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, 2008 (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, potential impairment of restricted stock, accounting for stock options, the valuation of deferred tax assets and the determination of other-than-temporary impairment losses on investments in securities.

Refer to the discussion of the allowance for loan losses calculation under "Non-performing Assets and Allowance for Loan Losses" in the "Changes in Financial Condition" section.

The Company uses the modified prospective transition method. Under this method companies are required to record compensation expense, based on the fair value of options over the vesting period.

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.

Restricted stock which represents required investment in the common stock of correspondent banks is carried at cost and as of September 30, 2009 and December 31, 2008, consists of the common stock of Federal Home Loan Bank of Pittsburgh. In December 2008, the FHLB of Pittsburgh notified member banks that it was suspending dividend payments and the repurchase of excess capital stock.

Management evaluates the restricted stock for impairment. Management's determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary decline in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of

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 September 30, 2009 and December 31, 2008 represent temporary impairment of the securities, related to changes in interest rates.

Changes in Financial Condition

General

Total assets as of September 30, 2009 were $514.9 million compared to $504.3 million as of December 31, 2008, an increase of $10.6 million. The increase reflects a $14.5 million increase in deposits used to fund $10.1 million growth in loans and pay down short-term borrowings.

Securities

The fair value of securities available for sale as of September 30, 2009 was $126.3 million compared to $130.1 million as of December 31, 2008. The Company purchased $41.9 million of securities using the proceeds from $34.5 million of securities called, maturities and principal reductions. The Company sold $13.6 million in securities from the available for sale portfolio.

Loans Receivable

Loans receivable totaled $359.5 million compared to $349.4 million as of December 31, 2008. Commercial real estate loans increased $14.0 million during the period, reflecting new activity principally centered in the Monroe County, Pennsylvania market area. Residential real estate loans decreased $5.9 million principally due to pay offs of home equity loans.

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

Types of loans
(dollars in thousands)                    September 30, 2009      December 31, 2008

Real Estate-Residential                  $    127,546     35.5 % $    133,417    38.1 %
Commercial                                    173,449     48.2        159,476    45.7
Construction and land development              16,100      4.5         14,856     4.2
Commercial, financial and agricultural         27,125      7.5         25,886     7.4
Consumer loans to individuals                  15,641      4.3         16,087     4.6
Total loans                                   359,861    100.0 %      349,722   100.0 %

Deferred fees (net)                              (379 )                  (318 )
                                              359,482                 349,404
Allowance for loan losses                      (4,663 )                (4,233 )
Net loans receivable                     $    354,819            $    345,171

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

                                        Three Months               Nine Months
                                     Ended September 30,       Ended September 30,
(dollars in thousands)                2009          2008        2009          2008
Balance, beginning                 $     4,574    $  4,237   $     4,233    $  4,081
Provision for loan losses                  140         130           585         315
Charge-offs                                (58 )       (45 )        (190 )      (116 )
Recoveries                                   7           9            35          51
Net charge-offs                            (51 )       (36 )        (155 )       (65 )
Balance, ending                    $     4,663    $  4,331   $     4,663    $  4,331

Allowance to total loans                  1.30 %      1.27 %        1.30 %      1.27 %
Net charge-offs to average loans
(annualized)                               .06 %       .04 %         .06 %       .03 %

The allowance for loan losses totaled $4,663,000 as of September 30, 2009 and represented 1.30% of total loans compared to $4,233,000 at the prior year end, and $4,331,000 as of September 30, 2008. The Company had net charge-offs for the nine months of $155,000 compared to $65,000 in the comparable period in 2008. 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 September 30, 2009 based on the Company's criteria. However, 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 September 30, 2009, non-performing loans totaled $3,177,000, which is .88% of total loans compared to $2,087,000, or 0.60% of total loans at December 31, 2008. The increase was principally related to one home equity loan in which the Company is in first lien position and two loans to a land developer. The recorded investment for impaired loans requiring a specific allowance for loan losses was $1,235,000 of which $50,000 was specifically reserved due to a shortfall in the collateral based upon a sales agreement for the property. Impaired loans not requiring a specific allowance for loan losses totaled $3,141,000 as of September 30, 2009 and $2,976,000 as of December 31, 2008. Other real estate totals $562,000 as of September 30, 2009 compared to $660,000 as of year-end. The balance principally consists of undeveloped residential building lots in Monroe County, PA.

                                  September 30,   December 31,
                                      2009            2008
(dollars in thousands)
Loans accounted for on a
non-accrual basis:
Commercial and all other          $           -   $           -
Real Estate                               2,646           2,087
Consumer                                      -               -
Total                                     2,646           2,087

Accruing loans which are
contractually
past due 90 days or more                    531               -
Total non-performing loans                3,177           2,087
Other real estate                           562             660
Total non-performing assets       $       3,739   $       2,747

Allowance for loan losses         $       4,663   $       4,233

Coverage of non-performing
loans                                      1.47 x          2.03 x
Non-performing loans to total
loans                                       .88 %           .60 %
Non-performing assets to total
assets                                      .73 %           .54 %

Deposits

Total deposits as of September 30, 2009 were $382.9 million increasing from $359.6 million as of December 31, 2008, an increase of $23.3 million. The growth in deposits is net of the sale of $3.6 million in deposits related to a branch closure as described in Note 10. Non-interest bearing demand deposits increased $6.8 million to $63.6 million reflecting seasonal growth in certain commercial and municipal accounts. Time deposits less than $100,000 totaled $126.1 million as of September 30, 2009, an increase of $8.9 million. The increase was principally due to the results of a 13 month CD product. The growth in deposits was used to fund loan growth and pay down short-term borrowings.

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

(dollars in thousands)           September 30, 2009     December 31, 2008

Non-interest bearing demand     $             63,600   $            56,839
Interest bearing demand                       37,107                35,322
Money Market Deposit Accounts                 62,921                60,623
Savings                                       43,564                44,577
Time deposits <$100,000                      126,120               117,179
Time deposits >$100,000                       49,551                45,095

Total                           $            382,863   $           359,635

Borrowings

Short-term borrowings as of September 30, 2009 totaled $19.6 million compared to $38.1 million as of December 31, 2008. Securities sold under agreements to repurchase declined $4.0 million principally due to the seasonality of school district cash management accounts. The Company utilized short-term deposits to replace the short term FHLB advances which declined by $11 million. Short-term borrowings consist of the following:

(dollars in thousands)

                                                   September 30, 2009      December 31, 2008
Securities sold under agreements to repurchase    $             19,387    $            23,404
Federal funds purchased                                              -                  3,600
Short-term FHLB advances                                             -                 11,000
U.S. Treasury demand notes                                         166                    122
                                                  $             19,553    $            38,126

Other borrowings consisted of the following:

(dollars in thousands)                          September 30, 2009      December 31, 2008
Notes with the FHLB:
Fixed rate note due September 2010 at 3.53%    $              5,000    $             5,000
Convertible note due January 2011 at 5.24%                    3,000                  3,000
Convertible note due August 2011 at 2.69%                    10,000                 10,000
Fixed rate note due September 2011 at 4.06%                   5,000                  5,000
Convertible note due October 2012 at 4.37%                    5,000                  5,000
Convertible note due May 2013 at 3.015%                       5,000                  5,000
Convertible note due January 2017 at 4.71%                   10,000                 10,000
                                               $             43,000    $            43,000

The convertible notes contain an option that 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 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

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. Commitments to grant loans totaled $11.7 million as of September 30, 2009 compared to $19.3 million as of December 31, 2008. The decrease is related to a slow down in new commercial and residential construction financing.

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

                                                  September 30, 2009      December 31, 2008
                                                               (in thousands)
Commitments to grant loans                       $             11,686    $            19,254
Unfunded commitments under lines of credit                     35,117                 36,980
Standby letters of credit                                       2,060                  1,897

                                                 $             48,863    $            58,131

In order to increase the funds available to the Deposit Insurance Fund, the Federal Deposit Insurance Corporation has proposed that all insured depository institutions prepay their federal deposit insurance assessments through 2012. If the proposal is made final in its current form, the prepayment would be due December 31, 2009 and would be based on the institution's assessment base and assessment rate as of September 30, 2009 assuming a three basis point increase in the assessment rate and 5% annual growth in deposits during years 2011 and 2012. Based on our deposits and assessment rate at September 30, 2009, we estimate that our prepayment amount will be approximately $1,651,000. We expect that we will be able to make the prepayment from available cash on hand.

Stockholders' Equity and Capital Ratios

At September 30, 2009, total stockholders' equity totaled $63.7 million, compared to $58.7 million as of December 31, 2008. The net change in stockholders' equity included $5,261,000 in net income, that was partially offset by $2,229,000 of dividends declared. In addition, accumulated other comprehensive income increased $1,381,000 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:

                            September 30, 2009     December 31, 2008
                                         (in thousands)
Tier 1 Capital
(To average assets)                   12.05 %               11.45 %
Tier 1 Capital
(To risk-weighted assets)             16.90 %               16.22 %
Total Capital
(To risk-weighted assets)             18.20 %               17.50 %

Liquidity

As of September 30, 2009, the Company had cash and cash equivalents of $12.0 million in the form of cash, federal funds sold and due from banks, and short-term deposits with other institutions. In addition, the Company had total securities available for sale of $126.3 million which could be used for liquidity needs. This totals $138.3 million and represents 26.9% of total assets compared to $136.6 million and 27.1% of total assets as of December 31, 2008. The Company also monitors other liquidity measures, all of which were within the Company's policy guidelines as of September 30, 2009 and December 31, 2008. 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 September 30, 2009 and December 31, 2008.

The Company has a line of credit commitment from Atlantic Central Bankers Bank for $7,000,000 which expires in May 2010. There were no borrowings under these lines as of September 30, 2009 and December 31, 2008. 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 $-0- as of September 30, 2009 and $3,600,000 as of December 31, 2008. The Bank has access to the Federal Reserve Discount Window with total availability of $8,000,000 based upon qualifying collateral held by the Federal Reserve Bank. Borrowings from the discount window were $-0- as of September 30, 2009 and December 31, 2008.

The Bank's maximum borrowing capacity with the Federal Home Loan Bank was approximately $168,000,000 of which $43,000,000 was outstanding at September 30, 2009 and $54,000,000 at December 31, 2008. 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 26 and page 30. 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.

Results of Operations

NORWOOD FINANCIAL CORP.

Consolidated Average Balance Sheets with Resultant Interest and Rates



(Tax-Equivalent Basis, dollars in
           thousands)                                Three Months Ended September 30,
                                                  2009                               2008
                                     Average                 Average    Average                 Average
                                     Balance     Interest     Rate      Balance     Interest     Rate
                                       (2)         (1)         (3)        (2)         (1)         (3)
Assets
Interest-earning assets:
Federal funds sold                  $   1,052   $        1      0.38 % $     180   $        1      2.22 %
Interest bearing deposits with
banks                                     185            -         -          65            -         -
Securities held-to-maturity(1)            708           15      8.47         706           16      9.07
Securities available for sale:
Taxable                                97,696          990      4.05     110,684        1,333      4.82
Tax-exempt (1)                         30,775          450      5.85      21,550          312      5.79
Total securities available for
sale (1)                              128,471        1,440      4.48     132,234        1,645      4.98
Loans receivable (4) (5) (1)          358,644        5,431      6.06     335,859        5,553      6.61
Total interest earning assets         489,060        6,887      5.63     469,044        7,215      6.15
Non-interest earning assets:
Cash and due from banks                 7,664                              8,358
Allowance for loan losses              (4,626 )                           (4,282 )
Other assets                           17,352                             18,962
Total non-interest earning assets      20,390                             23,038
Total Assets                        $ 509,450                          $ 492,082
Liabilities and Stockholders'
Equity
Interest bearing liabilities:
Interest bearing demand and money
market                              $  99,990          188      0.75   $ 107,663          355      1.32
Savings                                44,709           42      0.38      46,196           54      0.47
Time                                  172,787        1,203      2.78     149,204        1,371      3.68
Total interest bearing deposits       317,486        1,433      1.81     303,063        1,780      2.35
Short-term borrowings                  19,437           60      1.23      36,803          200      2.17
Other borrowings                       43,000          421      3.92      27,783          303      4.36
Total interest bearing
liabilities                           379,923        1,914      2.02     367,649        2,283      2.48
Non-interest bearing liabilities:
Demand deposits                        61,551                             62,667
Other liabilities                       5,382                              5,107
Total non-interest bearing
liabilities                            66,933                             67,774
Stockholders' equity                   62,594                             56,659
Total Liabilities and
Stockholders' Equity                $ 509,450                          $ 492,082

Net interest income (tax
equivalent basis)                                    4,973      3.62 %                  4,932      3.67 %
Tax-equivalent basis adjustment                       (207 )                             (156 )
Net interest income(GAAP basis)                 $    4,766                         $    4,776
Net interest margin (tax
equivalent basis)                                               4.07 %                             4.21 %

(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.

                              Increase/(Decrease)

               Three Months Ended September 30, 2009 Compared to

                     Three Months Ended September 30, 2008

                                Variance due to





                                              Volume       Rate      Net
                                                (dollars in thousands)
Interest earning assets:
Federal funds sold                           $       6   $     (6 ) $    -
Securities held to maturity                          -         (1 )     (1 )
. . .