**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

(Mark One)

 

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

For the quarterly period endedMarch 31,            2008 

OR

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

 

For the transition period from _________________ to            ________________

 

Commission file number0-28366

 

| **Norwood Financial Corp.**                                                       |
|-----------------------------------------------------------------------------------|
| (Exact name of Registrant as specified in its                            charter) |

 

| Pennsylvania                                                    |   | 23-2828306                           |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of

Incorporation or organization) |   | (I.R.S. Employer Identification No.) |

 

| 717 Main Street, Honesdale, Pennsylvania |   | 18431      |   |
|------------------------------------------|--------|------------|--------|
| (Address of principal executive offices) |   | (Zip Code) |   |

 

| (570) 253-1455                                                                        |
|---------------------------------------------------------------------------------------|
| (Registrant’s telephone number, including area                            code) |

 

| NA                                                                                                             |
|----------------------------------------------------------------------------------------------------------------|
| (Former name, former address and former fiscal year, if                            changed since last report)) |

 

Indicate by check (x) 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. Yesx      No o

 

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

 

|   | Large accelerated filero                                              |   | Accelerated filerx         |
|--------|-----------------------------------------------------------------------|--------|----------------------------|
|   | Non-accelerated filero

(Do not check if a smaller reporting company) |   | Smaller reporting companyo |

             

Indicate by check mark whether the registrant is a shell company (as            defined in Rule 12b-2 of the Exchange Act): o            Yes                   xNo

 

Indicate the number of shares outstanding of each of the issuer’s            classes of common stock, as of the latest practicable date.

 

| Class                                   |   | Outstanding as of May 9, 2008 |
|-----------------------------------------|--------|-------------------------------|
| Common stock, par value $0.10 per share |   | 2,740,149                     |

 

 

1

 

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**NORWOOD FINANCIAL CORP.**

**FORM 10-Q**

**FOR THE QUARTER ENDED MARCH 31, 2008**

 

 

|       |                                                                                                                   |  

Page

Number |
|------------|------------------------------------------------------------------------------------------------------------------------|----------------------|
| PART I -   | CONSOLIDATED FINANCIAL INFORMATION OF NORWOOD

FINANCIAL CORP.                                                         |                 |
|       |                                                                                                                   |                 |
| Item 1.    | Financial Statements                                                                                                   | 3                    |
| Item 2.    | Management’s Discussion and Analysis of Financial                            Condition and Results of Operations |  

13           |
| Item 3.    | Quantitative and Qualitative Disclosures about Market                            Risk                                  | 22                   |
| Item 4     | Controls and Procedures                                                                                                | 23                   |
| PART II -  | OTHER INFORMATION                                                                                                      |                 |
|       |                                                                                                                   |                 |
| Item 1.    | Legal Proceedings                                                                                                      | 23                   |
| Item 1A.   | Risk Factors                                                                                                           | 23                   |
| Item 2.    | Unregistered Sales of Equity Securities and Use of                            Proceeds                                 | 23                   |
| Item 3.    | Defaults upon Senior Securities                                                                                        | 24                   |
| Item 4.    | Submission of Matters to a Vote of Security                            Holders                                         | 24                   |
| Item 5     | Other Information                                                                                                      | 24                   |
| Item 6     | Exhibits                                                                                                               | 24                   |
|       |                                                                                                                   |                 |
| Signatures |                                                                                                                   | 27                   |

 

 

2

 

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**PART I. FINANCIAL INFORMATION**

**Item 1. Financial Statements**

NORWOOD FINANCIAL CORP.

Consolidated Balance Sheets**(**unaudited)

(dollars in thousands, except per share data)

 

|                                                                                                             |   | **March 31,** |    | **December 31,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|---------------|---------|------------------|--------|
|                                                                                                             |   | **2008**      |    | **2007**         |   |
| ASSETS                                                                                                           |   |          |    |             |   |   |   |
|                                                                                                             |   |          |    |             |   |   |   |
| Cash and due from banks                                                                                          |   | $             | 8,283   |             | $      | 9,014 |   |
| Interest bearing deposits with banks                                                                             |   |          | 33      |             |   | 50 |   |
|                                                                                                             |        |               |    |                  |        |   |  |
| Cash and cash equivalents                                                                                        |        |               | 8,316   |                  |        | 9,064 |  |
|                                                                                                             |   |          |    |             |   |   |   |
| Securities available for sale                                                                                    |   |          | 130,633 |             |   | 123,987 |   |
| Securities held to maturity, fair value 2008:$726, 2007: $721                                                    |   |          | 706     |             |   | 705 |   |
| Loans receivable (net of unearned income)                                                                        |   |          | 329,377 |             |   | 331,296 |   |
| Less: Allowance for loan losses                                                                                  |   |          | 4,137   |             |   | 4,081 |   |
| Net loans receivable                                                                                             |   |          | 325,240 |             |   | 327,215 |   |
| Investment in FHLB Stock, at cost                                                                                |   |          | 2,124   |             |   | 2,072 |   |
| Bank premises and equipment, net                                                                                 |   |          | 5,668   |             |   | 5,742 |   |
| Bank owned life insurance                                                                                        |   |          | 7,841   |             |   | 7,767 |   |
| Accrued interest receivable                                                                                      |   |          | 2,409   |             |   | 2,343 |   |
| Other assets                                                                                                     |   |          | 1,030   |             |   | 1,715 |   |
| TOTAL ASSETS                                                                                                     |   | $             | 483,967 |             | $      | 480,610 |   |
|                                                                                                             |   |          |    |             |   |   |   |
| LIABILITIES                                                                                                      |   |          |    |             |   |   |   |
| Deposits:                                                                                                        |   |          |    |             |   |   |   |
| Non-interest bearing demand                                                                                      |   | $             | 55,618  |             | $      | 60,061 |   |
| Interest-bearing                                                                                                 |   |          | 315,535 |             |   | 309,939 |   |
| Total deposits                                                                                                   |   |          | 371,153 |             |   | 370,000 |   |
| Short-term borrowings                                                                                            |   |          | 28,006  |             |   | 26,686 |   |
| Long-term debt                                                                                                   |   |          | 23,000  |             |   | 23,000 |   |
| Accrued interest payable                                                                                         |   |          | 2,621   |             |   | 3,198 |   |
| Other liabilities                                                                                                |   |          | 2,613   |             |   | 1,907 |   |
| TOTAL LIABILITIES                                                                                                |   |          | 427,393 |             |   | 424,791 |   |
|                                                                                                             |   |          |    |             |   |   |   |
| STOCKHOLDERS’ EQUITY                                                                                       |   |          |    |             |   |   |   |
| Common stock, $.10 par value per share,                            authorized10,000,000; shares issued 2,840,872 |   |          | 284     |             |   | 284 |   |
| Surplus                                                                                                          |   |          | 10,119  |             |   | 10,159 |   |
| Retained earnings                                                                                                |   |          | 47,603  |             |   | 47,030 |   |
| Treasury stock at cost: 2008: 101,328                            shares, 2007: 87,256                            |   |          | (3,152  | )                |   | (2,708 | ) |
| Accumulated other comprehensive income                                                                           |   |          | 1,720   |             |   | 1,054 |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                 |   |          | 56,574  |             |   | 55,819 |   |
| TOTAL LIABILITIES ANDSTOCKHOLDERS’ EQUITY                                                                  |   | $             | 483,967 |             | $      | 480,610 |   |

 

See            accompanying notes to the unaudited consolidated financial statements.

 

3

 

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NORWOOD FINANCIAL CORP. Consolidated Statements of Income            (unaudited)

(dollars in thousands, except per share data)

 

|                                               |   | **Three Months Ended** |
|----------------------------------------------------|--------|------------------------|
|                                               |   | **March 31,**          |
|                                               |   | **2008**               |   | **2007** |
|                                               |   |                   |   |   |   |   |
| INTEREST INCOME                                    |   |                   |   |   |   |   |
| Loans receivable, including fees                   |   | $                      | 5,641 |   | $ | 5,840 |
| Securities                                         |   |                   | 1,489 |   |   | 1,218 |
| Other                                              |   |                   | 19 |   |   | 21 |
| Total interest income                              |   |                   | 7,149 |   |   | 7,079 |
|                                               |   |                   |   |   |   |   |
| INTEREST EXPENSE                                   |   |                   |   |   |   |   |
| Deposits                                           |   |                   | 2,371 |   |   | 2,486 |
| Short-term borrowings                              |   |                   | 187 |   |   | 256 |
| Long-term debt                                     |   |                   | 267 |   |   | 246 |
| Total interest expense                             |   |                   | 2,825 |   |   | 2,988 |
| NET INTEREST INCOME                                |   |                   | 4,324 |   |   | 4,091 |
| PROVISION FOR LOAN LOSSES                          |   |                   | 75 |   |   | 50 |
| NET INTEREST INCOME AFTERPROVISION FOR LOAN LOSSES |   |                   | 4,249 |   |   | 4,041 |
|                                               |   |                   |   |   |   |   |
| OTHER INCOME                                       |   |                   |   |   |   |   |
| Service charges and fees                           |   |                   | 638 |   |   | 606 |
| Income from fiduciary activities                   |   |                   | 92 |   |   | 125 |
| Gain on sale of loans                              |   |                   | 388 |   |   | 7 |
| Other                                              |   |                   | 144 |   |   | 156 |
| Total other income                                 |   |                   | 1,262 |   |   | 894 |
|                                               |   |                   |   |   |   |   |
| OTHER EXPENSES                                     |   |                   |   |   |   |   |
| Salaries and employee benefits                     |   |                   | 1,546 |   |   | 1,497 |
| Occupancy, furniture & equipment, net          |   |                   | 430 |   |   | 415 |
| Data processing                                    |   |                   | 188 |   |   | 174 |
| Taxes, other than income                           |   |                   | 126 |   |   | 118 |
| Professional fees                                  |   |                   | 90 |   |   | 89 |
| Other                                              |   |                   | 581 |   |   | 568 |
| Total other expenses                               |   |                   | 2,961 |   |   | 2,861 |
|                                               |   |                   |   |   |   |   |
| INCOME BEFORE INCOME TAXES                         |   |                   | 2,550 |   |   | 2,074 |
| INCOME TAX EXPENSE                                 |   |                   | 771 |   |   | 611 |
| NET INCOME                                         |   | $                      | 1,779 |   | $ | 1,463 |
|                                               |   |                   |   |   |   |   |
| BASIC EARNINGS PER SHARE                           |   | $                      | 0.65 |   | $ | 0.52 |
|                                               |   |                   |   |   |   |   |
| DILUTED EARNINGS PER SHARE                         |   | $                      | 0.64 |   | $ | 0.51 |

 

See            accompanying notes to the unaudited consolidated financial statements.

 

 

 

4

 

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NORWOOD FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity            (unaudited)

 

 

| (dollars in thousands, except per share data)                                                                                             | **Number of shares issued** |   |   | **Common Stock** |   | **Surplus** |   |   | **Retained Earnings** |   | **Treasury Stock** | **Accumulated Other Comprehensive (Loss)                            Income** |   | **Total** |
|-------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------|--------|--------|------------------|--------|-------------|--------|--------|-----------------------|--------|--------------------|------------------------------------------------------------------------------|--------|-----------|
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance December 31, 2006                                                                                                                 | 2,840,872                   |   |   | $                | 284    |        |   | $      | 10,149                |   |               |                                                                         | $      | 43,125    |   |   | $ | (1,283 | ) | $ | (44 | ) |   | $ | 52,231 |   |
| Comprehensive Income:                                                                                                                     |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income                                                                                                                                |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   | 1,463     |   |   |   |   |   |   |   |   |   |   | 1,463 |   |
| Change in unrealized gainson securities available for sale, net of                            reclassification adjustment and tax effects |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   | 196 |   |   |   | 196 |   |
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Total comprehensive income                                                                                                                |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   | 1,659 |   |
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash dividends declared, $.23 per share                                                                                                   |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   | (642      | ) |   |   |   |   |   |   |   |   |   | (642 | ) |
| Acquisition of 9,267 shares oftreasury stock                                                                                              |                        |   |   |             |   |        |   |   |                  |   |               |                                                                         |   |      |   |   |   | (273 | ) |   |   |   |   |   | (273 | ) |
| Compensation expense related to stock options                                                                                             |                        |   |   |             |   |        |   |   | 84                    |   |               |                                                                         |   |      |   |   |   |   |   |   |   |   |   |   | 84 |   |
| Balance March 31, 2007                                                                                                                    | 2,840,872                   |   |   | $                | 284    |        |   | $      | 10,233                |   |               |                                                                         | $      | 43,946    |   |   | $ | (1,556 | ) | $ | 152 |   |   | $ | 53,059 |   |

 

|                                                                                                                                      | **Number of shares issued** |   |   | **Common Stock** |   | **Surplus** |   |   | **Retained Earnings** |   | **Treasury Stock** | **Accumulated Other Comprehensive                             Income** |   | **Total** |
|-------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------|--------|--------|------------------|--------|-------------|--------|--------|-----------------------|--------|--------------------|-----------------------------------------------------------------------------|--------|-----------|
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance December 31, 2007                                                                                                                 | 2,840,872                   |   |   | $                | 284    |        |   | $      | 10,159                |   |               |                                                                        | $      | 47,030    |   |   | $ | (2,708 | ) | $ | 1,054 |   |   | $ | 55,819 |   |
| Comprehensive Income:                                                                                                                     |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income                                                                                                                                |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   | 1,779     |   |   |   |   |   |   |   |   |   |   | 1,779 |   |
| Change in unrealized gainson securities available for sale, net of                            reclassification adjustment and tax effects |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   | 666 |   |   |   | 666 |   |
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Total comprehensive income                                                                                                                |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   | 2,445 |   |
|                                                                                                                                      |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash dividends declared, $.25 per share                                                                                                   |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   | (686      | ) |   |   |   |   |   |   |   |   |   | (686 | ) |
| Acquisition of 20,000 shares oftreasury stock                                                                                             |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   |      |   |   |   | (630 | ) |   |   |   |   |   | (630 | ) |
| Stock options exercised (5,928 shares)                                                                                                    |                        |   |   |             |   |        |   |   | (95                   | )      |               |                                                                        |   |      |   |   |   | 186 |   |   |   |   |   |   | 91 |   |
| Tax benefit on stock options exercised                                                                                                    |                        |   |   |             |   |        |   |   | 17                    |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   | 17 |   |
| Compnesation expense related to stock options                                                                                             |                        |   |   |             |   |        |   |   | 38                    |   |               |                                                                        |   |      |   |   |   |   |   |   |   |   |   |   | 38 |   |
| Cumulative effect of net periodic postretirement                            benefit                                                       |                        |   |   |             |   |        |   |   |                  |   |               |                                                                        |   | (520      | ) |   |   |   |   |   |   |   |   |   | (520 | ) |
| Balance March 31, 2008                                                                                                                    | 2,840,872                   |   |   | $                | 284    |        |   | $      | 10,119                |   |               |                                                                        | $      | 47,603    |   |   | $ | (3,152 | ) | $ | 1,720 |   |   | $ | 56,574 |   |

 

See            accompanying notes to the unaudited consolidated financial statements.

 

5

 

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NORWOOD            FINANCIAL CORP.

Consolidated Statements of Cash Flows (Unaudited)

| (dollars in thousands) |
|------------------------|

 

 

|                                                                                                                   |   | **Three Months Ended** |    |
|------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                                                                   |   | **March 31,**          |    |
|                                                                                                                   |   | **2008**               |    | **2007** |   |
|                                                                                                                   |   |                   |    |   |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                                                   |   |                   |    |   |   |   |   |
| Net Income                                                                                                             |   | $                      | 1,779   |   | $ | 1,463 |   |
| Adjustments to reconcile net income to net cash provided                            by (used in) operating activities: |   |                   |    |   |   |   |   |
| Provision for loan losses                                                                                              |   |                   | 75      |   |   | 50 |   |
| Depreciation                                                                                                           |   |                   | 138     |   |   | 144 |   |
| Amortization of intangible assets                                                                                      |   |                   | 13      |   |   | 13 |   |
| Deferred income taxes                                                                                                  |   |                   | (38     | ) |   | 82 |   |
| Net amortization of securities premiums and                            discounts                                       |   |                   | 16      |   |   | 49 |   |
| Net increase in investment in life insurance                                                                           |   |                   | (74     | ) |   | (70 | ) |
| Net gain on sale of mortgage loans                                                                                     |   |                   | (388    | ) |   | (7 | ) |
| Mortgage loans originated for sale                                                                                     |   |                   | — |   |   | (327 | ) |
| Proceeds from sale of mortgage loans originated for                            sale                                    |   |                   | — |   |   | 334 |   |
| Compensation expense related to stock options                                                                          |   |                   | 38      |   |   | 84 |   |
| Decrease in accrued interest receivable and other                            assets                                    |   |                   | 314     |   |   | 301 |   |
| Decrease in accrued interest payable and other                            liabilities                                  |   |                   | (389    | ) |   | (3,080 | ) |
| Net cash provided by (used in) operating                            activities                                         |   |                   | 1,484   |   |   | (964 | ) |
|                                                                                                                   |   |                   |    |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                                                   |   |                   |    |   |   |   |   |
| Securities available for sale:                                                                                         |   |                   |    |   |   |   |   |
| Proceeds from maturities and principal reductions on                            mortgage-backed securities             |   |                   | 15,286  |   |   | 13,861 |   |
| Purchases                                                                                                              |   |                   | (20,942 | ) |   | (13,300 | ) |
| Increase in investment in FHLB stock                                                                                   |   |                   | (52     | ) |   | (236 | ) |
| Net (increase) decrease in loans                                                                                       |   |                   | (11,705 | ) |   | (5,210 | ) |
| Proceeds from sale of mortgage loans                                                                                   |   |                   | 13,982  |   |   | — |   |
| Purchase of bank premises and equipment                                                                                |   |                   | (64     | ) |   | (59 | ) |
| Net cash used in investing activities                                                                                  |   |                   | (3,495  | ) |   | (4,944 | ) |
|                                                                                                                   |   |                   |    |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                                                   |   |                   |    |   |   |   |   |
| Net increase in deposits                                                                                               |   |                   | 1,153   |   |   | 1,931 |   |
| Net increase (decrease) in short-term                            borrowings                                            |   |                   | 1,320   |   |   | (2,750 | ) |
| Proceeds from other borrowings                                                                                         |   |                   | — |   |   | 10,000 |   |
| Stock options exercised                                                                                                |   |                   | 91      |   |   | — |   |
| Tax benefit of stock options exercised                                                                                 |   |                   | 17      |   |   | — |   |
| Acquisition of treasury stock                                                                                          |   |                   | (630    | ) |   | (273 | ) |
| Cash dividends paid                                                                                                    |   |                   | (688    | ) |   | (642 | ) |
| Net cash provided by financing activities                                                                              |   |                   | 1,263   |   |   | 8,266 |   |
| Increase (decrease) in cash and cash                            equivalents                                            |   |                   | (748    | ) |   | 2,358 |   |
|                                                                                                                   |   |                   |    |   |   |   |   |
| CASH AND CASH EQUIVALENTS, BEGINNING OF                            PERIOD                                              |   |                   | 9,064   |   |   | 9,517 |   |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                               |   | $                      | 8,316   |   | $ | 11,875 |   |
|                                                                                                                   |   |                   |    |   |   |   |   |

 

See            accompanying notes to the unaudited consolidated financial statements.

6

 

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**Notes to Unaudited Consolidated Financial            Statements**

 

| **1.** | **Basis of Presentation** |
|--------|---------------------------|

             

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

 

The accompanying unaudited consolidated financial statements have been            prepared in conformity with generally accepted accounting principles for interim            financial statements and with instructions to Form 10-Q. Accordingly, they do not            include all of the information and footnotes required by generally accepted accounting            principles for complete financial statements. In preparing the financial statements,            management is required to make estimates and assumptions that affect the reported            amounts of assets and liabilities as of the date of the balance sheet and revenues and            expenses for the period. Actual results could differ from those estimates. The            financial statements reflect, in the opinion of management, all normal, recurring            adjustments necessary to present fairly the financial position and results of            operations of the Company. The operating results for the three month period ended March            31, 2008 are not necessarily indicative of the results that may be expected for the            year ending December 31, 2008 or any other future interim period.

 

These statements should be read in conjunction with the consolidated            financial statements and related notes which are incorporated by reference in the            Company’s Annual Report on Form 10-K for the year-ended December 31,            2007.

 

| **2.** | **Earnings Per Share** |
|--------|------------------------|

             

Basic earnings per share represents income available to common            stockholders divided by the weighted average number of common shares outstanding during            the period. Diluted earnings per share reflects additional common shares that would            have been outstanding if dilutive potential common shares had been issued, as well as            any adjustment to income that would result from the assumed issuance. Potential common            shares that may be issued by the Company relate solely to outstanding stock options and            are determined using the treasury stock method.

 

The following table sets forth the weighted average shares outstanding            used in the computations of basic and diluted earnings per share:

 

| (in thousands)                                                             | **Three Months Ended**

**March 31,** |   |
|----------------------------------------------------------------------------|---------------------------------------|--------|
|                                                                       | **2008**                              |   |   | **2007** |   |
|                                                                       |                                  |   |   |   |   |
| Basic EPS weighted average shares outstanding                              | 2,753                                 |   |   | 2,791 |   |
| Dilutive effect of stock options                                           | 37                                    |   |   | 56 |   |
| Diluted EPS weighted average shares                            outstanding | 2,790                                 |   |   | 2,847 |   |

 

 

7

 

----

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            40,000 and 44,025 as of March 31, 2008 and 2007, respectively.

 

**3.****Stock-Based            Compensation**

             

The Company’s shareholders approved the Norwood Financial Corp            2006 Stock Option Plan at the annual meeting on April 25, 2006 and the Company awarded            47,700 options in 2006 and 22,000 options in 2007, all of which have a twelve month            vesting period. As of March 31, 2008, there was approximately $115,000 of total            unrecognized compensation cost related to nonvested options under the plan, which will            be fully amortized by December 31, 2008.

 

No stock options were granted during the three months ended March 31,            2008. A summary of stock options from all plans, adjusted for stock dividends declared,            is shown below.

 

|                           | **Options** |   |   | **Weighted Average Exercise Price**

**Per Share** |   | **Weighted Average Remaining Contractual                            Term** |   | **Aggregate Intrinsic Value ($000)** |   |
|--------------------------------|-------------|--------|--------|----------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                           |        |   |   |                                               |   |                                                                       |   |                                 |   |   |   |   |   |
| Outstanding at January 1, 2008 | 180,422     |   |   | $                                                  | 24.04  |                                                                       |   | 6.1                                  | Yrs.   |   | $ | 1,301 |   |
| Exercised                      | (5,928      | )      |   |                                               | 13.84  |                                                                       |   | ____                                 |   |   |   | _____ |   |
| Outstanding at March 31, 2008  | 174,494     |   |   | $                                                  | 24.39  |                                                                       |   | 5.8                                  |   |   | $ | 1,171 |   |
| Exerciseable at March 31, 2008 | 152,494     |   |   | $                                                  | 23.40  |                                                                       |   | 6.0                                  |   |   | $ | 1,174 |   |

 

Intrinsic value represents the amount by which the market price of the            stock on the measurement date exceeded the exercise price of the option. The intrinsic            value of options exercised during the three months ended March 31, 2008 was $89,000,            cash received from such exercises was $91,000 and the tax benefit recognized was            $17,000.

 

| **4.** | **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, all            of which mature within 90 days and federal funds sold.

 

Cash payments for interest for the periods ended March 31, 2008 and 2007            were $3,401,000 and $2,480,000 respectively. Cash payments for income taxes for the            periods ending March 31, 2008 and 2007 were $4,000. Non-cash investing activity for            2008 and 2007 included repossession of other assets of $11,000 and $24,000,            respectively.

 

| **5.** | **Comprehensive Income** |
|--------|--------------------------|

             

Accounting principles generally accepted in the United States of America            require that recognized revenue, expenses, gains and losses be included in net income.            Although certain changes in assets and liabilities such as unrealized gains and losses            on available for sale securities, are reported as a separate component of the equity            section of the balance sheet, such

 

8

 

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items,            along with net income, are components of comprehensive income. The components of other            comprehensive income and related tax effects are as follows.

 

|                                                     |   | **Three Months Ended** |
|----------------------------------------------------------|--------|------------------------|
| (In thousands)                                           |   | **March 31,**          |
|                                                     |   |                   | **2008** |   |   | **2007** |
| Unrealized holding gainson available for sale securities |   | $                      | 1,007 |   | $ | 294 |
| Reclassification adjustment for gainsrealized in income  |   |                   | — |   |   | — |
| Net unrealized gains                                     |   |                   | 1,007 |   |   | 294 |
| Income tax expense                                       |   |                   | 341 |   |   | 98 |
| Other comprehensive income                               |   | $                      | 666 |   | $ | 196 |

 

| **6.** | **Off-Balance Sheet Financial Instruments and                            Guarantees** |
|--------|---------------------------------------------------------------------------------------|

 

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:

 

| (in thousands)                             | **March 31,** |
|--------------------------------------------|---------------|
|                                       | **2008**      |   | **2007** |
|                                       |          |   |   |   |   |
| Commitments to grant loans                 | $             | 10,311 |   | $ | 8,940 |
| Unfunded commitments under lines of credit |          | 32,920 |   |   | 30,376 |
| Standby letters of credit                  |          | 2,214 |   |   | 6,914 |
|                                       |          |   |   |   |   |
|                                       | $             | 45,445 |   | $ | 46,230 |

 

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.

 

The Bank does not issue any guarantees that would require liability            recognition or disclosure, other than its standby letters of credit. Standby letters of            credit written are conditional

 

9

 

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commitments issued by the Bank to guarantee the performance of a            customer to a third party. Generally, all letters of credit, when issued have            expiration dates within one year. The credit risk involved in issuing letters of credit            is essentially the same as those that are involved in extending loan facilities to            customers. The Bank, generally, holds collateral and/or personal guarantees supporting            these commitments. Management believes that the proceeds obtained through a liquidation            of collateral and the enforcement of guarantees would be sufficient to cover the            potential amount of future payments required under the corresponding guarantees. The            current amount of the liability as of March 31, 2008 for guarantees under standby            letters of credit issued is not material.

 

| **7.** | **Fair Value Measurements** |
|--------|-----------------------------|

 

In September 2006, the FASB issued FASB Statement No.157,*Fair Value Measurements*(“SFAS            157”), which defines fair value, establishes a framework for measuring fair value            under GAAP, and expands disclosures about fair value measurements. SFAS 157 applies to            other accounting pronouncements that require or permit fair value measurements. The            standard is effective for financial statements issued for fiscal years beginning after            November 15, 2007, and for interim periods within those fiscal years. The Company            adopted SFAS 157 effective for its fiscal year beginning January 1, 2008. In December            2007, the FASB issued FASB Staff Position (FSP) No. SFAS 157-2, “Effective date            of FAS 157 for all non-financial assets and liabilities, except those that are            recognized or disclosed at fair value on a recurring basis (at least annually) to            fiscal years beginning after November 15,2008 and interim periods within those fiscal            years. The adoption of SFAS 157 and FSP No. FAS 157-2 had no impact on the amounts            reported in the consolidated financial statements.

 

The primary effect of SFAS 157 on the Company was to expand the required            disclosures pertaining to the methods used to determine fair values.

 

SFAS 157 establishes a fair value hierarchy that 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 under SFAS 157 are            as follows:

 

*Level 1:*Unadjusted quoted prices in active            markets that are accessible at the measurement date for

identical, unrestricted assets or            liabilities.

 

*Level 2:*Quoted prices in markets that are            not active, or inputs that are observable either directly or

indirectly, for substantially the full term of the asset or            liability.

 

*Level 3:*Prices or valuation techniques            that require inputs that are both significant to the fair value

 measurement and unobservable (i.e. supported with little or no            market activity).

 

As asset 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.

 

10

 

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For            financial assets measured at fair value on a recurring basis, the fair value            measurements by level within the fair value hierarchy used at March 31, 2008 are as            follows:

 

| **Description**               |   | **March 31,****2008** |    | **(Level 1)****Quoted Prices in****Active Markets****For Identical****Assets** |   | **(Level 2)****Significant****Other****Observable****Inputs** |   | **(Level 3)****Significant****Unobservable****Inputs** |
|-------------------------------|--------|-----------------------|---------|--------------------------------------------------------------------------------|--------|---------------------------------------------------------------|--------|--------------------------------------------------------|
|                          |   | (In Thousands)        |
|                          |   |                  |    |                                                                           |   |                                                          |   |                                                   |   |   |   |   |
| Securities available for sale |   | $                     | 130,633 |                                                                           | $      | 1,451                                                         |   | $                                                      | 129,182 |   | $ | — |
| Loans                         |   |                  | 3,230   |                                                                           |   | —                                                       |   |                                                   | — |   |   | 3,230 |
| Total                         |   | $                     | 133,863 |                                                                           | $      | 1,451                                                         |   | $                                                      | 129,182 |   | $ | 3,230 |

 

The following valuation techniques were used to measure fair value of            assets in the table above on a recurring basis as of March 31, 2008:

 

Available for Sale Securities:

The Company holds equity securities which are traded with quoted prices,            on an active market. Such securities are carried at a market price quote and considered            Level 1 Fair Values.

 

The Company also holds debt offerings of U.S. Government Agencies, state            and political subdivisions, high-grade corporate obligations and mortgage-backed            securities issued by U.S. Government agencies. The Company utilizes a third party            source to provide fair value of its fixed income securities. The methodology consists            of pricing models based on asset class and include available trade, bid, other market            information, broker quotes, proprietary models, various databases and trading desk            quotes. This valuation is based on observable inputs and is considered Level            2.

 

Loans:

Impaired loans are evaluated and valued at the time the loan is first            considered impaired. The realizable value is measured based on the value of the            collateral securing the loan and is considered a Level 3 measurement. The value of real            estate related collateral is established by a formal appraisal performed for the            Company. The loan is carried at the lower of cost or market, net of any valuation            allowance. Impaired loans are evaluated on a quarterly basis for additional impairment            and adjusted as needed. Impaired loans totaled $3,230,000 as of March 31, 2008 compared            to $3,208,000 as of December 31, 2007. There were no new impaired loans added during            the three months ended March 31, 2008, no principal reductions and a $22,000 advance on            one loan.

             

| **8.** | **New and Recently Adopted Accounting                            Pronouncements** |
|--------|-----------------------------------------------------------------------------------|

 

In September 2006, the FASB’s Emerging Issues Task Force (EITF)            issued EITF Issue No. 06-4, “Accounting for Deferred Compensation and            Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance            Arrangements” (EITF 06-4). EITF 06-4 requires the recognition of a liability            related to the postretirement benefits covered by an endorsement split-dollar life            insurance arrangement. The consensus highlights that the employer (who is also the            policyholder) has a liability for the benefit it is providing to its employee. As such,            if the policyholder has agreed to maintain the insurance policy in force for the            employee’s benefit

 

11

 

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during            his or her retirement, then the liability recognized during the employee’s active            service period should be based on the future cost of insurance to be incurred during            the employee’s retirement. Alternatively, if the policyholder has agreed to            provide the employee with a death benefit, then the liability for the future death            benefit should be recognized by following the guidance in SFAS No. 106 or Accounting            Principles Board (APB) Opinion No. 12, as appropriate. For transition, an entity can            choose to apply the guidance using either of the following approaches: (a) a change in            accounting principle through retrospective application to all periods presented or (b)            a change in accounting principle through a cumulative-effect adjustment to the balance            in retained earnings at the beginning of the year of adoption. The Company adopted EITF            06-4 on January 1, 2008 as a change in accounting principle through a cumulative effect            adjustment of retained earnings of $520,000.

             

In February 2007, the FASB issued SFAS No. 159, “The Fair Value            Option for Financial Assets and Financial Liabilities-including an amendment of FASB            Statement No. 115”. SFAS No. 159 permits entities to choose to measure many            financial instruments and certain other items at fair value. Unrealized gains and            losses on items for which the fair value option has been elected will be recognized in            earnings at each subsequent reporting date. SFAS No. 159 is effective for our Company            January 1, 2008. The Company adopted the standards but did not elect the fair value            option for any financial assets or financial liabilities as of January 1,            2008.

 

FASB Statement No. 141 (R) “Business Combinations” was            issued in December of 2007. This Statement establishes principles and requirements for            how the acquirer of a business recognizes and measures in its financial statements the            identifiable assets acquired, the liabilities assumed, and any noncontrolling interest            in the acquiree. The Statement also provides guidance for recognizing and measuring the            goodwill acquired in the business combination and determines what information to            disclose to enable users of the financial statements to evaluate the nature and            financial effects of the business combination. The guidance will become effective as of            the beginning of a company’s fiscal year beginning after December 15, 2008. This            new pronouncement will impact the Company’s accounting for business combinations            beginning January 1, 2009.

             

FASB Statement No. 160 “Noncontrolling Interests in Consolidated            Financial Statements – an amendment of ARB No. 51” was issued in December            of 2007. This Statement establishes accounting and reporting standards for the            noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.            The guidance will become effective as of the beginning of a company’s fiscal year            beginning after December 15, 2008. The Company believes that this new pronouncement            will not have a material impact on the Company’s consolidated financial            statements in future periods.

 

Staff Accounting Bulletin No. 109 (SAB 109), “Written Loan            Commitments Recorded at Fair Value Through Earnings” expresses the views of the            staff regarding written loan commitments that are accounted for at fair value through            earnings under generally accepted accounting principles. To make the staff’s            views consistent with current authoritative accounting guidance, the SAB revises and            rescinds portions of SAB No. 105, “Application of Accounting Principles to Loan            Commitments.” Specifically, the SAB revises the SEC staff’s views on            incorporating expected net future cash flows related to loan servicing activities in            the fair value

 

12

 

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measurement of a written loan commitment. The SAB retains the            staff’s views on incorporating expected net future cash flows related to            internally-developed intangible assets in the fair value measurement of a written loan            commitment. The staff expects registrants to apply the views in Question 1 of SAB 109            on a prospective basis to derivative loan commitments issued or modified in fiscal            quarters beginning after December 15, 2007. SAB 109 did not have a material impact on            the Company’s consolidated financial statements.

 

In June 2007, the Emerging Issues Task Force (EITF) reached a consensus            on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on            Share-Based Payment Awards” (EITF 06-11). EITF 06-11 states that an entity should            recognize a realized tax benefit associated with dividends on nonvested equity shares,            nonvested equity share units and outstanding equity share options charged to retained            earnings as an increase in additional paid in capital. The amount recognized in            additional paid in capital should be included in the pool of excess tax benefits            available to absorb potential future tax deficiencies on share-based payment awards.            EITF 06-11 should be applied prospectively to income tax benefits of dividends on            equity-classified share-based payment awards that are declared in fiscal years            beginning after December 15, 2007. EITF 06-11 did not have an impact on the            Company’s consolidated financial statements.

 

In March 2008, the FASB issued Statement No. 161, “Disclosures            about Derivative Instruments and Hedging Activities – an amendment of FASB            Statement No. 133” (Statement 161). Statement 161 requires entities that utilize            derivative instruments to provide qualitative disclosures about their objectives and            strategies for using such instruments, as well as any details of credit-risk-related            contingent features contained within derivatives. Statement 161 also requires entities            to disclose additional information about the amounts and location of derivatives            located within the financial statements, how the provisions of SFAS 133 has been            applied, and the impact that hedges have on an entity’s financial position,            financial performance, and cash flows. Statement 161 is effective for fiscal years and            interim periods beginning after November 15, 2008, with early application encouraged.            The Company is currently evaluating the potential impact the new pronouncement will            have on its consolidated financial statements.

 

In February 2008, the FASB issued a FASB Staff Position (FSP) FAS 140-3,            “Accounting for Transfers of Financial Assets and Repurchase Financing            Transactions.” This FSP addresses the issue of whether or not these transactions            should be viewed as two separate transactions or as one “linked”            transaction. The FSP includes a “rebuttable presumption” that presumes            linkage of the two transactions unless the presumption can be overcome by meeting            certain criteria. The FSP will be effective for fiscal years beginning after November            15, 2008 and will apply only to original transfers made after that date; early adoption            will not be allowed. The Company is currently evaluating the potential impact the new            pronouncement will have on its consolidated financial            statements.            

 

 

13

 

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**Item            2. Management’s Discussion and Analysis of Financial Condition and Results of            Operations**

 

**Forward-Looking Statements**

 

The Private Securities Litigation Reform Act of 1995 contains safe            harbor provisions regarding forward-looking statements. When used in this discussion,            the words believes, anticipates, contemplates, expects, and similar expressions are            intended to identify forward-looking statements. Such statements are subject to certain            risks and uncertainties, which could cause actual results to differ materially from            those projected. Those risks and uncertainties include changes in interest rates, risks            associated with the effect of opening a new branch, the ability to control costs and            expenses, demand for real estate 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 for the            year ended December 31, 2007 (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,            accounting for stock options, the valuation of deferred tax assets and the            determination of other-than-temporary impairment losses on securities. Please refer to            the discussion of the allowance for loan losses calculation under “Non-performing            Assets and Allowance for Loan Losses” in the “Financial Condition”            section.

 

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

 

In estimating other-than-temporary impairment losses on securities, the            Company considers 1) the length of time and extent to which the fair value has been            less than cost 2) the financial condition of the issuer and 3) the intent and ability            of the Company to hold the security to allow for a recovery to fair value. The Company            believes that the unrealized losses in certain specific securities at March 31, 2008            and December 31, 2007 represent temporary impairment of the securities.

 

14

 

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**Changes in Financial Condition**

 

**General**

             

Total assets as of March 31, 2008 were $484.0 million compared to $480.6            million as of December 31, 2007 an increase of $3.4 million. The increase reflects a            $6.6 million, or 5.4%, increase in the securities available for sale portfolio,            partially offset by a $2.0 million, or 0.6% decrease in loans receivable and a $748,000            or 8.3% decrease in cash and cash and cash equivalents.

 

**Securities**

             

The fair value of securities available for sale as of March 31, 2008 was            $130.6 million compared to $124 million as of December 31, 2007. The Company purchased            $20.9 million of securities principally using the proceeds from $15.3 million of            securities called, maturities and principal reductions.

 

The            carrying value of the Company’s securities portfolio (Available-for Sale and            Held-to Maturity) consisted of the following:

 

|                              |   | **March 31, 2008** |    | **December 31, 2007** |
|-----------------------------------|--------|--------------------|---------|-----------------------|
| (dollars in thousands)            |   | **Amount**         |    | **% of portfolio**    |   | **Amount** |   | **% of portfolio** |
|                              |   |               |    |                  |   |   |   |   |   |   |   |   |
| US Government agencies            |   | $                  | 40,923  |                  | 31.2 | % |   | $ | 41,508 |   | 33.4 | % |
| States and political subdivisions |   |               | 24,260  |                  | 18.5 |   |   |   | 22,622 |   | 18.1 |   |
| Corporate securities              |   |               | 5,006   |                  | 3.8 |   |   |   | 4,994 |   | 4.0 |   |
| Mortgage-backed securities        |   |               | 59,699  |                  | 45.4 |   |   |   | 54,082 |   | 43.3 |   |
| Equity securities                 |   |               | 1,451   |                  | 1.1 |   |   |   | 1,486 |   | 1.2 |   |
| Total                             |   | $                  | 131,339 |                  | 100.0 | % |   | $ | 124,692 |   | 100.0 | % |

 

The Company has securities in an unrealized loss position. In            Management’s opinion, the unrealized losses principally reflect changes in            interest rates subsequent to the acquisition of specific securities. The            Company’s available-for-sale portfolio has an average repricing term of 2.6            years. Interest rates in the 2-5 year section of the treasury yield curve decreased            during the three months ended March 31, 2008 favorably impacting the fair value of many            of the individual securities. Management believes that the unrealized losses represent            temporary impairment of the securities and are the result of changes in interest rates.            The Company has the intent and ability to hold these investments until maturity or            market price recovery. The Company monitors the credit ratings of its Corporate            Securities, which may impact the valuation of the securities. The credit ratings as of            March 31, 2008 and December 31, 2007 were all within the Company’s policy            Guidelines.

 

**Loans Receivable**

             

Loans receivable totaled $329.4 million compared to $331.3 million as of            December 31, 2007. Residential real estate loans decreased $10.2 million principally            due to the sale of $13.9 million of 30 year fixed rate residential mortgages. The loans            were sold for interest rate risk management to shorten the average life of the mortgage            loan portfolio. Commercial real estate

 

15

 

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loans            increased $8.3 million during the period. Consumer loans declined $0.9 million due to            continued run-off in the Company’s indirect automobile portfolio.

 

Set forth below is selected data relating to the composition of the loan            portfolio at the dates indicated:

 

|                                   |   | **March 31, 2008** |    | **December 31, 2007** |   |
|----------------------------------------|--------|--------------------|---------|-----------------------|--------|
| (dollars in thousands)                 |   |               |    |                  |   |   |   |   |   |   |   |
| Real Estate-Residential                |   | $                  | 119,717 |                  | 36.3   | % | $ | 129,888 |   | 39.2 | % |
| Commercial                             |   |               | 142,452 |                  | 43.2   |   |   | 133,593 |   | 40.3 |   |
| Construction                           |   |               | 18,252  |                  | 5.5    |   |   | 20,404 |   | 6.2 |   |
| Commercial, financial and agricultural |   |               | 31,634  |                  | 9.6    |   |   | 29,159 |   | 8.8 |   |
| Consumer loans to individuals          |   |               | 17,585  |                  | 5.3    |   |   | 18,526 |   | 5.6 |   |
| Total loans                            |   |               | 329,640 |                  | 100.0  | % |   | 331,570 |   | 100.0 | % |
|                                   |   |               |    |                  |   |   |   |   |   |   |   |
| Deferred fees (net)                    |   |               | (263    | )                     |   |   |   | (274 | ) |   |   |
|                                   |   |               | 329,377 |                  |   |   |   | 331,296 |   |   |   |
| Allowance for loan losses              |   |               | (4,137  | )                     |   |   |   | (4,081 | ) |   |   |
| Net loans receivable                   |   | $                  | 325,240 |                  |   |   | $ | 327,215 |   |   |   |

 

**Allowance for Loan Losses and Non-performing            Assets**

 

Following is a summary of changes in the allowance for loan losses for            the periods indicated:

 

|                                                      | **Three Months Ended** |   |
|-----------------------------------------------------------|------------------------|--------|
|                                                      | **March 31,**          |   |
|                                                      | **2008**               |   | **2007** |   |
| (dollars in thousands)                                    |                   |   |   |   |   |   |
| Balance, beginning                                        | $                      | 4,081  |   | $ | 3,828 |   |
| Provision for loan losses                                 |                   | 75     |   |   | 50 |   |
| Charge-offs                                               |                   | (35    | ) |   | (28 | ) |
| Recoveries                                                |                   | 16     |   |   | 21 |   |
| Net (charge-offs)                                         |                   | (19    | ) |   | (7 | ) |
| Balance, ending                                           | $                      | 4,137  |   | $ | 3,871 |   |
|                                                      |                   |   |   |   |   |   |
| Allowance to total loans                                  |                   | 1.26   | % |   | 1.21 | % |
| Net (charge-offs) recoveries to average loans(annualized) |                   | .02    | % |   | .01 | % |

 

The allowance for loan losses totaled $4,137,000 as of March 31, 2008            and represented 1.26% of total loans, compared to $4,081,000 at year end, and            $3,871,000 as of March 31, 2007. The Company had net charge-offs for the three months            ended March 31, 2008 of $19,000 compared to $7,000 in the comparable period in 2007.            The Company’s loan review process assesses the adequacy of the allowance for loan            losses on a quarterly basis. The process includes an analysis of the risks inherent in            the loan portfolio. It includes an analysis of impaired loans and a historical review            of credit losses by loan type. Other factors considered include: concentration of            credit in specific industries; economic and industry conditions; trends in            delinquencies and loan classifications, large dollar exposures and loan growth.            Management considers the allowance adequate at March 31, 2008 based on the            Company’s criteria. However,

 

16

 

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there            can be no assurance that the allowance for loan losses will be adequate to cover            significant losses, if any, that might be incurred in the future.

 

As of March 31, 2008, non-performing loans totaled $302,000, which is            .09% of total loans compared to $163,000, or 0.05% of total loans at December 31, 2007.            The Company had $2,034,000 in restructured loans as of March 31, 2008 related to a land            development loan to a borrower. The interest rate on the loan was reduced to improve            the borrower’s cash flow. The following table sets forth information regarding            non-performing loans and foreclosed real estate at the dates indicated:

 

|                                                       |   | **March 31, 2008** |    | **December 31, 2007** |
|------------------------------------------------------------|--------|--------------------|---------|-----------------------|
| (dollars in thousands)                                     |   |               |    |                  |   |   |  |
| Loans accounted for on a non-accrual basis:                |   |               |    |                  |   |   |  |
| Commercial and all other                                   |   | $                  | — |                  | $ | — |   |
| Real Estate                                                |   |               | 192     |                  |   | 109 |  |
| Consumer                                                   |   |               | 14      |                  |   | 2 |  |
| Total                                                      |   |               | 206     |                  |   | 111 |  |
|                                                       |   |               |    |                  |   |   |  |
| Accruing loans which are contractually                     |   |               |    |                  |   |   |  |
| past due 90 days or more                                   |   |               | 96      |                  |   | 52 |  |
| Total non-performing loans                                 |   |               | 302     |                  |   | 163 |  |
| Foreclosed real estate                                     |   |               | — |                  |   | — |  |
| Total non-performing assets                                |   | $                  | 302     |                  | $ | 163 |  |
| Restructured Loans on Accrual Status                       |   | $                  | 2,034   |                  | $ | — |  |
| Allowance for loans lossesCoverage of non-performing loans |   | $                  | 4,137   |                  | $ | 4,084 |  |
| Non-performing loans to total loans                        |   |               | .09     | %                     |   | .05 | % |
| Non-performing assets to total assets                      |   |               | .06     | %                     |   | .03 | % |

 

**Deposits** 

 

Total deposits as of March 31, 2008 were $371.2 million increasing            slightly from $370.0 million as of December 31, 2007.

 

The following table sets forth deposit balances as of the dates            indicated:

 

|                          |   | **March 31, 2008** |    | **December 31, 2007** |
|-------------------------------|--------|--------------------|---------|-----------------------|
| (dollars in thousands)        |   |               |    |                  |   |   |
| Non-interest bearing demand   |   | $                  | 55,618  |                  | $ | 60,061 |
| Interest bearing demand       |   |               | 36,244  |                  |   | 32,426 |
| Money Market Deposit Accounts |   |               | 66,418  |                  |   | 57,970 |
| Savings                       |   |               | 43,197  |                  |   | 42,962 |
| Time deposits <$100,000    |   |               | 115,463 |                  |   | 114,318 |
| Time deposits >$100,000    |   |               | 54,213  |                  |   | 62,263 |
|                          |   |               |    |                  |   |   |
| Total                         |   | $                  | 371,153 |                  | $ | 370,000 |
|                          |   |               |    |                  |   |   |

 

 

17

 

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**Borrowings**

 

Short-term borrowings as of March 31, 2008 totaled $28.0 million            compared to $26.7 million as of December 31, 2007. Short-term borrowings consist of the            following:

 

|                                                                      |   | **March 31, 2008** |   | **December 31, 2007** |   |
|---------------------------------------------------------------------------|--------|--------------------|--------|-----------------------|--------|
| (dollars in thousands)                                                    |   |               |   |                  |   |   |   |
| Securities sold under agreements to                            repurchase |   | $                  | 21,223 |                  | $      | 24,885 |   |
| Federal Funds Purchased                                                   |   |               | 6,660  |                  |   | 800 |   |
| U.S. Treasury demand notes                                                |   |               | 123    |                  |   | 1,001 |   |
|                                                                      |   | $                  | 28,006 |                  | $      | 26,286 |   |

 

|   | Long-term debt consisted of the following: |
|--------|--------------------------------------------|

 

| (dollars in thousands)                     |   |               |   |                  |   |
|--------------------------------------------|--------|--------------------|--------|-----------------------|--------|
|                                       |   | **March 31, 2008** |   | **December 31, 2007** |   |
| Notes with the FHLB:                       |   |               |   |                  |   |   |   |
| Fixed rate note due April 2008 at 4.17%    |   | $                  | 5,000  |                  | $      | 5,000 |   |
| Convertible note due April 2011 at 5.24%   |   |               | 3,000  |                  |   | 3,000 |   |
| Convertible note due January 2012 at 4.37% |   |               | 5,000  |                  |   | 5,000 |   |
| Convertible note due January 2017 at 4.71% |   |               | 10,000 |                  |   | 10,000 |   |
|                                       |   | $                  | 23,000 |                  | $      | 23,000 |   |

 

The convertible notes contain an option which allows the FHLB, at            quarterly intervals to change the note to an adjustable-rate advance at three month            LIBOR plus 11 to 17 basis points. If the notes are converted, the option allows the            Bank to put the funds back to the FHLB at no            charge.               

 

**Off-Balance Sheet Arrangements**

 

The Bank is 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 sheet.

 

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.

 

18

 

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A summary of the contractual amount of the Company’s financial            instrument commitments is as follows:

 

             

 

|                                       |   | **March 31, 2008** |   | **December 31, 2007** |   |
|--------------------------------------------|--------|--------------------|--------|-----------------------|--------|
|                                       |   | (In Thousands)     |   |
|                                       |   |               |   |                  |   |   |   |
| Commitments to grant loans                 |   | $                  | 10,311 |                  | $      | 10,835 |   |
| Unfunded commitments under lines of credit |   |               | 32,920 |                  |   | 34,146 |   |
| Standby letters of credit                  |   |               | 2,214  |                  |   | 2,348 |   |
|                                       |   |               |   |                  |   |   |   |
|                                       |   | $                  | 45,445 |                  | $      | 47,329 |   |

 

**Stockholders’ Equity and Capital Ratios**

 

As of March 31, 2008, stockholders’ equity totaled $56.6 million,            compared to $55.8 million as of December 31, 2007. The net change in            stockholders’ equity included $1,779,000 in net income, that was partially offset            by $686,000 of dividends declared. In addition, accumulated other comprehensive income            increased $666,000 due to an increase in fair value of securities in the available for            sale portfolio, net of tax. This increase in fair value is the result of a change in            interest rates, which may impact the value of the securities. Because of interest rate            volatility, the Company’s accumulated other comprehensive income could materially            fluctuate for each interim and year-end period.

 

A comparison of the Company’s regulatory capital ratios is as            follows:

 

 

|                      |   | **March 31, 2008** |   | **December 31, 2007** |   |
|---------------------------|--------|--------------------|--------|-----------------------|--------|
| Tier 1 Capital            |   |               |   |                  |   |
| (To average assets)       |   | 11.48%             |   | 11.38%                |   |
| Tier 1 Capital            |   |               |   |                  |   |
| (To risk-weighted assets) |   | 16.13%             |   | 16.26%                |   |
| Total Capital             |   |               |   |                  |   |
| (To risk-weighted assets) |   | 17.46%             |   | 17.60%                |   |

 

The minimum capital requirements imposed by the FDIC on the Bank for            leverage, Tier 1 and Total Capital are 4%, 4% and 8%, respectively. The Company has            similar capital requirements imposed by the Board of Governors of the Federal Reserve            System (FRB). The Bank is also subject to more stringent Pennsylvania Department of            Banking (PDB) guidelines. The Bank’s capital ratios do not differ significantly            from the Company’s ratios. Although not adopted in regulation form, the PDB            utilizes capital standards requiring a minimum of 6.5% leverage capital and 10% total            capital. The Company and the Bank were in compliance with FRB, FDIC and PDB capital            requirements as of March 31, 2008 and December 31, 2007.

 

**Liquidity**

 

As of March 31, 2008, the Company had cash and cash equivalents of $8.3            million in the form of cash, due from banks, and short-term deposits with other            institutions. In addition, the Company had total securities available for sale of            $130.6 million which could be used for liquidity needs. This totals $138.9 million and            represents 28.7% of total assets compared to

 

19

 

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$133.1            million and 27.7% of total assets as of December 31, 2007. The Company also monitors            other liquidity measures, all of which were within the Company’s policy            guidelines as of March 31, 2008 and December 31, 2007. Based upon these measures, the            Company believes its liquidity is adequate.

 

**Capital Resources**

 

The            Company has a line of credit commitment available from the Federal Home Loan Bank            (FHLB) of Pittsburgh for borrowings of up to $20,000,000 which expires in December            2011. There were no borrowings under this line at March 31, 2008 and December 31,            2007.

 

The Company has a line of credit commitment from Atlantic Central            Bankers Bank for $7,000,000 which expires in May 2008 and Wachovia Bank for $2,000,000            which has no stated expiration date. There were no borrowings under these lines as of            March 31, 2008 and December 31, 2007. The Company has a line of credit commitment            available which has no stated expiration date from PNC for $12,000,000. Borrowings            under this line were $6,660,000 as of March 31, 2008 and $800,000 as of December 31,            2007.

 

The Bank’s maximum borrowing capacity with the Federal Home Loan            Bank was approximately $222,250,000 of which $23,000,000 was outstanding at March 31,            2008 and at December 31, 2007. Advances from the Federal Home Loan Bank are secured by            qualifying assets of the Bank.

 

**Non-GAAP Financial Measures**

 

This report contains or references fully taxable-equivalent (fte)            interest income and net interest income, which are non-GAAP financial measures.            Interest income (fte) and net interest income (fte) are derived from GAAP interest            income and net interest income using an assumed tax rate of 34%. We believe the            presentation of interest income (fte) and net interest income (fte) ensures            comparability of interest income and net interest income arising from both taxable and            tax-exempt sources and is consistent with industry practice. Net interest income (fte)            is reconciled to GAAP net interest income on page 21. 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.

 

20

 

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**Results of Operations**

NORWOOD            FINANCIAL CORP.

Consolidated Average Balance Sheets with Resultant Interest and            Rates

(Tax            Equivalent Basis, dollars in thousands)

 

|                                                                        |   | **Three Months Ended March 31,** |    |
|-----------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                        |   | **2008**                         |    | **2007** |   |
|                                                                        |   | **Average Balance****(2)**       |    | **Interest****(1)** |   | **Average****Rate****(3)** |   | **Average****Balance****(2)** |   | **Interest****(1)** |   | **Average****Rate****(3)** |   |
| Assets                                                                      |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                                    |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                                                          |   | $                                | 2,403   |   | $ | 18 |   | 3.00 | % | $ | 1,445 |   | $ | 19 |   | 5.26 | % |
| Interest bearing deposits with banks                                        |   |                             | 82      |   |   | 1 |   | 4.88 |   |   | 152 |   |   | 2 |   | 5.26 |   |
| Securities held-to-maturity                                                 |   |                             | 706     |   |   | 15 |   | 8.50 |   |   | 954 |   |   | 22 |   | 9.22 |   |
| Securities available for sale:                                              |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                     |   |                             | 105,489 |   |   | 1,277 |   | 4.84 |   |   | 97,831 |   |   | 1,045 |   | 4.27 |   |
| Tax-exempt                                                                  |   |                             | 22,087  |   |   | 306 |   | 5.54 |   |   | 17,756 |   |   | 241 |   | 5.43 |   |
| Total securities available for sale (1)                                     |   |                             | 127,576 |   |   | 1,583 |   | 4.96 |   |   | 115,587 |   |   | 1,286 |   | 4.45 |   |
| Loans receivable (4) (5)                                                    |   |                             | 328,347 |   |   | 5,689 |   | 6.93 |   |   | 319,934 |   |   | 5,879 |   | 7.35 |   |
| Total interest earning assets                                               |   |                             | 459,114 |   |   | 7,306 |   | 6.37 |   |   | 438,072 |   |   | 7,208 |   | 6.58 |   |
| Non-interest earning assets:                                                |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                                     |   |                             | 7,103   |   |   |   |   |   |   |   | 8,137 |   |   |   |   |   |   |
| Allowance for loan losses                                                   |   |                             | (4,121  | ) |   |   |   |   |   |   | (3,856 | ) |   |   |   |   |   |
| Other assets                                                                |   |                             | 16,861  |   |   |   |   |   |   |   | 17,017 |   |   |   |   |   |   |
| Total non-interest earning assets                                           |   |                             | 19,843  |   |   |   |   |   |   |   | 21,298 |   |   |   |   |   |   |
| Total Assets                                                                |   | $                                | 478,957 |   |   |   |   |   |   | $ | 459,370 |   |   |   |   |   |   |
| Liabilities and Stockholders’ Equity                                  |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                               |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing demand and money market                                    |   | $                                | 95,512  |   |   | 432 |   | 1.81 |   | $ | 85,691 |   |   | 430 |   | 2.01 |   |
| Savings                                                                     |   |                             | 42,555  |   |   | 49 |   | 0.46 |   |   | 44,660 |   |   | 51 |   | 0.46 |   |
| Time                                                                        |   |                             | 175,250 |   |   | 1,890 |   | 4.31 |   |   | 175,612 |   |   | 2,005 |   | 4.57 |   |
| Total interest bearing deposits                                             |   |                             | 313,317 |   |   | 2,371 |   | 3.03 |   |   | 305,963 |   |   | 2,486 |   | 3.25 |   |
| Short-term borrowings                                                       |   |                             | 25,776  |   |   | 187 |   | 2.90 |   |   | 22,578 |   |   | 256 |   | 4.54 |   |
| Other borrowings                                                            |   |                             | 23,000  |   |   | 267 |   | 4.64 |   |   | 20,222 |   |   | 246 |   | 4.87 |   |
| Total interest bearing liabilities                                          |   |                             | 362,093 |   |   | 2,825 |   | 3.12 |   |   | 348,763 |   |   | 2,988 |   | 3.43 |   |
| Non-interest bearing liabilities:                                           |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                             |   |                             | 55,679  |   |   |   |   |   |   |   | 53,378 |   |   |   |   |   |   |
| Other liabilities                                                           |   |                             | 4,911   |   |   |   |   |   |   |   | 4,531 |   |   |   |   |   |   |
| Total non-interest bearing liabilities                                      |   |                             | 60,590  |   |   |   |   |   |   |   | 57,909 |   |   |   |   |   |   |
| Stockholders’ equity                                                  |   |                             | 56,274  |   |   |   |   |   |   |   | 52,698 |   |   |   |   |   |   |
| Total Liabilities and Stockholders’                            Equity |   | $                                | 478,957 |   |   |   |   |   |   | $ | 459,370 |   |   |   |   |   |   |
|                                                                        |   |                             |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income (tax equivalent basis)                                  |   |                             |    |   |   | 4,481 |   | 3.25 | % |   |   |   |   | 4,220 |   | 3.15 | % |
| Tax-equivalent basis adjustment                                             |   |                             |    |   |   | (157 | ) |   |   |   |   |   |   | (129 | ) |   |   |
| Net interest income                                                         |   |                             |    |   | $ | 4,324 |   |   |   |   |   |   | $ | 4,091 |   |   |   |
| Net interest margin (tax equivalent basis)                                  |   |                             |    |   |   |   |   | 3.90 | % |   |   |   |   |   |   | 3.85 | % |

 

| (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) | Annualized                                                                                                |
|-----|-----------------------------------------------------------------------------------------------------------|
| (4) | Loan balances include non-accrual loans and are net of                            unearned income.        |
| (5) | Loan yields include the effect of amortization of                            deferred fees, net of costs. |

 

21

 

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**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)****Three Months Ended March 31, 2008 Compared                            to****Three Months Ended March 31, 2007****Variance due to** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                        |   | **Volume** |   | **Rate** |   | **Net** |   |
|                                                                                                                                                        |   | **(dollars in thousands)** |   |
| Interest earning assets:                                                                                                                                    |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                                                                                                                                          |   | $ | 39 |   | $ | (40 | ) | $ | (1 | ) |
| Interest bearing deposits with banks                                                                                                                        |   |   | (1 ) |   |   | -- |   |   | (1 | ) |
| Securities held to maturity                                                                                                                                 |   |   | (5) |   |   | (2 | ) |   | (7 | ) |
| Securities available for sale:                                                                                                                              |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                                                                                     |   |   | 86 |   |   | 146 |   |   | 232 |   |
| Tax-exempt securities                                                                                                                                       |   |   | 60 |   |   | 5 |   |   | 65 |   |
| Total securities                                                                                                                                            |   |   | 146 |   |   | 151 |   |   | 297 |   |
| Loans receivable                                                                                                                                            |   |   | 787 |   |   | (977 | ) |   | (190 | ) |
| Total interest earning assets                                                                                                                               |   |   | 966 |   |   | (868 | ) |   | 98 |   |
|                                                                                                                                                        |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                                                                                                               |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing demand and money market                                                                                                                    |   |   | 188 |   |   | (181 | ) |   | 2 |   |
| Savings                                                                                                                                                     |   |   | (5 | ) |   | 3 |   |   | (2 | ) |
| Time                                                                                                                                                        |   |   | (4 | ) |   | (111 | ) |   | (115 | ) |
| Total interest bearing deposits                                                                                                                             |   |   | 174 |   |   | (289 | ) |   | (115 | ) |
| Short-term borrowings                                                                                                                                       |   |   | 189 |   |   | (258 | ) |   | (69 | ) |
| Other borrowings                                                                                                                                            |   |   | 83 |   |   | (62) |   |   | 21 |   |
| Total interest bearing liabilities                                                                                                                          |   |   | 446 |   |   | (609 | ) |   | (163 | ) |
| Net interest income (tax-equivalent basis)                                                                                                                  |   | $ | 520 |   | $ | (259 | ) | $ | 261 |   |
|                                                                                                                                                        |   |   |   |   |   |   |   |   |   |   |

 

1)            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.

 

 

22

 

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**Comparison of Operating Results for The Three Months Ended March            31, 2008 to March 31, 2007**

 

**General**

 

For the three months ended March 31, 2008, net income totaled            $1,779,000, an increase of $316,000, or 21.6%, over $1,463,000 earned in the similar            period of 2007. Earnings per share for the current period were $.65 basic and $.64 on a            fully diluted basis, compared to $.52 basic and $.51 on a fully diluted basis for the            three months ended March 31, 2007. The resulting annualized return on average assets            and annualized return on average equity for the three months ended March 31, 2008, was            1.49% and 12.71%, respectively, compared to 1.29% and 11.26%, respectively, for the            similar period in 2007.

 

The following table sets forth changes in net income:

 

| (dollars in thousands)                       |   | **Three Months Ended**                  |   |
|----------------------------------------------|--------|-----------------------------------------|--------|
|                                         |   | **March 31, 2008 to****March 31, 2007** |   |
|                                         |   |                                    |   |   |
| Net income three months ended March 31, 2007 |   | $                                       | 1,463  |   |
| Change due to:                               |   |                                    |   |   |
| Net interest income                          |   |                                    | 233    |   |
| Provision for loan losses                    |   |                                    | (25    | ) |
| Gain on sales of loans                       |   |                                    | 381    |   |
| Other income                                 |   |                                    | (13    | ) |
| Salaries and employee benefits               |   |                                    | (49    | ) |
| All other expenses                           |   |                                    | (51    | ) |
| Income tax effect                            |   |                                    | (160   | ) |
|                                         |   |                                    |   |   |
| Net income three months ended March 31, 2008 |   | $                                       | 1,779  |   |

 

**Net Interest Income**

 

Net interest income on a fully taxable equivalent basis (fte) for the            three months ended March 31, 2008, totaled $4,481,000, an increase of $261,000 or 6.2%            over the similar period in 2007. The fte net interest spread and net interest margin            were 3.25% and 3.90%, respectively, for the three months ended March 31, 2008 compared            to 3.15% and 3.85%, respectively for the similar period in 2007.

 

Interest income (fte) totaled $7,306,000 with a yield on average earning            assets of 6.37% compared to $7,208,000 and 6.58% for the 2007 period. The decrease in            yield was due to the lower prime interest rate which was 5.25% as of March 31, 2008            compared to 8.25% as of March 31, 2007. The Company has $67 million of floating rate            loans tied to prime rate. As a result, the fte yield on loans declined to 6.93% in the            current period from 7.35% for the same period in the prior year. The yield on the            securities available for sale portfolio increased to 4.96% for the three months ended            March 31, 2008 from 4.45% for the three months ended March 31, 2007. The increase in            yield was the result of lower yielding securities originally purchased in the lower            interest rate environment of 2003 and 2004, maturing with the proceeds invested in            securities with higher yields. In addition, an increase of $21 million in average            earning assets partially offset the lower loan yields.

 

23

 

----

Interest expense for the three months ended March 31, 2008 totaled            $2,825,000 at an average cost of 3.12% compared to $2,988,000 and 3.43% for the similar            period in 2007. As a result of the decrease in short-term interest rates, the Company            reduced rates paid on its money market and cash management accounts included in            short-term borrowings. Also, the cost of time deposits declined to 4.31% in the current            period from 4.57% for the similar period in the prior year. As time deposits matured,            they repriced at the current lower rates resulting in the decrease.

 

**Other Income**

 

Other income totaled $1,262,000 for the three months ended March 31,            2008 compared to $894,000 for the similar period in 2007. The increase is due to the            gain of $388,000 on the sale of $13.9 million in 30 year fixed rate residential            mortgages to FNMA in the current period compared to $7,000 in similar gains for the            three months ended March 31, 2007.

 

**Other Expense**

 

Other expense for the three months ended March 31, 2008 totaled            $2,961,000, an increase of $100,000 or 3.5% over $2,861,000 for the similar period in            the prior year. Salaries and employee benefit expenses increased $49,000 or 3.3%. Data            processing related expenses increased $14,000 or 8.1% principally due to costs            associated with the Bank’s remote deposit capture product and branch image            capture. The efficiency ratio, other expense as a percentage of net interest income            (fte) plus other income, was 51.6% for the three months ended March 31, 2008, improving            from 55.9% for the similar period in            2007.        

 

**Income Tax Expense**

 

Income tax expense totaled $771,000 for an effective tax rate of 30.2%            for the period ending March 31, 2008 compared to $611,000 for an effective tax rate of            29.5% for the similar period in 2007.

 

**Item            3. Quantitative and Qualitative Disclosures about Market Risk**

 

**Market Risk**

 

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

 

Net interest income, which is the primary source of the Company’s            earnings, is impacted by changes in interest rates and the relationship of different            interest rates. To manage the impact of the rate changes, the balance sheet must be            structured so that repricing opportunities exist for both assets and liabilities at            approximately the same time intervals. The Company uses net interest simulation to            assist in interest rate risk management. The process includes simulating various            interest rate environments and their impact on net interest income. As of March 31,            2008, the level of net interest income at risk in a 200 basis points change in interest            rates was within the Company’s policy limits. The Company’s policy allows            for a decline of no more than 8% of net interest income.

 

24

 

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

 

As of March 31, 2008, the Bank had a positive 90 day interest            sensitivity gap of $17.0 million or 3.5% of total assets, increasing from $6.0 million            or 1.3% of total assets as of December 31, 2007. The change was principally due to a            lower level of time deposits maturing in the 90 day time frame as of March 31, 2008. A            positive gap means that rate-sensitive assets are greater than rate-sensitive            liabilities at the time interval. This would indicate that in a declining rate            environment, the yield on interest-earning assets could decrease faster than the cost            of interest-bearing liabilities in the 90 day time frame. The repricing intervals are            managed by ALCO strategies, including adjusting the average life of the investment            portfolio, pricing of deposit liabilities to attract longer term time deposits, loan            pricing to encourage variable rate products and evaluation of loan sales of long-term            fixed rate mortgages.

 

March 31, 2008

Rate            Sensitivity Table

(dollars in thousands)

 

|                                                                        |   | **3****Months** |    | **3-12****Months** |   | **1 to 3****Years** |   | **3 Years** |    |   | **Total** |    |
|-----------------------------------------------------------------------------|--------|-----------------|---------|--------------------|--------|---------------------|--------|-------------|---------|--------|-----------|---------|
| Federal funds sold and interest bearing                            deposits |   | $               | 33      |               | $      | —             |   | $           | — |   | $         | — |   | $ | 33 |   |
| Securities                                                                  |   |            | 19,332  |               |   | 34,571              |   |        | 40,735  |   |      | 36,701  |   |   | 131,339 |   |
| Loans Receivable                                                            |   |            | 89,626  |               |   | 49,494              |   |        | 82,579  |   |      | 107,678 |   |   | 329,377 |   |
| Total RSA                                                                   |   |            | 108,991 |               |   | 84,065              |   |        | 123,314 |   |      | 144,379 |   |   | 460,749 |   |
|                                                                        |   |            |    |               |   |                |   |        |    |   |      |    |   |   |   |   |
| Non-maturity interest-bearing deposits                                      |   |            | 23,143  |               |   | 25,881              |   |        | 68,345  |   |      | 28,490  |   |   | 145,859 |   |
| Time Deposits                                                               |   |            | 49,560  |               |   | 82,464              |   |        | 24,219  |   |      | 13,433  |   |   | 169,676 |   |
| Other                                                                       |   |            | 19,322  |               |   | 7,494               |   |        | 24,190  |   |      | — |   |   | 51,006 |   |
| Total RSL                                                                   |   |            | 92,025  |               |   | 115,839             |   |        | 116,754 |   |      | 41,923  |   |   | 366,541 |   |
|                                                                        |   |            |    |               |   |                |   |        |    |   |      |    |   |   |   |   |
| Interest Sensitivity Gap                                                    |   | $               | 16,966  |               |   | ($31,774            | )      | $           | 6,560   |   | $         | 102,456 |   | $ | 94,208 |   |
| Cumulative Gap                                                              |   |            | 16,966  |               |   | (14,808             | )      |        | (8,248  | )      |      | 94,208  |   |   |   |   |
| RSA/RSL-cumulative                                                          |   |            | 118.4   | %                  |   | 92.9                | %      |        | 97.5    | %      |      | 125.7   | % |   |   |   |
|                                                                        |   |            |    |               |   |                |   |        |    |   |      |    |   |   |   |   |
| December 31, 2007                                                           |   |            |    |               |   |                |   |        |    |   |      |    |   |   |   |   |
|                                                                        |   |            |    |               |   |                |   |        |    |   |      |    |   |   |   |   |
| Interest Sensitivity Gap                                                    |   | $               | 5,996   |               |   | ($33,969            | )      | $           | 17,012  |   | $         | 107,374 |   | $ | 96,413 |   |
| Cumulative Gap                                                              |   |            | 5,996   |               |   | (27,973             | )      |        | (10,961 | )      |      | 96,413  |   |   |   |   |
| RSA/RSL-cumulative                                                          |   |            | 105.7   | %                  |   | 86.9                | %      |        | 96.6    | %      |      | 126.8   | % |   |   |   |

 

**Item            4. 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 the            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.

 

25

 

----

 

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.

 

**Part            II. OTHER INFORMATION**

 

**Item            1. Legal Proceedings**

 

Not            applicable

 

**Item            1A. Risk Factors**

 

No            material changes from those disclosed in the Form 10-K for the year ended December 31,            2007.

 

**Item            2. Unregistered Sales of Equity Sales and Use of Proceeds**

 

On            January 18, 2008, the Registrant issued 3,565 shares of common stock pursuant to the            exercise of options by a director under the 1999 Directors Stock Option Plan in a            transaction that was exempt from registration pursuant to section 4(2) of the            Securities Act of 1933. Such shares were sold for cash at an exercise price equal to            the fair market value of the common stock on the date that the option was            granted.

 

 

|                                 |   | **Issuer Purchases of Equity Securities**  |   |
|--------------------------------------|--------|--------------------------------------------|--------|
|                                 |   | **Total number****of shares****purchased** |   | **Average price****paid per****share** |   | **Total number of****shares purchased****as part of publicly****announced plans****or programs(1)** |   | **Maximum number****of shares (or approximate****dollar value) that may yet****be purchased****under the plans****or programs (2)** |   |
|                                 |   |                                       |   |   |   |   |   |   |   |
| January 1 – January 31, 2008   |   | --                                         |   | $ | -- |   | -- |   | -- |   |
| February 1 – February 29, 2008 |   | 20,000                                     |   |   | 31.50 |   | 20,000 |   | -- |   |
| March 1 – March 31, 2008       |   | --                                         |   |   | - |   | -- |   | 137,000 |   |
|                                 |   | 20,000                                     |   | $ | 31.50 |   | 20,000 |   | 137,000 |   |
|                                 |   |                                       |   |   |   |   |   |   |   |   |

 

(1) On            March 19, 2008, the Registrant announced that it had completed its 5% open market stock            repurchase plan announced on June 15, 2005.

 

(2) On            March 19, 2008 the Company announced its intention to repurchase up to 5% of its            outstanding common stock (approximately 137,000 shares) in the open market.

 

26

 

----

**Item            3. Defaults Upon Senior Securities**

 

Not            applicable

 

**Item            4. Submission of Matters to a Vote of Security Holders**

 

None

 

**Item            5. Other Information**

 

None

 

**Item            6. Exhibits**

 

| (a)    |   | 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.***                                     |
|   |   | 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  |   | Wayne Bank Stock Option Plan*                                                                                             |
|   |   | 10.5  |   | Salary Continuation Agreement between the Bank and                            William W. Davis, Jr.****                   |
|   |   | 10.6  |   | Salary Continuation Agreement between the Bank and Lewis                            J. Critelli****                       |
|   |   | 10.7  |   | Salary Continuation Agreement between the Bank and                            Edward C. Kasper****                        |
|   |   | 10.8  |   | 1999 Directors Stock Compensation Plan****                                                                                |
|   |   | 10.9  |   | Salary Continuation Agreement between the Bank and                            Joseph A. Kneller*****                      |
|   |   | 10.10 |   | Salary Continuation Agreement between the Bank and John                            H. Sanders*****                        |
|   |   | 10.11 |   | 2006 Stock Option Plan******                                                                                              |
|   |   | 10.12 |   | First and Second Amendments to Salary Continuation                            Agreement with William W. Davis, Jr.******* |
|   |   | 10.13 |   | First and Second Amendments to Salary Continuation                            Agreement with Lewis J. Critelli*******     |
|   |   | 10.14 |   | First and Second Amendments to Salary Continuation                            Agreement with Edward C. Kasper*******      |
|   |   | 10.15 |   | First and Second Amendments to Salary Continuation                            Agreement with Joseph A. Kneller*******     |
|   |   | 10.16 |   | First and Second Amendments to Salary Continuation                            Agreement with John H. Sanders*******       |
|   |   | 31.1  |   | Rule 13a-14(a)/15d-14(a) Certification (Chief Executive                            Officer)                               |
|   |   | 31.2  |   | Rule 13a-14(a)/15d-14(a) Certification (Chief Financial                            Officer)                               |
|   |   | 32.1  |   | Section 1350 Certification (Chief Executive                            Officer)                                           |
|   |   | 32.2  |   | Section 1350 Certification (Chief Financial                            Officer)                                           |

 

 

27

 

----

 

 

| *       | Incorporated herein by reference to the identically                            numbered exhibits of the Registrant’s Form 10 Registration                            Statement initially filed with the Commission on April 29,                            1996.

                              |
|---------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **      | Incorporated herein by reference to the identically                            numbered exhibit to the Registrant’s Annual Report on Form 10-K                            Filed with the Commission on March 14, 2008.

                                                                        |
| ***     | Incorporated herein by reference to the identically                            numbered exhibits to the Registrant’s Form 8-K filed with the                            Commission on March 6, 2006.

                                                                                          |
| ****    | Incorporated herein by reference to the identically                            numbered exhibits of the Registrant’s Form 10-K filed with the                            Commission on March 20, 2000.

                                                                                        |
| *****   | Incorporated herein by reference to the identically                            numbered exhibit to the Registrants Form 10-K filed with the Commission                            on March 22, 2004.

                                                                                                |
| ******  | Incorporated herein by reference to the                            Registrant’s Form 8-K filed with the Commission on April 25,                            2006.

                                                                                                                              |
| ******* | Incorporated herein by reference from the Exhibits to                            the Registrant’s Current Report on Form 8-K filed on April 4,                            2006.                                                                                                                      |

 

 

28

 

----

**Signatures**

 

Pursuant to the requirements 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.**                     |
|---------------------------------------------------------------------------|--------|-------------------------------------------------|
|  

                             

Date:  May 12, 2008 |   |  

                             

By: |  

                             

/s/ William W. Davis, Jr. |
|                                                                      |   |                                            | William W. Davis, Jr.

President and Chief Executive Officer

(Principal Executive Officer) |
|  

                             

Date:  May 12, 2008 |   |  

                             

By: |  

                             

/s/ Lewis J. Critelli |
|                                                                      |   |                                            | Lewis J. Critelli

Executive Vice President, Chief Operating Officer and                            Chief Financial Officer

(Principal Financial Officer) |

 

 

 

29