Overview

Our principal business consists of attracting deposits and making loans secured by various types of collateral, including real estate and other assets in the markets in which we operate. Attracting and maintaining deposits is affected by a number of factors, including interest rates paid on competing investments offered by other financial and non-financial institutions, account maturities, fee structures, and levels of personal income and savings. Lending activities are affected by the demand for funds and thus are influenced by interest rates, the number and quality of lenders and regional economic conditions. Sources of funds for lending activities include deposits, borrowings, repayments on loans, cash flows from investment securities and income provided from operations.

Our earnings depend primarily on our level of net interest income, which is the difference between interest earned on our interest-earning assets, consisting primarily of loans and investment securities, and the interest paid on interest-bearing liabilities, consisting primarily of deposits, borrowed funds, and trust-preferred securities. Net interest income is a function of our interest rate spread, which is the difference between the average yield earned on our interest-earning assets and the average rate paid on our interest-bearing liabilities, as well as a function of the average balance of interest-earning assets compared to the average balance of interest-bearing liabilities. Also contributing to our earnings is noninterest income, which consists primarily of service charges and fees on loan and deposit products and services, fees related to insurance and investment management and trust services, and net gains and losses on the sale of assets. Net interest income and noninterest income are offset by provisions for loan losses, general administrative and other expenses, including employee compensation and benefits and occupancy and equipment costs, as well as by state and federal income tax expense.

Our net income was $63.6 million, or $0.68 per diluted share, for the year ended December 31, 2012 compared to $64.2 million, or $0.64 per diluted share, for the year ended December 31, 2011 and $57.5 million, or $0.53 per diluted share, for the year ended December 31, 2010. The loan loss provision was $26.3 million for the year ended December 31, 2012 compared to $34.2 million for the year ended December 31, 2011 and $40.5 million for the year ended December 31, 2010. We recorded other-than-temporary impairment losses on securities, which were reflected as a reduction of noninterest income, of $331,000, $937,000 and $1.5 million for the years ended December 31, 2012, 2011 and 2010, respectively.

We did not significantly change our loan underwriting standards in the past several years nor did we add non-traditional residential loan products. Other than our loans for the construction of one- to four-family residential mortgage loans, we do not solicit "interest only" mortgage loans on one- to four-family residential properties (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan). We also do not offer loans that provide for negative amortization of principal, such as "Option ARM" loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. We do not directly solicit "subprime loans" (loans that generally target borrowers with FICO scores of less than 660) or Alt-A loans (traditionally defined as loans having less than full documentation). However, a portion of the loans originated by one of our subsidiaries, Northwest Consumer Discount Company ("NCDC"), consists of loans to persons with credit scores that would cause such loans to be considered subprime. NCDC has been in operation for over 25 years and has 52 offices throughout Pennsylvania. NCDC offers a variety of consumer loans for automobiles, appliances and furniture as well as residential mortgage loans. At December 31, 2012, NCDC's total loan portfolio was approximately $114.4 million with an average loan size of $4,354, an average FICO score of 619 and an average yield of approximately 18.0%. NCDC's total delinquency is approximately 4.9% of outstanding loans, with loans nonperforming for 90 days or more at 1.2% of loans outstanding. Annual net charge-offs average approximately $3.2 million, or 2.8% of outstanding loans, and it maintains an allowance for loan losses of $5.7 million, or 5.0% of loans. Although loans originated through NCDC have higher average rates of delinquency and charge-offs than similar loans originated directly by Northwest Savings Bank, management believes that the higher yields on loans originated through NCDC compensate for the incremental credit risk exposure.

Critical Accounting Policies

Certain accounting policies are important to the understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances, including, but without limitation, changes in interest rates, performance of the economy, financial condition of borrowers and laws and regulations. The following are the accounting policies we believe are critical.

Allowance for Loan Losses. We recognize that losses will be experienced on loans and that the risk of loss will vary with, among other things, the type of loan, the creditworthiness of the borrower, general economic conditions and the quality of the collateral for the loan. We maintain an allowance for loan losses inherent in the loan portfolio. The allowance for loan losses represents management's estimate of probable losses based on all available information. The allowance for loan losses is based on management's evaluation of the collectability of the loan portfolio, including past loan loss experience, known and inherent losses, information about specific borrower situations, estimated collateral values, and current economic conditions. The loan portfolio and other credit exposures are reviewed regularly by management in its determination of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes a review of historical losses, peer group comparisons, industry data and economic conditions. As an integral part of their examination process, regulatory agencies periodically review our allowance for loan losses and may require us to make additional provisions for estimated losses based upon judgments different from those of management. In establishing the allowance for loan losses, loss factors are applied to various pools of outstanding loans. Loss factors are derived using our historical loss experience and may be adjusted for factors that affect the collectability of the portfolio as of the evaluation date. Commercial loans over $1.0 million that are criticized are evaluated individually to determine the required allowance for loan losses and to evaluate the potential impairment. Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of loans deteriorate as a result of the factors discussed previously. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations. The allowance is based on information known at the time of the review. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. Such changes could impact future results. Management believes that all known losses as of December 31, 2012 and 2011 have been recorded as of those dates.

Valuation of Investment Securities. Our investment securities are classified as either held-to-maturity or available-for-sale. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value. Unrealized gains or losses, net of deferred taxes, are reported in other comprehensive income. In general, fair value is based upon quoted market prices of identical assets, when available. If quoted market prices are not available, fair value is based upon valuation models that use cash flow, security structure and other observable information. Where sufficient data is not available to produce a fair valuation, fair value is based on broker quotes for similar assets. Semi-annually (at May 31 and November 30), we validate the prices received from these third parties by comparing them to prices provided by a different independent pricing service. We have also reviewed the detailed valuation methodologies provided to us by our pricing services. Broker quotes may be adjusted to ensure that financial instruments are recorded at fair value. Adjustments may include unobservable parameters, among other things. No adjustments were made to any broker quotes received by us.

We conduct a quarterly review and evaluation of all investment securities to determine if any declines in fair value are other than temporary. In making this determination, we consider the period of time the securities were in an unrealized loss position, the percentage decline in comparison to the securities' amortized cost, the financial condition of the issuer, if applicable, and the delinquency or default rates of underlying collateral. We consider our intent to sell the investment securities evaluated and the likelihood that we will not have to sell the investment securities before recovery of their cost basis. If impairment exists, credit related impairment losses are recorded in earnings while noncredit related impairment losses are recorded in accumulated other comprehensive income. Any future deterioration in the fair value of an investment security, or the determination that the existing unrealized loss of an investment security is other-than-temporary, may have a material adverse affect on future earnings.

Goodwill. Goodwill is not subject to amortization but must be tested for impairment at least annually, and possibly more frequently if certain events or changes in circumstances arise. Impairment testing requires that the fair value of each reporting unit be compared to its carrying amount, including goodwill. Reporting units are identified based upon analyzing each of our individual operating segments. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. Goodwill is allocated to the carrying value of each reporting unit based on its relative fair value at the time it is acquired. Determining the fair value of a reporting unit requires a high degree of subjective management judgment. With the assistance of an independent third party, we evaluate goodwill for possible impairment using four valuation methodologies including a public market peers approach, a comparable transactions approach, a control premium approach and a discounted cash flow approach. Future changes in the economic environment or the operations of the reporting units could cause changes to these variables, which could give rise to declines in the estimated fair value of the reporting unit. Declines in fair value could result in impairment being identified. We have established June 30 of each year as the date for conducting our annual goodwill impairment assessment. Quarterly, we evaluate if there are any triggering events that would require an update to our previous assessment. The variables are selected as of that date and the valuation model is run to determine the fair value of each reporting unit. We did not identify any individual reporting unit where the fair value was less than the carrying value.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Using this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on an ongoing basis as regulatory and business factors change. A reduction in estimated future taxable income could require us to record a valuation allowance. Changes in levels of valuation allowances could result in increased income tax expense, and could negatively affect earnings.

Pension Benefits. Pension expense and obligations are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, anticipated salary increases, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with U.S. generally accepted accounting principles, actual results that differ from the assumptions are amortized over average future service and, therefore, generally affect recognized expense. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect our pension obligations and future expense.

In determining the projected benefit obligations for pension benefits at December 31, 2012 and 2011, we used a discount rate of 4.06% and 4.39%, respectively. We use the Citigroup Pension Liability Index rates matching the duration of our benefit payments as of the measurement date to determine the discount rate. Our measurement date is December 31.

Balance Sheet Analysis

Assets. Total assets at December 31, 2012 were $7.943 billion, a decrease of $15.1 million, or 0.2%, from $7.958 billion at December 31, 2011. This decrease in assets was primarily caused by a decrease in our interest-earning deposits in other financial institutions of $230.6 million, or 38.9%, to $362.8 million at December 31, 2012 from $593.4 million at December 31, 2011.

Cash and Investments. Total cash and investments decreased by $142.2 million, or 7.8%, to $1.686 billion at December 31, 2012, from $1.828 billion at December 31, 2011. This decrease was a result of using cash to fund an increase in net loans receivable of $148.9 million and the repurchase of 4,403,262 shares of common stock at a total cost of $52.0 million during 2012.

Loans receivable. Net loans receivable increased by $148.9 million, or 2.7%, to $5.629 billion at December 31, 2012, from $5.480 billion at December 31, 2011. During 2012 personal banking loans decreased by $188,000, or 0.1% compared to last year. Consumers continue to take advantage of historically low interest rates as residential mortgage loans increased by $18.3 million, even with the sale of $236.5 million of our wholesale mortgage loans into the secondary market. However, consumers appear to have concerns about incurring addition debt as home equity loans and other consumer loans decreased by $8.1 million and $10.3 million, respectively, during the year. Our efforts to expand beyond traditional residential mortgage lending continues to produce results as our commercial banking loan portfolio increased by $151.1 million, or 8.3% to $1.975 billion at December 31, 2012 from $1.824 billion at December 31, 2011. Commercial real estate loans increased by $150.0 million, or 10.5%, and commercial loans increased by $1.1 million compared to the prior year.

Total loans 30 days or more delinquent decreased by $17.5 million, or 10.0%, to $157.4 million at December 31, 2012 from $174.9 million at December 31, 2011. The December 31, 2012 amount consisted of 3,642 loans, while the December 31, 2011 amount consisted of 3,412 loans. Delinquencies for all classes of loans with the exception of commercial loans decreased during the year ended December 31, 2012. Delinquencies on residential mortgage loans decreased by $3.9 million, or 5.6%, delinquencies on home equity loans decreased by $1.9 million, or 10.3%, delinquencies on other consumer loans decreased by $86,000, or 0.9% and delinquencies on commercial real estate loans decreased by $16.3 million, or 27.8%, while delinquencies on commercial loans increased by $4.7 million, or 26.5%. Loans 90 days or more delinquent decreased by $27.5 million, or 28.7%, to $68.3 million at December 31, 2012 from $95.8 million at December 31, 2011. This represents the lowest level of loans 90 or more days delinquent since the economic downturn began in 2008.

Set forth below are selected data related to the composition of our loan portfolio by type of loan as of the dates indicated.

                                                                                  At December 31,
                                          2012                   2011                  2010                  2009                  2008
                                    Amount      Percent    Amount     Percent    Amount     Percent    Amount     Percent    Amount     Percent
                                                                             (Dollars in thousands)
Personal Banking:
Residential mortgage loans        $ 2,431,860      42.0 % 2,414,992      42.9 % 2,432,421      42.9 % 2,371,996      43.8 % 2,492,940      47.2 %
Home equity loans                   1,076,637      18.6 % 1,084,786      19.3 % 1,095,953      19.3 % 1,080,011      19.9 % 1,035,954      19.6 %
Other consumer loans:
Automobile                             78,577       1.3 %    80,839       1.4 %    88,486       1.6 %   101,046       1.9 %   102,267       2.0 %
Education loans                        14,606       0.3 %    18,840       0.3 %    21,957       0.4 %    32,860       0.6 %    38,152       0.7 %
Loans on savings accounts               9,759       0.2 %    11,764       0.2 %    11,850       0.2 %    12,209       0.2 %    11,191       0.2 %
Other (1)                             132,425       2.3 %   134,246       2.4 %   133,483       2.3 %   127,750       2.4 %   115,913       2.2 %
Total other consumer loans            235,367       4.1 %   245,689       4.3 %   255,776       4.5 %   273,865       5.1 %   267,523       5.1 %
Total Personal Banking              3,743,864      64.7 % 3,745,467      66.5 % 3,784,150      66.7 % 3,725,872      68.8 % 3,796,417      71.9 %

Business Banking:
Commercial real estate              1,615,701      27.9 % 1,481,127      26.3 % 1,423,021      25.1 % 1,292,145      23.8 % 1,100,218      20.8 %
Commercial loans                      432,944       7.4 %   408,462       7.2 %   463,006       8.2 %   403,589       7.4 %   387,145       7.3 %
Total Business Banking              2,048,645      35.3 % 1,889,589      33.5 % 1,886,027      33.3 % 1,695,734      31.2 % 1,487,363      28.1 %
Total loans receivable, gross       5,792,509     100.0 % 5,635,056     100.0 % 5,670,177     100.0 % 5,421,606     100.0 % 5,283,780     100.0 %

Deferred loan fees                     (1,624 )              (4,752 )              (7,165 )              (7,030 )              (5,041 )
Undisbursed loan proceeds             (88,405 )             (78,785 )            (129,007 )            (115,111 )             (81,918 )
Allowance for loan losses:
Personal Banking:
Residential mortgage loans             (8,002 )              (8,482 )              (6,854 )              (9,349 )              (4,138 )
Home equity loans                      (8,294 )              (8,687 )              (7,675 )              (6,293 )              (4,476 )
Other consumer loans:                  (5,156 )              (5,325 )              (5,810 )              (6,554 )              (6,125 )
Total Personal Banking                (21,452 )             (22,494 )             (20,339 )             (22,196 )             (14,739 )
Business Banking:
Commercial real estate                (34,499 )             (32,148 )             (35,832 )             (23,942 )             (20,501 )
Commercial loans                      (13,242 )             (12,080 )             (15,770 )             (20,073 )             (15,044 )
Total Business Banking                (47,741 )             (44,228 )             (51,602 )             (44,015 )             (35,545 )
Unallocated                            (4,026 )              (4,416 )              (4,471 )              (4,192 )              (4,645 )
Total allowance for loan losses       (73,219 )             (71,138 )             (76,412 )             (70,403 )             (54,929 )
Total loans receivable, net       $ 5,629,261             5,480,381             5,457,593             5,229,062             5,141,892

The following table sets forth the recorded investment in loans receivable by state (based on borrowers' residence) at December 31, 2012.

                                                                                            Commercial
                         Residential                                     Other             real estate             Commercial
(Dollars in thousands)     mortgage      (1)    Home equity     (2)    consumer     (3)       loans        (4)       loans        (5)       Total       (6)
Pennsylvania             $  2,024,520    83.9 %      917,645    85.2 %   213,604    90.9 %      853,290    53.8 %      269,415    69.3 %   4,278,474    75.0 %
New York                      158,090     6.5 %      111,461    10.4 %    10,235     4.3 %      443,940    28.0 %       55,517    14.3 %     779,243    13.7 %
Ohio                           19,290     0.8 %       10,828     1.0 %     3,066     1.3 %       34,261     2.2 %       12,878     3.3 %      80,323     1.4 %
Maryland                      152,676     6.3 %       29,734     2.8 %     1,291     0.5 %      136,600     8.6 %       25,497     6.5 %     345,798     6.1 %
All other                      61,073     2.5 %        6,969     0.6 %     7,171     3.0 %      117,742     7.4 %       25,687     6.6 %     218,642     3.8 %
Total                    $  2,415,649   100.0 % $  1,076,637   100.0 % $ 235,367   100.0 % $  1,585,833   100.0 % $    388,994   100.0 % $ 5,702,480   100.0 %

(2) Percentage of total home equity loans

(3) Percentage of total other consumer loans

(4) Percentage of total commercial real estate loans

(5) Percentage of total commercial loans

(6) Percentage of total loans

The following table sets forth the maturity or period of re-pricing of our loan portfolio at December 31, 2012. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Adjustable and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature, and fixed-rate loans are included in the period in which the final contractual repayment is due.

                                                        Due after     Due after     Due after
                                                        one year      two year      three year
                                        Due in one     through two     through     through five   Due after
At December 31, 2012 (In thousands)    year or less       years      three years      years       five years     Total
Personal Banking:
Residental mortgage loans             $      139,695       115,354       115,726        235,357    1,825,728   2,431,860
Home equity loans                            367,218        74,429        74,487        136,855      423,648   1,076,637
Other consumer loans                          98,953        39,567        35,232         60,103        1,512     235,367
Total Personal Banking                       605,866       229,350       225,445        432,315    2,250,888   3,743,864

Business Banking:
Commercial real estate loans                 564,588       265,377       228,838        452,126      104,772   1,615,701
Commercial loans                             252,477        40,909        41,366         44,501       53,691     432,944
Total Business Banking                       817,065       306,286       270,204        496,627      158,463   2,048,645
Total                                 $    1,422,931       535,636       495,649        928,942    2,409,351   5,792,509

The following table sets forth at December 31, 2012, the dollar amount of all fixed-rate and adjustable-rate loans due one year or more after the date indicated. Adjustable and floating-rate loans are included in the table based on the contractual due date of the loan.

At December 31, 2012 (In thousands)      Fixed      Adjustable     Total
Personal Banking:
Residental mortgage loans             $ 2,340,857       32,215   2,373,072
Home equity loans                         767,433      262,515   1,029,948
Other consumer loans                      147,587       26,631     174,218
Total Personal Banking                  3,255,877      321,361   3,577,238

Business Banking:
Commercial real estate loans              369,408      903,330   1,272,738
Commercial loans                           87,780      118,844     206,624
Total Business Banking                    457,188    1,022,174   1,479,362
Total                                 $ 3,713,065    1,343,535   5,056,600

Investment securities. Investment securities increased by $94.4 million, or 8.3%, to $1.234 billion at December 31, 2012 from $1.140 billion at December 31, 2011. This increase was a result of our decision to use the excess funds deposited in other financial institutions to purchase investment securities thereby improving our rate of return while assisting in maintaining our net interest margin. During the year ended December 31, 2012, we recognized other-than-temporary credit related impairment charges of $331,000 on one private label collateralized mortgage obligation.

The following table sets forth certain information regarding the amortized cost . . .