NORWOOD FINANCIAL CORP quarterly report, Q3 FY2019

Norwood Financial Corp. — Q3 2019 Form 10-Q

Business context and reporting period. Unaudited results cover the quarter and nine months ended September 30, 2019; balance-sheet comparisons are with December 31, 2018. Norwood is a Pennsylvania bank holding company operating through Wayne Bank, with lending primarily in northeastern Pennsylvania and nearby New York counties. Dollar amounts below are in millions unless stated otherwise.

Financial performance and position

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Net interest income	$9.891	$9.388	$28.773	$27.410
Provision for loan losses	$0.300	$0.375	$1.050	$1.350
Net income	$3.907	$3.710	$10.619	$10.352
Diluted EPS	$0.62	$0.58	$1.68	$1.64
Net interest margin, tax-equivalent	3.60%	3.57%	3.51%	3.52%
Efficiency ratio	56.5%	56.5%	58.4%	56.9%

Q3 net income increased about 5%; nine-month net income increased about 3%. Management attributed the improvement primarily to higher net interest income.
Q3 annualized return on average assets/equity was 1.27%/11.56%, versus 1.28%/12.55% a year earlier. Nine-month returns were 1.17%/10.97%, versus 1.21%/11.94%.
At September 30, total assets were $1,215.9, loans $905.6, deposits $974.4, and stockholders’ equity $134.9. Loans increased $55.4 from year-end, while deposits rose $27.7.
Cash and cash equivalents were $20.9; available-for-sale securities were $211.2, down from $243.3 at year-end. Management cited securities sales, calls, maturities and principal reductions, with portfolio runoff helping fund loan growth.
Nine-month cash flows: operating activities provided $14.7; investing activities used $18.6; financing activities provided $6.5. Cash increased $2.6 to $20.9.
Short-term borrowings were $52.8 and other borrowings $35.9, together $88.7 versus $105.3 at year-end. Available liquidity, defined by the company as cash and securities, was $232.1, or 19.1% of assets, versus $261.6, or 22.1%, at year-end. Management said liquidity was adequate.
Regulatory capital ratios at September 30 included Tier 1 capital to average assets of 10.07%, Common Equity Tier 1 to risk-weighted assets of 13.01%, and total capital to risk-weighted assets of 13.91%. The company reported compliance with applicable capital requirements, including the capital conservation buffer.

Material changes versus comparable periods

Loan growth supported interest income: average loans rose $84.8 in Q3 and $87.6 for the nine-month comparison. Average securities declined as runoff was used to fund loans.
Funding costs increased. Q3 interest expense rose to $2.168 from $1.398; nine-month expense rose to $6.526 from $3.841. Average cost of interest-bearing liabilities increased to 1.02% from 0.69% in Q3 and to 1.02% from 0.63% year to date. Higher time-deposit rates were a key factor. The nine-month net interest margin edged down to 3.51% from 3.52%.
Other income declined to $1.882 in Q3 and $5.083 year to date. Comparisons were affected by a litigation settlement included in 2018 other income; the filing attributes $0.283 of the Q3 decrease and $0.358 of the nine-month decrease to that prior-period item. Lower bank-owned life insurance income also contributed year to date.
Other expenses rose 3% in Q3 and 5% year to date, mainly from salaries and employee benefits and data processing costs. The nine-month efficiency ratio worsened from 56.9% to 58.4%.
The allowance for loan losses was $8.405, or 0.93% of loans, versus $8.452, or 0.99%, at year-end. Nine-month net charge-offs were $1.097 versus $0.704, including two commercial credits written down by $0.786 in aggregate. Nonperforming loans increased to $1.391 from $1.140; nonperforming assets rose to $2.963 from $2.255.
Unrealized securities losses improved substantially: accumulated other comprehensive income was positive $1.143 at September 30, versus a loss of $5.020 at year-end, largely reflecting interest-rate and spread movements. Management considered remaining unrealized losses temporary and recorded no other-than-temporary impairment in 2019.

Outlook, risks and unusual items

The filing provides no specific earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year or future results.
Management identified credit losses beyond the allowance, commercial lending and real-estate collateral risks, regional economic conditions, interest-rate and liquidity risk, deposit competition, capital availability, regulatory requirements, cybersecurity and other factors as risks. It reported no material changes to the risk factors in the 2018 Form 10-K.
Commercial rentals and hospitality/lodging were the largest cited industry concentrations, at $80.7 (8.9% of loans) and $65.0 (7.2%), respectively. Management reported no charge-offs in these named concentrations during 2019.
Off-balance-sheet commitments to grant loans, unfunded credit lines and standby letters of credit totaled $119.3. The filing notes that commitments may expire undrawn; standby-letter-of-credit liability was not material.
Foreclosed real estate was $1.572, up from $1.115 at year-end. The company recorded a $0.451 charge-off on a previously restructured commercial real-estate loan before transferring it to foreclosed real estate. Three residential properties with aggregate carrying value of $0.300 were in formal foreclosure proceedings.
The company adopted lease accounting on January 1, 2019, recording right-of-use assets and related lease liabilities of $5.3 each. It expected a future cumulative-effect adjustment when adopting the credit-loss standard, but could not yet estimate its size. Following an October 2019 FASB vote, the filing anticipated deferral for smaller reporting companies to fiscal years beginning after December 15, 2022; final guidance was pending at filing date.
Interest-rate simulations were within company policy limits for a plus or minus 200-basis-point shift. The company’s stated policy permits no more than a 10% decline in net interest income under such a shift. The filing also reported a positive 90-day interest-sensitivity gap of $16.1.

Key facts for investors to verify

Whether loan growth can continue to offset higher deposit and borrowing costs, and how the net interest margin responds to rate changes.
Credit trends, especially commercial real-estate charge-offs, criticized loans, foreclosed assets and allowance adequacy as loan balances grow.
Deposit mix and seasonality: the filing attributed much of the deposit increase to seasonal municipal demand deposits; assess funding stability and liquidity against the lower liquidity-to-assets ratio.
How securities portfolio values and accumulated other comprehensive income respond to interest-rate movements, and whether securities need to be sold before recovery.
The eventual impact and adoption timing of the expected credit-loss accounting standard, and any resulting allowance or retained-earnings adjustment.
Whether increased operating expenses and the weaker year-to-date efficiency ratio persist; also distinguish recurring income from prior-year litigation-settlement comparisons.