in commercial real estate loans.  Residential mortgage loans and construction loans increased $5.4 million internally after the sale of $1.7 million in  fixed-rate residential mortgage loans for the purpose of interest rate risk management.  Consumer loans increased $13.7 million internally in 2016 due to a $16.5 million increase in indirect auto and marine financing.  Total non-performing loans decreased from $7.1 million and 1.27% of total loans at the end of 2015 to $1.8 million, or 0.25% of total loans on December 31, 2016.  The significant decrease includes the transfer of one loan relationship with a balance of $5,015,000 on December 31, 2015 to foreclosed real estate owned in 2016.  Net charge-offs totaled $2,885,000 in 2016 which was a decrease from the $3,157,000 recorded in 2015.  Based on management's analysis, the Company determined that it would be appropriate to allocate $2,050,000 to the allowance for loan losses in 2016 which resulted in a decrease in the ratio of the allowance for loan losses to total loans outstanding to 0.91% compared to 1.30% on December 31, 2015.  The decrease in the ratio of the allowance for loan losses to total loans outstanding reflects the impact of the loans acquired from Delaware with no allowance.  Based on the improvement in credit quality, the allowance for loan losses represented 335% of total non-performing loans on December 31, 2016 compared to 102% as of December 31, 2015.

Other income for the year ended December 31, 2016 totaled $5,179,000 compared to $4,699,000 in the prior year, an increase of $480,000.  Gains on the sale of loans and investment securities decreased $392,000 in the aggregate, while all other items of other income increased $872,000, net. Service charges and fees collected from the expanded customer base contributed to this increase.

Other expenses were $23,124,000 in 2016 compared to $17,100,000 for the similar period in 2015, an increase of $6,024,000.  Salaries and benefits costs increased $2,393,000 in 2016 while occupancy and furniture and equipment costs increased $543,000 and all other operating expenses increased $3,088,000, net, due to costs related to the acquisition and the operation of twelve new community offices.  Included in the increased expenses are $1.8 million of merger related expenses.  Income tax expense for the year totaled $1,884,000 which was an increase of $252,000 from the prior year.  The effective tax rate in 2016 was 21.9% compared to 21.6% in 2015.
 
The following table sets forth changes in net income (in thousands):
     
     
Net income 2015
$
 5,908
Net interest income
  
 4,069
Provision for loan losses
  
 2,530
Net gains on sales of loans and securities
  
 (392)
Other income
  
 872
Salaries and employee benefits
  
 (2,393)
Occupancy, furniture and equipment
  
 (543)
Foreclosed real estate owned
  
 231
Merger related
  
 (1,806)
Other expenses
  
 (1,513)
Income tax expense
  
 (252)
Net income for 2016
$
 6,711
 
 
13
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT


FINANCIAL CONDITION

Total Assets

Total assets as of December 31, 2017, were $1.133 billion compared to $1.111 billion as of year-end 2016, an increase of $21.7 million.  The increase in assets was primarily attributable to organic loan growth.

Loans Receivable

As of December 31, 2017, loans receivable totaled $764.1 million compared to $713.9 million as of year-end 2016, an increase of $50.2 million.  Commercial loans grew $34.7 million, while retail loans increased $15.5 million during the year.
 
Residential real estate loans, which include home equity lending, totaled $235.8 million as of December 31, 2017, compared to $237.2 million as of year-end 2016, a decrease of $1.4 million.  The Company does not originate any non-traditional mortgage products such as interest-only loans or option adjustable rate mortgages and has no sub-prime mortgage exposure.  The Company evaluates sales of its long-term, fixed-rate residential loan production for interest rate risk management.  No sales were initiated during 2017.  In the current interest rate environment, the Company expects to evaluate selling mortgage loans in 2018. The Company's home equity loan portfolio, which is included in residential real estate loans, increased $600,000 in 2017.

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 $342.9 million as of December 31, 2017, increasing from $320.2 million as of December 31, 2016.  The terms for commercial real estate loans are typically 15 to 20 years, with adjustable rates based on a spread to the prime rate or fixed for the initial three to five year period then adjusting to a spread to the prime rate. The majority of the Company's commercial real estate portfolio is owner occupied and includes the personal guarantees of the principals. Commercial loans consisting principally of lines of credit and term loans secured by equipment or other assets increased $12.0 million to $97.5 million as of December 31, 2017.

The Company's indirect lending portfolio (included in consumer loans to individuals) increased $19.4 million to $60.8 million as of December 31, 2017.

Allowance for Loan Losses and Non-Performing Assets

The allowance for loan losses totaled $7,634,000 as of December 31, 2017 and represented 1.00% of total loans receivable compared to $6,463,000 and 0.91% of total loans as of year-end 2016. Net charge-offs for 2017 totaled $1,029,000 and represented 0.14% of average loans compared to $2,885,000 and 0.46% of average loans in 2016.

Non-performing assets consist of non-performing loans and real estate owned as a result of foreclosure, which is held for sale. Loans are placed on non-accrual status when management believes that a borrower's financial condition is such that collection of interest is doubtful. Commercial and real estate related loans are generally placed on non-accrual when interest is 90 days delinquent. When loans are placed on non-accrual, accrued interest is reversed from current earnings.
 
 
14
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT


As of December 31, 2017, non-performing loans totaled $2,479,000 and represented 0.32% of total loans compared to $1,927,000 or 0.27% as of December 31, 2016.  The increase in the level of non-performing loans includes one loan with a balance of $409,000 at December 31, 2017 which is guaranteed by the USDA on which full recovery is expected in 2018.  Based on management's analysis, the Company added $2,200,000 to the allowance for loan losses for the year ended December 31, 2017 compared to $2,050,000 in 2016.

Foreclosed real estate owned totaled $1,661,000 as of December 31, 2017 and $5,302,000 as of December 31, 2016.  During 2017, six properties with a carrying value of $3.5 million were disposed of through sales.  The Company recorded a net loss of $158,000 from the sale of the properties.

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

The Company has limited exposure to higher-risk loans. The Company does not originate option ARM products, interest only loans, sub-prime loans or loans with initial teaser rates in its residential real estate portfolio. The Company has $9.2 million of junior lien home equity loans. For 2017, there were no charge-offs for this portfolio.
 
As of December 31, 2017, the Company considered its concentration of credit risk profile to be acceptable. The highest concentrations are in commercial rentals and the hospitality lodging industry.
 
During 2017, the Company recognized an increase in its adversely classified loans due to the transfer of one loan relationship with a balance of $5.5 million to Special Mention during 2017. The reclassified loan is adequately collateralized and has made all timely payments, but was classified due to insufficient debt coverage.  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, 2017, the recorded investment in impaired loans, not requiring an allowance for loan losses was $1,247,000 (net of charge-offs against the allowance for loan losses of $277,000).  There were no loans requiring an allowance. The recorded investment in impaired loans not requiring an allowance for loan losses was $2,624,000 (net of charge-offs of $831,000) and there were no loans requiring an allowance as of December 31, 2016.

As a result of its analysis, after applying these factors, management considers the allowance as of December 31, 2017, 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.
 
 
15
NORWOOD FINANICAL CORP - 2017 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)
  
   
2017
    
2016
    
2015
    
2014
    
2013
  
                               
Allowance balance at beginning of period
$
 6,463
  
$
 7,298
  
$
 5,875
  
$
 5,708
  
$
 5,502
  
Charge-offs:
                              
Real Estate loans
                              
  Residential
  
 (83)
    
 (123)
    
 (224)
    
 (270)
    
 (603)
  
  Commercial
  
 (902)
    
 (2,711)
    
 (2,883)
    
 (1,196)
    
 (1,488)
  
  Construction
  
 (28)
    
 -
    
 -
    
 -
    
 (40)
  
Commercial loans
  
 -
    
 (15)
    
 -
    
 -
    
 (4)
  
Consumer loans
  
 (207)
    
 (102)
    
 (91)
  
 (80)
    
 (90)
  
Total
  
 (1,220)
    
 (2,951)
    
 (3,198)
    
 (1,546)
    
 (2,225)
  
Recoveries:
                              
Real Estate loans
                              
  Residential
  
 6
    
 6
    
 20
    
 -
    
 9
  
  Commercial
  
 159
    
 15
    
 -
    
 2
    
 -
  
  Construction
  
 -
    
 -
    
 -
    
 -
    
 -
  
Commercial loans
  
 -
    
 -
    
 -
    
 -
    
 -
  
Consumer loans
  
 26
    
 45
    
 21
    
 31
    
 22
  
Total
  
 191
    
 66
    
 41
    
 33
    
 31
  
Provision expense
  
 2,200
    
 2,050
    
 4,580
    
 1,680
    
 2,400
  
Allowance balance at end of period
$
 7,634
  
$
 6,463
  
$
 7,298
  
$
 5,875
  
$
 5,708
  
Allowance for loan losses as a percent
                              
of total loans outstanding
  
 1.00
%
  
 0.91
%
  
 1.30
%
  
 1.17
%
  
 1.13
%
Net loans charged off as a percent of
                              
average loans outstanding
  
 0.14
%
  
 0.46
%
  
 0.60
%
  
 0.30
%
  
 0.45
%
Allowance coverage of non-performing loans
  
 3.1
x
  
 3.4
x
  
 1.0
x
  
 1.1
x
  
 0.6
x


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

                               
                               
 
December 31,
 
(dollars in thousands)
   
2017
    
2016
    
2015
    
2014
    
2013
  
Non-accrual loans:
                              
Real Estate loans
                              
  Residential
$
 1,706
  
$
 1,136
  
$
 440
  
$
 1,675
  
$
 1,704
  
  Commercial
  
 277
    
 762
    
 6,649
    
 3,921
    
 7,843
  
  Construction
  
 —
    
 28
    
 —
    
 —
    
 —
  
Commercial loans
  
 —
    
 —
    
 43
    
 —
    
 —
  
Consumer loans
  
 —
    
 —
    
 —
    
 4
    
 —
  
Total
  
 1,983
    
 1,926
    
 7,132
    
 5,600
    
 9,547
  
                               
Accruing loans which are contractually
                              
past due 90 days or more
  
 496
    
 1
    
 —
    
 —
    
 —
  
                               
Total non-performing loans
  
 2,479
    
 1,927
    
 7,132
    
 5,600
    
 9,547
  
Foreclosed real estate
  
 1,661
    
 5,302
    
 2,847
    
 3,726
    
 1,009
  
Total non-performing assets
$
 4,140
  
$
 7,229
  
$
 9,979
  
$
 9,326
  
$
 10,556
  
                               
Non-performing loans to total loans
  
 0.32
%
  
 0.27
%
  
 1.27
%
  
 1.12
%
  
 1.90
%
                               
Non-performing loans to total assets
  
 0.22
%
  
 0.17
%
  
 0.95
%
  
 0.79
%
  
 1.34
%
                               
Non-performing assets to total assets
  
 0.37
%
  
 0.6
%
  
 1.33
%
  
 1.31
%
  
 1.48
%
 
 
16
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

Securities

The securities portfolio consists of issues of United States Treasury securities, mortgage-backed securities issued by government sponsored entities, 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, 2017, there were no securities carried in the HTM portfolio. Securities classified as AFS are eligible to be sold due to liquidity needs or interest rate risk management. These securities are adjusted to and carried at their fair value with any unrealized gains or losses recorded net of deferred income taxes, as an adjustment to capital and reported in the equity section of the Consolidated Balance Sheet as other comprehensive income. As of December 31, 2017, $281.1 million of securities were so classified and carried at their fair value, with unrealized losses, net of tax, of $3,041,000 included in accumulated other comprehensive loss as a component of stockholders' equity.

As of December 31, 2017, the average life of the portfolio was 5.5 years. The Company has maintained a relatively short average life in the portfolio in order to generate cash flow to support loan growth and maintain liquidity levels.  Purchases for the year totaled $20.0 million, while maturities and cash flow totaled $26.9 million and proceeds from sales were $15.6 million. The purchases were funded principally by cash flow generated from the portfolio and excess overnight liquidity.

    The carrying value of the securities portfolio at December 31 is as follows:
                       
                       
 
2017
  
2016
 
(dollars in thousands)
 
Carrying
  
% of
    
Carrying
  
% of
  
 
Value
  
portfolio
    
Value
  
portfolio
  
                       
U.S. Treasury securities
$
 1,998
  
 0.7
%
  
$
 1,997
  
 0.7
%
States and political subdivisions
  
 120,478
  
 42.9
%
    
 125,101
  
 41.4
%
Corporate obligations
  
 9,989
  
 3.5
%
    
 10,112
  
 3.3
%
Mortgage-backed securities – government sponsored entities
  
 148,656
  
 52.9
%
    
 164,930
  
 54.5
%
Equity securities – financial services
  
 —
  
 —
%
    
 424
  
 0.1
%
                       
Total
$
 281,121
  
 100.0
%
  
$
 302,564
  
 100.0
%

The portfolio had no adjustable-rate instruments as of December 31, 2017 and 2016. The portfolio contained no private label mortgage-backed securities, collateralized debt obligations (CDOs), or  trust preferred securities, and no off-balance sheet derivatives were in use.   As of December 31, 2017, the portfolio did not contain any step-up bonds.  The mortgage-backed securities portfolio includes pass-through bonds and collateralized mortgage obligations (CMO's) issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (GNMA).

The Company evaluates the securities in its portfolio for other-than-temporary-impairment (OTTI) as fair value declines below cost. In estimating OTTI management considers (1) the length of time and the extent of the decline in fair value and (2) the financial condition and near-term prospects of the issuer. As of December 31, 2017, the Company held 201 investment securities in a loss position which had a combined unrealized loss of $5.4 million. Management believes that these losses are principally due to changes in interest rates and represent temporary impairment as the Company does not have the intent to sell these securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis. During 2017, the Company disposed of a small portfolio of equity securities of other financial institutions.  No impairment charges have been recognized in 2017, 2016 or 2015.
 
 
17
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

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 $281.1 million, which represents 24.8% of total assets at December 31, 2017,  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, 2017 and 2016.

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, 2017 and 2016 was $223,000 and $250,000, respectively.

DEPOSITS

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

Total deposits as of December 31, 2017, totaled $929.4 million, increasing $4.0 million from year-end 2016. Deposit growth included a $13.7 million increase in non-interest bearing demand balances and a $24.7 million increase in certificates of deposit.  The large increase in certificates of deposit includes deposits of local municipalities and school districts which were held in more liquid accounts at year-end 2016.  The $34.4 million decrease in other interest-bearing deposits includes transfers to certificates of deposit and the sale of $13.7 million of deposits with a Community Office.

Time deposits of $250,000 or more, which consist principally of school district funds, other public funds and short-term deposits from large commercial customers with maturities generally less than one year, totaled $92.5 million as of December 31, 2017, compared to $64.0 million at year-end 2016.  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.
 
 
18
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

As of December 31, 2017, non-interest bearing demand deposits totaled $205.1 million compared to $191.5 million at year-end 2016. Cash management accounts in the form of securities sold under agreements to repurchase included in short-term borrowings, totaled $24.3 million at year end 2017 compared to $32.8 million as of December 31, 2016. 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, 2017, the level of net interest income at risk in a ± 200 basis points increase was within the Company's policy limit of a decline less than 8% of net interest income.
Imbalances in repricing opportunities at a given point in time reflect interest-sensitivity gaps measured as the difference between rate-sensitive assets and rate-sensitive liabilities. These are static gap measurements that do not take into account any future activity, and as such are principally used as early indicators of potential interest rate exposures over specific intervals.

At December 31, 2017, the Bank had a positive 90-day interest sensitivity gap of $20.3 million or 1.8% of total assets.  A positive gap indicates that the balance sheet has a higher level of rate-sensitive assets (RSA) than rate-sensitive liabilities (RSL) at the specific time interval. This would indicate that in an increasing rate environment, the yield on interest-earning assets would increase faster than the cost of interest-bearing liabilities in the 90-day time frame. The level of RSA and RSL for an interval is managed by ALCO strategies, including adjusting the average life of the investment portfolio through purchases and sales, pricing of deposit liabilities to attract long or short-term time deposits, utilizing borrowings to fund loan growth, loan pricing to encourage variable-rate products and evaluation of loan sales of long-term, fixed-rate mortgages.

The Company analyzes and measures the time periods in which RSA and RSL will mature or reprice in accordance with their contractual terms and assumptions. Management believes that the assumptions used are reasonable. The interest rate sensitivity of assets and liabilities could vary substantially if differing assumptions were used or if actual experience differs from the assumptions used in the analysis. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Interest rates may change at different rates changing the shape of the yield curve. The level of rates on the investment securities may also be affected by the spread relationship between different investments.  Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed. Finally, the ability of borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase. It should be noted that the operating results of the Company are not subject to foreign currency exchange or commodity price risk.
 
 
19
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT


The following table displays interest-sensitivity as of December 31, 2017 (dollars in thousands):

                             
                             
 
3 Months
  
3-12
      
Over
    
 
Or Less
  
Months
  
1-3 Years
  
3 Years
  
Total
Federal funds sold and
                            
interest-bearing deposits
$
 485
  
$
 —
  
$
 —
  
$
 —
  
$
 485
Securities
  
 8,279
    
 21,899
    
 50,859
    
 200,084
    
 281,121
Loans Receivable
  
 139,528
    
 163,270
    
 230,022
    
 231,272
    
 764,092
Total Rate Sensitive Assets (RSA)
$
 148,292
  
$
 185,169
  
$
 280,881
  
$
 431,356
  
$
 1,045,698
                             
Non-maturity interest-bearing deposits
$
 60,057
  
$
 59,377
  
$
 157,589
  
$
 126,929
  
$
 403,952
Time Deposits
  
 41,652
    
 144,100
    
 98,806
    
 35,736
    
 320,294
Borrowings
  
 26,256
    
 16,661
    
 31,411
    
 4,147
    
 78,475
Total Rate Sensitive Liabilities (RSL)
$
 127,965
  
$
 220,138
  
$
 287,806
  
$
 166,812
  
$
 802,721
                             
Interest sensitivity gap
$
 20,327
  
$
 (34,969)
  
$
 (6,925)
  
$
 264,544
  
$
 242,977
Cumulative gap
  
 20,327
    
 (14,642)
    
 (21,567)
    
 242,977
      
RSA/RSL-cumulative
  
 115.9
%
  
 95.8
%
  
 96.6
%
  
 130.3
%
    
                             
As of December 31, 2016
                            
Interest sensitivity gap
$
 34,669
  
$
 (21,445)
  
$
 (23,293)
  
$
 230,044
  
$
 219,975
Cumulative gap
  
 34,669
    
 13,224
    
 (10,069)
    
 219,975
      
RSA/RSL-cumulative
  
 126.1
%
  
 103.9
%
  
 98.4
%
  
 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 a non-maturity deposit study which was prepared by an independent third party provider in 2017.  The purpose of the study was to estimate the average lives of various deposit types and their pricing sensitivity to movements in market interest rates.

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, 2017, the Company had cash and cash equivalents of $16.7 million in the form of cash, due from banks, balances with the Federal Reserve Bank, and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $281.1 million, which could be used for liquidity needs. This totals $297.8 million and represents 26.3% of total assets compared to $319.7 million and 28.8% of total assets as of December 31, 2016. The Company also monitors other liquidity measures, all of which were within the Company's policy guidelines as of December 31, 2017. Based upon these measures, the Company believes its liquidity position is adequate.

The Company maintains established lines of credit with the Federal Home Loan Bank of Pittsburgh (FHLB), the Atlantic Community Bankers Bank (ACBB) and other correspondent banks, which support liquidity needs. The total available under all the lines was $190.0 million, with $18.2 million outstanding at December 31, 2017 and $0 outstanding at December 31, 2016. The maximum borrowing capacity from FHLB was $369.6 million. As of December 31, 2017, the Company had $35.9 million in term borrowings from the FHLB, compared to $32.0 million at December 31, 2016.
 
 
20
NORWOOD FINANICAL CORP - 2017 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, 2017 totaled $113.1 million. They consisted of $45.0 million of commitments for residential and commercial real estate, construction and land developments loans, $25.6 million in unused home equity lines of credit, $5.9 million in performance and standby letters of credit and $36.6 million in other unused commitments, principally commercial lines of credit. Because these instruments have fixed maturity dates and many of them will expire without being drawn upon, management believes 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.
 
CONTRACTUAL OBLIGATIONS
 
The following table presents information on known contractual obligations to make future payments (in thousands):
                             
                             
 
December 31, 2017
   
Total
    
Less than 1 year
    
1-3 years
    
4-5 years
    
Over 5 years
                             
Time deposits
$
 320,294
  
$
 185,752
  
$
 98,806
  
$
 35,597
  
$
 139
Long-term debt
  
 35,945
    
 874
    
 23,595
    
 11,476
    
 —
Operating leases
  
 6,928
    
 467
    
 905
    
 902
    
 4,654
                             
 
$
 363,167
  
$
 187,093
  
$
 123,306
  
$
 47,975
  
$
 4,793

 
RESULTS OF OPERATIONS


NET INTEREST INCOME

Net interest income is the most significant source of revenue for the Company and represented 83.5% of total revenue for the year ended December 31, 2017.  Net interest income (fte) totaled $37,090,000 for the year ended December 31, 2017 compared to $30,339,000 for 2016, an increase of $6,751,000.  The resulting fte net interest spread and net interest margin were 3.44% and 3.56%, respectively, in 2017 compared to 3.46% and 3.60%, respectively, in 2016.

Interest income (fte) for the year ended December 31, 2017 totaled $41,170,000 compared to $33,993,000 in 2016.  The fte yield on average earning assets was 3.95%, decreasing eight basis points from the 4.03% reported last year.  The tax-equivalent yield on total loans remained stable at 4.50% in 2017, while average loans outstanding increased $110.9 million due to growth during the year and a full year's effect on the loans acquired from Delaware in 2016, resulting in an increase in interest income (fte) from loans of $5.0 million.  The yield on securities decreased 12 basis points in 2017 due primarily to a full year's effect from the lower yielding portfolio acquired from Delaware in 2016.  A $91.5 million increase in average securities outstanding offset the lower yield, and interest income (fte) from the portfolio improved $2.2 million.

Interest expense was $4,080,000 in 2017 which resulted in an average cost of interest-bearing liabilities of 0.51% compared to total interest expense of $3,654,000 in 2016 with an average cost of 0.57%.  Total interest-bearing deposits cost 0.46% in 2017 which was equal to the cost in the prior year.  Non-maturity deposit rates
 
 
21
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

 
remained fairly stable, but time certificates of deposit repriced to current market rates upon maturity and new growth was added, resulting in an increase in the rate paid from 0.94% in 2016 to 0.98%.  Long-term borrowings repriced downward in 2017 reflecting the impact from lower cost borrowings originated in recent years.

Net interest income represented 84.7% of total revenue for the year ended December 31, 2016.  Net interest income (fte) totaled $30,339,000 for the year ended December 31, 2016 compared to $25,882,000 for 2015, an increase of $4,457,000.  The resulting fte net interest spread and net interest margin were 3.46% and 3.60%, respectively, in 2016 compared to 3.61% and 3.75%, respectively, in 2015.

Interest income (fte) for the year ended December 31, 2016 totaled $33,993,000 compared to $29,140,000 in 2015.  The fte yield on average earning assets was 4.03%, decreasing 20 basis points from the 4.23% reported last year.  The low interest rate environment impacted the yield earned as new loan production was added at historically low rates.  This impacted loan yields which earned 4.50% in 2016 compared to 4.61% in the prior year.  The reduced yield was offset by a $96.9 million increase in average loans outstanding due primarily to loans acquired from Delaware, and interest income (fte) from loans increased $3.8 million.  The yield on securities decreased 33 basis points in 2016 due primarily to the lower yielding portfolio acquired from Delaware.  A $55.6 million increase in average securities outstanding offset the lower yield, and interest income (fte) from the portfolio improved $1.0 million.

Interest expense was $3,654,000 in 2016 which resulted in an average cost of interest-bearing liabilities of 0.57% compared to total interest expense of $3,258,000 in 2015 with an average cost of 0.62%.  The continued low rate environment also impacted rates paid on deposits as the Company reduced rates paid on time deposits to market levels.  Total interest-bearing deposits cost 0.46% in 2016 which was 6 basis points lower than the 0.52% cost in the prior year.  Time certificates of deposit repriced to current market rates upon maturity and new growth was added at the reduced levels.  Time deposits acquired from Delaware also impacted the cost of deposits.  Long-term borrowings also repriced downward in 2016 reflecting the impact from low-cost borrowings originated in recent years.

OTHER INCOME

Other income totaled $6,911,000 for the year ended December 31, 2017 compared to $5,179,000 in 2016, an increase of $1,732,000.  Gains from the sales of loans and securities increased $77,000 from the prior year, while all other items of other income increased $1,655,000, net.  The increase reflects a full year effect from the increased fees related to the Delaware acquisition.

Other income totaled $5,179,000 for the year ended December 31, 2016 compared to $4,699,000 in 2015, an increase of $480,000.  Gains from the sales of loans and securities decreased $392,000 from the prior year, while all other items of other income increased $872,000, net.  The increase reflects the increased fees related to the Delaware acquisition.


 
22
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

 
 
Other Income (dollars in thousands)                 
For the year ended December 31                
   
2017
    
2016
    
2015
Service charges on deposit accounts
$
 255
  
$
 200
  
$
 168
ATM Fees
  
 362
    
 258
    
 220
Overdraft Fees
  
 1,639
    
 1,171
    
 850
Safe deposit box rental
  
 100
    
 66
    
 62
Loan related service fees
  
 445
    
 319
    
 451
Debit card
  
 1,186
    
 874
    
 660
Fiduciary activities
  
 510
    
 448
    
 439
Commissions on mutual funds & annuities
  
 146
    
 143
    
 143
Gain on sales of loans
  
 67
    
 54
    
 104
Earnings on and proceeds from bank-owned life insurance
  
 1,133
    
 888
    
 664
Other income
  
 720
    
 474
    
 312
   
 6,563
    
 4,895
    
 4,073
Net realized gains on sales of securities
  
 348
    
 284
    
 626
                 
Total
$
 6,911
  
$
 5,179
  
$
 4,699

 
OTHER EXPENSES

Other expenses totaled $24,870,000 for the year ended December 31, 2017 compared to $23,124,000 in the prior year.  The $1,746,000 increase in costs reflects a full year effect of operating twelve new Community Offices.  Salaries and benefits costs increased $1,922,000 in 2017 while occupancy and equipment costs increased $736,000.  All other operating expenses decreased $912,000, net, which includes a $484,000 increase in foreclosed real estate costs and a $1,806,000 decrease from the merger expenses recorded in 2016.  The Company's efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 56.5% in 2017 compared to 65.1% in 2016.  Merger costs contributed to the higher ratio in 2016.

Other expenses totaled $23,124,000 for the year ended December 31, 2016 compared to $17,100,000 in the prior year.  The $6,024,000 increase in costs includes $1,806,000 of merger expenses plus the costs of acquiring and operating twelve new Community Offices.  Salaries and benefits costs increased $2,393,000 in 2016 while occupancy and equipment costs increased $543,000.  All other operating expenses increased $3,088,000, net, which includes $1,806,000 of merger expenses.  The Company's efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 65.1% in 2016 compared to 55.9% in 2015.  Merger costs contributed to the higher ratio in 2016.

 
 

 
Other Expenses (dollars in thousands)                 
For the year ended December 31                 
   
2017
    
2016
    
2015
Salaries
$
 8,317
  
$
 7,054
  
$
 5,752
Employee benefits
  
 4,533
    
 3,874
    
 2,783
Occupancy
  
 2,662
    
 2,077
    
 1,660
Furniture and equipment
  
 699
    
 548
    
 422
Data processing and related operations
  
 1,353
    
 1,337
    
 943
Federal Deposit Insurance Corporation insurance assessment
  
 377
    
 412
    
 411
Advertising
  
 268
    
 283
    
 240
Professional fees
  
 949
    
 836
    
 730
Postage and telephone
  
 664
    
 566
    
 436
Office supplies
  
 426
    
 379
    
 255
Taxes, other than income
  
 661
    
 731
    
 711
Foreclosed real estate
  
 1,164
    
 680
    
 911
Amortization of intangible assets
  
 150
    
 122
    
 105
Merger related
  
 -
    
 1,806
    
 -
Other
  
 2,647
    
 2,419
    
 1,741
Total
$
 24,870
  
$
 23,124
  
$
 17,100
 
 
23
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT


INCOME TAXES

Income tax expense for the year ended December 31, 2017 totaled $6,551,000 which resulted in an effective tax rate of 44.4% compared to $1,884,000 and 21.9% for 2016.  On December 22, 2017, the President signed the Tax Cut and Jobs Act (the "Act") into law.  Among other things, the Act reduced the corporate tax rate from a maximum of 35% to a flat 21% rate effective January 1, 2018.  Prior to December 22, 2017, the Company had a net deferred tax asset totaling $7.6 million, based on the pre-Act federal tax rate of 35%.  As a result of the reduction in the corporate income tax rate to 21%, the Company revalued its net deferred tax asset as of December 31, 2017, which resulted in a $3,060,000 reduction in its value.  The reduction in the value of the net deferred tax asset has been recorded as additional income tax expense in 2017.  Excluding this one-time adjustment, the effective tax rate for 2017 would have been 23.7%.

Income tax expense for the year ended December 31, 2016 totaled $1,884,000 which resulted in an effective tax rate of 21.9% compared to $1,632,000 and 21.6% for 2015.


CAPITAL AND DIVIDENDS

Total stockholders' equity as of December 31, 2017, was $115.7 million, compared to $111.1 million as of year-end 2016.  The increase was due primarily to earnings retention net of a $5.4 million reduction resulting from cash dividends declared.  As of  December 31, 2017 the Company had a leverage capital ratio of 9.36%, a Tier 1 risk-based capital ratio and a common equity Tier 1 risk-based capital ratio of 13.16% and a total risk-based capital ratio of 14.11% compared to 9.16%,  13.27% and 14.12%, respectively, at December 31, 2016.

The Company's common stock is traded on the Nasdaq Global Market under the symbol, NWFL. As of December 31, 2017, there were approximately 2,600 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 periods indicated:

                 
                 
 
Closing Price Range
   Cash dividends
 
High
  
Low
  
Declared per share
Year 2017
            
 
First Quarter
$
 27.93
  
$
 21.24
  
$
 0.213
Second Quarter
  
 28.34
    
 24.65
    
 0.213
Third Quarter
  
 29.52
    
 26.71
    
 0.220
Fourth Quarter
  
 34.91
    
 28.00
    
 0.220
                 
Year 2016
                
First Quarter
$
 20.60
  
$
 17.50
  
$
 0.207
Second Quarter
  
 19.33
    
 18.34
    
 0.207
Third Quarter
  
 19.83
    
 18.40
    
 0.207
Fourth Quarter
  
 23.00
    
 19.02
    
 0.213

The book value of the common stock was $18.61 per share as of December 31, 2017 compared to $17.43 as of December 31, 2016.  As of year-end 2017, the closing stock price was $33.00 per share, compared to $22.09 as of December 31, 2016.  All per share information has been adjusted to reflect the 50% stock dividend declared in 2017.
 
 
24
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

 
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% based on then-current federal tax rates. 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. This annual report also references core operating results, core operating results per diluted share, core operating results return on average assets and core operating results return on average equity which are also a non-GAAP financial measure.  Core operating results excludes the $3,060,000 of non-recurring additional income tax expense resulting from the revaluation of our net deferred tax asset as required by the Tax Cuts and Jobs Act.  We believe this presentation provides the reader with a more concise understanding of the impact from the required revaluation of deferred tax assets and facilitates period-to-period comparisons.  Tax-equivalent net interest income is reconciled to GAAP net interest income on page 28. A reconcilement of core operating results is located below.  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.

The following table reconciles net income to core operating results:
               
               
(dollars in thousands)
Year Ended December 31,
 
2017
  
2016
               
Net income
$
 8,198
    
$
6,711
  
Add:   net deferred tax asset revaluation charge
  
3.060
 
    
 -
 
Core operating results
$
11,258
    
$
 6,711
  

    The following table reconciles diluted earnings per share to core operating results per diluted share:
               
               
Year Ended December 31,
 
2017
  
2016
               
Diluted earnings per share
$
 1.31
    
$
1.15
  
Add:   net deferred tax asset revaluation charge
  
0.49
 
    
 -
 
Core operating results per diluted share
$
1.80
    
$
 1.15
  
 
The following table reconciles return on average assets to core operating results return on average assets:

 
               
               
Year Ended December 31,
 
2017
  
2016
               
Return on average assets
 
 0.73%
    
 
0.74%
  
Add:   net deferred tax asset revaluation charge
  
0.29%
 
    
 -
 
Core operating results return on average assets
 
1.02%
    
 
 0.74%
  
 
    The following table reconciles return on average equity to core operating results return on average equity:

 
               
               
Year Ended December 31,
 
2017
  
2016
               
Return on average equity
 
 7.04%
    
 
6.17%
  
Add:   net deferred tax asset revaluation charge
  
3.35%
 
    
 -
 
Core operating results return on average equity
 
10.39%
    
 
6.17%
  
 
 
 
 
25
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT


STOCK PERFORMANCE GRAPH

Set forth below is a stock performance graph comparing the cumulative total shareholder return on the Common Stock with (a) the cumulative total stockholder return on stocks included in the Nasdaq Stock Market index and (b) the cumulative total stockholder return on stocks included in the Nasdaq Bank index, as prepared by Zack's Investment Research, Inc. using data from the Center for Research in Securities Prices (CRSP) at the University of Chicago. All three investment comparisons assume the investment of $100 at the market close on December 31, 2012 and the reinvestment of dividends paid. The graph provides comparison at December 31, 2012 and each fiscal year through December 31, 2017.
____________________________________________________________________________________



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.
LEGEND

8
              
Symbol
CRSP Total Returns Index for:
12/31/12
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
♦
Norwood Financial Corp
$100.00
$103.50
$116.55
$120.38
$145.00
$223.87
■
CRSP Nasdaq U.S. Index
  100.00
  139.38
  160.72
  173.11
  190.07
  203.16
▲
Nasdaq Bank Index
  100.00
  143.13
  150.40
  163.81
  221.79
  236.30
 
 
Notes:

A.  Data complete through last fiscal year.
B.  Corporate Performance Graph with peer group only performance (excludes only company).
C.  Peer group indices use beginning of period market capitalization weighting.
D.  Prepared by Zacks Investment Research, Inc. Used with permission.  All rights reserved.  Copyright 1980-2018.
E.  Index Data:  Calculated (or Derived) based from CRSP NASDAQ Stock Market (US Companies) and CRSP NASDAQ Banks Index, Center for Research in Security Prices (CRSP®), Graduate School of  Business, The University of  Chicago.  Copyright 2018.  Used with permission.  All rights reserved.

 
26
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NORWOOD FINANCIAL CORP
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
(Dollars in thousands, except per share amounts)



                       
                       
2017
December 31
  
September 30
  
June 30
  
March 31
                       
Interest income
$
 10,075
  
$
 9,896
  
$
 9,582
  
$
 9,434
Interest expense
  
 1,191
    
 1,026
    
 926
    
 937
Net interest income
  
 8,884
    
 8,870
    
 8,656
    
 8,497
Provision for loan losses
  
 400
    
 600
    
 600
    
 600
Other income
  
 1,573
    
 1,729
    
 1,625
    
 1,637
Net realized gains on sales of securities
  
 181
    
 129
    
 31
    
 6
Other expense
  
 5,886
    
 6,239
    
 6,130
    
 6,614
Income before income taxes
  
 4,352
    
 3,889
    
 3,582
    
 2,926
Income tax expense
  
 4,195
    
 948
    
 858
    
 550
NET INCOME
$
 157
  
$
 2,941
  
$
 2,724
  
$
 2,376
                       
Basic earnings per share
$
0.03
  
$
0.47
  
$
0.44
  
$
0.38
                       
Diluted earnings per share
$
0.03
  
$
0.47
  
$
0.43
  
$
0.38
                       
2016
                      
 
December 31
  
September 30
  
June 30
  
March 31
                       
Interest income
$
 9,456
  
$
 8,528
  
$
 7,234
  
$
 7,026
Interest expense
  
 1,005
    
 958
    
 840
    
 851
Net interest income
  
 8,451
    
 7,570
    
 6,394
    
 6,175
Provision for loan losses
  
 450
    
 450
    
 700
    
 450
Other income
  
 1,475
    
 1,399
    
 1,018
    
 1,003
Net realized gains on sales of securities
  
 15
    
 -
    
 205
    
 64
Other expense
  
 6,568
    
 7,679
    
 4,528
    
 4,349
Income before income taxes
  
 2,923
    
 840
    
 2,389
    
 2,443
Income tax expense
  
 577
    
 228
    
 511
    
 567
NET INCOME
$
 2,346
  
$
 612
  
$
 1,878
  
$
 1,876
                       
Basic earnings per share
$
0.38
  
$
0.10
  
$
0.34
  
$
0.34
                       
Diluted earnings per share
$
0.37
  
$
0.10
  
$
0.34
  
$
0.34
                       

 
27
NORWOOD FINANICAL CORP - 2017 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
2017
2016
        
2015
      
   
Average
        
Average
    
Average
        
Average
    
Average
        
Average
  
   
Balance(2)
    
Interest(1)
  
Rate
    
Balance(2)
    
Interest(1)
  
Rate
    
Balance(2)
    
Interest(1)
  
Rate
  
                                                 
ASSETS
                                                
Interest-earning assets:
                                                
Interest-bearing deposits with banks
$
 4,742 
  
$
 48 
  
 1.01 
%
$
 8,182 
  
$
 42 
  
 0.51 
%
$
 6,392 
  
$
 16 
  
 0.25 
%
Securities available for sale:
                                                
Taxable
  
 180,087 
    
 3,548 
  
 1.97 
    
 123,364 
    
 2,375 
  
 1.93 
    
 93,294 
    
 1,918 
  
 2.06 
  
Tax-exempt
  
 119,991 
    
 4,345 
  
 3.62 
    
 85,170 
    
 3,358 
  
 3.94 
    
 59,659 
    
 2,792 
  
 4.68 
  
Total securities available for sale
  
 300,078 
    
 7,893 
  
 2.63 
    
 208,534 
    
 5,733 
  
 2.75 
    
 152,953 
    
 4,710 
  
 3.08 
  
Loans receivable (3)(4)
  
 737,765 
    
 33,229 
  
 4.50 
    
 626,907 
    
 28,218 
  
 4.50 
    
 529,989 
    
 24,414 
  
 4.61 
  
Total interest-earning assets
  
 1,042,585 
    
 41,170 
  
 3.95 
    
 843,623 
    
 33,993 
  
 4.03 
    
 689,334 
    
 29,140 
  
 4.23 
  
Non-interest earning assets:
                                                
Cash and due from banks
  
 14,193 
              
 11,275 
              
 8,638 
            
Allowance for loan losses
  
 (7,416)
              
 (6,719)
              
 (5,945)
            
Other assets
  
 76,427 
              
 62,069 
              
 44,794 
            
Total non-interest earning assets
  
 83,204 
              
 66,625 
              
 47,487 
            
TOTAL ASSETS
$
 1,125,789 
            
$
 910,248 
            
$
 736,821 
            
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                
Interest-bearing liabilities:
                                                
Interest-bearing demand and money market
$
 245,717 
    
 406 
  
 0.17 
  
$
 208,373 
    
 336 
  
 0.16 
  
$
 177,104 
    
 301 
  
 0.17 
  
Savings
  
 189,548 
    
 95 
  
 0.05 
    
 125,904 
    
 66 
  
 0.05 
    
 74,753 
    
 37 
  
 0.05 
  
Time
  
 293,641 
    
 2,876 
  
 0.98 
    
 234,026 
    
 2,201 
  
 0.94 
    
 209,930 
    
 2,083 
  
 0.99 
  
Total interest-bearing deposits
  
 728,906 
    
 3,377 
  
 0.46 
    
 568,303 
    
 2,603 
  
 0.46 
    
 461,787 
    
 2,421 
  
 0.52 
  
Short-term borrowings
  
 39,170 
    
 199 
  
 0.51 
    
 41,593 
    
 174 
  
 0.42 
    
 34,022 
    
 85 
  
 0.25 
  
Other borrowings
  
 31,276 
    
 504 
  
 1.61 
    
 36,509 
    
 877 
  
 2.40 
    
 28,742 
    
 752 
  
 2.62 
  
Total interest-bearing liabilities
  
 799,352 
    
 4,080 
  
 0.51 
    
 646,405 
    
 3,654 
  
 0.57 
    
 524,551 
    
 3,258 
  
 0.62 
  
Non-interest bearing liabilities:
                                                
Non-interest bearing demand deposits
  
 200,368 
              
 146,578 
              
 106,601 
            
Other liabilities
  
 9,662 
              
 8,482 
              
 4,305 
            
Total non-interest bearing liabilities
  
 210,030 
              
 155,060 
              
 110,906 
            
Stockholders' equity
  
 116,407 
              
 108,783 
              
 101,364 
            
TOTAL LIABILITIES AND STOCKHOLDERS'                                                
 EQUITY
$
 1,125,789 
            
$
 910,248 
            
$
 736,821 
            
                                                 
                                                 
Net Interest Income
                                                
(tax equivalent basis)
        
 37,090 
  
 3.44 
%
        
 30,339 
  
 3.46 
%
        
 25,882 
  
 3.61 
%
Tax-equivalent basis adjustment
        
 (2,182)
              
 (1,749)
              
 (1,361)
      
Net Interest Income
      
$
 34,908 
            
$
 28,590 
            
$
 24,521 
      
Net interest margin
                                                
(tax equivalent basis)
            
 3.56 
%
            
 3.60 
%
            
 3.75 
%

(1)
Interest and yields are presented on a tax-equivalent basis using a marginal tax rate of 34%.
(2)
Average balances have been calculated based on daily balances.
(3)
Loan balances include non-accrual loans and are net of unearned income.
(4)
Loan yields include the effect of amortization of purchased credit marks and deferred fees net of costs.
 
28
NORWOOD FINANICAL CORP - 2017 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)
2017 compared to 2016
  
2016 compared to 2015
 
Variance due to
  
Variance due to
 
Volume
  
Rate
  
Net
  
Volume
  
Rate
  
Net
INTEREST-EARNING ASSETS:
                                  
Interest-bearing deposits
$
 (25)
  
$
 31
  
$
 6
  
$
 8
  
$
 18
  
$
 26
Securities available for sale:
                                  
Taxable
  
 1,102
    
 71
    
 1,173
    
 609
    
 (152)
    
 457
Tax-exempt securities
  
 1,346
    
 (359)
    
 987
    
 1,122
    
 (556)
    
 566
Total securities available for sale
  
 2,448
    
 (288)
    
 2,160
    
 1,731
    
 (708)
    
 1,023
Loans receivable
  
 5,011
    
 -
    
 5,011
    
 4,476
    
 (672)
    
 3,804
Total interest-earning assets
  
 7,434
    
 (257)
    
 7,177
    
 6,215
    
 (1,362)
    
 4,853
                                   
INTEREST-BEARING LIABILITIES
                                  
Interest-bearing demand and money market
  
 50
    
 20
    
 70
    
 54
    
 (19)
    
 35
Savings
  
 29
    
 -
    
 29
    
 29
    
 -
    
 29
Time
  
 563
    
 112
    
 675
    
 232
    
 (114)
    
 118
Total interest-bearing deposits
  
 642
    
 132
    
 774
    
 315
    
 (133)
    
 182
Short-term borrowings
  
 (11)
    
 36
    
 25
    
 28
    
 61
    
 89
Other borrowings
  
 (95)
    
 (278)
    
 (373)
    
 199
    
 (74)
    
 125
Total interest-bearing liabilities
  
 536
    
 (110)
    
 426
    
 542
    
 (146)
    
 396
                                   
Net interest income (tax-equivalent basis)
$
 6,898
  
$
 (147)
  
$
 6,751
  
$
 5,673
  
$
 (1,216)
  
$
 4,457


Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.
 
 
29
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

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

TO THE STOCKHOLDERS OF NORWOOD FINANCIAL CORP

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

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

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

Management assessed the effectiveness of Norwood's internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria established in Internal Control – Integrated Framework as set forth by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.  Based upon its assessment, management has concluded that, as of December 31, 2017, the Company's internal control over financial reporting, including controls over the preparation of regulatory financial statements in accordance with all federal and state laws and regulations, is effective based on the criteria established in the Internal Control – Integrated Framework.

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


/s/ Lewis J. Critelli          /s/ William S. Lance

Lewis J. Critelli William S. Lance
President and     Executive Vice President and
Chief Executive Officer                              Chief Financial Officer
 
 
 
30
 
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Stockholders and the Board of Directors of Norwood Financial Corp.

Opinion on the Financial Statements

  We have audited the accompanying consolidated balance sheet of Norwood Financial Corp. and subsidiaries (the "Company") as of December 31, 2017 and 2016; the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2017; and the related notes to the consolidated financial statements (collectively, the financial statements).  In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

  We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 13, 2018, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

Basis for Opinion

  These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

  We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

  Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
 
  We have served as the Company's auditor since 2009.

Cranberry Township, Pennsylvania
March 13, 2018

 
 
31
 
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Stockholders and the Board of Directors of Norwood Financial Corp.

Opinion on Internal Control over Financial Reporting

  We have audited Norwood Financial Corp. and subsidiaries' (the "Company") internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. 

  We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2017, of the Company and our report dated March 13, 2018, expressed an unqualified opinion.

Basis for Opinion

  The Company'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 in the accompanying Management's Annual Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

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

  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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (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 receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) 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.

Cranberry Township, Pennsylvania
March 13, 2018
 
 
 
32
 
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
CONSOLIDATED BALANCE SHEETS

           
           
   
December 31,
    
December 31,
   
2017
    
2016
 
(In Thousands, Except Share and Per Share Data)
ASSETS
          
Cash and due from banks
$
 16,212
  
$
 14,900
Interest bearing deposits with banks
  
 485
    
 2,274
           
Cash and cash equivalents
  
 16,697
    
 17,174
           
Securities available for sale
  
 281,121
    
 302,564
Loans receivable (net of allowance for loan losses 2017: $7,634; 2016: $6,463)
  
 756,458
    
 707,426
Regulatory stock, at cost
  
 3,505
    
 2,119
Premises and equipment, net
  
 13,864
    
 13,531
Bank owned life insurance
  
 37,060
    
 36,133
Accrued interest receivable
  
 3,716
    
 3,643
Foreclosed real estate owned
  
 1,661
    
 5,302
Goodwill
  
 11,331
    
 11,331
Other intangibles
  
 462
    
 612
Deferred tax asset
  
 4,781
    
 8,989
Other assets
  
 2,260
    
 2,359
           
Total Assets
$
 1,132,916
  
$
 1,111,183
           
LIABILITIES AND STOCKHOLDERS' EQUITY
          
LIABILITIES
          
Deposits:
          
Non-interest bearing demand
$
 205,138
  
$
 191,445
Interest-bearing demand
  
 91,479
    
 93,485
Money market deposit accounts
  
 146,362
    
 153,020
Savings
  
 166,111
    
 191,878
Time
  
 320,294
    
 295,557
           
Total Deposits
  
 929,384
    
 925,385
           
Short-term borrowings
  
 42,530
    
 32,811
Other borrowings
  
 35,945
    
 32,001
Accrued interest payable
  
 1,434
    
 1,069
Other liabilities
  
 7,884
    
 8,838
           
Total Liabilities
  
 1,017,177
    
 1,000,104
           
STOCKHOLDERS' EQUITY
          
Common stock, $.10 par value, authorized 10,000,000 shares,
          
issued: 2017: 6,256,063 shares, 2016: 4,164,723 shares
  
 626
    
 416
Surplus
  
 47,431
    
 47,682
Retained earnings
  
 70,426
    
 67,225
Treasury stock at cost: 2017: 2,608 shares, 2016: 4,509 shares
  
 (77)
    
 (125)
Accumulated other comprehensive loss
  
 (2,667)
    
 (4,119)
           
Total Stockholders' Equity
  
 115,739
    
 111,079
           
Total Liabilities and Stockholders' Equity
$
 1,132,916
  
$
 1,111,183


See notes to consolidated financial statements
 
 
33
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF INCOME


                 
                 
 
Years Ended December 31,
 
2017
  
2016
  
2015
 
(In Thousands, Except per Share Data)
INTEREST INCOME
                
Loans receivable, including fees
$
 32,524
  
$
 27,611
  
$
 24,002
Securities
                
Taxable
  
 3,548
    
 2,375
    
 1,918
Tax exempt
  
 2,868
    
 2,216
    
 1,843
Other
  
 48
    
 42
    
 16
Total Interest Income
  
 38,988
    
 32,244
    
 27,779
                 
INTEREST EXPENSE
                
Deposits
  
 3,377
    
 2,603
    
 2,421
Short-term borrowings
  
 199
    
 130
    
 85
Other borrowings
  
 504
    
 921
    
 752
Total Interest Expense
  
 4,080
    
 3,654
    
 3,258
                 
Net Interest Income
  
 34,908
    
 28,590
    
 24,521
PROVISION FOR LOAN LOSSES
  
 2,200
    
 2,050
    
 4,580
Net Interest Income After
                
Provision for Loan Losses
  
 32,708
    
 26,540
    
 19,941
                 
OTHER INCOME
                
Service charges and fees
  
 4,079
    
 2,951
    
 2,440
Income from fiduciary activities
  
 510
    
 449
    
 439
Net realized gains on sales of securities
  
 348
    
 284
    
 626
Net gain on sale of loans
  
 67
    
 54
    
 104
Earnings and proceeds on life insurance policies
  
 1,133
    
 888
    
 665
Other
  
 774
    
 553
    
 425
Total Other Income
  
 6,911
    
 5,179
    
 4,699
                 
OTHER EXPENSES
                
Salaries and employee benefits
  
 12,850
    
 10,928
    
 8,535
Occupancy
  
 2,662
    
 2,077
    
 1,660
Furniture and equipment
  
 699
    
 548
    
 422
Data processing and related operations
  
 1,353
    
 1,337
    
 943
Federal Deposit Insurance Corporation insurance assessment
  
 377
    
 412
    
 411
Advertising
  
 268
    
 283
    
 240
Professional fees
  
 949
    
 836
    
 730
Postage and telephone
  
 664
    
 566
    
 436
Taxes, other than income
  
 661
    
 731
    
 711
Foreclosed real estate
  
 1,164
    
 680
    
 911
Amortization of intangible assets
  
 150
    
 122
    
 105
Merger related
  
 -
    
 1,806
    
 -
Other
  
 3,073
    
 2,798
    
 1,996
Total Other Expenses
  
 24,870
    
 23,124
    
 17,100
                 
Income before Income Taxes
  
 14,749
    
 8,595
    
 7,540
INCOME TAX EXPENSE
  
 6,551
    
 1,884
    
 1,632
Net income
$
 8,198
  
$
 6,711
  
$
 5,908
EARNINGS PER SHARE
                
BASIC
$
 1.32
  
$
 1.16
  
$
 1.07
DILUTED
$
 1.31
  
$
 1.15
  
$
 1.07

See notes to consolidated financial statements
 
 
34
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
                 
   
Years Ended December 31,
         
 
      
   
2017
    
2016
    
2015
NET INCOME
$
 8,198
  
$
 6,711
  
$
 5,908
                 
Other comprehensive income (loss):
                
 Unrealized gain on pension liability
  
 (17)
    
 490
    
 -
Tax Effect
  
 6
    
 (172)
    
 -
Investment securities available for sale:
                
 Unrealized holding gains (losses)
  
 3,224
    
 (7,180)
    
 656
Tax Effect
  
 (1,097)
    
 2,440
    
 (217)
   Reclassification of gains from sale of securities
  
 (348)
    
 (284)
    
 (626)
Tax Effect
  
 118
    
 99
    
 213
Net of tax amount
  
 1,886
    
 (4,607)
    
 26
                 
COMPREHENSIVE INCOME
$
 10,084
  
$
 2,104
  
$
 5,934


See notes to consolidated financial statements
 
 
35
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                               
                                               
   
Years Ended December 31, 2017, 2016 and 2015
                                       
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, 2014
  
 3,718,018 
  
$
 372 
  
$
 35,206 
  
$
 64,078 
    
 40,576 
  
$
 (1,077)
  
$
 462 
  
$
 99,041 
Net Income
  
 -
    
 -
    
 -
    
 5,908 
    
 -
    
 -
    
 -
    
 5,908 
Other comprehensive income
  
 -
    
 -
    
 -
    
 -
    
 -
    
 -
    
 26 
    
 26 
Cash dividends declared ($0.83 per share)
  
-
    
 -
    
 -
    
 (4,574)
    
 -
    
 -
    
 -
    
 (4,574)
Acquisition of treasury  stock
  
 -
    
 -
    
 -
    
 -
    
 4,374 
    
 (127)
    
 -
    
 (127)
Stock options exercised
  
 -
    
 -
    
 (9)
    
 -
    
 (16,859)
    
 450 
    
 -
    
 441 
Tax benefit on stock options exercised
  
 -
    
 -
    
 16 
    
 -
    
 -
    
 -
    
 -
    
 16 
Sale of treasury stock for ESOP
  
 -
    
 -
    
 10 
    
 -
    
 (5,060)
    
 136 
    
 -
    
 146 
Compensation expense related to
                                              
stock options
  
 -
    
 -
    
 66 
    
 -
    
 -
    
 -
    
 -
    
 66 
Restricted stock awards
  
 6,650 
    
 1 
    
 62 
    
 -
    
 280 
    
 (8)
    
 -
    
 55 
BALANCE - DECEMBER 31, 2015
  
 3,724,668 
    
 373 
    
 35,351 
    
 65,412 
    
 23,311 
    
 (626)
    
 488 
    
 100,998 
Net Income
  
 -
    
 -
    
 -
    
 6,711 
    
 -
    
 -
    
 -
    
 6,711 
Other comprehensive loss
  
 -
    
 -
    
 -
    
 -
    
 -
    
 -
    
 (4,607)
    
 (4,607)
Cash dividends declared ($0.83 per share)
  
-
    
 -
    
 -
    
 (4,898)
    
 -
    
 -
    
 -
    
 (4,898)
Acquisition of treasury  stock
  
 -
    
 -
    
 -
    
 -
    
 15,538 
    
 (447)
    
 -
    
 (447)
Stock options exercised
  
 -
    
 -
    
 (8)
    
 -
    
 (30,823)
    
 851 
    
 -
    
 843 
Tax benefit on stock options exercised
  
 -
    
 -
    
 38 
    
 -
    
 -
    
 -
    
 -
    
 38 
Sale of treasury stock for ESOP
  
 -
    
 -
    
 21 
    
 -
    
 (3,967)
    
 110 
    
 -
    
 131 
Compensation expense related to
                                              
stock options
  
 -
    
 -
    
 71 
    
 -
    
 -
    
 -
    
 -
    
 71 
Restricted stock awards
  
 8,450 
    
 -
    
 102 
    
 -
    
 450 
    
 (13)
    
 -
    
 89 
Delaware Bancshares acquisition
  
 431,605 
    
 43 
    
 12,107 
    
 -
    
 -
    
 -
          
 12,150 
BALANCE - DECEMBER 31, 2016
  
 4,164,723 
    
 416 
    
 47,682 
    
 67,225 
    
 4,509 
    
 (125)
    
 (4,119)
    
 111,079 
Net Income
  
 -
    
 -
    
 -
    
 8,198 
    
 -
    
 -
    
 -
    
 8,198 
Other comprehensive income
  
 -
    
 -
    
 -
    
 -
    
 -
    
 -
    
 1,886 
    
 1,886 
Reclassification of certain income tax
                                              
   efects from accumulated other
                                              
   comprehensive income
  
 -
    
 -
    
 -
    
 434 
    
 -
    
 -
    
 (434)
    
 -
Cash dividends declared ($0.87 per share)
  
-
    
 -
    
 -
    
 (5,412)
    
 -
    
 -
    
 -
    
 (5,412)
Acquisition of treasury  stock
  
 -
    
 -
    
 -
    
 -
    
 42,257 
    
 (1,587)
    
 -
    
 (1,587)
Stock options exercised
  
 -
    
 -
    
 (291)
    
 -
    
 (44,219)
    
 1,522 
    
 -
    
 1,231 
Sale of treasury stock for ESOP
  
 -
    
 -
    
 14 
    
 -
    
 (3,847)
    
 113 
    
 -
    
 127 
Compensation expense related to
                                              
stock options
  
 -
    
 -
    
 93 
    
 -
    
 -
    
 -
    
 -
    
 93 
Restricted stock awards
  
 9,400 
    
 1 
    
 142 
    
 -
    
 -
    
 -
    
 -
    
 143 
50% stock dividend
  
 2,082,362 
    
 209 
    
 (209)
    
 -
    
 3,908 
    
 -
    
 -
    
 -
Cash-in-lieu stock dividend adjustment
  
 (422)
    
 -
    
 -
    
 (19)
    
 -
    
 -
    
 -
    
 (19)
BALANCE - DECEMBER 31, 2017
  
 6,256,063 
  
$
 626 
  
$
 47,431 
  
$
 70,426 
    
 2,608 
  
$
 (77)
  
$
 (2,667)
  
$
 115,739 

See notes to consolidated financial statements.


 
36
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS

 
                 
 
Years Ended December 31,
   
2017
    
2016
    
2015
 
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
                
Net income
$
 8,198
  
$
 6,711
  
$
 5,908
Adjustments to reconcile net income to net cash provided by operating  activities:
                
Provision for loan losses
  
 2,200
    
 2,050
    
 4,580
Depreciation
  
 922
    
 726
    
 551
Amortization of intangible assets
  
 150
    
 122
    
 105
Deferred income taxes
  
 (331)
    
 746
    
 (387)
Revaluation of deferred tax assets, net
  
 3,060
    
 -
    
 -
Net amortization of securities premiums and discounts
  
 2,115
    
 1,648
    
 936
Net realized gains on sales of securities
  
 (348)
    
 (284)
    
 (626)
Gain on sales of deposits
  
 (209)
    
 -
    
 -
Earnings and proceeds on life insurance policies
  
 (1,133)
    
 (888)
    
 (665)
Loss on sales of fixed assets and foreclosed real estate owned
  
 774
    
 11
    
 427
Net gain on sale of loans
  
 (67)
    
 (54)
    
 (113)
Mortgage loans originated for sale
  
 -
    
 (1,685)
    
 (4,297)
Proceeds from sale of loans originated for sale
  
 -
    
 1,739
    
 4,410
Compensation expense related to stock options
  
 93
    
 71
    
 66
Compensation expense related to restricted stock
  
 142
    
 89
    
 55
(Increase) decrease  in accrued interest receivable
  
 (73)
    
 346
    
 (24)
Increase (decrease) in accrued interest payable
  
 365
    
 17
    
 (9)
Other, net
  
 193
    
 11
    
 (419)
Net Cash Provided by Operating Activities
  
 16,051
    
 11,376
    
 10,498
                 
CASH FLOWS FROM INVESTING ACTIVITIES
                
Securities available for sale:
                
Proceeds from sales
  
 15,612
    
 110,748
    
 44,976
Proceeds from maturities and principal reductions on mortgage-backed securities
  
 26,893
    
 26,182
    
 22,853
Purchases
  
 (19,955)
    
 (100,982)
    
 (50,565)
Purchase of regulatory stock
  
 (5,842)
    
 (2,883)
    
 (4,095)
Redemption of  regulatory stock
  
 4,456
    
 4,455
    
 2,397
Net increase in loans
  
 (51,980)
    
 (43,468)
    
 (65,830)
Proceeds from bank-owned life insurance
  
 -
    
 205
    
 -
Purchase of bank-owned life insurance
  
 -
    
 (2,000)
    
 -
Purchase of premises and equipment
  
 (1,633)
    
 (511)
    
 (290)
Proceeds from sales of foreclosed real estate owned
  
 3,341
    
 685
    
 4,310
Proceeds from sales of bank premises and fixed assets
  
 515
    
 -
    
 -
Acquisition, net of cash and cash equivalents acquired
  
 -
    
 11,112
    
 -
Net Cash (Used in) Provided by Investing Activities
  
 (28,593)
    
 3,543
    
 (46,244)
                 
CASH FLOWS FROM FINANCING ACTIVITIES
                
Net increase (decrease) in deposits
  
 17,867
    
 47,213
    
 (9,035)
Deposits sold
  
 (13,659)
    
 -
    
 -
Net increase (decrease) in short-term borrowings
  
 9,719
    
 (21,800)
    
 27,540
Repayments of other borrowings
  
 (24,056)
    
 (28,981)
    
 (10,074)
Proceeds from other borrowings
  
 28,000
    
 -
    
 29,000
Stock options exercised
  
 1,040
    
 843
    
 441
ESOP purchase of shares from treasury stock
  
 127
    
 131
    
 146
Purchase of treasury stock
  
 (1,587)
    
 (447)
    
 (127)
Cash dividends paid
  
 (5,386)
    
 (4,714)
    
 (4,527)
                 
Net Cash Provided by (Used in) Financing Activities
  
 12,065
    
 (7,755)
    
 33,364
Net (Decrease) Increase in Cash and Cash Equivalents
  
 (477)
    
 7,164
    
 (2,382)
                 
CASH AND CASH EQUIVALENTS - BEGINNING
  
 17,174
    
 10,010
    
 12,376
CASH AND CASH EQUIVALENTS - ENDING
$
 16,697
  
$
 17,174
  
$
 10,010
                 
 
 
37
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
 
                 
 
Years Ended December 31,
   
2017
    
2016
    
2015
 
(In Thousands)
                 
Supplemental Disclosures of Cash Flow Information
                
  Cash payments for:
                
     Interest paid
$
 3,715
  
$
 3,542
  
$
 3,267
     Income taxes paid, net of refunds
$
 3,040
  
$
 1,535
  
$
 2,315
Supplemental Schedule of Noncash Investing Activities
                
   Transfers of loans to foreclosed real estate owned and repossession of other assets
$
 750
  
$
 3,246
  
$
 3,880
   Dividends payable
$
 1,375
  
$
 1,331
  
$
 1,147
                 
Merger with Delaware Bancshares, Inc.
                
   Noncash assets acquired:
                
     Securities available-for-sale
      
$
 208,488
      
     Regulatory stock
        
 279
      
     Loans
        
 116,674
      
     Premises and equipment, net
        
 7,292
      
     Accrued interest receivable
        
 1,626
      
     Bank-owned life insurance
        
 14,762
      
     Core deposit intangible
        
 449
      
     Deferred tax assets
        
 3,034
      
     Other assets
        
 3,281
      
     Goodwill
        
 1,616
      
       
$
 357,501
      
                 
   Liabilities assumed:
                
     Time deposits
      
$
 71,342
      
     Deposits other than time deposits
        
 255,921
      
     Borrowings
        
 21,232
      
     Accrued interest payable
        
 95
      
     Other liabilities
        
 7,873
      
         
 356,463
      
       Net Noncash Assets Acquired
        
 1,038
      
       Cash Acquired
      
$
 14,977
      


 

See notes to consolidated financial statements
 
 
38
NORWOOD FINANICAL CORP - 2017 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 bank-related services which include interest earnings on commercial mortgages, residential real estate mortgages, commercial and consumer loans, as well as interest earnings on investment securities and fees from deposit services to its customers. The Company is subject to regulation and supervision by the Federal Reserve Board while the Bank is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.

Change in Accounting Principle

On February 14, 2018, the Financial Accounting Standards Board finalized ASU 2018-02 - Income Statement-Reporting Comprehensive Income (Topic 220). This accounting standard allows companies to reclassify the "stranded" tax effect in accumulated other comprehensive income that resulted from the U.S. federal government enacted tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (Tax Cuts and Jobs Act), which requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws. 

The Company has elected to early-adopt this accounting standard, which provides a benefit to the financial statements by more accurately aligning the impacts of the items carried in accumulated other comprehensive income with the associate tax effect.  The adoption resulted in a one-time cumulative effect adjustment of $434,000 between Retained Earnings and Accumulated Other Comprehensive Income on the Consolidated Balance Sheet.  The adjustment had no impact on Net Income or any prior periods presented.


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. In June 2017, the Bank adopted a plan of dissolution for Norwood Settlement Services, LLC.  All significant intercompany accounts and transactions have been eliminated in consolidation.

Estimates

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

Most of the Company's activities are with customers located within its markets in Northeastern Pennsylvania and the Southern Tier of New York. 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.
 
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Concentrations of Credit Risk

The Bank operates primarily in Wayne, Pike, Lackawanna and Monroe Counties, Pennsylvania and Delaware and Sullivan Counties, New York.  Accordingly, the Bank has extended credit primarily to commercial entities and individuals in these areas 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 related 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.

Regulatory Stock

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

Management evaluates the regulatory stock for impairment. Management's determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management considers the FHLB's regulatory capital ratios, liquidity, and the fact that new shares of FHLB stock continue to change hands at the $100 par value.  Management believes no impairment charge is necessary related to FHLB stock as of December 31, 2017.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Loans Receivable

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

The 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, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk.

Loans Acquired

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

For purchased loans acquired that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value.  Loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics.  Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts.  The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Mortgage Servicing Rights

Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon a third party appraisal. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. The Company's loan servicing assets at December 31, 2017 and 2016, respectively, were not impaired. Total servicing assets included in other assets as of December 31, 2017 and 2016, were $200,000 and $232,000, 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 and general components. The specific component relates to loans that are classified as substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

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

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans were acquired with impairment or are the subject of a restructuring agreement.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Premises and Equipment

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

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


Transfers of Financial Assets

Transfers of financial assets, including loan and loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity 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 select group of employees. The Company is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Income from the increase in cash surrender value of the policies or from death benefits realized is included in other income on the Consolidated Statements of  Income.

Goodwill

In connection with two acquisitions the Company recorded goodwill in the amount of $11.3 million, representing the excess of amounts paid over the fair value of net assets of the institutions acquired.  Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value.  The value of the goodwill can change in the future.  We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of the Bank.  If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss. No impairment was recognized for the years ended December 31, 2017, 2016 and 2015.

Other Intangible Assets

At December 31, 2017, the Company had other intangible assets of $462,000 which is net of accumulated amortization of $883,000.  These intangible assets will continue to be amortized using the sum-of-the-years digits method of amortization over ten years.  At December 31, 2016, the Company had other intangible assets of $612,000 which was net of accumulated amortization of $732,000.  Amortization expense related to other intangible assets was $150,000, $122,000 and $105,000 for the years ended December 31, 2017, 2016 and 2015, respectively.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

As of December 31, 2017, the estimated future amortization expense for the core deposit intangible is as follows (in thousands):


       
       
       
2018
$
 126
  
2019
  
 101
  
2020
  
 77
  
2021
  
 52
  
2022
  
 38
  
Thereafter
  
 68
  
 
$
 462
  
       
 
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. On December 22, 2017, the President signed the Tax Cut and Jobs Act (the "Act") into law.  Among other things, the Act reduced the corporate tax rate from a maximum of 35% to a flat 21% rate effective January 1, 2018.  As a result of the reduction in the corporate income tax rate to 21%, the Company revalued its net deferred tax asset as of December 31, 2017, which resulted in a $3,060,000 reduction in its value.  The reduction in the value of the net deferred tax asset has been recorded as additional income tax expense in the fourth quarter of 2017.

 The Company and its subsidiary file a consolidated federal income tax return. The Company recognizes interest and penalties on income taxes as a component of income tax expense.

The Company analyzes each tax position taken in its tax returns and determines the likelihood that the position will be realized. Only tax positions that are "more-likely-than-not" to be realized can be recognized in an entity's financial statements. For tax positions that do not meet this recognition threshold, an entity will record an unrecognized tax benefit for the difference between the position taken on the tax return and the amount recognized in the financial statements. The Company does not have any unrecognized tax benefits at December 31, 2017 or 2016 or during the years then ended. No unrecognized tax benefits are expected to arise within the next twelve months.

Advertising Costs

Advertising costs are expensed as incurred.

Earnings per Share

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

Employee Benefit Plans

The Company has a defined contributory profit-sharing plan which includes provisions of a 401(k) plan.  The Company's contributions are expensed as the cost is incurred.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The Company has several supplemental executive retirement plans.  To fund the benefits under these plans, the Company is the owner of single premium life insurance policies on the participants.

The Company provides pension benefits to eligible employees.  The Company's funding policy is to contribute at least the minimum required contributions annually.

Stock Option Plans

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

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

Cash Flow Information

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

Off-Balance Sheet Financial Instruments

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

Trust Assets

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

Treasury Stock

Common shares repurchased are recorded as treasury stock at cost.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and defined benefit pension obligations, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income as presented in the Consolidated Statement of Comprehensive Income.
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Segment Reporting

The Company acts as an independent community financial services provider and offers traditional banking related financial services to individual, business and government customers. Through its Community Office 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.


Reclassification of Comparative Amounts

Certain comparative amounts for the prior year have been reclassified to conform to current-year classifications. Such reclassifications had no material effect on net income or stockholders' equity.
New Accounting Standards

 In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The Update's core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this Update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  Since the guidance scopes out revenue associated with financial instruments, including loan receivables and investment securities, we do not expect the adoption of the new standard, or any of the amendments, to result in a material change from our current accounting for revenue because the majority of the Company's revenue is not within the scope of Topic 606.  However, we do expect that the standard will result in new disclosure requirements, which are currently being evaluated.

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

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10):  Recognition and Measurement of Financial Assets and Financial Liabilities.  This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments.  Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (g) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  For all other entities, including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operations

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet.  A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  A short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise.  For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years.  For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.  The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period.  The Company is currently assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial statements. Based on the Company's preliminary analysis of its current portfolio, the impact to the Company's balance sheet is estimated to result in less than a 1 percent increase in assets and liabilities. The Company also anticipates additional disclosures to be provided at adoption.

In March 2016, the FASB issued ASU 2016-04, Liabilities – Extinguishments of Liabilities (Subtopic 405-20). The standard provides that liabilities related to the sale of prepaid stored-value products within the scope of this Update are financial liabilities. The amendments in the Update provide a narrow-scope exception to the guidance in Subtopic 405-20 to require that breakage for those liabilities be accounted for consistent with the breakage guidance in Topic 606. The amendments in this Update are effective for public business entities, certain not-for-profit entities, and certain employee benefit plans for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Earlier application is permitted, including adoption in an interim period.  This Update is not expected to have a significant impact on the Company's financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606). The amendments in this Update affect entities with transactions included within the scope of Topic 606, which includes entities that enter into contracts with customers to transfer goods or services (that are an output of the
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
 
entity's ordinary activities) in exchange for consideration.  The amendments in this Update do not change the core principle of the guidance in Topic 606; they simply clarify the implementation guidance on principal versus agent considerations. The amendments in this Update are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements of Update 2014-09. ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year.  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 April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606).  The amendments in this Update affect entities with transactions included within the scope of Topic 606, which includes entities that enter into contracts with customers to transfer goods or services in exchange for consideration. The amendments in this Update do not change the core principle for revenue recognition in Topic 606. Instead, the amendments provide (1) more detailed guidance in a few areas and (2) additional implementation guidance and examples based on feedback the FASB received from its stakeholders. The amendments are expected to reduce the degree of judgment necessary to comply with Topic 606, which the FASB expects will reduce the potential for diversity arising in practice and reduce the cost and complexity of applying the guidance.  The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by Update 2014-09). ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year.  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 May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606), which among other things clarifies the objective of the collectability criterion in Topic 606, as well as certain narrow aspects of Topic 606. The amendments in this Update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by Update 2014-09). ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year. This Update is not expected to have a significant impact on the Company's financial statements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations.  The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management's current estimate of credit losses that are expected to occur over the remaining life of a financial asset.  The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after
 
 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230):  Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing diversity in practice.  Among these include recognizing cash payments for debt prepayment or debt extinguishment as cash outflows for financing activities; cash proceeds received from the settlement of insurance claims should be classified on the basis of the related insurance coverage; and cash proceeds received from the settlement of bank-owned life insurance policies should be classified as cash inflows from investing activities while the cash payments for premiums on bank-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.  The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this Update should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Company is currently evaluating the impact the adoption of the standard will have on the Company's statement of cash flows.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740), which requires recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset (excluding inventory) when the transfer occurs.  Consequently, the amendments in this Update eliminate the exception for an intra-entity transfer of an asset other than inventory. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those annual reporting periods. For all other entities, the amendments are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual periods beginning after December 15, 2019.  Early adoption is permitted for all entities as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. That is, earlier adoption should be in the first interim period if an entity issues interim financial statements. The amendments in this Update should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.  This Update is not expected to have a significant impact on the Company's financial statements.

In October 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), which requires that a statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.
 
 
49
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.  The amendments in this Update should be applied using a retrospective transition method to each period presented.  The Company is currently evaluating the impact the adoption of the standard will have on the Company's statement of cash flows.

In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.  This Update, among others things, clarifies that guarantee fees within the scope of Topic 460, Guarantees, (other than product or service warranties) are not within the scope of Topic 606. The effective date and transition requirements for ASU 2016-20 are the same as the effective date and transition requirements for the new revenue recognition guidance. For public entities with a calendar year-end, the new guidance is effective in the quarter and year beginning January 1, 2018. For all other entities with a calendar year-end, the new guidance is effective in the year ending December 31, 2019, and interim periods in 2020.  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 January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business, which provides a more robust framework to use in determining when a set of assets and activities (collectively referred to as a "set") is a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated.  Public business entities should apply the amendments in this Update to annual periods beginning after December 15, 2017, including interim periods within those periods. All other entities should apply the amendments to annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.  The amendments in this Update should be applied prospectively on or after the effective date.  This Update is not expected to have a significant impact on the Company's financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test.  In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination.  Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020.  All other entities, including not-for-profit entities that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company's financial statements.
 
 
50
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In February 2017, the FASB issued ASU 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20). The amendments in this Update clarify what constitutes a financial asset within the scope of Subtopic 610-20.  The amendments also clarify that entities should identify each distinct nonfinancial asset or in substance nonfinancial asset that is promised to a counterparty and to derecognize each asset when the counterparty obtains control.  There is also additional guidance provided for partial sales of a nonfinancial asset and when derecognition, and the related gain or loss, should be recognized.  The amendments in this Update are effective at the same time as the amendments in Update 2014-09. Therefore, for public entities, the amendments are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period.  For all other entities, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.  This Update is not expected to have a significant impact on the Company's financial statements.

In February 2017, the FASB issued ASU 2017-06, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), and Health and Welfare Benefit Plans (Topic 965). This Update relates primarily to the reporting by an employee benefit plan for its interest in a master trust, which is a trust for which a regulated financial institution serves as a trustee or custodian and in which assets of more than one plan sponsored by a single employer or by a group of employers under common control are held.  For each master trust in which a plan holds an interest, the amendments in this Update require a plan's interest in that master trust and any change in that interest to be presented in separate line items in the statement of net assets available for benefits and in the statement of changes in net assets available for benefits, respectively.  The amendments in this Update remove the requirement to disclose the percentage interest in the master trust for plans with divided interests and require that all plans disclose the dollar amount of their interest in each of those general types of investments, which supplements the existing requirement to disclose the master trusts balances in each general type of investments.  There are also increased disclosure requirements for investments in master trusts.  The amendments in this Update are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted.  This Update is not expected to have a significant impact on the Company's financial statements.

In March 2017, the FASB issued ASU 2017-07, Compensation—Retirement Benefits (Topic 715). The amendments in this Update require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period.  The other components of net benefit cost as defined in paragraphs 715-30-35-4 and 715-60-35-9 are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, that line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed.  The amendments in this Update are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. For other entities, the amendments in this Update are effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.  The amendments in this Update should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. This Update is not expected to have a significant impact on the Company's financial statements.
 
 
51
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.  For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.  Early adoption is permitted, including adoption in an interim period.  If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.  An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle.  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 May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718), which affects any entity that changes the terms or conditions of a share-based payment award.  This Update amends the definition of modification by qualifying that modification accounting does not apply to changes to outstanding share-based payment awards that do not affect the total fair value, vesting requirements, or equity/liability classification of the awards.  The amendments in this Update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date. This Update is not expected to have a significant impact on the Company's financial statements.

In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements (Topic 853), which applies to the accounting by operating entities for service concession arrangements within the scope of Topic 853. The amendments in this Update clarify that the grantor (government), rather than the third-party drivers, is the customer of the operation services in all cases for service concession arrangements within the scope of Topic 853. For an entity that has not adopted Topic 606 before the issuance of this Update, the effective date and transition requirements for the amendments in this Update generally are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by ASU 2014-09, Revenue from Contracts with Customers (Topic 606)). ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, deferred the effective date of Update 2014-09 by one year.  This Update is not expected to have a significant impact on the Company's financial statements.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), and Derivative and Hedging (Topic 815). The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down-round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down-round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity's own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down-round feature. For freestanding equity classified financial instruments, the amendments require entities
 
 
52
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down-round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down- round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this Update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Accounting Standards Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments in Part I of this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in Part I of this Update should be applied either retrospectively to outstanding financial instruments with a down-round feature by means of a cumulative-effect adjustment to the statement of financial position as of the beginning of the first fiscal year and interim period(s) in which the pending content that links to this paragraph is effective or retrospectively to outstanding financial instruments with a down-round feature for each prior reporting period presented in accordance with the guidance on accounting changes in paragraphs 250-10-45-5 through 45-10. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect.  This Update is not expected to have a significant impact on the Company's financial statements.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 850), the objective of which is to improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. In addition, the amendments in this Update make certain targeted improvements to simplify the application and disclosure of the hedge accounting guidance in current general accepted accounting principles.  For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. Early application is permitted in any period after issuance.  For cash flow and net investment hedges existing at the date of adoption, an entity should apply a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that an entity adopts the amendments in this Update. The amended presentation and disclosure guidance is required only prospectively.   This Update is not expected to have a significant impact on the Company's financial statements.

In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842), which provides an optional transition practical expedient to not evaluate under Topic 842 existing or expired land easements that were not previously accounted for as leases under the current lease guidance in Topic 840.  An entity that elects this practical expedient should evaluate new or modified land easements under Topic 842 beginning at the date the entity adopts Topic 842; otherwise, an entity should evaluate all existing or expired land easements in connection with the adoption of the new lease requirements in Topic 842 to assess whether they meet the definition of a lease.  The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in ASU 2016-02.  This Update is not expected to have a significant impact on the Company's financial statements.

 
53
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 3 - SECURITIES

The amortized cost, gross unrealized gains and losses, and fair value of securities were as follows:
                         
   
December 31, 2017
           
Gross
    
Gross
      
     
Amortized
    
Unrealized
    
Unrealized
    
Fair
     
Cost
    
Gains
    
Losses
    
Value
   
(In Thousands)
AVAILABLE FOR SALE:
                        
U.S. Treasury securities
  
$
 2,001
  
$
 -
  
$
 (3)
  
$
 1,998
States and political subdivisions
    
 120,000
    
 1,535
    
 (1,057)
    
 120,478
Corporate obligations
    
 10,068
    
 16
    
 (95)
    
 9,989
Mortgage-backed securities-
                        
government sponsored entities
    
 152,901
    
 17
    
 (4,262)
    
 148,656
   Total debt securities
  
$
 284,970
  
$
 1,568
  
$
 (5,417)
  
$
 281,121
                         

                         
   
December 31, 2016
           
Gross
    
Gross
      
     
Amortized
    
Unrealized
    
Unrealized
    
Fair
     
Cost
    
Gains
    
Losses
    
Value
   
(In Thousands)
AVAILABLE FOR SALE:
                        
U.S. Treasury securities
  
$
 2,005
  
$
 -
  
$
 (8)
  
$
 1,997
States and political subdivisions
    
 127,585
    
 884
    
 (3,368)
    
 125,101
Corporate obligations
    
 10,255
    
 37
    
 (180)
    
 10,112
Mortgage-backed securities-
                        
government sponsored entities
    
 169,124
    
 26
    
 (4,220)
    
 164,930
   Total debt securities
    
 308,969
    
 947
    
 (7,776)
    
 302,140
Equity securities-financial services
    
 320
    
 104
    
 -
    
 424
   
$
 309,289
  
$
 1,051
  
$
 (7,776)
  
$
 302,564
                         
                         
 
 
54
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 3 - SECURITIES (CONTINUED)
 
The following tables show the Company's investments' gross unrealized losses and fair value aggregated by security type and length of time that individual securities have been in a continuous unrealized loss position:
                                   
 
December 31, 2017
 
Less than 12 Months
  
12 Months or More
  
Total
 
Fair Value
  
Unrealized Losses
  
Fair Value
  
Unrealized Losses
  
Fair Value
  
Unrealized Losses
  (In Thousands)
U.S. Treasury securities
$
 -
  
$
 -
  
$
 1,998
  
$
 (3)
  
$
 1,998
  
$
 (3)
States and political subdivisions
  
 17,310
    
 (228)
    
 44,948
    
 (829)
    
 62,258
    
 (1,057)
Corporate obligations
  
 -
    
 -
    
 6,859
    
 (95)
    
 6,859
    
 (95)
Mortgage-backed securities-
    government sponsored entities
  
 22,250
    
 (320)
    
 125,846
    
 (3,942)
    
 148,096
    
 (4,262)
 
$
 39,560
  
$
 (548)
  
$
 179,651
  
$
 (4,869)
  
$
 219,211
  
$
 (5,417)

 
                                   
 
December 31, 2016
 
Less than 12 Months
  
12 Months or More
  
Total
 
Fair Value
  
Unrealized Losses
  
Fair Value
  
Unrealized Losses
  
Fair Value
  
Unrealized Losses
  (In Thousands)  
U.S. Treasury securities
$
 1,997
  
$
 (8)
  
$
 -
  
$
 -
  
$
 1,997
  
$
 (8)
States and political subdivisions
  
 90,109
    
 (3,362)
    
 205
    
 (6)
    
 90,314
    
 (3,368)
Corporate obligations
  
 6,895
    
 (180)
    
 -
    
 -
    
 6,895
    
 (180)
Mortgage-backed securities-
    government sponsored entities
  
 152,614
    
 (3,912)
    
 9,967
    
 (308)
    
 162,581
    
 (4,220)
 
$
 251,615
  
$
 (7,462)
  
$
 10,172
  
$
 (314)
  
$
 261,787
  
$
 (7,776)

 
The Company has 39 debt securities in the less than twelve month category and 162 debt securities in the twelve months or more category as of December 31, 2017.  In management's opinion, the unrealized losses on securities reflect changes in interest rates subsequent to the acquisition of specific securities.  No other-than-temporary-impairment charges were recorded in 2017.  Management believes that all other unrealized losses represent temporary impairment of the securities, and it is more likely than not that it will not have to sell the securities before recovery of their cost basis.


The amortized cost and fair value of debt securities as of December 31, 2017 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
           
 
Amortized
  
Fair
 
Cost
  
Value
   
(In Thousands)
Due in one year or less
$
 5,514
  
$
 5,517
Due after one year through five years
  
 21,383
    
 21,269
Due after five years through ten years
  
 45,373
    
 44,705
Due after ten years
  
 59,799
    
 60,974
   
 132,069
    
 132,465
           
Mortgage-backed securities-
    government sponsored entities
  
 152,901
    
 148,656
 
$
 284,970
  
$
 281,121

 
55
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 3 - SECURITIES (CONTINUED)
Gross realized gains and gross realized losses on sales of securities available for sale were $354,000 and $6,000, respectively, in 2017, compared to $284,000 and $0, respectively, in 2016, and $626,000 and $0, respectively, in 2015. The proceeds from the sales of securities totaled $15,612,000, $110,748,000 and $44,976,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

Securities with a carrying value of $213,065,000 and $230,263,000 at December 31, 2017 and 2016, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law.

 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Set forth below is selected data relating to the composition of the loan portfolio (in thousands):


                       
                       
  Types of Loans
  (dollars in thousands)
 
December 31, 2017
    
December 31, 2016
Real Estate:
                      
Residential
$
 235,759
  
 30.8
%
  
$
 237,177
  
 33.2
%
Commercial
  
 342,934
  
 44.9
      
 320,187
  
 44.8
  
Construction
  
 17,228
  
 2.3
      
 19,709
  
 2.8
  
Commercial, financial and agricultural
  
 97,461
  
 12.7
      
 85,508
  
 12.0
  
Consumer loans to individuals
  
 70,953
  
 9.3
      
 51,524
  
 7.2
  
Total loans
  
 764,335
  
 100.0
%
    
 714,105
  
 100.0
%
                       
Deferred fees, net
  
 (243)
          
 (216)
      
Total loans receivable
  
 764,092
          
 713,889
      
Allowance for loan losses
  
 (7,634)
          
 (6,463)
      
Net loans receivable
$
 756,458
        
$
 707,426
      

 
The following table presents the components of the purchase accounting adjustments related to the purchased credit-impaired loans acquired:
       
       
(In Thousands)
    
  July 31, 2016
       
Contractually required principal and interest
  
$
 2,621
Non-accretable discount
    
 (1,014)
Expected cash flows
    
 1,607
Accretable discount
    
 (239)
Estimated fair value
  
$
 1,368
       
 
Changes in the accretable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31:
               
                 
 
2017
  
2016
  
2015
(In thousands)                 
Balance at beginning of period
$
 208
  
$
 -
  
$
8
Additions
  
 -
    
 239
    
 -
Accretion
  
 (73)
    
 (30)
  
 
 (1)
Reclassification and other
  
 (27)
    
 (1)
    
 (7)
Balance at end of period
$
 108
  
$
 208
  
$
 -

 
56
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):
           
           
 
December 31, 2017
  
December 31, 2016
           
Outstanding Balance
$
 1,444
  
$
 1,821
Carrying Amount
$
 1,174
  
$
 1,386

There were no material increases or decreases in the expected cash flows of these loans since the acquisition date. There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality.  As of December 31, 2017, for loans that were acquired prior to 2017 with or without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation. For loans that were acquired in 2016 with or without specific evidence of deterioration in credit quality, there were no adjustments to the allowance for loan losses calculation.

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

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.
 
 
57
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following tables show the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:
                                   
                                   
 
Real Estate Loans
                  
                   
Commercial
  
Consumer
      
 
Residential
  
Commercial
  
Construction
  
Loans
  
Loans
  
Total
 
(In thousands)
December 31, 2017
                                  
Individually evaluated for  impairment
$
 23
  
$
 1,224
  
$
 -
  
$
 -
  
$
 -
  
$
 1,247
Loans acquired with deteriorated credit quality
  
 833
    
 341
    
 -
    
 -
    
 -
    
 1,174
Collectively evaluated for impairment
  
234,903
    
 341,369
    
 17,228
    
 97,461
    
 70,953
    
 761,914
Total Loans
$
 235,759
  
$
 342,934
  
$
 17,228
  
$
 97,461
  
$
 70,953
  
$
 764,335

 
                                   
                                   
 
Real Estate Loans
                  
                   
Commercial
  
Consumer
      
 
Residential
  
Commercial
  
Construction
  
Loans
  
Loans
  
Total
 
(In thousands)
December 31, 2016
                                  
Individually evaluated for  impairment
$
 23
  
$
 2,601
  
$
 -
  
$
 -
  
$
 -
  
$
 2,624
Loans acquired with deteriorated credit quality
  
 821
    
 565
    
 -
    
 -
    
 -
    
 1,386
Collectively evaluated for impairment
  
236,333
    
 317,021
    
 19,709
    
 85,508
    
 51,524
    
 710,095
Total Loans
$
 237,177
  
$
 320,187
  
$
 19,709
  
$
 85,508
  
$
 51,524
  
$
 714,105

 
58
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable.
                 
                 
       
Unpaid
      
 
Recorded
  
Principal
  
Associated
 
Investment
  
Balance
  
Allowance
December 31, 2017
  (In thousands)
With no related allowance recorded:
                
Real Estate Loans
                
    Residential
$
 23
  
$
 28
  
$
-
    Commercial
  
 1,224
    
 1,496
    
-
          Subtotal
  
 1,247
    
 1,524
    
 -
                 
Total:
                
Real Estate Loans
                
    Residential
  
 23
    
 28
    
 -
    Commercial
  
 1,224
    
 1,496
    
 -
          Total Impaired Loans
$
 1,247
  
$
 1,524
  
$
 -



                 
                 
       
Unpaid
      
 
Recorded
  
Principal
  
Associated
 
Investment
  
Balance
  
Allowance
December 31, 2016
  (In thousands)
With no related allowance recorded:
                
Real Estate Loans
                
    Residential
$
 23
  
$
 28
  
$
-
    Commercial
  
 2,601
    
 3,427
    
-
          Subtotal
  
 2,624
    
 3,455
    
 -
                 
Total:
                
Real Estate Loans
                
    Residential
  
 23
    
 28
    
 -
    Commercial
  
 2,601
    
 3,427
    
 -
          Total Impaired Loans
$
 2,624
  
$
 3,455
  
$
 -
                 
The following information for impaired loans is presented for the years ended December 31, 2017, 2016 and 2015:
                            
 
Average Recorded
  
Interest Income
   Investment  
Recognized
 
 
2017		  
2016
    
2015
  
2017
  
2016
    
2015
 
                               (In thousands)
      
Total:
                                  
Real Estate Loans
                                  
Residential
$
 23
  
$
 25
  
$
 159
  
$
 -
  
$
 -
  
$
 4
Commercial
  
 1,209
    
 2,671
    
 8,847
    
 56
    
 91
    
 526
Commercial Loans
  
 -
    
 -
    
 9
    
 -
    
 -
    
 2
Total Loans
$
 1,232
  
$
 2,696
  
$
 9,015
  
$
 56
  
$
 91
  
$
 532
 
 
59
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.  As of December 31, 2017, troubled debt restructured loans totaled $1.1 million and resulted in specific reserves of $0.  During 2017, there were no new loan relationships identified as troubled debt restructurings, while one loan identified as a troubled debt restructuring with a balance of $322,000 as of December 31, 2016 was paid in full during 2017.  During 2017, the Company recognized charge-offs totaling $55,000 on loans classified as troubled debt restructurings.

As of December 31, 2016, troubled debt restructured loans totaled $1.5 million and resulted in specific reserves of $0.  During 2016, there were no new loan relationships identified as troubled debt restructurings, while one loan with a balance of $5.0 million as of December 31, 2015 was transferred to Foreclosed Real Estate Owned during 2016 as a result of foreclosure on the property and one loan relationship with a balance of $82,000 as of December 31, 2015 was charged-off in 2016. During 2016, the Company recognized charge-offs totaling $2.6 million on loans classified as troubled debt restructurings.


Foreclosed assets acquired in settlement of loans are carried at fair value less estimated costs to sell and are included in foreclosed real estate owned on the Consolidated Balance Sheets.  As of December 31, 2017 and 2016, foreclosed real estate owned totaled $1,661,000 and $5,302,000, respectively.  As of December 31, 2017, included within foreclosed real estate owned is $34,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the year end.  As of December 31, 2017, the Company has initiated formal foreclosure proceedings on 15 consumer residential mortgage loans with an outstanding balance of $1,166,000.

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio.  The first four categories are considered not criticized, and are aggregated as "Pass" rated.  The criticized rating categories utilized by management generally follow bank regulatory definitions.  The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  Loans greater than 90 days past due are considered Substandard unless full payment is expected.  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 nonperformance, repossession, or death occurs to raise awareness of a possible credit event.  The Company's Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis.  Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration.  Loan Review also annually reviews relationships of $1,500,000 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.
 
 
60
NORWOOD FINANICAL CORP - 2017 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, 2017 and December 31, 2016 (in thousands):
                                   
                                   
       
Special
                        
 
Pass
  
Mention
  
Substandard
  
Doubtful
  
Loss
  
Total
December 31, 2017
                                  
Commercial real estate loans
$
 329,617
  
$
 9,680
  
$
 3,637
  
$
 -
  
$
 -
  
$
 342,934
Commercial
  
 97,389
    
 16
    
 56
    
 -
    
 -
    
 97,461
Total
$
 427,006
  
$
 9,696
  
$
 3,693
  
$
 -
  
$
 -
  
$
 440,395


                                   
                                   
       
Special
                        
 
Pass
  
Mention
  
Substandard
  
Doubtful
  
Loss
  
Total
December 31, 2016
                                  
Commercial real estate loans
$
 310,432
  
$
 5,432
  
$
 4,323
  
$
 -
  
$
 -
  
$
 320,187
Commercial
  
 84,600
    
 885
    
 23
    
 -
    
 -
    
 85,508
Total
$
 395,032
  
$
 6,317
  
$
 4,346
  
$
 -
  
$
 -
  
$
 405,695

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits. Nonperforming loans include loans that have been placed on nonaccrual status and loans remaining in accrual status on which the contractual payment of principal and interest has become 90 days past due.

 The following table presents the recorded investment in the loan classes based on payment activity as of December 31, 2017 and December 31, 2016 (in thousands):



                 
                 
 
Performing
  
Nonperforming
  
Total
December 31, 2017
                
Residential real estate loans
$
 233,966
  
$
 1,793
  
$
 235,759
Construction
  
 17,228
    
 -
    
 17,228
Consumer loans to individuals
  
 70,953
    
 -
    
 70,953
Total
$
 322,147
  
$
 1,793
  
$
 323,940

 
                 
                 
 
Performing
  
Nonperforming
  
Total
December 31, 2016
                
Residential real estate loans
$
 235,829
  
$
 1,137
  
$
 237,177
Construction
  
 19,681
    
 28
    
 19,709
Consumer loans to individuals
  
 51,524
    
 -
    
 51,524
Total
$
 307,034
  
$
 1,165
  
$
 308,410

 
61
NORWOOD FINANICAL CORP - 2017 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, 2017 and December 31, 2016 (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, 2017
                                        
Real Estate loans
                                        
Residential
$
 233,291
  
$
 594
  
$
 81
  
$
 87
  
$
 1,706
  
$
 2,468
  
$
 235,759
Commercial
  
 341,602
    
 646
    
 -
    
 409
    
 277
    
 1,332
    
 342,934
Construction
  
 17,228
    
 -
    
 -
    
 -
    
 -
    
 -
    
 17,228
Commercial  loans
  
 97,424
    
 10
    
 27
    
 -
    
 -
    
 37
    
 97,461
Consumer  loans
  
 70,869
    
 60
    
 24
    
 -
    
 -
    
 84
    
 70,953
Total
$
 760,414
  
$
 1,310
  
$
 132
  
$
 496
  
$
 1,983
  
$
 3,921
  
$
 764,335

 
                                         
                                         
 
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, 2016
                                        
Real Estate loans
                                        
Residential
$
 234,790
  
$
 986
  
$
 264
  
$
 1
  
$
 1,136
  
$
 2,387
  
$
 237,177
Commercial
  
 318,979
    
 445
    
 1
    
 -
    
 762
    
 1,208
    
 320,187
Construction
  
 19,681
    
 -
    
 -
    
 -
    
 28
    
 28
    
 19,709
Commercial  loans
  
 85,355
    
 143
    
 10
    
 -
    
 -
    
 153
    
 85,508
Consumer  loans
  
 51,456
    
 39
    
 29
    
 -
    
 -
    
 68
    
 51,524
Total
$
 710,261
  
$
 1,613
  
$
 304
  
$
 1
  
$
 1,926
  
$
 3,844
  
$
 714,105

 
62
NORWOOD FINANICAL CORP - 2017 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, 2016
$
 1,092
  
$
 4,623
  
$
 78
  
$
 307
  
$
 363
  
$
 6,463
Charge Offs
  
 (83)
    
 (902)
    
 (28)
    
 -
    
 (207)
    
 (1,220)
Recoveries
  
 6
    
 159
    
 -
    
 -
    
 26
    
 191
Provision for loan losses
  
 257
    
 1,385
    
 40
    
 156
    
 362
    
 2,200
Ending balance, December 31, 2017
$
 1,272
  
$
 5,265
  
$
 90
  
$
 463
  
$
 544
  
$
 7,634
Ending balance individually evaluated
 for impairment
$
 -
  
$
 -
  
$
 -
  
$
 -
  
$
 -
  
$
 -
Ending balance collectively evaluated
 for impairment
$
 1,272
  
$
 5,265
  
$
 90
  
$
 463
  
$
 544
  
$
 7,634

 
                                   
                                   
(In thousands)
Residential Real Estate
  
Commercial Real Estate
  
Construction
  
 Commercial
  
Consumer
  
Total
Beginning balance, December 31, 2015
$
 1,069
  
$
 5,506
  
$
 90
  
$
 397
  
$
 236
  
$
 7,298
Charge Offs
  
 (123)
    
 (2,711)
    
 -
    
 (15)
    
 (102)
    
 (2,951)
Recoveries
  
 6
    
 15
    
 -
    
 -
    
 45
    
 66
Provision for loan losses
  
 140
    
 1,813
    
 (12)
    
 (75)
    
 184
    
 2,050
Ending balance, December 31, 2016
$
 1,092
  
$
 4,623
  
$
 78
  
$
 307
  
$
 363
  
$
 6,463
Ending balance individually evaluated
 for impairment
$
 -
  
$
 3
  
$
 -
  
$
 -
  
$
 -
  
$
 3
Ending balance collectively evaluated
 for impairment
$
 1,092
  
$
 4,620
  
$
 78
  
$
 307
  
$
 363
  
$
 6,460

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

 
63
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)

The recorded investment in impaired loans, not requiring an allowance for loan losses was $1,247,000 (net of charge-offs against the allowance for loan losses of $277,000) and $2,624,000 (net of charge-offs against the allowance for loan losses of $831,000) at December 31, 2017 and 2016, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $0 at December 31, 2017 and 2016, respectively. The specific reserve related to impaired loans was $0 for 2017 and 2016. For the years ended December 31, 2017 and 2016, the average recorded investment in these impaired loans was $1,232,000, and $2,696,000, respectively, and the interest income recognized on these impaired loans was $56,000 and $91,000, respectively.

During the period ended December 31, 2017, the allowance for commercial real estate loans increased from $4,623,000 to $5,265,000.  This $642,000 increase in the required allowance was due primarily to a $22,747,000 increase in loan balances and an increase in the amount of reserve required for classified loans.  This increase was partially offset by a reduction in the historical loss factor from 0.80% at December 31, 2016 to 0.74% on December 31, 2017.

During the period ended December 31, 2016, the allowance for commercial real estate loans decreased from $5,506,000 to $4,623,000.  This $883,000 decrease in the required allowance was due to a $1,610,000 decrease in the specific reserve component resulting from the transfer of an impaired loan with a specific reserve allowance of $1,596,000 at December 31, 2015 to foreclosed real estate during 2016.  This reduction was partially offset by a $419,000 increase in the allowance for commercial real estate loans due to an increase in the historical loss factor from 0.70% at December 31, 2015 to 0.80% on December 31, 2016.

  Interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of the loans was $163,000, $163,000 and $515,000 for 2017, 2016 and 2015, respectively.

As of December 31, 2017 and 2016, the Company considered its concentration of credit risk to be acceptable.  As of December 31, 2017, the highest concentrations are in commercial rentals and the hospitality lodging industry, with loans outstanding of $68.1 million, or 63.6% of bank capital, to commercial rentals, and $53.9 million, or 50.4% of bank capital to the hospitality and lodging industry.  Charge-offs on loans within these concentrations were $762,000, $31,000 and $643,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

The Company did not sell any residential mortgage loans in 2017.  Gross realized gains and gross realized losses on sales of residential mortgage loans were $54,000 and $0, respectively, in 2016 and $113,000 and $0, respectively, in 2015.  The proceeds from the sales of residential mortgage loans totaled $1.7 million and $4.4 million for the years ended December 31, 2016 and 2015, respectively.  As of December 31, 2017 and 2016, the outstanding value of loans serviced for others totaled $29.0 million and $35.5 million, respectively.


NOTE 5 - PREMISES AND EQUIPMENT
 
Components of premises and equipment at December 31 are as follows:
           
           
 
2017
  
2016
 
(In Thousands)
Land and improvements
$
 2,771
  
$
 2,925
Buildings and improvements
  
 17,613
    
 17,662
Furniture and equipment
  
 6,636
    
 6,351
   
 27,020
    
 26,938
Accumulated depreciation
  
 (13,156)
    
 (13,407)
           
 
$
 13,864
  
$
 13,531
 
 
64
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 5 - PREMISES AND EQUIPMENT (CONTINUED)
Depreciation expense totaled $922,000, $726,000 and $551,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

Certain facilities are leased under various operating leases. Rental expense for these leases was $405,000, $367,000 and $341,000, respectively, for the years ended December 31, 2017, 2016 and 2015. Future minimum rental commitments under noncancellable leases as of December 31, 2017 were as follows (in thousands):

       
       
 
2018
$
 467
 
2019
  
 454
 
2020
  
 451
 
2021
  
 451
 
2022
  
 451
 
Thereafter
  
 4,654
   
$
 6,928

NOTE 6 - DEPOSITS

Aggregate time deposits in denominations of $250,000 or more were $92,527,000 and $63,982,000 at December 31, 2017 and 2016, respectively.
 
At December 31, 2017, the scheduled maturities of time deposits are as follows (in thousands):

       
       
 
2018
$
 185,752
 
2019
  
 71,222
 
2020
  
 27,584
 
2021
  
 17,380
 
2022
  
 18,217
 
Thereafter
  
 139
   
$
 320,294

NOTE 7 – BORROWINGS

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

           
           
 
2017
  
2016
 
(In Thousands)
Securities sold under agreements to repurchase
$
 24,286
  
$
 32,811
Federal Home Loan Bank short-term borrowings
  
 18,244
    
 -
 
$
 42,530
  
$
 32,811

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

               
               
 
Years Ended December 31,
 
2017
  
2016
 
(Dollars In Thousands)
Average balance during the year
$
 39,170
    
$
 41,593
  
Average interest rate during the year
  
 0.51
%
    
 0.31
%
Maximum month-end balance during the year
$
 54,286
    
$
 52,672
  
Weighted average interest rate at the end of the year
  
 0.87
%
    
 0.32
%

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 $27,255,000 and $26,626,000 at December 31, 201 and $35,770,000 and $35,147,000 at December 31, 2016, respectively, were pledged as collateral for these agreements. The securities underlying the agreements were under the Company's control.

 
65
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 7 – BORROWINGS (CONTINUED)

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

                       
     
As of December 31, 2017  
     
Remaining Contractual Maturity of the Agreements  
     
Overnight and continuous
  
Up to 30 days
  
30-90 days
  
Greater than 90 days
  
b
Repurchase Agreements:
                      
  Mortgage-backed securities - government sponsored entities
    
$26,626
  
$0
  
$0
  
$0
  
$26,626
                       
Total liability recognized for repurchase agreements
                    
$24,286

                       
                       
     
As of December 31, 2016  
     
Remaining Contractual Maturity of the Agreements  
     
Overnight and continuous
  
Up to 30 days
  
30-90 days
  
Greater than 90 days
  
Total
Repurchase Agreements:
                      
  Obligations of U.S. Government  agencies
    
$34,917
  
$0
  
$0
  
$230
  
$35,147
                       
Total liability recognized for repurchase agreements
                    
$32,811

The Company has a line of credit commitment available from the FHLB of Pittsburgh for borrowings of up to $150,000,000 which renews annually in May.  At December 31, 2017, there were $18,244,000 of borrowings outstanding on this line.  There were no borrowings under this line of credit at December 31, 2016.    The Company has a line of credit commitment available from Atlantic Community Bankers Bank for $7,000,000 which expires on June 30, 2018.  There were no borrowings under this line of credit at December 31, 2017 and 2016. The Company has a line of credit commitment available from PNC Bank for $16,000,000 at December 31, 2017. There were no borrowings under this line of credit at December 31, 2017 and December 31, 2016.  The Company also has a line of credit commitment from Zions Bank for $17,000,000.  There were no borrowings under this line of credit at December 31, 2017 and December 31, 2016.

Other borrowings consisted of the following at December 31, 2017 and 2016:
           
           
 
2017
  
2016
 
(In Thousands)
           
Notes with the FHLB:
          
           
Convertible note due January 2017 at 4.71%
$
 -
  
$
 10,000
Amortizing fixed rate borrowing due December 2017 at 1.27%
  
 -
    
 4,025
Amortizing fixed rate borrowing due January 2018 at 0.91%
  
 51
    
 662
Amortizing fixed rate borrowing due December 2018 at 1.42%
  
 823
    
 1,634
Amortizing fixed rate borrowing due January 2019 at 1.39%
  
 5,451
    
 -
Fixed rate term borrowing due August 2019 at 1.61%
  
 10,000
    
 -
Amortizing fixed rate borrowing due June 2020 at 1.49%
  
 5,093
    
 7,078
Amortizing fixed rate borrowing due December 2020 at 1.71%
  
 3,051
    
 4,034
Amortizing fixed rate borrowing due March 2022 at 1.75%
  
 3,730
    
 4,568
Amortizing fixed rate borrowing due October 2022 at 1.88%
  
 7,746
    
 -
 
$
 35,945
  
$
 32,001

 
66
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 7 – BORROWINGS (CONTINUED)
 
    Contractual maturities and scheduled cash flows of other borrowings at December 31, 2017 are as follows (in thousands):
       
       
 
2018
$
11,316
 
2019
  
15,926
 
2020
  
4,556
  2021  
2,534
 
2022
  
 1,613
   
$
 35,945

The Bank's maximum borrowing capacity with the FHLB was $369,580,000 of which $54,188,000 was outstanding at December 31, 2017. Advances from the FHLB are secured by qualifying assets of the Bank.


NOTE 8 – EMPLOYEE BENEFIT PLANS

The Company has a defined contributory profit-sharing plan which includes provisions of a 401(k) plan. The plan permits employees to make pre-tax contributions up to 15% of the employee's compensation, not to exceed the limits set by the Internal Revenue Service. The amount of contributions to the plan, including matching contributions, is at the discretion of the Board of Directors. All employees over the age of 21 are eligible to participate in the plan and receive Company contributions after one year of employment. Eligible employees are able to contribute to the Plan at the beginning of the first quarterly period after their date of employment.  Employee contributions vest immediately, and any Company contributions are fully vested after five years. The Company's contributions are expensed as the cost is incurred, funded currently, and amounted to $605,000, $538,000 and $445,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

     The Company has several non-qualified supplemental executive retirement plans for the benefit of certain executive officers and former officers. At December 31, 2017 and 2016, other liabilities include $3,360,000 and $3,575,000 accrued under the Plan. Compensation expense includes approximately $301,000, $174,000 and $122,000 relating to the supplemental executive retirement plan for 2017, 2016 and 2015, 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, 2017 and 2016, the cash value of these policies was $37,060,000 and $36,133,000, respectively.

The Company provides postretirement benefits in the form of split-dollar life arrangements to employees who meet the eligibility requirements. The net periodic postretirement benefit expense included in salaries and employee benefits was $168,000, $26,000 and $89,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

FASB authoritative guidance on accounting for deferred compensation and postretirement benefit aspects of endorsement split-dollar life insurance arrangements requires the recognition of a liability and related compensation expense for endorsement split-dollar life insurance that provides a benefit to an employee that extends to postretirement periods.  The life insurance policies purchased for the purpose of providing such benefits do not effectively settle an entity's obligation to the employee.  Accordingly, the entity must recognize a liability and related compensation expense during the employee's active service period based on the future cost of insurance to be incurred during the employee's retirement.  This expense is included in the SERP plan expense for 2017 discussed above.  If the entity has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the FASB authoritative guidance on employer's accounting for postretirement benefits other than pensions.  The accumulated postretirement benefit obligation was $1,142,000 and $976,000 at December 31, 2017 and 2016, respectively.
 
 
67
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
Through its acquisition of Delaware, the Company also has certain director fee deferral and continuation plans.  These plans allow directors to defer current director fees and provide a benefit payment for a period of five to fifteen years.  The Company expensed $9,000 and $1,000 under these plans in 2017 and 2016, respectively.  At December 31, 2017 and 2016, the liability under these plans was $331,000 and $413,000, respectively.

Certain key executives have change in control agreements with the Company.  These agreements provide certain potential benefits in the event of termination of employment following a change in control.

The Company participates in the Pentegra Mulitemployer Defined Benefit Pension Plan (EIN 13-5645888 and Plan # 333) as a result of its acquisition of North Penn.  As of December 31, 2017 and 2016, the Company's Plan was 89.0% and 80.0% funded, respectively, and total contributions made are not more than 5% of the total contributions to the Plan.  The Company's expense related to the Plan was $46,000 in 2017, $54,000 in 2016 and $48,000 in 2015.  During the plan years ending December 31, 2017, 2016 and 2015, the Company made contributions of $46,000, $54,000 and $48,000, respectively.

As a result of its acquisition of Delaware, the Company is a member of the New York State Bankers Retirement System.  Substantially all full-time employees who were former employees of Delaware are covered under this defined benefit pension plan (the "Delaware Plan").  The Company's funding policy is to contribute at least the minimum required contribution annually.  Pension cost is computed using the projected unit credit actuarial cost method.  Effective December 31, 2012, the Delaware Plan was closed to new participants and accrued benefits were frozen.

The following table sets forth the projected benefit obligation and change in plan assets for the Delaware Plan at December 31:
           
           
(in Thousands of Dollars)
    
2017
  
2016
           
   Change in projected benefit obligation:
          
           
   Projected benefit obligation at beginning of year
  
$
 (8,084)
$
 -
   Projected benefit obligation acquired
    
 -
  
(8,843)
   Service cost
    
 (68)
  
(28)
   Interest cost
    
 (303)
  
(113)
   Actuarial gain (loss)
    
 (587)
  
662
   Benefits paid
    
 577
  
238
   Benefit obligation at end of year
  
$
 (8,465)
$
(8,084)
           
   Change in plan assets:
          
           
   Fair value of plan assets at beginning of year
  
$
 6,702
$
 -
   Fair value acquired
    
 -
  
6,932
   Actual return on plan assets
    
 981
  
12
   Benefits paid
    
 (573)
  
(242)
   Fair value of assets at end of year
    
 7,110
  
6,702
   Funded status at end of year
  
$
 (1,355)
$
(1,382)

 
68
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
       The Delaware Plan paid $577,000 and $238,000 in benefit payments in 2017 and 2016, respectively.  Estimated benefit payments under the Delaware Plan are expected to be approximately $509,000, $498,000, $489,000, $478,000 and $480,000 for the next five years.  Payments are expected to be approximately $2,253,000 in total for the five-year period ending December 31, 2027.  The Company was not required to make any contributions to the Delaware Plan in 2017 or 2016.  The decrease in the projected discount rate contributed approximately $480,000 to the overall increase in the projected benefit obligation for the year ended December 31, 2017.

The accumulated benefit obligation for the Delaware Plan was $8,465,000 and $8,084,000 at December 31, 2017 and 2016, respectively.

The following table sets forth the amounts recognized in accumulated other comprehensive income for the years ended December 31 (in thousands):


           
     
2017
  
2016
Transition asset
  
$
 -
$
 -
Prior service credit
    
 -
  
 -
Gain
    
 473
  
 490
   Total
  
$
 473
$
 490

          Net pension cost (income) included the following components (in thousands):

           
           
     
2017
  
2016
           
Service cost benefits earned during the period
  
$
 68
$
 28
Interest cost on projected benefit obligation
    
303
  
113
Actual return on assets
    
(416)
  
(180)
Net amortization and deferral
    
 -
  
 -
           
     NET PERIODIC PENSION COST (INCOME)
  
$
(45)
$
(39)

          The weighted average assumptions used to determine the benefit obligation at December 31 are as follows:
           
           
   
2017
  
2016
  
           
Discount rate
  
3.43
%
3.90
%


     The weighted average assumptions used to determine the net periodic pension cost at December 31 are as follows:

           
           
   
2017
  
2016
  
           
Discount rate
  
3.90
%
3.18
%
Expected long-term return on plan assets
  
6.50
%
6.50
%
Rate of compensation increase
  
0.00
%
0.00
%

           The expected long-term return on plan assets was determined based upon expected returns on individual asset types included in the asset portfolio.

     The Delaware Plan's weighted-average asset allocations at December 31, by asset category, are as follows:
           
           
   
2017
  
2016
  
           
Cash equivalents
  
6.4
%
6.1
%
Equity securities
  
50.2
%
47.9
%
Fixed income securities
  
40.2
%
42.6
%
Other
  
3.2
%
3.4
%
   
100.0
%
100.0
%

 
69
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
The Delaware Plan's overall investment strategy is to achieve a mix of approximately 97 percent of investments for long-term growth and 3 percent for near-term benefit payments with a wide diversification of asset types, fund strategies, and fund managers.  The target allocation for the Delaware Plan assets is 0 to 20 percent cash equivalents, 40 to 60 percent equity securities, 40 to 60 percent fixed income securities, and 0 to 5 percent other.  Cash equivalents consist primarily of government issues and short-term investment funds.  Equity securities primarily include investments in common stock, depository receipts, preferred stock, and real estate investment trusts.  Fixed income securities include corporate bonds, government issues, mortgage-backed securities, municipals, and other asset backed securities.

The fair value of the Delaware Plan's assets, by asset category, is as follows:


                         
                         
   
 December 31, 2017
         
Quoted Market
  
Other
      
         
Price in
  
Observable
  
Unobservable
         
Active Markets
  
Inputs
  
Inputs
   
Total
  
(Level 1)
  
(Level 2)
  
(Level 3)
 
(in Thousands of Dollars)
                         
Cash equivalents:
                        
   Cash (including foreign currencies)
  
$
 70
  
$
 70
  
$
 -
  
$
 -
   Short-term investment funds
    
 19
    
 -
    
 19
    
 -
Equity securities:
                        
   Common stock
    
 1,401
    
 1,401
    
 -
    
 -
   Depository receipts
    
 35
    
 35
    
 -
    
 -
   Commingled Pension Trust Fund
    
 2,203
    
 -
    
 2,203
    
 -
   Preferred stock
    
 31
    
 31
    
 -
    
 -
Fixed income securities:
                        
   Corporate bonds
    
 296
    
 -
    
 296
    
 -
   Government issue
    
 992
    
 -
    
 992
    
 -
   Mortgage-backed securities
    
 6
    
 -
    
 6
    
 -
   Collateralized mortgage obligations
    
 56
    
 -
    
 56
    
 -
Commingled Pension Trust Fund
    
 1,746
    
 -
    
 1,746
    
 -
Other
    
 255
    
 -
    
 -
    
 255
Total
  
$
 7,110
  
$
 1,537
  
$
 5,318
  
$
 255
                         
                         
   
 December 31, 2016
         
Quoted Market
  
Other
      
         
Price in
  
Observable
  
Unobservable
         
Active Markets
  
Inputs
  
Inputs
   
Total
  
(Level 1)
  
(Level 2)
  
(Level 3)
 
(in Thousands of Dollars)
                         
Cash equivalents:
                        
   Cash (including foreign currencies)
  
$
11
  
$
11
  
$
 -
  
$
 -
   Short-term investment funds
    
33
    
 -
    
33
    
 -
Equity securities:
                        
   Common stock
    
1,430
    
1,430
    
 -
    
 -
   Depository receipts
    
42
    
42
    
 -
    
 -
   Commingled Pension Trust Fund
    
1,680
    
 -
    
1,680
    
 -
Fixed income securities:
                        
   Corporate bonds
    
307
    
 -
    
307
    
 -
   Government issue
    
1,112
    
 -
    
1,112
    
 -
   Mortgage-backed securities
    
4
    
 -
    
4
    
 -
   Collateralized mortgage obligations
    
68
    
 -
    
68
    
 -
Commingled Pension Trust Fund
    
1,732
    
 -
    
1,732
    
 -
Other
    
283
    
 -
    
 -
    
283
Total
  
$
6,702
  
$
1,483
  
$
4,936
  
$
283

 
70
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
The following table sets forth a summary of the changes in the Level 3 assets for the year ended December 31, 2017 and 2016 (in thousands of dollars).
           
           
     
2017
  
2016
           
Balance, January 1
  
$
 283
$
 -
Purchase
    
 -
  
 -
Unrealized gain (loss)
    
 (28)
  
 283
Balance, December 31
  
$
 255
$
 283

 
NOTE 9 - INCOME TAXES

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

                 
                 
 
Years Ended December 31,
 
2017
  
2016
  
2015
(In Thousands)
 
Current
$
 3,822
  
$
 1,138
  
$
 2,019
Change in corporate tax rate
  
 3,060
    
 -
    
 -
Deferred
  
 (331)
    
 746
    
 (387)
 
$
 6,551
  
$
 1,884
  
$
 1,632

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. As of December 31, 2017, the Company has a $5,329,000 net operating loss carryforward that will begin to expire in 2035.  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,
  
 
2017
  
2016
  
2015
Tax at statutory rates
 35.0
%
  
 35.0
%
  
 34.0
%
Tax exempt interest income, net of interest expense disallowance
 (9.6)
    
 (13.1)
    
 (11.3)
  
Nondeductible merger expenses
 -
    
 2.7
    
 -
  
Incentive stock options
 0.2
    
 0.3
    
 0.3
  
Earnings and proceeds on life insurance
 (2.7)
    
 (2.8)
    
 (1.8)
  
Change in corporate tax rate
 20.8
    
 -
    
 -
  
Other
 0.7
    
 (0.2)
    
 0.4
  
                 
 
 44.4
%
  
 21.9
%
  
 21.6
%
 
 
 
71
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 9 - INCOME TAXES (CONTINUED)

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

           
           
 
2017
  
2016
 
(In Thousands)
Deferred tax assets:
          
Allowance for loan losses
$
 1,603
  
$
 2,197
Deferred compensation
  
 775
    
 1,430
Core deposit intangible
  
 232
    
 485
Prepaid expenses
  
 125
    
 267
Pension liability
  
 384
    
 655
Foreclosed real estate valuation allowance
  
 7
    
 19
AMT tax credit carryforward
  
 260
    
 260
Net operating loss carryforward
  
 1,249
    
 2,147
Net unrealized loss on securities
  
 808
    
 2,286
Other
  
 92
    
 310
Total Deferred Tax Assets
  
 5,535
    
 10,056
           
           
           
Deferred tax liabilities:
          
Premises and equipment
  
 210
    
 347
Deferred loan fees
  
 142
    
 192
Net unrealized gain on pension liability
  
 99
    
 171
Purchase price adjustment
  
 303
    
 357
           
Total Deferred Tax Liabilities
  
 754
    
 1,067
           
Net Deferred Tax Asset
$
 4,781
  
$
 8,989

The Company's federal and state income tax returns for taxable years through 2014 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, Tier 1 and Common Equity Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2017 and 2016, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
 
 
72
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY (CONTINUED)
As of December 31, 2017, 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 Company's actual capital amounts and ratios are presented in the following table:

                               
                               
                       
To be Well Capitalized
               
under Prompt
         
For Capital Adequacy
  
Corrective Action
 
Actual
  
Purposes
  
Provision
 
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
 
(Dollars  in Thousands)
                               
As of December 31, 2017:
                              
Total capital (to risk-weighted assets)
$
 113,091 
  
14.11
%
  
≥$64,126
  
≥8.00
%
  
≥$80,158
  
≥10.00
%
Tier 1 capital (to risk-weighted assets)
  
 105,457 
  
13.16
    
≥48,095
  
≥6.00
    
≥64,126
  
≥8.00
  
Common Equity Tier 1 capital
                              
         (to risk-weighted assets)
  
 105,457 
  
13.16
    
≥36,071
  
≥4.50
    
≥52,103
  
≥6.50
  
Tier 1 capital (to average assets)
  
 105,457 
  
9.36
    
≥45,075
  
≥4.00
    
≥56,343
  
≥5.00
  
                               
As of December 31, 2016:
                              
Total capital (to risk-weighted assets)
$
 107,765 
  
14.12
%
  
≥$61,057
  
≥8.00
%
  
≥$76,321
  
≥10.00
%
Tier 1 capital (to risk-weighted assets)
  
 101,302 
  
13.27
    
≥45,793
  
≥6.00
    
≥61,057
  
≥8.00
  
Common Equity Tier 1 capital
                              
         (to risk-weighted assets)
  
 101,302 
  
13.27
    
≥34,344
  
≥4.50
    
≥49,609
  
≥6.50
  
Tier 1 capital (to average assets)
  
 101,302 
  
9.16
    
≥44,251
  
≥4.00
    
≥55,314
  
≥5.00
  

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

Effective January 1, 2015, the Company and the Bank became subject to new regulatory capital rules which, among other things, impose a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), set the minimum leverage ratio for all banking organizations at a uniform 4% of total assets, increased the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigned a higher risk-weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property.  The new rules also require unrealized gains and losses on certain "available-for-sale" securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt out is exercised, which the Company and the Bank have done.  The final rule limits a banking organization's dividends, stock repurchases and other capital distributions, and certain discretionary bonus payments to executive officers, if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above regulatory minimum risk-based requirements.  The capital conservation buffer requirements will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer will be effective.  The Company and the Bank are in compliance with their respective new capital requirements, including the capital conservation buffer, as of December 31, 2017.

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, 2017 and 2016 was approximately $1,111,000 and $1,099,000, respectively.
 
 
73
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 10 - REGULATORY MATTERS AND STOCKHOLDERS' EQUITY (CONTINUED)

Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2017, $64,661,000 of retained earnings were available for dividends without prior regulatory approval, subject to the regulatory capital requirements discussed above. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including the Company, unless such loans are collateralized by specific obligations.

NOTE 11 - STOCK BASED COMPENSATION

The Company's shareholders approved the Norwood Financial Corp 2006 Stock Option Plan at the Annual Meeting on April 26, 2006. An aggregate of 412,500 shares of authorized but unissued Common Stock of the Company were reserved for future issuance under the Plan. This includes up to 66,000 shares for awards to outside directors. Under this plan, the Company granted 11,135 options to employees in 2015, 18,750 options to employees in 2014, and 42,900 options, which included 6,000 options granted to outside directors in 2013.  No options were granted under this plan in 2017 or 2016.  As of December 31, 2017, there were no shares available for future awards under this plan. All share information has been restated to reflect the 50% stock dividend declared in 2017.

At the Annual Meeting held on April 22, 2014, the Company's shareholders approved the Norwood Financial Corp 2014 Equity Incentive Plan. An aggregate of 375,000 shares of authorized but unissued Common Stock of the Company were reserved for future issuance under the Plan. This includes up to 60,000 shares for awards to outside directors. The Plan also authorized the Company to award restricted stock to officers and outside directors, limited to 63,000 shares of restricted stock awards for officers and 12,000 shares of restricted stock awards for outside directors. Under this plan, the Company granted 44,150 shares in 2017 which included 26,750 options to employees, 9,000 shares of restricted stock to officers, 8,000 options to directors and 400 shares of restricted stock to directors.  In 2016, the Company granted 36,675 shares which included 24,000 options to employees, 9,000 shares of restricted stock to officers and 3,675 shares of restricted stock to directors.  In 2015, the Company granted 20,591 shares which included 10,616 options to employees, 6,375 shares of restricted stock to officers and 3,600 shares of restricted stock to directors.  In 2014, the Company granted 13,950 shares, which included 4,200 shares of restricted stock to outside directors.  All shares granted in 2014 were for restricted stock.  The restricted shares vest over a five-year period.  The product of the number of shares granted and the grant date market price of the Company's common stock determine the fair value of restricted stock under the company's restricted stock plan.  Management recognizes compensation expense for the fair value of restricted stock on a straight-line basis over the requisite service period for the entire award.  As of December 31, 2017, there were 259,6535 shares available for future awards under this plan, which includes 219,510 shares available for officer awards and 40,125 shares available for awards to outside directors.  Included in these totals are 28,875 shares available for restricted stock awards to officers and 125 shares available for restricted stock awards to outside directors.  All share information has been restated to reflect the 50% stock dividend declared in 2017.

Total unrecognized compensation cost related to stock options was $237,000 as of December 31, 2017, $93,000 as of December 31, 2016 and $71,000 as of December 31, 2015.  Salaries and employee benefits expense includes $93,000, $71,000 and $66,000 of compensation costs related to options for the years ended December 31, 2017, 2016 and 2015, respectively.   Compensation costs related to restricted stock amounted to $143,000, $89,000 and $55,000 for the years ended December 31, 2017, 2016 and 2015, respectively.  The expected future compensation expense relating to non-vested restricted stock outstanding as of December 31, 2017 and 2016 was $744,000 and $579,000, respectively.  Net income was reduced by $187,000, $130,000 and $92,000 for the years ended December 31, 2017, 2016 and 2015, respectively.

 
74
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 11 - STOCK BASED COMPENSATION (CONTINUED)

A summary of the Company's stock option activity and related information for the years ended December 31 follows:
                                               
                                               
 
2017
  
2016
  
2015
     
Weighted
          
Weighted
          
Weighted
      
     
Average
  
Average
      
Average
  
Average
      
Average
  
Aggregate
     
Exercise
  
Intrinsic
      
Exercise
  
Intrinsic
      
Exercise
  
Intrinsic
 
Options
  
Price
  
Value
  
Options
  
Price
  
Value
  
Options
  
Price
  
Value
                                               
Outstanding,                                              
      beginning of year
 225,669
  
$
 19.46
        
 276,807
  
$
 17.94
        
 294,720
  
$
 17.83
      
Granted
 34,750
    
 32.81
        
 24,000
    
 22.37
        
 21,750
    
 19.03
      
Exercised
 (44,219)
    
 23.53
        
 (46,235)
    
 18.23
        
 (25,289)
    
 17.46
      
Forfeited
 (3,475)
    
 21.71
        
 (28,904)
    
 18.57
        
 (14,375)
    
 18.01
      
                                               
Outstanding, end of year
 212,725
  
$
 20.76
  
$
 2,604,097
  
 225,669
  
$
 19.46
  
$
 931,963
  
 276,807
  
$
 17.94
  
$
 362,754
                                               
Exercisable, end of year
 177,975
  
$
 18.41
  
$
 2,597,494
  
 216,644
  
$
 17.59
  
$
 931,963
  
 270,032
  
$
 17.85
  
$
 359,854


 
Exercise prices for options outstanding as of December 31, 2017 ranged from $16.65 to $32.81 per share. The weighted average remaining contractual life is 6.1 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
                 
                 
 
Years Ended December 31,
 
2017
  
2016
  
2015
Dividend yield
  
3.89%
    
3.93%
    
3.77%
Expected life
  
10 years
    
10 years
    
10 years
Expected volatility
  
29.11%
    
24.84%
    
24.35%
Risk-free interest rate
  
2.41%
    
2.44%
    
2.28%
Weighted average fair value of options granted
$
 6.83
  
$
 5.79
  
$
 4.89


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 $1,040,000 in 2017. Shares issued in connection with stock option exercises are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. During 2017, all the shares issued in connection with stock option exercises, 44,219 shares in total, were issued from available treasury shares.  All share information has been adjusted to reflect the 50% stock dividend declared in 2017.

 
75
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 11 - STOCK BASED COMPENSATION (CONTINUED)

    As of December 31, 2017, outsanding stock options consist of the following:
                       
                       
     
Average
          
Average
 
Options
  
Exercise
  
Remaining
  
Options
  
Exercise
 
Outstanding
  
Price
  
Life, Years
  
Exercisable
  
Price
 
 9,075
  
$
 16.67
  
 1.0
  
 9,075
  
$
 16.67
 
 17,325
    
 17.33
  
 2.0
  
 17,325
    
 17.33
 
 15,675
    
 16.83
  
 3.0
  
 15,675
    
 16.83
 
 20,625
    
 16.65
  
 4.0
  
 20,625
    
 16.65
 
 29,700
    
 18.03
  
 5.0
  
 29,700
    
 18.03
 
 1,650
    
 18.36
  
 5.0
  
 1,650
    
 18.36
 
 3,000
    
 19.30
  
 5.8
  
 3,000
    
 19.30
 
 26,925
    
 17.93
  
 6.0
  
 26,925
    
 17.93
 
 14,250
    
 19.39
  
 6.9
  
 14,250
    
 19.39
 
 16,500
    
 19.03
  
 7.9
  
 16,500
    
 19.03
 
 23,250
    
 22.37
  
 9.0
  
 23,250
    
 22.37
 
 34,750
    
 32.81
  
 10.0
  
 -
    
 -
                       
Total       
 212,725
            
 177,975
      

    A summary of the Company's restricted stock activity and related information for the years ended December 31 is as follows:
                 
   
2017
  
2016
       
Weighted-Average
      
Weighted-Average
   
Number of
  
Grant Date
  
Number of
  
Grant Date
   
Shares
  
Fair Value
  
Shares
  
Fair Value
                 
Non-vested, beginning of year
  
 28,035
  
$20.64
  
 20,715
  
$19.21
Granted
  
 9,400
  
 32.81
  
 12,675
  
 22.37
Vested
  
 (7,020)
  
 20.37
  
 (4,680)
  
 19.23
Forfeited
  
 -
  
 -
  
 (675)
  
 19.20
Non-vested at December 31
  
 30,415
  
$24.46
  
 28,035
  
$20.64

 
NOTE 12 - EARNINGS PER SHARE

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


                 
                 
 
Years Ended December 31,
 
2017
  
2016
  
2015
 
(In Thousands, Except Per Share Data)
                 
Numerator, net income
$
 8,198
  
$
 6,711
  
$
 5,908
                 
Denominator:
                
Weighted average shares outstanding
  
 6,238
    
 5,816
    
 5,523
  Less:  Weighted average unvested restricted shares
  
 (28)
    
 (21)
    
 (14)
Denominator:  Basic earnings per share
  
 6,210
    
 5,795
    
 5,510
                 
Weighted average shares outstanding
  
 6,210
    
 5,795
    
 5,523
Add:  Dilutive effect of stock options
  
 61
    
 33
    
 14
Denominator:  Diluted earnings per share
  
 6,271
    
 5,828
    
 5,537
                 
Basic earnings per common share
$
 1.32
  
$
 1.16
  
$
 1.07
                 
Diluted earnings per common share
$
 1.31
  
$
 1.15
  
$
 1.07
 
 
76
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 12 - EARNINGS PER SHARE (CONTINUED)

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 0, 24,000, and 21,000 for the years ended December 31, 2017, 2016 and 2015, respectively, based on the closing price of the Company's common stock which was $33.00, $22.09 and $19.17 at December 31, 2017, 2016 and 2015, respectively.  All share and per share information has been restated to reflect the 50% stock dividend declared in 2017.

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,
 
2017
  
2016
 
(In Thousands)
Commitments to grant loans
$
 44,970
  
$
 22,210
Unfunded commitments under lines of credit
  
 62,228
    
 54,789
Standby letters of credit
  
 5,919
    
 5,642
 
$
 113,117
  
$
 82,641

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

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

NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end.
 
 
77
NORWOOD FINANICAL CORP - 2017 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 or indirectly, for substantially the full term of the asset or liability.
     
Level 3:
  
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable (i.e. supported with little or no market activity).
 
 
An asset's or liability's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

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, 2017 and 2016 are as follows (in thousands):


                         
                         
   
Fair Value Measurement Reporting Date using
Description
  
Total
  
Level 1
  
Level 2
  
Level 3
December 31, 2017
                        
Available for Sale:
                        
U.S. Treasury securities
  
$
 1,998
  
$
 -
  
$
 1,998
  
$
 -
States and political subdivisions
    
 120,478
    
 -
    
 120,478
    
 -
Corporate obligations
    
 9,989
    
 -
    
 9,989
    
 -
Mortgage-backed securities-government
                        
  sponsored entities
    
 148,656
    
 -
    
 148,656
    
 -
Total available for sale
  
$
 281,121
  
$
 -
  
$
 281,121
  
$
 -
                         
December 31, 2016
                        
Available for Sale:
                        
U.S. Treasury securities
  
$
 1,997
  
$
 -
  
$
 1,997
  
$
 -
States and political subdivisions
    
 125,101
    
 -
    
 125,101
    
 -
Corporate obligations
    
 10,112
    
 -
    
 10,112
    
 -
Mortgage-backed securities-government
                        
  sponsored entities
    
 164,930
    
 -
    
 164,930
    
 -
Equity securities-financial services
    
 424
    
 424
    
 -
    
 -
Total available for sale
  
$
 302,564
  
$
 424
  
$
 302,140
  
$
 -
 
 
78
NORWOOD FINANICAL CORP - 2017 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, 2017 and 2016 are as follows (in thousands):


                         
                         
   
Fair Value Measurement Reporting Date using
Description
  
Total
  
Level 1
  
Level 2
  
Level 3
December 31, 2017
                        
Impaired Loans
  
$
 1,247
  
$
 -
  
$
 -
  
$
 1,247
Foreclosed real estate
    
 1,661
    
 -
    
 -
    
 1,661
                         
                         
December 31, 2016
                        
Impaired Loans
  
$
 2,624
  
$
 -
  
$
 -
  
$
 2,624
Foreclosed real estate
    
 5,302
    
 -
    
 -
    
 5,302

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


               
               
 
Quantitative Information about Level 3 Fair Value Measurements
(dollars in thousands)
Fair Value Estimate
  
Valuation Techniques
Unobservable Input
  
Range (Weighted Average)
December 31, 2017
              
Impaired loans
$
 131
  
Appraisal of collateral(1)
Appraisal adjustments(2)
  
10% (10%)
Impaired loans
$
 1,116
  
Present value of future cash flows
Loan discount rate
  
4-5.25% (5.11%)
         
Probability of default
  
0%
               
Foreclosed real estate owned
$
 1,661
  
Appraisal of collateral(1)
Liquidation Expenses(2)
  
0-42.60% (14.68%)
               
               
December 31, 2016
              
Impaired loans
 $
 1,473
  
Appraisal of collateral(1)
Appraisal adjustments(2)
  
10% (10%)
Impaired loans
 $
 1,151
  
Present value of future cash flows
Loan discount rate
  
4-5.25% (5.11%)
           Probability of default  
0%
               
Foreclosed real estate owned
 $
 5,302
  
Appraisal of collateral(1)
Liquidation Expenses(2)
  
10%
 
(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable, less any associated allowance.
(2)  Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
 
79
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

 
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, 2017 and 2016.

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) 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, 2017, the fair value investment in impaired loans totaled $1,247,000 which included five loans 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, 2017, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $277,000 over the life of the loans.
 
 
80
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

 
As of December 31, 2016, the fair value investment in impaired loans totaled $2,624,000 which included seven loans 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, 2016, the Company has recognized charge-offs against the allowance for loan losses on these impaired loans in the amount of $831,000 over the life of the loans.

Mortgage servicing rights (generally carried at cost):

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

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

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

Bank owned life insurance (carried at cost):

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

Accrued interest receivable and payable (carried at cost):

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

Deposit liabilities (carried at cost except certificates of deposit which are at fair value):

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

Short-term borrowings (carried at cost):

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

Other borrowings (carried at cost):

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
 
 
81
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)

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, 2017 and December 31, 2016 (In thousands):
                             
                             
 
Fair Value Measurements at December 31, 2017
                       
 
Carrying
  
Fair
            
 
Amount
  
Value
  
Level 1
  
Level 2
  
Level 3
Financial assets:
                            
Cash and cash equivalents
$
 16,697
  
$
 16,697
  
$
 16,697
  
$
 -
  
$
 -
Securities
  
 281,121
    
 281,121
    
 -
    
 281,121
    
 -
Loans receivable, net
  
 756,458
    
 756,092
    
 -
    
 -
    
 756,092
Mortgage servicing rights
  
 200
    
 223
    
 -
    
 -
    
 223
Regulatory stock
  
 3,505
    
 3,505
    
 3,505
    
 -
    
 -
Bank owned life insurance
  
 37,060
    
 37,060
    
 37,060
    
 -
    
 -
Accrued interest receivable
  
 3,716
    
 3,716
    
 3,716
    
 -
    
 -
                             
Financial liabilities:
                            
Deposits
  
 929,384
    
 929,709
    
 609,090
    
 -
    
 320,619
Short-term borrowings
  
 42,530
    
 42,530
    
 42,530
    
 -
    
 -
Other borrowings
  
 35,945
    
 35,514
    
 -
    
 -
    
 35,514
Accrued interest payable
  
 1,434
    
 1,434
    
 1,434
    
 -
    
 -
                             
Off-balance sheet financial instruments:
                            
Commitments to extend credit and                             
outstanding letters of credit
  
 -
    
 -
    
 -
    
 -
    
 -

 
                             
                             
 
Fair Value Measurements at December 31, 2016
                       
 
Carrying
  
Fair
            
 
Amount
  
Value
  
Level 1
  
Level 2
  
Level 3
Financial assets:
                            
Cash and cash equivalents
$
 17,174
  
$
 17,174
  
$
 17,174
  
$
 -
  
$
 -
Securities
  
 302,564
    
 302,564
    
 424
    
 302,140
    
 -
Loans receivable, net
  
 707,426
    
 716,661
    
 -
    
 -
    
 716,661
Mortgage servicing rights
  
 232
    
 250
    
 -
    
 -
    
 250
Regulatory stock
  
 2,119
    
 2,119
    
 2,119
    
 -
    
 -
Bank owned life insurance
  
 36,133
    
 36,133
    
 36,133
    
 -
    
 -
Accrued interest receivable
  
 3,643
    
 3,643
    
 3,643
    
 -
    
 -
                             
Financial liabilities:
                            
Deposits
  
 925,385
    
 925,561
    
 629,829
    
 -
    
 295,732
Short-term borrowings
  
 32,811
    
 32,811
    
 32,811
    
 -
    
 -
Other borrowings
  
 32,001
    
 31,863
    
 -
    
 -
    
 31,863
Accrued interest payable
  
 1,069
    
 1,069
    
 1,069
    
 -
    
 -
                             
Off-balance sheet financial instruments:
                            
Commitments to extend credit and                             
outstanding letters of credit
  
 -
    
 -
    
 -
    
 -
    
 -
 
 
82
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 15 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following tables present the changes in accumulated other comprehensive income (loss) (in thousands) by component, net of tax, for the years ended December 31, 2017 and 2016:


             
             
 
Unrealized gains (losses)
    
 
on available for sale
Unrealized gain (loss) on
  
 
securities (a)
pension liability (a)
Total (a)
Balance as of December 31, 2016
$
 (4,437)
$
 318
$
 (4,119)
Other comprehensive income (loss) before reclassification
  
 2,127
  
 (11)
  
 2,116
Amount reclassified from accumulated other comprehensive income
  
 (230)
  
 -
  
 (230)
Total other comprehensive income
  
 1,897
  
 (11)
  
 1,886
Reclassification of certain income tax effects from accumulated
            
   other comprehensive income
  
 (501)
  
 67
  
 (434)
Balance as of December 31, 2017
$
 (3,041)
$
 374
$
 (2,667)
             
             
             
             
             
 
Unrealized gains (losses)
    
 
on available for sale
Unrealized gain on
  
 
securities (a)
pension liability (a)
Total (a)
Balance as of December 31, 2015
$
 488
$
 -
$
 488
Other comprehensive income (loss) before reclassification
  
 (4,740)
  
 318
  
 (4,422)
Amount reclassified from accumulated other comprehensive income
  
 (185)
  
 -
  
 (185)
Total other comprehensive loss
  
 (4,925)
  
 318
  
 (4,607)
Balance as of December 31, 2016
$
 (4,437)
$
 318
$
 (4,119)

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

    The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) (in thousands) for the years ended December 31, 2017 and 2016:


                 
   
Amount Reclassified
    
   
From Accumulated
  
Affected Line Item in
   
Other
  
Consolidated
   
Comprehensive
  
Statement of
Details about other comprehensive income
  
Income (Loss) (a)
  
Income
                 
     
Twelve months
    
Twelve months
    
     
ended
    
ended
    
     
December 31,
    
December 31,
    
     
2017
    
2016
    
Unrealized gains on available for sale securities
  
$
 348
  
$
 284
  
Net realized gains on sales of securities
     
 (118)
    
 (99)
  
Income tax expense
   
$
 230
  
$
 185
    

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

 
83
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 16 – ACQUISITION OF DELAWARE BANCSHARES, INC.

  On July 31, 2016, Norwood Financial Corp. (the "Company") closed on its acquisition of Delaware Bancshares, Inc. ("Delaware")  pursuant to the terms of the Agreement and Plan of Merger, dated March 10, 2016, by and among the Company, Wayne Bank, Delaware and The National Bank of Delaware County (the "Merger Agreement").

Pursuant to the terms of the Merger Agreement, Delaware was merged with and into the Company, with the Company as the surviving corporation of the merger (the "Merger").  At the effective time of the Merger, each outstanding share of the common stock of Delaware was converted into, at the election of the holder but subject to the limitations and allocation and proration provisions set forth in the Merger Agreement, either $16.68 in cash or 0.6221 of a share of the common stock, par value $0.10 per share (the "Common Stock") of the Company.  In the aggregate, the merger consideration paid to Delaware shareholders consisted of approximately $3,860,000 in cash and 431,605 shares of Norwood common stock.  Immediately following the Merger, The National Bank of Delaware County ("NBDC") was merged with and into Wayne Bank, a wholly-owned subsidiary of the Company, with Wayne Bank as the surviving entity.

In connection with the Merger, the Company assumed the obligations of Delaware under the Indenture, dated as of October 31, 2007, by and between Delaware, as issuer, and Wells Fargo Bank, National Association, as trustee (the "Indenture") and Delaware's Junior Subordinated Debt Securities, due January 1, 2038 (the "Debt Securities") issued thereunder.  The Debt Securities were issued by Delaware in connection with a private placement completed on October 31, 2007 of $8.0 million of trust preferred securities issued through the Delaware Bancshares Capital Trust I (the "Trust").  The proceeds from the initial sale of the trust preferred securities were used by the Trust to purchase the Debt Securities.  The Debt Securities bore interest at a variable rate which reset quarterly at LIBOR plus 2.4%, and were redeemable, in whole or in part, without penalty, at the option of the Company, beginning on January 1, 2013 and on any January 1, April 1, July 1 or October 1 thereafter.  The interest payments on the Debt Securities made by the Company were used to pay the quarterly distributions payable by the Trust to the holders of the trust preferred securities.  On October 3, 2016, the Company redeemed the Debt Securities and the trust preferred securities in full.

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, appraised collateral values, expected cash flows, and historical loss factors of NBDC.  The Company also recorded an identifiable intangible asset representing the core deposit base of NBDC 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 determine the fair value of investment securities.

The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration.  NBDC 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 non-accretable difference.  At the acquisition date, the Company recorded $1,410,000 of purchased credit-impaired loans subject to a non-accretable difference of $260,000.  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.
 
 
84
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 16 – ACQUISITION OF DELAWARE BANCSHARES, INC. (CONTINUED)
 
NBDC'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, NBDC's loan portfolio without evidence of deterioration totaled $111,307,000 and was recorded at a fair value of $109,693,000.

The following table summarizes the purchase of Delaware Bancshares, Inc. as of July 31, 2016:

             
             
(Dollars in Thousands, Except Per Share Data)
            
             
Purchase Price Consideration in Common Stock
Delaware Bancshares, Inc. common shares settled for stock
    
 694,114
      
Exchange Ratio
    
 0.6221
      
Norwood Financial Corp. shares issued
    
 431,605
      
Value assigned to Norwood Financial Corp. common share
  
$
 28.15
      
Purchase price assigned to Delaware Bancshares, Inc. common shares
        
$
 12,150
  exchanged for Norwood Financial Corp.
            
             
Purchase Price Consideration - Cash for Common Stock
            
Delaware Bancshares, Inc. shares exchanged for cash
    
 231,385
      
Purchase price paid to each Delaware Bancshares, Inc. common share exchanged for cash
  
$
 16.68
      
Purchase price assigned to Delaware Bancshares, Inc. common shares exchanged for cash
        
$
 3,860
Purchase price consideration - Cash-in-lieu of Fractional Shares
          
 6
Total Purchase Price
        
$
 16,016
             
Net Assets Acquired:
            
             
Delaware Bancshares, Inc. shareholders' equity
  
$
 19,357
      
Delaware Bancshares, Inc. goodwill and intangibles
    
 (7,640)
      
Total tangible equity
    
 11,717
      
             
Adjustments to reflect assets acquired at fair value:
            
Investments
    
 219
      
Loans
            
   Interest rate
    
 1,486
      
   General credit
    
 (1,614)
      
   Specific credit - non-amortizing
    
 (260)
      
   Specific credit - amortizing
    
 (239)
      
Core deposit intangible
    
 449
      
Deferred loan fees
    
 (296)
      
Premises and equipment
    
 3,053
      
Allowance for loan and lease losses
    
 1,651
      
Deferred tax assets
    
 (1,417)
      
Other
    
 (97)
      
             
Adjustments to reflect liabilities acquired at fair value:
            
Time deposits
    
(252)
      
           
 14,400
Goodwill resulting from merger
        
$
 1,616
 
 
85
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 16 – ACQUISITION OF DELAWARE BANCSHARES, INC.  (CONTINUED)
    The following condensed statement reflects the values assigned to Delaware Bancshares, Inc. net assets as of acquisition date:

(In Thousands)


             
Total purchase price
        
$
 16,016
             
Net assets acquired:
            
Cash
  
$
 14,977
      
Securities available for sale
    
 208,488
      
Loans
    
 116,674
      
Premises and equipment, net
    
 7,292
      
Regulatory stock
    
 279
      
Accrued interest receivable
    
 1,626
      
Bank-owned life insurance
    
 14,762
      
Core deposit intangible
    
 449
      
Deferred tax assets
    
 3,034
      
Other assets
    
 3,282
      
Time deposits
    
 (71,342)
      
Deposits other than time deposits
    
 (255,921)
      
Borrowings
    
 (21,232)
      
Accrued interest payable
    
 (95)
      
Other liabilities
    
 (7,873)
      
           
 14,400
             
Goodwill resulting from Delaware Bancshares, Inc., Merger
        
$
 1,616


The Company recorded goodwill and other intangibles associated with the purchase of Delaware Bancshares, Inc. totaling $1,616,000.  Goodwill is not amortized, but is periodically evaluated for impairment.  The Company did not recognize any impairment during the twelve months ended December 31, 2017 and 2016.  The carrying amount of the goodwill at December 31, 2017 and 2016, related to the Delaware acquisition was $1,616,000.

Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. The core deposit intangible recorded with the purchase of Delaware is being amortized over ten years.  Such lives are also periodically reassessed to determine if any amortization period adjustments are required.  During the twelve months ended December 31, 2017 and 2016, no such adjustments were recorded.  The identifiable intangible assets consist of a core deposit intangible which is being amortized on an accelerated basis over the useful life of such assets.  The carrying amount of the core deposit intangible at December 31, 2017 and 2016 was $337,000 and $416,000 with $112,000 and $34,000, respectively, of accumulated amortization as of that date.
 
As of December 31, 2017, the current year and estimated future amortization expense for the core deposit intangible is:

       
       
(In thousands)
      
       
2018
  
$
70
2019
    
62
2020
    
54
2021
    
46
2022
    
37
After five years
    
68
   
$
337
 
 
86
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
NOTE 16 – ACQUISITION OF DELAWARE BANCSHARES, INC. (CONTINUED)


The following table presents unaudited pro forma information for the years ended December 31, 2017 and 2016 as if the acquisition of Delaware Bancshares, Inc. had occurred on January 1, 2016 under the "Pro Forma" columns.  The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative of future results.  Furthermore, the unaudited pro-forma information does not reflect management's estimate of any revenue-enhancing opportunities nor anticipated cost savings as a result of the integration and consolidation of the acquisition.  Merger and acquisition integration costs and amortization of fair value adjustments are included in the numbers below.

                 
                 
               
               
       
Pro Forma
       
Year Ended December 31,
(In Thousands, Except Per Share Data)
    
2017
  
2016
Net interest income
      
$
 34,908
  
$
 37,199
Non-interest income
        
 6,911
    
 6,487
Net income
        
 8,198
    
 3,588
Pro forma earnings per share:
                
  Basic
      
$
 1.32
  
$
 0.58
  Diluted
      
$
 1.31
  
$
 0.58

    Nonrecurring merger and acquisition integration costs included in the pro-forma table above are (in thousands):
                 
                 
Professional fees
      
$
 -
  
$
 1,602
Data processing related
        
 -
    
 638
Other
        
 -
    
 810

 
87
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT

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

BALANCE SHEETS

   
December 31,
   
2017
  
2016
   
(In Thousands)
ASSETS
            
Cash on deposit in bank subsidiary
  
$
 4,782
  
$
 3,005
Securities available for sale
    
 -
    
 397
Investment in bank subsidiary
    
 110,218
    
 105,138
Other assets
    
 2,858
    
 4,539
   Total assets
  
$
 117,858
  
$
 113,079
LIABILITIES AND STOCKHOLDERS' EQUITY
            
Liabilities
  
$
 2,119
  
$
 2,000
Stockholders' equity
    
 115,739
    
 111,079
   Total liabilities and stockholders' equity
  
$
 117,858
  
$
 113,079

 
STATEMENTS OF INCOME

   
Years Ended December 31,
   
2017
  
2016
  
2015
Income:
  
(In Thousands)
Dividends from bank subsidiary
  
$
 5,412
  
$
 28,598
  
$
 4,574
Net realized gain on sales of securities
    
 130
    
 -
    
 -
Other interest income
    
 8
    
 12
    
 11
     
 5,550
    
 28,610
    
 4,585
Expenses
    
 511
    
 1,347
    
 313
     
 5,039
    
 27,263
    
 4,272
Income tax benefit
    
 (127)
    
 (225)
    
 (103)
     
 5,166
    
 27,488
    
 4,375
Equity in undistributed earnings of subsidiary
    
 3,032
    
 (20,777)
    
 1,533
Net Income
  
$
 8,198
  
$
 6,711
  
$
 5,908
Comprehensive Income
  
$
 10,084
  
$
 2,104
  
$
 5,934

 
STATEMENTS OF CASH FLOWS

   
Years Ended December 31,
   
2017
  
2016
  
2015
   
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
                  
Net income
  
$
 8,198
  
$
 6,711
  
$
 5,908
Adjustments to reconcile net income to
                  
net cash provided by operating activities:
                  
Undistributed earnings of bank subsidiary
    
 (3,032)
    
 20,777
    
 (1,533)
Net gains on sales of securities
    
 (130)
    
 -
    
 -
Decrease in prepaid federal income tax
    
 1,736
    
 -
    
 -
Other, net
    
 389
    
 (267)
    
 (3)
Net Cash Provided by Operating Activities
    
 7,161
    
 27,221
    
 4,372
                   
CASH FLOWS FROM INVESTING ACTIVITIES
                  
   Proceeds from sales of securities
    
 422
    
 -
    
 -
   Outlays for business acquisitions
    
 -
    
 (2,324)
    
 -
Net Cash Provided by (Used in) Investing Activities
    
 422
    
 (2,324)
    
 -
                   
CASH FLOWS FROM FINANCING ACTIVITIES
                  
  Repayment of borrowings
    
 -
    
 (19,856)
    
 -
   Stock options exercised
    
 1,040
    
 843
    
 441
   ESOP purchase of shares from treasury stock
    
 127
    
 131
    
 146
   Purchase of treasury stock
    
 (1,587)
    
 (447)
    
 (127)
   Cash dividends paid
    
 (5,386)
    
 (4,714)
    
 (4,527)
Net Cash Used in Financing Activities
    
 (5,806)
    
 (24,043)
    
 (4,067)
Net Increase in Cash and Cash Equivalents
    
 1,777
    
 854
    
 305
                   
CASH AND CASH EQUIVALENTS - BEGINNING
    
 3,005
    
 2,151
    
 1,846
CASH AND CASH EQUIVALENTS - ENDING
  
$
 4,782
  
$
 3,005
  
$
 2,151
 
88
NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
INVESTOR INFORMATION

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


     
Boenning & Scattergood, Inc.
West Conshohocken, PA  19428
 800-883-1212
  
RBC Capital Markets
Philadelphia, PA  19103
888-848-4677
     
Janney Montgomery Scott, LLC
 Scranton, PA  18503
800-638-4417
  
Stifel Nicolaus
St,. Louis, MO  63102
314-342-2000

TRANSFER AGENT
Computershare provides Transfer Agent services for the Company.  Stockholders who may have questions regarding their stock ownership should contact the Transfer Agent at 800-662-7232, by regular mail at P.O. Box 50500, Louisville, KY  40233-5000, or by overnight delivery at 462 South 4th Street Suite 1600, Louisville, KY  40202.

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

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

SEC REPORTS AND ADDITIONAL INFORMATION
A copy of the Company's annual report on Form 10-K for its fiscal year ended December 31, 2017 including financial statements and schedules thereto, required to be filed with the Securities and Exchange Commission is available on the Company's website at www.waynebank.com under the Stockholder Services tab.  A copy of the report may be obtained upon written request of any stockholder, investor or analyst by contacting William S. Lance, Executive Vice President, Chief Financial Officer and Secretary, Norwood Financial Corp., 717 Main Street, PO Box 269, Honesdale, PA  18431, 570-253-1455.

 
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NORWOOD FINANICAL CORP - 2017 CONSOLIDATED FINANCIAL REPORT
 
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