UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One):
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2005,
-----------------
Or
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ________ to ________.
Commission File No. 0-28366
Norwood Financial Corp.
--------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2828306
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(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization) Identification No.)
717 Main Street, Honesdale, Pennsylvania 18431
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(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (570) 253-1455
--------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
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(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. [ ] YES [X] NO
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. [ ] YES [X] NO
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).: [ ] Yes [X] No
As of March 14, 2006, there were 2,677,426 shares outstanding of the
registrant's Common Stock.
The Registrant's voting stock trades on the NASDAQ National Market
under the symbol "NWFL." The aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the last price the Registrant's
Common Stock was sold on June 30, 2005, was $71,361,875 ($32.50 per share based
on 2,195,750 shares of Common Stock outstanding).
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year ended
December 31, 2005. (Parts I, II, and IV)
2. Portions of the Proxy Statement for the 2006 Annual Meeting of
Stockholders. (Part III)
PART I
Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 contains safe
harbor provisions regarding forward-looking statements. When used in this
discussion, the words "believes," "anticipates," "contemplates," "expects," and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. Those risks and
uncertainties as detailed in Item 1A include:
o our ability to effectively manage future growth
o loan losses in excess of our allowance
o risks inherent in commercial lending
o real estate collateral which is subject to declines in value
o regional economic factors
o loss of senior officers
o comparatively low legal lending limits
o limited market for the Company's stock
o restrictions on ability to pay dividends
o common stock may lose value
o competitive environment
o issuing additional shares may dilute ownership
o extensive and complex governmental regulation and associated cost
o interest rate risks
Norwood Financial Corp. undertakes no obligation to publicly release
the results of any revisions to those forward-looking statements which may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
Item 1. Business
-----------------
General
Norwood Financial Corp. (the "Company"), a Pennsylvania corporation, is
the holding company for Wayne Bank. On March 29, 1996, the Bank completed a
holding company reorganization and became a wholly owned subsidiary of the
Company. As of December 31, 2005, the Company had total assets of $433.6
million, deposits of $340.6 million, and stockholders' equity of $48.1 million.
Wayne Bank is a Pennsylvania chartered commercial bank headquartered in
Honesdale, Pennsylvania. The Bank was originally chartered on February 17, 1870
as Wayne County Savings Bank. Wayne County Savings Bank changed its name to
Wayne County Bank and Trust in December 1943. In September 1993, the Bank
adopted the name Wayne Bank. The Bank's deposits are currently insured by the
Bank Insurance Fund ("BIF") as administered by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is regulated by the Pennsylvania Department of
Banking ("PDB") and the FDIC.
The Bank is an independent community bank with six offices in Wayne
County, three offices in Pike County and two offices in Monroe County. The Bank
offers a wide variety of personal and business credit services and trust and
investment products and real estate settlement services to the
1
consumers, businesses, nonprofit organizations, and municipalities in each of
the communities that the Bank serves. The Bank primarily serves the Pennsylvania
counties of Wayne, Pike and Monroe, and to a much lesser extent, the counties of
Lackawanna and Susquehanna. In addition, the Bank operates eleven automated
teller machines, one in each of its eleven branch locations. The Company's main
office is located at 717 Main Street, Honesdale, Pennsylvania and its telephone
number is (570) 253-1455. The Bank maintains a website at www.waynebank.com.
Competition
The competition for deposit products comes from other insured financial
institutions such as commercial banks, thrift institutions, credit unions, and
multi-state regional banks in the Company's market area of Wayne, Pike and
Monroe Counties, Pennsylvania. Based on data compiled by the FDIC as of June 30,
2005 (the latest date for which data is available), the Bank had the second
largest share of FDIC-insured deposits in Wayne County with approximately 21%,
third in Pike County with 19%, and 12th in Monroe County with 1%. This data does
not reflect deposits held by credit unions with which the Bank also competes.
Deposit competition also includes a number of insurance products sold by local
agents and investment products such as mutual funds and other securities sold by
local and regional brokers. Loan competition varies depending upon market
conditions and comes from other insured financial institutions such as
commercial banks, thrift institutions, credit unions, multi-state regional
banks, and mortgage bankers.
Personnel
As of December 31, 2005, the Bank had 112 full-time and 4 part-time
employees. None of the Bank's employees are represented by a collective
bargaining group.
Lending Activities
The Bank's loan products include loans for personal and business use.
This includes mortgage lending to finance principal residences as well as second
home dwellings. The products include adjustable rate mortgages with terms up to
30 years which are retained and serviced through the Bank, fixed rate mortgage
products which may be sold, servicing retained, in the secondary market through
the Federal National Mortgage Association (Fannie Mae) or held in the Bank's
portfolio subject to asset/liability management. Fixed-rate home equity loans
are originated on terms up to 180 months, as well as offering a home equity line
of credit tied to prime rate. The Bank also offers indirect dealer financing of
automobiles (new and used), boats, and recreational vehicles through a limited
network of dealers in Northeast Pennsylvania.
Commercial loans and commercial mortgages are provided to local small
and mid-sized businesses at a variety of terms and rate structures. Commercial
lending activities include lines of credit, revolving credit, term loans,
mortgages, various forms of secured lending and a limited amount of letter of
credit facilities. The structure may be fixed, immediately repricing tied to the
prime rate or adjustable at set intervals.
Adjustable-rate loans decrease the risks associated with changes in
interest rates by periodically repricing, but involve other risks because as
interest rates increase, the underlying payments by the borrower increase, thus
increasing the potential for default. At the same time, the marketability of the
underlying collateral may be adversely affected by higher interest rates. Upward
adjustment of the
2
contractual interest rate may also be limited by the maximum periodic interest
rate adjustment permitted in certain adjustable-rate mortgage loan documents,
and, therefore is potentially limited in effectiveness during periods of rapidly
rising interest rates. These risks have not had an adverse effect on the Bank.
Consumer lending, including indirect financing provides benefits to the
Bank's asset/liability management program by reducing the Bank's exposure to
interest rate changes, due to their generally shorter terms. Such loans may
entail additional credit risks compared to owner-occupied residential mortgage
lending. As a result, the Bank has de-emphasized the indirect lending product
line.
Commercial lending including real-estate related loans entail
significant additional risks when compared with residential real estate and
consumer lending. For example, commercial loans typically involve larger loan
balances to single borrowers or groups of related borrowers. The payment
experience on such loans typically is dependent on the successful operation of
the project and these risks can be significantly impacted by the cash flow of
the borrowers and market conditions for commercial office, retail, and warehouse
space. In periods of decreasing cash flows, the commercial borrower may permit a
lapse in general maintenance of the property causing the value of the underlying
collateral to deteriorate. The liquidation of commercial property is often more
costly and may involve more time to sell than residential real estate. The Bank
offsets such factors with requiring more owner equity, a lower loan to value
ratio and by obtaining the personal guaranties of the principals. In addition, a
majority of the Bank's commercial real estate portfolio is owner occupied
property.
Due to the type and nature of the collateral, consumer lending
generally involves more credit risk when compared with residential real estate
lending. Consumer lending collections are typically dependent on the borrower's
continuing financial stability, and thus, are more likely to be adversely
affected by job loss, divorce, illness and personal bankruptcy. In most cases,
any repossessed collateral for a defaulted consumer loan will not provide an
adequate source of repayment of the outstanding loan balance. The remaining
deficiency is usually turned over to a collection agency.
There are additional risks associated with indirect automobile lending
since we must rely on the automobile dealer to provide accurate information to
us and accurate disclosures to the borrowers. These loans are principally done
on a non-recourse basis. We seek to mitigate these risks by only dealing with
dealers with whom we have a long-standing relationship.
Loan Solicitation and Processing
The Bank has established various lending limits for its officers and
also maintains an Officer Loan Committee. The loan committee is comprised of the
President and Chief Executive Officer, Senior Lending Officer and other Bank
officers. The Loan Committee has the authority to approve all loans up to set
limits based on the type of loan and the collateral. Requests in excess of these
limits must be submitted to the Directors Loan Committee or Board of Directors
for approval. Additionally, the President and Chief Executive Officer, and the
Senior Lending Officer and other officers have the authority to approve secured
and unsecured loans up to amounts approved by the Board of Directors and
maintained in the Bank's Loan Policy. Notwithstanding individual lending
authority, certain loan policy exceptions must be submitted to the loan
committee for approval.
Hazard insurance coverage is required on all properties securing loans
made by the Bank. Flood insurance is also required, when applicable.
3
Loan applicants are notified of the credit decision by letter. If the
loan is approved, the loan commitment specifies the terms and conditions of the
proposed loan including the amount, interest rate, amortization term, a brief
description of the required collateral, and the required insurance coverage. The
borrower must provide proof of fire, flood (if applicable) and casualty
insurance on the property serving as collateral, and these applicable insurances
must be maintained during the full term of the loan.
4
Types of Loans. Set forth below is selected data relating to the
composition of the Bank's loan portfolio at the date indicated.
As of December 31,
--------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
--------------- --------------- --------------- -------------- ---------------
$ % $ % $ % $ % $ %
------- --- ------- --- ------- --- ------- --- ------- ---
(dollars in thousands)
Type of Loans:
--------------
Commercial, Financial and Agricultural... $ 26,755 9.2 $ 20,263 7.9 $ 17,022 7.3 $ 15,074 6.9 $ 17,442 8.1
Real Estate-Construction................. 5,944 2.0 4,890 1.9 5,904 2.5 4,109 1.9 4,642 2.2
Real Estate-Mortgage
Residential.................. 100,705 34.6 90,606 35.5 77,459 33.1 69,040 31.6 64,635 30.1
Commercial................... 133,495 45.8 111,164 43.6 96,276 41.1 79,623 36.5 63,609 29.6
Lease financing, net of unearned income.. - - - - 316 .1 1,592 .7 6,126 2.9
Consumer Loans to Individuals............ 24,353 8.4 28,193 11.1 37,219 15.9 48,951 22.4 58,143 27.1
------- --- ------- --- ------- --- ------- --- ------- ---
291,252 100.0 255,116 100.0 234,196 100.0 218,389 100.0 214,597 100.0
===== ===== ===== ===== =====
Unearned income and deferred fees........ (362) (359) (463) (419) (403)
Allowance for loan losses................ (3,669) (3,448) (3,267) (3,146) (3,216)
------ ------ ------ ------ ------
Total Loans $287,221 $251,309 $230,466 $214,824 $210,978
======== ======== ======== ======== ========
5
Maturities and Sensitivities of Loans to Changes in Interest Rates. The
following table sets forth maturities and interest rate sensitivity for selected
categories of loans as of December 31, 2005. Scheduled repayments are reported
in the maturity category in which payment is due.
Less than One to Over
One Year Five Years Five Years Total
-------- ---------- ---------- -----
(in thousands)
Commercial, Financial
and Agricultural $ 8,898 $9,367 $8,490 $26,755
Real Estate -Construction 5,944 -- -- 5,944
------- ------ ------ -------
Total $14,842 $9,367 $8,490 $32,699
======= ====== ====== =======
Loans with fixed-rates $ 2,352 $4,779 $4,716 $11,847
Loans with floating
rates 12,490 4,588 3,774 20,852
------- ------ ------ -------
Total $14,842 $9,367 $8,490 $32,699
======= ====== ====== =======
Non-performing Assets. The following table sets forth information
regarding non-accrual loans, foreclosed real estate owned and loans that are 90
days or more delinquent but on which the Bank was accruing interest at the dates
indicated. The Bank did not have any loans accounted for as troubled debt
restructurings at the dates indicated. For the year ended December 31, 2005,
interest income that would have been recorded on loans accounted for on a
non-accrual basis under the original terms of such loans was $5,000 of which
$-0- was collected.
6
As of December 31,
------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(dollars in thousands)
Non-accrual loans:
Commercial and all other.................... $ -- $-- $ -- $ -- $ 64
Real estate................................. 330 32 125 213 597
Consumer.................................... 11 8 - 3 11
---- --- ---- ---- ----
Total......................................... 341 40 125 216 672
Accruing loans which are contractually past-
due 90 days or more:
Commercial and all other................... -- -- -- -- --
Real estate................................ -- 5 -- --
Consumer................................... 12 22 18 5 11
---- --- ---- ---- ----
Total......................................... 12 27 18 5 11
---- --- ---- ---- ----
Total non-performing loans.................... 353 67 143 221 683
Foreclosed real estate........................ - - - 21 54
---- --- ---- ---- ----
Total non-performing assets................... $353 $67 $143 $242 $737
==== === ==== ==== ====
Total non-performing loans to total loans..... .12% .03% .06% .10% .32%
Total non-performing loans to total assets.... .08% .02% .04% .06% .20%
Total non-performing assets to total assets... .08% .02% .04% .07% .21%
The recorded investment in impaired loans, not requiring an allowance
for loan losses was $310,000 and $-0- at December 31, 2005 and 2004,
respectively. The recorded investment in impaired loans requiring an allowance
for loan losses was $-0- at December 31, 2005 and 2004. The related allowance
for loan losses associated with these loans was $-0- at December 31, 2005 and
2004. For the years, ended December 31, 2005, 2004 and 2003, the average
recorded investment in these impaired loans was $316,000, $-0- and $337,000 and
the interest income recognized on these impaired loans was $11,000, $0 and
$30,000, respectively.
Potential Problem Loans. As of December 31, 2005, there were no loans
not previously disclosed, where known information about possible credit problems
of borrowers causes management to have serious doubts as to the ability of such
borrowers to comply with the present loan repayment terms.
Analysis of the Allowance for Loan Losses. The following table sets
forth information with respect to the Bank's allowance for loan losses for the
years indicated:
7
Years Ended December 31,
----------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(dollars in thousands)
Total loans receivable net of unearned income ................ $ 290,890 $ 254,757 $ 233,733 $ 217,970 $ 214,194
Average loans receivable ..................................... 274,053 245,783 225,680 213,814 214,905
--------- --------- --------- --------- ---------
Allowance balance at beginning of period ..................... $ 3,448 $ 3,267 $ 3,146 $ 3,216 $ 3,300
Charge-offs:
Commercial and all other ................................... (4) (19) (121) (34) (12)
Real Estate ................................................ (6) (10) - (122) (11)
Consumer ................................................... (200) (342) (478) (608) (711)
Leases ..................................................... - (11) (36) (30) (152)
--------- --------- --------- --------- ---------
Total ........................................................ (210) (382) (635) (794) (886)
Recoveries:
Commercial and all other ................................... 12 13 5 -- 8
Real Estate ................................................ 18 8 24 13 1
Consumer ................................................... 46 78 64 72 85
Leasing .................................................... 5 9 3 9 13
--------- --------- --------- --------- ---------
Total ........................................................ 81 108 96 94 107
Net Charge-offs .............................................. (129) (274) (539) (700) (779)
Provision Expense ............................................ 350 455 660 630 695
--------- --------- --------- --------- ---------
Allowance balance at end of period ........................... $ 3,669 $ 3,448 $ 3,267 $ 3,146 $ 3,216
========= ========= ========= ========= =========
Allowance for loan losses as a percent of total loans
outstanding .................................................. 1.26% 1.35% 1.40% 1.44% 1.50%
Net loans charged off loans percent of average
outstanding .................................................. .05% .11% .24% .33% .36%
Allocation of the Allowance For Loan Losses. The following table sets
forth the allocation of the Bank's allowance for loan losses by loan category
and the percent of loans in each category to total loans at the date indicated.
The allocation is made for analytical purposes and is not necessarily indicative
of the categories in which credit losses may occur. The total allowance is
available to absorb losses from any type of loan.
8
As of December 31,
---------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
% of % of % of % of % of
Loans Loans Loans Loans Loans
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Commercial, financial and agricultural $ 427 9.2% $ 337 7.9% $ 291 7.3% $ 265 6.9% $ 426 8.1%
Real estate - construction 36 2.0 20 1.9 27 2.5 21 1.9 70 2.2
Real estate - mortgage 2,713 80.4 2,480 79.1 2,222 74.2 1,926 68.1 1,421 59.7
Consumer loans to individuals 442 8.4 483 11.1 634 15.9 788 22.4 715 27.1
Lease Financing - -- - -- 9 .1 24 .7 92 2.9
General Risk Allocation 51 -- 128 -- 84 -- 122 -- 492 --
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total $3,669 100.0% $3,448 100.0% $3,267 100.0% $3,146 100.0% $3,216 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
9
INVESTMENT ACTIVITIES
---------------------
General. The Company maintains a portfolio of investment securities
consisting principally of obligations of the U.S. Government and its agencies
and obligations of states, counties and municipalities including school
districts. The Company considers its investment portfolio a source of earnings
and liquidity.
Securities Portfolio. Carrying values of securities at the dates
indicated are as follows:
As of December 31,
----------------------------------------
(dollars in thousands) 2005 2004 2003
-------- -------- --------
Securities:
(carrying value)
U.S. Treasury Securities............ $ 1,989 $ 2,014 $ 2,065
U.S. Government Agencies............ 51,996 47,151 47,632
State and political subdivisions... 21,175 24,256 24,678
Corporate Obligations............... 10,450 15,308 13,665
Mortgage-backed securities.......... 29,954 32,060 40,508
Equity Securities................... 1,702 1,868 2,023
-------- -------- --------
Total Securities $117,266 $122,657 $130,571
======== ======== ========
Fair value of Securities........... $117,294 $122,811 $130,798
======== ======== ========
10
Maturity Distribution of Securities. The following table sets forth
certain information regarding carrying values, weighted average yields, and
maturities of the Company's securities portfolio as of December 31, 2005. Yields
on tax-exempt securities are stated on a fully taxable equivalent basis using a
Federal tax rate of 34%. Actual maturities may differ from contractual
maturities as certain instruments have call features which allow prepayment of
obligations. Maturity on the mortgage-backed securities is based upon
contractual terms, the average life may differ as a result of changes in cash
flow. Equity securities with no stated maturity are classified as "one year or
less."
Investment Portfolio Maturities After one through After five through Total Investment
One year or Less five years ten years After ten years Securities
----------------- ------------------ ------------------ ------------------ -------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
(Dollars in thousands) Value Yield Value Yield Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
U.S. Treasuries $1,989 2.39% $ --- ---% $ --- --- $ --- --- $ 1,989 2.39%
U.S. Government Agencies 17,799 2.88% 34,197 3.11% --- --- --- --- 51,996 3.03%
State and political subdivisions 1,900 3.48% 6,666 3.69% 7,283 6.47% 5,326 7.16% 21,175 5.50%
Mortgage-backed Securities --- --- 10,627 3.84% 2,731 4.29% 16,596 4.32% 29,954 4.14%
Corporate Obligations 2,013 2.75% 8,437 3.18% --- --- --- --- 10,450 3.09%
Equity Securities 1,702 3.35% --- --- --- --- --- --- 1,702 3.35%
------- ---- ------- ---- ------- ---- ------- ---- -------- ----
Total Investment Securities $25,403 2.91% $59,927 3.31% $10,014 5.88% $21,922 5.01% $117,266 3.76%
======= ==== ======= ==== ======= ==== ======= ==== ======== ====
11
Deposit Activities.
General. The Bank provides a full range of deposit products to its retail
and business customers. These include interest-bearing and noninterest bearing
transaction accounts, statement savings and money market accounts. Certificate
of deposit terms range up to 5 years for retail instruments. The Bank
participates in Jumbo CD ($100,000 and over) markets with local municipalities
and school districts which are typically priced on a competitive bid basis.
Other services the Bank offers its customers on a limited basis include cash
management, direct deposit and Automated Clearing House (ACH) activity. The Bank
operates eleven automated teller machines and is affiliated with the STAR ATM
network. Internet banking including bill-pay is offered through the website at
www.waynebank.com.
The following table sets forth information regarding deposit categories of the
Company.
2005 2004 2003
---- ---- ----
(dollars in thousands) Average Average Average
----------------- ------------------ -------------------
Balance Rate Paid Balance Rate Paid Balance Rate Paid
------- --------- ------- --------- ------- ---------
Non-interest bearing
demand $ 52,109 --% $ 47,399 --% $ 39,119 --%
Interest-bearing demand 44,026 .10% 42,385 .10% 41,139 .17%
Money Market 49,721 1.86% 47,466 1.07% 41,457 1.12%
Savings 57,128 .47% 58,243 .47% 55,055 .78%
Time 128,704 2.82% 118,512 2.31% 127,995 2.87%
------- -------- --------
Total $331,688 $314,005 $304,765
======== ======== ========
Maturities of Time Deposits. The following table indicates the amount of
the Bank's certificates of deposit in amounts of $100,000 or more and other time
deposits of $100,000 or more by time remaining until maturity as of December 31,
2005.
(dollars in thousands)
Maturity Period
Within three months........................... $27,202
Over three through six months................. 6,191
Over six through twelve months................ 4,771
Over twelve months............................ 10,693
-------
$48,857
=======
12
Short-Term Borrowings
The following table sets forth information concerning short-term borrowings
(those maturing within one year) which consist principally of federal funds
purchased, securities sold under agreements to repurchase, Federal Home Loan
Bank advances and U.S. Treasury demand notes, that the Company had during the
periods indicated.
(dollars in thousands ) Years ended December 31,
-------------------------------
2005 2004 2003
---- ---- ----
Short term borrowings:
Average balance during the year.......................... $15,059 $12,965 $9,081
Maximum month-end during the year........................ 24,956 22,982 12,859
Average interest rate during the year.................... 2.76% 1.17% 1.09%
Total short-term borrowings at end of the year........... $18,564 $22,982 $12,859
Weighted average interest rate at the end of the year.... 3.76% 1.83% .99%
Trust Activities
The Bank operates a Wealth Management/Trust Department which provides estate
planning, investment management and financial planning to customers for which it
is generally compensated based on a percentage of assets under management. As of
December 31, 2005, the Bank had $87.0 million of assets under management
compared to $83.4 million as of December 31, 2004.
Subsidiary Activities
The Bank, a Pennsylvania chartered bank, is the only wholly owned
subsidiary of the Company. Norwood Investment Corp. (NIC), a Pennsylvania
Corporation incorporated in 1996, a Pennsylvania licensed insurance agency, is a
wholly-owned subsidiary of the Bank. NIC's business is annuity and mutual fund
sales and discount brokerage activities primarily to customers of the Bank. The
annuities, mutual funds and other investment products are not insured by the
FDIC or any other government agency. They are not deposits, obligations of or
guaranteed by any bank. The securities are offered through Invest Financial a
registered broker/dealer. NIC had sales volume of $11.9 million in 2005,
generating gross revenues for the Company of $150,000, compared to $154,000 in
2004 included in Other Income.
WCB Realty Corp. a Pennsylvania Corporation is a wholly-owned real estate
subsidiary of the Bank whose principal asset is the administrative offices of
the Company, which also includes the Main Office of the Bank.
WTRO Properties Inc. a Pennsylvania Corporation is a wholly-owned real
estate subsidiary of the Bank established to hold title to certain real estate
upon which the Bank has foreclosed. WTRO did not hold title to any property as
of December 31, 2005 and 2004.
Norwood Settlement Services, LLC a Pennsylvania Limited Liability Company
was established in 2004 to provide title and settlement services to bank
customers and non-customers. The subsidiary is 70% owned by Wayne Bank and 30%
owned by Title Strategies, LLC. Gross revenues, included in other income, for
2005 totaled $26,000 and $17,000 in 2004.
13
Regulation
Set forth below is a brief description of certain laws which relate to
the regulation of the Registrant and the Bank. The description does not purport
to be complete and is qualified in its entirety by reference to applicable laws
and regulations.
Regulation of the Company
General. The Company, as a bank holding company under the Bank Holding
Company Act of 1956, as amended ("BHCA"), is subject to regulation and
supervision by the Board of Governors of the Federal Reserve System ("Federal
Reserve") and by the Pennsylvania Department of Banking (the "Department"). The
Company is required to file annually a report of its operations with, and is
subject to examination by, the Federal Reserve and the Department. This
regulation and oversight is generally intended to ensure that the Company limits
its activities to those allowed by law and that it operates in a safe and sound
manner without endangering the financial health of its subsidiary banks.
Under the BHCA, the Company must obtain the prior approval of the
Federal Reserve before it may acquire control of another bank or bank holding
company, merge or consolidate with another bank holding company, acquire all or
substantially all of the assets of another bank or bank holding company, or
acquire direct or indirect ownership or control of any voting shares of any bank
or bank holding company if, after such acquisition, the bank holding company
would directly or indirectly own or control more than 5% of such shares.
Federal statutes impose restrictions on the ability of a bank holding
company and its nonbank subsidiaries to obtain extensions of credit from its
subsidiary bank, on the subsidiary bank's investments in the stock or securities
of the holding company, and on the subsidiary bank's taking of the holding
company's stock or securities as collateral for loans to any borrower. A bank
holding company and its subsidiaries are also prevented from engaging in certain
tie-in arrangements in connection with any extension of credit, lease or sale of
property, or furnishing of services by the subsidiary bank.
A bank holding company is required to serve as a source of financial
and managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, it is the policy of the
Federal Reserve that a bank holding company should stand ready to use available
resources to provide adequate capital to its subsidiary banks during periods of
financial stress or adversity and should maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligations to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve regulations, or both.
Non-Banking Activities. The business activities of the Company, as a
bank holding company, are restricted by the BHCA. Under the BHCA and the Federal
Reserve's bank holding company regulations, the Company may only engage in, or
acquire or control voting securities or assets of a company engaged in, (1)
banking or managing or controlling banks and other subsidiaries authorized under
the BHCA and (2) any BHCA activity the Federal Reserve has determined to be so
closely related to banking or managing or controlling banks
14
to be a proper incident thereto. These include any incidental activities
necessary to carry on those activities, as well as a lengthy list of activities
that the Federal Reserve has determined to be so closely related to the business
of banking as to be a proper incident thereto.
Financial Modernization. The Gramm-Leach-Bliley Act, permits greater
affiliation among banks, securities firms, insurance companies, and other
companies under a new type of financial services company known as a "financial
holding company." A financial holding company essentially is a bank holding
company with significantly expanded powers. Financial holding companies are
authorized by statute to engage in a number of financial activities previously
impermissible for bank holding companies, including securities underwriting,
dealing and market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; and merchant banking activities. The Act also
permits the Federal Reserve and the Treasury Department to authorize additional
activities for financial holding companies if they are "financial in nature" or
"incidental" to financial activities. A bank holding company may become a
financial holding company if each of its subsidiary banks is well capitalized,
well managed, and has at least a "satisfactory" CRA rating. A financial holding
company must provide notice to the Federal Reserve within 30 days after
commencing activities previously determined by statute or by the Federal Reserve
and Department of the Treasury to be permissible. The Company has not submitted
notice to the Federal Reserve of its intent to be deemed a financial holding
company.
Regulatory Capital Requirements. The Federal Reserve has adopted
capital adequacy guidelines pursuant to which it assesses the adequacy of
capital in examining and supervising a bank holding company and in analyzing
applications to it under the Bank Holding Company Act. The Federal Reserve's
capital adequacy guidelines are similar to those imposed on the Bank by the
Federal Deposit Insurance Corporation. See "Regulation of the Bank-Regulatory
Capital Requirements."
Regulation of the Bank
General. As a Pennsylvania chartered, insured commercial bank, the Bank
is subject to extensive regulation and examination by the Department and by the
FDIC, which insures its deposits to the maximum extent permitted by law. The
federal and state laws and regulations applicable to banks regulate, among other
things, the scope of their business, their investments, the reserves required to
be kept against deposits, the timing of the availability of deposited funds and
the nature and amount of and collateral for certain loans. The laws and
regulations governing the Bank generally have been promulgated to protect
depositors and not for the purpose of protecting stockholders. This regulatory
structure also gives the federal and state banking agencies extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulation, whether by the Department, the FDIC or the United
States Congress, could have a material impact on the Company, the Bank and their
operations.
Pennsylvania Banking Law. The Pennsylvania Banking Code ("Banking
Code") contains detailed provisions governing the organization, location of
offices, rights and responsibilities of directors, officers, and employees, as
well as corporate powers, savings and investment operations and other aspects of
the Bank and its affairs. The Banking Code delegates extensive rule-making power
and administrative discretion to the Department so that the supervision and
regulation of state chartered banks may be flexible and readily responsive to
changes in economic conditions and in savings and lending practices.
The Federal Deposit Insurance Corporation Act ("FDIA"), however,
prohibits state chartered banks from making new investments, loans, or becoming
involved in activities as principal and equity investments which are
15
not permitted for national banks unless (1) the FDIC determines the activity or
investment does not pose a significant risk of loss to the BIF and (2) the bank
meets all applicable capital requirements. Accordingly, the additional operating
authority provided to the Bank by the Banking Code is significantly restricted
by the FDIA.
Federal Deposit Insurance. The FDIC is an independent federal agency
that insures the deposits, up to prescribed statutory limits, of federally
insured banks and savings institutions and safeguards the safety and soundness
of the banking and savings industries. The FDIC administers two separate
insurance funds, the BIF, which generally insures commercial bank and state
savings bank deposits, and the Savings Insurance Fund ("SAIF"), which generally
insures savings association deposits. The Bank is a member of the BIF and its
deposit accounts are insured by the FDIC, up to prescribed limits.
The FDIC is authorized to establish separate annual deposit insurance
assessment rates for members of the BIF and the SAIF, and to increase assessment
rates if it determines such increases are appropriate to maintain the reserves
of either insurance fund. In addition, the FDIC is authorized to levy emergency
special assessments on BIF and SAIF members. The FDIC has set the deposit
insurance assessment rates for BIF-member institutions for the first six months
of 2006 at 0% to .027% of insured deposits on an annualized basis, with the
assessment rate for most institutions set at 0%.
In addition, all insured institutions of the FDIC are required to pay
assessments to fund interest payments on bonds issued by the Financing
Corporation, an agency of the Federal government established to finance
resolutions of insolvent thrifts. These assessments, the current quarterly rate
of which is approximately .0154 of insured deposits, will continue until the
Financing Corporation bonds mature in 2017.
Deposit Insurance Reform. Under the Federal Deposit Insurance Reform
Act of 2005, which was signed into law on February 15, 2006 (i) the Bank
Insurance Fund and the Savings Association Insurance Fund will be merged into a
new combined fund, to be called the Deposit Insurance Fund effective July 1,
2006, (ii) the current $100,000 deposit insurance coverage will be indexed for
inflation (with adjustments every five years, commencing January 1, 2011); and
(iii) deposit insurance coverage for retirement accounts will be increased to
$250,000 per participant subject to adjustment for inflation. The FDIC will be
given greater latitude in setting the assessment rates for insured depository
institutions which could be used to impose minimum assessments.
The FDIC will be authorized to set the reserve ratios for the Deposit
Insurance Fund annually at between 1.15% and 1.5% of estimated insured deposits.
If the Deposit Insurance Fund's reserves exceed the designated reserve ratio,
the FDIC is required to pay out all or, if the reserve ratio is less than 1.5%,
a portion of the excess as a dividend to insured depository institutions based
on the percentage of insured deposits held on December 31, 1996 adjusted for
subsequently paid premiums. Insured depository institutions that were in
existence on December 31, 1996 and paid assessments prior to that date (or their
successors) are entitled to a one-time credit against future assessments based
on their past contributions to the BIF or SAIF.
Regulatory Capital Requirements. The FDIC has promulgated capital
adequacy requirements for state-chartered banks that, like the Bank, are not
members of the Federal Reserve System. At December 31, 2005, the Bank exceeded
all regulatory capital requirements and was classified as "well capitalized."
The FDIC's capital regulations establish a minimum 3% Tier I leverage
capital requirement for the most highly-rated state-chartered, non-member banks,
with an additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively increases the minimum Tier
I leverage ratio for such other banks to 4% to 5%. Under the FDIC's regulation,
the highest-rated banks are those that the FDIC determines are not anticipating
or experiencing significant growth and have well diversified risk, including no
16
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and, in general, which are considered a strong banking organization,
rated composite 1 under the Uniform Financial Institutions Rating System. Tier I
or core capital is defined as the sum of common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus,
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain servicing and purchased credit card relationships, and minus
certain other listed assets.
The FDIC's regulations also require that state-chartered, non-member
banks meet a risk-based capital standard. The risk-based capital standard
requires the maintenance of total capital (which is defined as Tier I capital
and supplementary (Tier 2) capital) to risk weighted assets of 8%. In
determining the amount of risk-weighted assets, all assets, plus certain off
balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on
the risks the FDIC believes are inherent in the type of asset or item. The
components of Tier I capital for the risk-based standards are the same as those
for the leverage capital requirement. The components of supplementary (Tier 2)
capital include cumulative perpetual preferred stock, mandatory subordinated
debt, perpetual subordinated debt, intermediate-term preferred stock, up to 45%
of unrealized gains on equity securities and a bank's allowance for loan and
lease losses. Allowance for loan and lease losses includable in supplementary
capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the
amount of supplementary capital that may be included in total capital is limited
to 100% of Tier I capital.
A bank that has less than the minimum leverage capital requirement is
subject to various capital plan and activities restriction requirements. The
FDIC's regulations also provide that any insured depository institution with a
ratio of Tier I capital to total assets that is less than 2.0% is deemed to be
operating in an unsafe or unsound condition pursuant to Section 8(a) of the FDIA
and could be subject to potential termination of deposit insurance.
The Bank is also subject to minimum capital requirements imposed by the
Department on Pennsylvania-chartered depository institutions. Under the
Department's capital regulations, a Pennsylvania bank or savings bank must
maintain a minimum leverage ratio of Tier 1 capital (as defined under the FDIC's
capital regulations) to total assets of 4%. In addition, the Department has the
supervisory discretion to require a higher leverage ratio for any institutions
based on the institution's substandard performance in any of a number of areas.
The Bank was in compliance with both the FDIC and Pennsylvania capital
requirements as of December 31, 2005.
Affiliate Transaction Restrictions. Federal laws strictly limit the
ability of banks to engage in transactions with their affiliates, including
their bank holding companies. In particular loans by a subsidiary bank and its
parent company or the nonbank subsidiaries of the bank holding company are
limited to 10% of a bank subsidiary's capital and surplus and, with respect to
such parent company and all such nonbank subsidiaries, to an aggregate of 20% of
the bank subsidiary's capital and surplus. Further, loans and other extensions
of credit generally are required to be secured by eligible collateral in
specified amounts. Federal law also requires that all transactions between a
bank and its affiliates be on terms as favorable to the bank as transactions
with non-affiliates.
Loans to One Borrower. Under Pennsylvania law, commercial banks have,
subject to certain exemptions, lending limits to one borrower in an amount equal
to 15% of the institution's capital accounts. An institution's capital account
includes the aggregate of all capital, surplus, undivided profits, capital
securities and general reserves for loan losses. Pursuant to the national bank
parity provisions of the Pennsylvania Banking Code, the Bank may also lend up to
the maximum amounts permissible for national banks, which are allowed to make
loans to one borrower of up to 25% of capital and surplus in certain
circumstances. As of December 31,
17
2005, the loans-to-one-borrower limitation was $7.6 million and the Bank was in
compliance with such limitation.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from funds deposited by member institutions and proceeds from the sale of
consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by the Board of
Trustees of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to the greater of 1% of its aggregate
unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year or 5% of the Bank's outstanding
advances from the FHLB. At December 31, 2005, the Bank was in compliance with
this requirement.
Federal Reserve System. The Federal Reserve requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking and NOW accounts) and
non-personal time deposits. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve may be used to satisfy the liquidity
requirements that are imposed by the Department. At December 31, 2005, the Bank
met its reserve requirements.
Restrictions on Dividends. The Pennsylvania Banking Code states, in
part, that dividends may be declared and paid only out of accumulated net
earnings and may not be declared or paid unless surplus (retained earnings) is
at least equal to contributed capital. The Bank has not declared or paid any
dividends which cause the Bank's retained earnings to be reduced below the
amount required. Finally, dividends may not be declared or paid if the Bank is
in default in payment of any assessment due the FDIC.
The Federal Reserve has issued a policy statement on the payment of
cash dividends by bank holding companies, which expresses the Federal Reserve's
view that a bank holding company should pay cash dividends only to the extent
that the holding company's net income for the past year is sufficient to cover
both the cash dividends and a rate of earnings retention that is consistent with
the holding company's capital needs, asset quality and overall financial
condition. The Federal Reserve also indicated that it would be inappropriate for
a company experiencing serious financial problems to borrow funds to pay
dividends. Furthermore, under the federal prompt corrective action regulations,
the Federal Reserve may prohibit a bank holding company from paying any
dividends if the holding company's bank subsidiary is classified as
"undercapitalized."
Item 1A. Risk Factors
----------------------
In determining whether to invest in our securities, investors should
consider, among other factors, the following:
Risks Related to Our Business
Our success will depend upon our ability to effectively manage our future
growth.
We believe that we have in place the management and systems, including
data processing systems, internal controls and a strong credit culture, to
support continued growth. However, our continued growth and profitability depend
on the ability of our officers and key employees to manage such growth
effectively, to attract and retain skilled employees and to maintain adequate
internal controls and a strong credit culture. Accordingly,
18
there can be no assurance that we will be successful in managing our expansion,
and the failure to do so would adversely affect our financial condition and
results of operations.
If we experience loan losses in excess of our allowance, our earnings will be
adversely affected.
The risk of credit losses on loans varies with, among other things,
general economic conditions, the type of loan being made, the creditworthiness
of the borrower over the term of the loan and, in the case of a collateralized
loan, the value and marketability of the collateral for the loan. Management
maintains an allowance for loan losses based upon, among other things,
historical experience, an evaluation of economic conditions and regular reviews
of delinquencies and loan portfolio quality. Based upon such factors, management
makes various assumptions and judgments about the ultimate collectibility of the
loan portfolio and provides an allowance for loan losses based upon a percentage
of the outstanding balances and for specific loans when their ultimate
collectibility is considered questionable. If management's assumptions and
judgments prove to be incorrect and the allowance for loan losses is inadequate
to absorb future losses, or if the bank regulatory authorities require us to
increase the allowance for loan losses as a part of their examination process,
our earnings and capital could be significantly and adversely affected.
As of December 31, 2005, our allowance for loan losses was $3,669,000
which represented 1.26% of outstanding loans. At such date, we had 10
nonperforming loans totaling $353,000. We actively manage our nonperforming
loans in an effort to minimize credit losses. Although management believes that
its allowance for loan losses is adequate, there can be no assurance that the
allowance will prove sufficient to cover future loan losses. Further, although
management uses the best information available to make determinations with
respect to the allowance for loan losses, future adjustments may be necessary if
economic conditions differ substantially from the assumptions used or adverse
developments arise with respect to our non-performing or performing loans.
Material additions to our allowance for loan losses would result in a decrease
in our net income and capital, and could have a material adverse effect on our
financial condition and results of operations.
Most of our loans are to commercial borrowers, which have a higher degree of
risk than other types of loans.
Commercial loans are often larger and may involve greater risks than
other types of lending. Because payments on such loans are often dependent on
the successful operation of the property or business involved, repayment of such
loans may be more sensitive than other types of loans to adverse conditions in
the real estate market or the economy. Unlike residential mortgage loans, which
generally are made on the basis of the borrower's ability to make repayment from
his or her employment and other income and which are secured by real property
whose value tends to be more easily ascertainable, commercial loans typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may be substantially dependent on the success of
the business itself and the general economic environment. If the cash flow from
business operations is reduced, the borrower's ability to repay the loan may be
impaired.
Most of our loans are secured, in whole or in part, with real estate collateral
which is subject to declines in value.
In addition to the financial strength and cash flow characteristics of
the borrower in each case, we often secure our loans with real estate
collateral. As of December 31, 2005, approximately 83% of our loans, including
loans held for sale, had real estate as a primary, secondary or tertiary
component of collateral. Real estate values and real estate markets are
generally affected by, among other things, changes in national, regional
19
or local economic conditions, fluctuations in interest rates and the
availability of loans to potential purchasers, changes in tax laws and other
governmental statutes, regulations and policies, and acts of nature. The real
estate collateral in each case provides an alternate source of repayment in the
event of default by the borrower. If real estate prices in our markets decline,
the value of the real estate collateral securing our loans could be reduced. If
we are required to liquidate the collateral securing a loan during a period of
reduced real estate values to satisfy the debt, our earnings and capital could
be adversely affected.
Our business is geographically concentrated and is subject to regional economic
factors that could have an adverse impact on our business.
Substantially all of our business is with customers in our market area of
Northeastern Pennsylvania. Most of our customers are consumers and small and
medium-sized businesses which are dependent upon the regional economy. Adverse
changes in economic and business conditions in our markets could adversely
affect our borrowers, their ability to repay their loans and to borrow
additional funds, and consequently our financial condition and performance.
Additionally, we often secure our loans with real estate collateral, most
of which is located in Northeastern Pennsylvania. A decline in local economic
conditions could adversely affect the values of such real estate. Consequently,
a decline in local economic conditions may have a greater effect on our earnings
and capital than on the earnings and capital of larger financial institutions
whose real estate loan portfolios are geographically diverse.
The loss of senior chief executive officers and certain other key personnel
could hurt our business.
Our success depends, to a great extent, upon the services of William W.
Davis, Jr., our President and Chief Executive Officer, and Lewis J. Critelli,
our Executive Vice President and Chief Financial Officer. Although we have
employments agreements with non-compete provisions with Messrs. Davis and
Critelli, the existence of such agreements does not assure that we will retain
their services. The unexpected loss of these individuals could have a material
adverse effect on our operations. From time to time, we also need to recruit
personnel to fill vacant positions for experienced lending officers and branch
managers. Competition for qualified personnel in the banking industry is
intense, and there can be no assurance that we will continue to be successful in
attracting, recruiting and retaining the necessary skilled managerial, marketing
and technical personnel for the successful operation of our existing lending,
operations, accounting and administrative functions or to support the expansion
of the functions necessary for our future growth. Our inability to hire or
retain key personnel could have a material adverse effect on our results of
operations.
Our legal lending limits are relatively low and restrict our ability to compete
for larger customers.
At December 31, 2005, our lending limit per borrower was approximately $7.6
million, or approximately 15% of our capital plus allowance for loan losses.
Accordingly, the size of loans that we can offer to potential borrowers is less
than the size of loans that many of our competitors with larger capitalization
are able to offer. We may engage in loan participations with other banks for
loans in excess of our legal lending limits. However, there can be no assurance
that such participations will be available at all or on terms which are
favorable to us and our customers.
20
Risks Related to Our Common Stock
There is a limited trading market for our common stock, which may adversely
impact your ability to sell your shares and the price you receive for your
shares.
Although our common stock is quoted on the Nasdaq National Market, there
has been limited trading activity in our stock and an active trading market is
not expected to develop. This means that there may be limited liquidity for our
common stock, which may make it difficult to buy or sell our common stock, may
negatively affect the price of our common stock and may cause volatility in the
price of our common stock.
There are restrictions on our ability to pay cash dividends.
Although the company has paid quarterly cash dividends since its inception
in 1996 and the bank has paid dividends for many years prior, there is no
assurance that we will continue to pay cash dividends. Future payment of cash
dividends, if any, will be at the discretion of the Board of Directors and will
be dependent upon our financial condition, results of operations, capital
requirements and such other factors as the Board may deem relevant and will be
subject to applicable federal and state laws that impose restrictions on our
ability to pay dividends.
Our common stock is not insured and you could lose the value of your entire
investment.
An investment in shares of our common stock is not a deposit and is not
insured against loss by the government.
Our management and significant shareholders control a substantial percentage of
our stock and therefore have the ability to exercise substantial control over
our affairs.
As of December 31, 2005, our directors and executive officers beneficially
owned approximately 337,566 shares, or approximately 12.1 % of our common stock,
including options to purchase approximately 106,365 shares, in the aggregate, of
our common stock at exercise prices ranging from $10.88 to $31.50 per share.
Because of the large percentage of stock held by our directors and executive
officers and other significant shareholders, these persons could influence the
outcome of any matter submitted to a vote of our shareholders.
We may issue additional shares of common or preferred stock, which may dilute
the ownership and voting power of our shareholders and the book value of our
common stock.
We are currently authorized to issue up to 10,000,000 shares of common
stock of which 2,684,526 shares are currently outstanding and up to 5,000,000
shares of preferred stock of which no shares are outstanding. Our Board of
Directors has authority, without action or vote of the shareholders, to issue
all or part of the authorized but unissued shares and to establish the terms of
any series of preferred stock. These authorized but unissued shares could be
issued on terms or in circumstances that could dilute the interests of other
stockholders. As of December 31, 2005, options to purchase a total of 133,615
shares were exercisable and had exercise prices ranging from $10.88 to $31.50.
Any such issuance will dilute the percentage ownership interest of shareholders
and may further dilute the book value of our common stock.
Provisions of our Articles of Incorporation and the Pennsylvania Business
Corporation Law could deter takeovers which are opposed by the Board of
Directors.
Our articles of incorporation require the approval of 80% of our
outstanding shares for any merger or consolidation unless the transaction meets
certain fair price criteria or the business combination has been
21
approved or authorized by the Board of Directors. In addition, our articles of
incorporation may require the disgorgement of profits realized by any person who
attempts to acquire control of the Company. As a Pennsylvania corporation with a
class of securities registered with the Securities and Exchange Commission, the
Company is governed by certain provisions of the Pennsylvania Business
Corporation Law that, inter alia, permit the disparate treatment of certain
shareholders; prohibit calls of special meetings of shareholders; require
unanimous written consent for shareholder action in lieu of a meeting; require
shareholder approval for certain transactions in which a shareholder has an
interest; and impose additional requirements on business combinations with
persons who are the beneficial owners of more than 20% of the Company's stock.
Risks Related to Our Industry
We operate in a competitive market which could constrain our future growth and
profitability.
We operate in a competitive environment, competing for deposits and loans
with commercial banks, savings associations and other financial entities.
Competition for deposits comes primarily from other commercial banks, savings
associations, credit unions, money market and mutual funds and other investment
alternatives. Competition for loans comes primarily from other commercial banks,
savings associations, mortgage banking firms, credit unions and other financial
intermediaries. Many of the financial intermediaries operating in our market
area offer certain services, such as international banking services, which we do
not offer. Moreover, banks with a larger capitalization and financial
intermediaries not subject to bank regulatory restrictions have larger lending
limits and are thereby able to serve the needs of larger customers.
We are required to comply with extensive and complex governmental regulation
which can adversely affect our business.
Our operations are and will be affected by current and future legislation
and by the policies established from time to time by various federal and state
regulatory authorities. We are subject to supervision and periodic examination
by the Federal Reserve Board (the "FRB"), the Federal Deposit Insurance
Corporation (the "FDIC") and the Pennsylvania Department of Banking. Banking
regulations, designed primarily for the safety of depositors, may limit a
financial institution's growth and the return to its investors by restricting
such activities as the payment of dividends, mergers with or acquisitions by
other institutions, investments, loans and interest rates, interest rates paid
on deposits, expansion of branch offices, and the offering of securities or
trust services. We are also subject to capitalization guidelines established by
federal law and could be subject to enforcement actions to the extent that we
are found by regulatory examiners to be undercapitalized. It is not possible to
predict what changes, if any, will be made to existing federal and state
legislation and regulations or the effect that any such changes may have on our
future business and earnings prospects. Further, the cost of compliance with
regulatory requirements may adversely affect our ability to operate
profitability.
In addition, the monetary policies of the FRB have had a significant effect
on the operating results of banks in the past and are expected to continue to do
so in the future. Among the instruments of monetary policy used by the FRB to
implement its objectives are changes in the discount rate charged on bank
borrowings and changes in the reserve requirements on bank deposits. It is not
possible to predict what changes, if any, will be made to the monetary policies
of the FRB or to existing federal and state legislation or the effect that such
change may have on our future business and earnings prospects.
During the past several years, significant legislative attention has been
focused on the regulation and deregulation of the financial services industry.
Non-bank financial institutions, such as securities brokerage
22
firms, insurance companies and money market funds, have been permitted to engage
in activities which compete directly with traditional bank business.
We realize income primarily from the difference between interest earned on loans
and investments and interest paid on deposits and borrowings, and changes in
interest rates may adversely affect our profitability and assets.
Changes in prevailing interest rates may hurt our business. We derive our
income mainly from the difference or "spread" between the interest earned on
loans, securities and other interest-earning assets, and interest paid on
deposits, borrowings and other interest-bearing liabilities. In general, the
larger the spread, the more we earn. When market rates of interest change, the
interest we receive on our assets and the interest we pay on our liabilities
will fluctuate. This can cause decreases in our spread and can adversely affect
our income.
Interest rates affect how much money we can lend. For example, when
interest rates rise, the cost of borrowing increases and loan originations tend
to decrease. In addition, changes in interest rates can affect the average life
of loans and investment securities. A reduction in interest rates generally
results in increased prepayments of loans and mortgage-backed securities, as
borrowers refinance their debt in order to reduce their borrowing cost. This
causes reinvestment risk, because we generally are not able to reinvest
prepayments at rates that are comparable to the rates we earned on the prepaid
loans or securities. Changes in market interest rates could also reduce the
value of our financial assets. If we are unsuccessful in managing the effects of
changes in interest rates, our financial condition and results of operations
could suffer.
As a public company, we are subject to numerous reporting requirements that are
currently evolving and could substantially increase our operating expenses and
divert management's attention from the operation of our business.
The Sarbanes-Oxley Act of 2002, which became law in July 2002, has
required changes in some of our corporate governance, securities disclosure and
compliance practices. In response to the requirements of that Act, the SEC has
promulgated new rules covering a variety of subjects. Compliance with these new
rules has significantly increased our legal and financial and accounting costs,
and we expect these increased costs to continue. In addition, compliance with
the requirements has taken a significant amount of management's and the Board of
Directors' time and resources. Likewise, these developments may make it more
difficult for us to attract and retain qualified members of our board of
directors, particularly independent directors, or qualified executive officers.
As directed by Section 404 of the Sarbanes-Oxley Act, the SEC adopted
rules requiring public companies to include a report of management on the
company's internal control over financial reporting in their annual reports on
Form 10-K that contains an assessment by management of the effectiveness of the
company's internal control over financial reporting. In addition, in the future,
the public accounting firm auditing the company's financial statements must
attest to and report on management's assessment of the effectiveness of the
company's internal control over financial reporting. This requirement is first
applicable to our annual report on Form 10-K for fiscal 2007 and for all future
annual reports. The costs associated with the implementation of this
requirement, including documentation and testing, have not been estimated by us.
If we are ever unable to conclude that we have effective internal control over
financial reporting or, if our independent auditors are unable to provide us
with an unqualified report as to the effectiveness of our internal control over
financial reporting for any future year-ends as required by Section 404,
investors could lose confidence in the reliability of our financial statements,
which could result in a decrease in the value of our securities.
23
Item 1B. Unresolved Staff Comments
-----------------------------------
None
Item 2. Properties
--------------------
The Bank operates from its main office located at 717 Main Street,
Honesdale, Pennsylvania and ten additional branch offices. The Bank's total
investment in office property and equipment is $12.2 million with a net book
value of $5.4 million as of December 31, 2005. The Bank currently operates
automated teller machines at all eleven of its facilities. The Bank leases three
of its locations with minimum lease commitments of $2,510,000 through 2029. The
three locations have various renewal options.
Item 3. Legal Proceedings
--------------------------
Neither the Company nor its subsidiaries are involved in any pending
legal proceedings, other than routine legal matters occurring in the ordinary
course of business, which in the aggregate involve amounts which are believed by
management to be immaterial to the consolidated financial condition or results
of operations of the Company.
Item 4. Submission of Matters to a Vote of Security-Holders
------------------------------------------------------------
None.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
--------------------------------------------------------------------------------
Issuer Purchase of Equity Securities
------------------------------------
Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Market and Dividend Information" in
the Registrant's Annual Report to Stockholders for the fiscal year ended
December 31, 2005 ("Annual Report") and is incorporated herein by reference.
Issuer Purchases of
Equity Securities
---------------------
Maximum number
of shares (or
approximate
Total number of dollar value) that
shares purchased may yet
Total number Average price as part of publicly be purchased
of shares paid per announced plans under the plans
purchased share or programs * or programs
--------- ----- ----------- -----------
October 1-October 31, 2005 3,000 $30.90 3,000 116,000
November 1-November 30, 2005 5,000 31.59 5,000 111,000
December 1-December 31, 2005 - - - -
------ ------ ------ --------
Total 8,000 $31.33 8,000 111,000
====== ====== ====== ========
* On June 15, 2005, the Registrant announced its intention to repurchase up
to 5% of its outstanding common stock (approximately 134,000 shares) in the
open market.
24
Item 6. Selected Financial Data
--------------------------------
The above-captioned information appears under "Summary of Operations"
in the Annual Report, and is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Conditions and Results
--------------------------------------------------------------------------------
of Operations
-------------
The above-captioned information appears under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report and is incorporated herein by reference from the Annual Report.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
-------------------------------------------------------------------
The above-captioned information appears under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report and is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
The Company's consolidated financial statements listed in Item 15 are
incorporated herein by reference.
Item 9. Changes In and Disagreements with Accountants on Accounting and
--------------------------------------------------------------------------------
Financial Disclosure
--------------------
None.
Item 9A. Controls and Procedures
---------------------------------
The Company's management evaluated, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, the effectiveness
of the Company's disclosure controls and procedures, as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
There were no changes in the Company's internal control over financial
reporting that occurred during the Company's last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Item 9B. Other Information
---------------------------
None.
25
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information contained under the sections captioned "Section 16(a)
Beneficial Ownership Reporting Compliance" and "Proposal I -- Election of
Directors" in the Proxy Statement for the 2006 Annual Meeting of Stockholders
are incorporated herein by reference.
The Company has adopted a Code of Ethics that applies to its principal
executive officer, principal financial officer and principal accounting officer
or controller. The Company undertakes to provide a copy of the Code of Ethics to
any person without charge, upon request to Lewis J. Critelli, Executive Vice
President and Chief Financial Officer, Norwood Financial Corp., 717 Main Street,
Honesdale, PA 18431.
Item 11. Executive Compensation
--------------------------------
The information contained under the section captioned "Director and
Executive Compensation" in the Proxy Statement is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the Section captioned "Voting Securities and
Principal Holders Thereof-- Security Ownership of Certain
Beneficial Owners" of the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Voting Securities and
Principal Holders Thereof -- Security Ownership of Certain
Beneficial Owners" and "Proposal I -- Election of Directors"
of the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including
any pledge by any person of securities of the Company, the
operation of which may at a subsequent date result in a change
in control of the registrant.
(d) Equity Compensation Plan Information
The information required by this item is incorporated herein
by reference to section in the Proxy Statement captioned
"Equity Compensation Plan Information"
26
Item 13. Certain Relationships and Related Transactions
--------------------------------------------------------
The information required by this item is incorporated herein by
reference to the section in the Proxy Statement captioned "Certain Relationships
and Related Transactions".
Item 14. Principal Accounting Fees and Services
------------------------------------------------
The information required by this item is incorporated herein by
reference to the section on the Proxy Statement captioned "Proposal
3-Ratification of Appointment of Independent Accountants."
PART IV
Item 15. Exhibits, Financial Statement, and Schedules
------------------------------------------------------
(a) Listed below are all financial statements and exhibits filed
as part of this report, and are incorporated by reference.
1. The consolidated balance sheets of Norwood Financial Corp. and
subsidiary as of December 31, 2005 and 2004, and the related
consolidated statements of income, stockholders' equity and
cash flows for each of the years in the three year period
ended December 31, 2005, together with the related notes and
the independent auditor's report of Beard Miller Company LLP,
independent accountants.
2. Schedules omitted as they are not applicable.
3. Exhibits
3(i) Articles of Incorporation of Norwood Financial Corp.*
3(ii) Bylaws of Norwood Financial Corp.*
4.0 Specimen Stock Certificate of Norwood Financial Corp.*
10.1+ Amended Employment Agreement with William W.Davis, Jr.**
27
10.2+ Amended Employment Agreement with Lewis J. Critelli **
10.3+ Form of Change-in-Control Severance Agreement with seven key employees of the Bank***
10.4+ Consulting Agreement with Russell L. Ridd****
10.5+ Norwood Financial Corp. Stock Option Plan*****
10.6+ Salary Continuation Agreement between the Bank and William W. Davis, Jr.***
10.7+ Salary Continuation Agreement between the Bank and Lewis J. Critelli***
10.8+ Salary Continuation Agreement between the Bank and Edward C. Kasper***
10.9+ 1999 Directors Stock Compensation Plan***
10.10+ Salary Continuation Agreement between the Bank and Joseph A. Kneller******
10.11+ Salary Continuation Agreement between the Bank and John H. Sanders******
13 Annual Report to Stockholders for the fiscal year ended December 31, 2005
21 Subsidiaries of Norwood Financial Corp. (see Item 1. Business, General and Subsidiary Activity)
23 Consent of Independent Accountants.
31.1 Rule 13a-14(a)/15d-14(a) Certification of CEO
31.2 Rule 13a-14(a)/15d-14(a) Certification of CFO
32 Certification pursuant to 18 U.S.C. SS.1350, as adopted
pursuant to SS.906 of Sarbanes Oxley Act of 2002.
------------------------
+ Management contract or compensatory plan arrangement
* Incorporated herein by reference into this document from the Exhibits
to Form 10, Registration Statement initially filed with the Commission
on April 29, 1996, Registration No.0-28366.
** Incorporated by reference into this document from the identically
numbered exhibits to the registrant's Form 8-K filed with the
Commission on March 6, 2006
*** Incorporated herein by reference into this document from the Exhibits
to the Registrant's Form 10-K filed with the Commission on March 23,
2000, File No. 0-28366.
**** Incorporated by reference into this document from the Exhibit to the
Registrant's Form 10-K filed with the Commission on March 31, 1997,
File No. 0-28366
***** Incorporated by reference into this document from the Exhibits to Form
S-8 filed with the Commission on August 14, 1998, File No. 333-61487
****** Incorporated by reference into this document from the identically
numbered exhibits to the Registrant's Form 10-K filed with the
Commission on March 22, 2004, File No. 0-28366
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NORWOOD FINANCIAL CORP.
Dated: March 20, 2006 By: /s/William W. Davis, Jr.
--------------------------------
William W. Davis, Jr.
President, Chief Executive
Officer and Director
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this
Report has been signed below on March 20, 2006 by the following persons on
behalf of the Registrant and in the capacities indicated.
By: /s/William W. Davis, Jr. By: /s/Lewis J. Critelli
-------------------------------------- --------------------------------------------
William W. Davis, Jr. Lewis J. Critelli
President, Chief Executive Officer Executive Vice President
and Director and Chief Financial Officer
(Principal Financial and Accounting Officer)
By: /s/John E. Marshall
--------------------------------------------
John E. Marshall
Director
By: /s/Daniel J. O'Neill By: /s/Dr. Kenneth A. Phillips
-------------------------------------- --------------------------------------------
Daniel J. O'Neill Dr. Kenneth A. Phillips
Director Director
By: By: /s/Russell L. Ridd
-------------------------------------- --------------------------------------------
Gary P. Rickard Russell L. Ridd
Director Director
By: /s/Ralph A. Matergia By: /s/Richard L. Snyder
-------------------------------------- --------------------------------------------
Ralph A. Matergia Richard L. Snyder
Director Director
29