10-Q 1 form10q-71727_stewardship.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2005 |_| TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 0-21855 Stewardship Financial Corporation -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) New Jersey 22-3351447 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 630 Godwin Avenue, Midland Park, NJ 07432 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (201) 444-7100 ---------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by a checkmark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The number of shares outstanding of the Issuer's Common Stock, no par value, as of November 10, 2005 was 4,787,627, as adjusted for a 5% stock dividend payable November 15, 2005. Stewardship Financial Corporation INDEX PAGE NUMBER ------ PART I - CONSOLIDATED FINANCIAL INFORMATION ------------------------------------------- ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statements of Financial Condition at September 30, 2005 (Unaudited) and December 31, 2004 ...... 1 Consolidated Statements of Income for the Nine Months ended September 30, 2005 and 2004 (Unaudited) ......... 2 Consolidated Statements of Income for the Three Months ended September 30, 2005 and 2004 (Unaudited) ......... 3 Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2005 and 2004 (Unaudited) ......... 4 Consolidated Statement of Changes in Stockholders' Equity for the Nine Months ended September 30, 2005 and 2004 (Unaudited) ............................................. 5 Notes to Consolidated Financial Statements (Unaudited) ....... 6 - 12 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................................................ 13 - 25 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ......................................... 26 ITEM 4 - CONTROLS AND PROCEDURES ..................................... 26 PART II - OTHER INFORMATION --------------------------- ITEM 6 - EXHIBITS ..................................................... 27 SIGNATURES ............................................................ 28 ---------- EXHIBIT INDEX ......................................................... 29 - 32 ------------- Stewardship Financial Corporation and Subsidiary Consolidated Statements of Financial Condition
September 30, December 31, 2005 2004 ------------------------------- (Unaudited) Assets Cash and due from banks $ 13,102,000 $ 15,297,000 Other interest-earning assets 4,792,000 495,000 Federal funds sold 5,000,000 9,000,000 ------------------------------- Cash and cash equivalents 22,894,000 24,792,000 Securities available for sale 64,947,000 56,514,000 Securities held to maturity; estimated fair value of $39,524,000 (2005) and $40,501,000 (2004) 39,609,000 40,111,000 FHLB-NY stock, at cost 1,646,000 1,643,000 Loans, net of allowance for loan losses of of $3,714,000 (2005) and $3,299,000 (2004) 321,843,000 292,909,000 Mortgage loans held for sale 3,426,000 228,000 Premises and equipment, net 5,855,000 3,433,000 Accrued interest receivable 2,198,000 1,922,000 Intangible assets, net of accumulated amortization of $601,000 (2005) and $571,000 (2004) 149,000 179,000 Bank owned life insurance 8,132,000 -- Other assets 2,894,000 2,575,000 ------------------------------- Total assets $473,593,000 $424,306,000 =============================== Liabilities and stockholders' equity Liabilities Deposits: Noninterest-bearing $ 92,411,000 $ 90,241,000 Interest-bearing 317,187,000 266,677,000 ------------------------------- Total deposits 409,598,000 356,918,000 Other borrowings 15,477,000 24,129,000 Subordinated debentures 7,217,000 7,217,000 Securities sold under agreements to repurchase 5,280,000 3,370,000 Accrued expenses and other liabilities 2,709,000 2,212,000 ------------------------------- Total liabilities 440,281,000 393,846,000 ------------------------------- Commitments and contingencies -- -- Stockholders' equity Common stock, no par value; 10,000,000 shares authorized; 4,774,834 and 3,365,983 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively 28,022,000 23,893,000 Retained earnings 5,786,000 6,746,000 Accumulated other comprehensive loss (496,000) (179,000) ------------------------------- Total stockholders' equity 33,312,000 30,460,000 ------------------------------- Total liabilities and stockholders' equity $473,593,000 $424,306,000 ===============================
Share data has been restated to reflect a 5% stock dividend payable November 15, 2005, a 5% stock dividend paid November 15, 2004 and a 4 for 3 stock split issued July 1, 2005. See notes to unaudited consolidated financial statements. 1 Stewardship Financial Corporation and Subsidiary Consolidated Statements of Income (Unaudited)
Nine Months Ended September 30, ------------------------------- 2005 2004 ------------------------------- Interest income: Loans $ 15,268,000 $ 12,741,000 Securities held to maturity: Taxable 679,000 777,000 Non-taxable 421,000 474,000 Securities available for sale: Taxable 1,580,000 1,588,000 Non-taxable 26,000 27,000 Other interest-earning assets 202,000 36,000 ------------------------------- Total interest income 18,176,000 15,643,000 ------------------------------- Interest expense: Deposits 3,802,000 2,699,000 Borrowed money 879,000 879,000 ------------------------------- Total interest expense 4,681,000 3,578,000 ------------------------------- Net interest income before provision for loan losses 13,495,000 12,065,000 Provision for loan losses 450,000 390,000 ------------------------------- Net interest income after provision for loan losses 13,045,000 11,675,000 ------------------------------- Noninterest income: Fees and service charges 1,912,000 1,755,000 Gain on sales of mortgage loans 167,000 97,000 Loss on sales of securities -- (4,000) Bank owned life insurance 132,000 -- Miscellaneous 188,000 180,000 ------------------------------- Total noninterest income 2,399,000 2,028,000 ------------------------------- Noninterest expenses: Salaries and employee benefits 4,565,000 4,160,000 Occupancy, net 742,000 730,000 Equipment 547,000 617,000 Data processing 850,000 749,000 Advertising 341,000 218,000 FDIC insurance premium 35,000 37,000 Amortization of intangible assets 30,000 30,000 Charitable contributions 580,000 397,000 Stationery and supplies 196,000 172,000 Merchant processing 598,000 512,000 Bank-card related services 329,000 273,000 Miscellaneous 1,505,000 1,388,000 ------------------------------- Total noninterest expenses 10,318,000 9,283,000 ------------------------------- Income before income tax expense 5,126,000 4,420,000 Income tax expense 1,824,000 1,602,000 ------------------------------- Net income $ 3,302,000 $ 2,818,000 =============================== Basic earnings per share $ 0.69 $ 0.60 =============================== Diluted earnings per share $ 0.69 $ 0.59 =============================== Weighted average number of common shares outstanding 4,745,751 4,666,979 =============================== Weighted average number of diluted common shares outstanding 4,802,029 4,734,847 ===============================
Share data has been restated to reflect a 5% stock dividend payable November 15, 2005, a 5% stock dividend paid November 15, 2004 and a 4 for 3 stock split issued July 1, 2005. See notes to unaudited consolidated financial statements. 2 Stewardship Financial Corporation and Subsidiary Consolidated Statements of Income (Unaudited)
Three Months Ended September 30, -------------------------- 2005 2004 -------------------------- Interest income: Loans $5,399,000 $4,357,000 Securities held to maturity Taxable 231,000 239,000 Non-taxable 135,000 153,000 Securities available for sale Taxable 586,000 540,000 Non-taxable 9,000 8,000 Other interest-earning assets 101,000 11,000 -------------------------- Total interest income 6,461,000 5,308,000 -------------------------- Interest expense: Deposits 1,562,000 849,000 Borrowed money 285,000 288,000 -------------------------- Total interest expense 1,847,000 1,137,000 -------------------------- Net interest income before provision for loan losses 4,614,000 4,171,000 Provision for loan losses 150,000 150,000 -------------------------- Net interest income after provision for loan losses 4,464,000 4,021,000 -------------------------- Noninterest income: Fees and service charges 669,000 601,000 Gain on sales of mortgage loans 66,000 30,000 Bank owned life insurance 77,000 -- Miscellaneous 42,000 43,000 -------------------------- Total noninterest income 854,000 674,000 -------------------------- Noninterest expenses: Salaries and employee benefits 1,587,000 1,424,000 Occupancy, net 254,000 240,000 Equipment 168,000 176,000 Data processing 298,000 254,000 Advertising 113,000 80,000 FDIC insurance premium 11,000 12,000 Amortization of intangible assets 11,000 9,000 Charitable contributions 210,000 135,000 Stationery and supplies 59,000 58,000 Merchant processing 214,000 181,000 Bank-card related services 116,000 89,000 Miscellaneous 511,000 439,000 -------------------------- Total noninterest expenses 3,552,000 3,097,000 -------------------------- Income before income tax expense 1,766,000 1,598,000 Income tax expense 607,000 584,000 -------------------------- Net income $1,159,000 $1,014,000 ========================== Basic earnings per share $ 0.24 $ 0.21 ========================== Diluted earnings per share $ 0.24 $ 0.21 ========================== Weighted average number of common shares outstanding 4,770,405 4,696,805 ========================== Weighted average number of diluted common shares outstanding 4,829,947 4,765,206 ==========================
Share data has been restated to reflect a 5% stock dividend payable November 15, 2005, a 5% stock dividend paid November 15, 2004 and a 4 for 3 stock split issued July 1, 2005. See notes to unaudited consolidated financial statements. 3 Stewardship Financial Corporation and Subsidiary Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, 2005 ------------------------------- 2005 2004 ------------------------------- Cash flows from operating activities: Net income $ 3,302,000 $ 2,818,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of premises and equipment 438,000 541,000 Amortization of premiums and accretion of discounts, net 333,000 459,000 Accretion of deferred loan fees (107,000) (97,000) Provision for loan losses 450,000 390,000 Originations of mortgage loans held for sale (20,105,000) (8,842,000) Proceeds from sale of mortgage loans 17,074,000 9,417,000 Gain on sale of loans (167,000) (97,000) Loss on sale of securities available for sale -- 4,000 Loss on writeoff of branch startup costs -- 63,000 Deferred income tax benefit (179,000) (115,000) Amortization of intangible assets 30,000 30,000 (Increase) decrease in accrued interest receivable (277,000) 33,000 Increase in bank owned life insurance (132,000) -- Decrease in other assets 60,000 245,000 Increase (decrease) in other liabilities 567,000 (78,000) ------------ ------------ Net cash provided by operating activities 1,287,000 4,771,000 ------------ ------------ Cash flows from investing activities: Purchase of securities available for sale (14,910,000) (11,932,000) Proceeds from maturities and principal repayments on securities available for sale 5,320,000 6,280,000 Proceeds from sales and calls on securities available for sale 500,000 6,996,000 Purchase of securities held to maturity (5,324,000) (2,434,000) Proceeds from maturities and principal repayments on securities held to maturity 5,634,000 8,039,000 Proceeds from calls of securities held to maturity -- 4,735,000 Purchase of FHLB-NY stock (3,000) (321,000) Net increase in loans (29,277,000) (14,885,000) Purchase of bank owned life insurance (8,000,000) -- Additions to premises and equipment (2,860,000) (406,000) ------------ ------------ Net cash used in investing activities (48,920,000) (3,928,000) ------------ ------------ Cash flows from financing activities: Net increase in noninterest-bearing deposits 2,170,000 1,222,000 Net increase (decrease) in interest-bearing deposits 50,510,000 (2,066,000) Net increase (decrease) in securities sold under agreement to repurchase 1,910,000 (1,434,000) Net decrease in short term borrowings (7,500,000) (2,000,000) Payments on long term borrowings (1,152,000) (993,000) Cash dividends paid on common stock (926,000) (761,000) Purchase of treasury stock -- (454,000) Exercise of stock options 143,000 292,000 Issuance of common stock 580,000 517,000 ------------ ------------ Net cash provided by (used in) financing activities 45,735,000 (5,677,000) ------------ ------------ Net decrease in cash and cash equivalents (1,898,000) (4,834,000) Cash and cash equivalents - beginning 24,792,000 19,138,000 ------------ ------------ Cash and cash equivalents - ending $ 22,894,000 $ 14,304,000 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the year for interest 4,124,000 3,686,000 Cash paid during the year for income taxes 1,855,000 1,580,000
See notes to unaudited consolidated financial statements. 4 Stewardship Financial Corporation and Subsidiary Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2005 --------------------------------------------------------------------------- Accumulated Other Comprehensive Common Stock Retained Loss, Shares Amount Earnings Net Total --------------------------------------------------------------------------- Balance -- December 31, 2004 3,365,983 $23,893,000 $ 6,746,000 $ (179,000) $30,460,000 Dividends paid -- -- (926,000) -- (926,000) Stock Split - 4 for 3 1,133,661 -- -- -- -- 5% stock dividend (payable November 15, 2005) 227,374 3,336,000 (3,336,000) -- -- Common stock issued under stock plans 32,126 580,000 -- -- 580,000 Exercise of stock options 15,690 143,000 -- -- 143,000 Tax benefit on stock options exercised -- 70,000 -- -- 70,000 Comprehensive income: Net income for the nine months ended September 30, 2005 -- -- 3,302,000 -- 3,302,000 Unrealized holding losses on securities available for sale arising during the period (net tax benefit of $199,000) -- -- -- (317,000) (317,000) ----------- Total comprehensive income, net of tax 2,985,000 --------------------------------------------------------------------------- Balance -- September 30, 2005 4,774,834 $28,022,000 $ 5,786,000 $ (496,000) $33,312,000 ===========================================================================
For the Nine Months Ended September 30, 2004 -------------------------------------------------------- Common Stock Treasury Stock Shares Amount Shares Amount -------------------------------------------------------- Balance -- December 31, 2003 4,431,326 $19,552,000 -- $ -- Dividends paid -- -- -- -- Treasury stock -- -- (28,000) (454,000) 5% stock dividend (payable November 15, 2004) 224,249 3,623,000 (314) (5,000) Common stock issued under stock plans 11,159 170,000 21,731 347,000 Exercise of stock options 42,498 292,000 -- -- Comprehensive income: Net income for the nine months ended September 30, 2004 -- -- -- -- Unrealized holding losses on securities available for sale arising during the period (net tax benefit of $1,000) -- -- -- -- Reclassification adjustment for losses in net income (net tax benefit of $1,000) -- -- -- -- Total comprehensive income, net of tax -------------------------------------------------------- Balance -- September 30, 2004 4,709,232 $23,637,000 (6,583) $ (112,000) ======================================================== For the Nine Months Ended September 30, 2004 -------------------------------------------- Accumulated Other Comprehensive Retained Income (Loss), Earnings Net Total ------------------------------------------- Balance -- December 31, 2003 $ 7,593,000 $ 4,000 $27,149,000 Dividends paid (761,000) -- (761,000) Treasury stock -- -- (454,000) 5% stock dividend (payable November 15, 2004) (3,618,000) -- -- Common stock issued under stock plans 517,000 Exercise of stock options 292,000 Comprehensive income: Net income for the nine months ended September 30, 2004 2,818,000 -- 2,818,000 Unrealized holding losses on securities available for sale arising during the period (net tax benefit of $1,000) -- (2,000) (2,000) Reclassification adjustment for losses in net income (net tax benefit of $1,000) -- (3,000) (3,000) ----------- Total comprehensive income, net of tax 2,813,000 ------------------------------------------- Balance -- September 30, 2004 $ 6,032,000 $ (1,000) $29,556,000 ===========================================
See notes to unaudited consolidated financial statements. 5 Stewardship Financial Corporation and Subsidiary Notes to Consolidated Financial Statements September 30, 2005 (Unaudited) Note 1. Summary of Significant Accounting Policies Certain information and footnote disclosures normally included in the unaudited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2004. Principles of consolidation The consolidated financial statements include the accounts of Stewardship Financial Corporation, (the "Corporation") and its wholly owned subsidiary, Atlantic Stewardship Bank (the "Bank"). The Bank includes its wholly owned subsidiaries, Stewardship Investment Corp. and Stewardship Realty LLC. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Certain prior period amounts have been reclassified to conform to the current presentation. The consolidated financial statements of the Corporation have been prepared in conformity with accounting principles generally accepted in the United States of America. 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 dates of the statements of financial condition and revenues and expenses during the reporting periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions in the market area. Stock-Based Compensation The Corporation has two stock-based employee compensation plans and two director compensation plans. The Corporation accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. For those plans that issue options, no stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. For the stock issued under the Director Stock Plan, compensation expense is recorded at the fair value of the stock issued and is reflected in net income. The following 6 table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three Months Ended Nine Months Ended September 30 September 30 2005 2004 2005 2004 --------------------------- --------------------------- Net Income: Net income as reported $ 1,159,000 $ 1,014,000 $ 3,302,000 $ 2,818,000 Stock-based compensation expense included in net Income, net of related tax effects 3,000 6,000 9,000 17,000 Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (18,000) (22,000) (56,000) (68,000) ----------- ----------- ----------- ----------- Pro forma net income $ 1,144,000 $ 998,000 $ 3,255,000 $ 2,767,000 =========== =========== =========== =========== Earnings per share: As reported Basic earnings per share $ 0.24 $ 0.21 $ 0.69 $ 0.60 As reported Diluted earnings per share 0.24 0.21 0.69 0.59 Pro forma Basic earnings per share 0.24 0.21 0.69 0.59 Pro forma Diluted earnings per share 0.24 0.21 0.68 0.58
Share data has been restated to reflect a 5% stock dividend paid November 15, 2004, a 4 for 3 stock split issued July 1, 2005 and a 5% stock dividend payable November 15, 2005. Note 2. Basis of presentation The interim unaudited consolidated financial statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission ("SEC") and, therefore, do not include information or footnotes necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the nine months ended September 30, 2005 are not necessarily indicative of the results which may be expected for the entire year. All share and per share amounts have been restated for stock splits and stock dividends. 7 Stewardship Financial Corporation and Subsidiary Notes to Consolidated Financial Statements Continued (Unaudited) Note 3. Securities Available for Sale The following table sets forth the amortized cost and market value of the Corporation's securities available for sale as of September 30, 2005 and December 31, 2004. In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", securities available for sale are carried at estimated fair value.
September 30, 2005 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value ----------------------------------------------------------- U.S. Treasury securities $ 501,000 $ -- $ 7,000 $ 494,000 U.S. government-sponsored agencies 32,646,000 14,000 398,000 32,262,000 Obligations of state and political subdivisions 2,076,000 -- 30,000 2,046,000 Mortgage-backed securities 29,470,000 14,000 386,000 29,098,000 Community Reinvestment Act Fund 1,058,000 -- 11,000 1,047,000 ----------------------------------------------------------- $65,751,000 $ 28,000 $ 832,000 $64,947,000 =========================================================== December 31, 2004 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Carrying Cost Gains Losses Value ----------------------------------------------------------- U.S. Treasury securities $ 503,000 $ -- $ 8,000 $ 495,000 U.S. government-sponsored agencies 23,556,000 29,000 241,000 23,344,000 Obligations of state and political subdivisions 1,943,000 2,000 30,000 1,915,000 Mortgage-backed securities 29,780,000 128,000 178,000 29,730,000 Community Reinvestment Act Fund 1,021,000 9,000 -- 1,030,000 ----------------------------------------------------------- $56,803,000 $ 168,000 $ 457,000 $56,514,000 ===========================================================
On a quarterly basis, the Corporation makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security is impaired on an other-than-temporary basis. The Corporation considers many factors including the length of time the security has had a market value less than the cost basis; the intent and ability of the Corporation to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Management considers the impairment of these securities to be temporary. Mortgage-backed securities are comprised primarily of government agencies such as the Government National Mortgage Association ("GNMA") and government-sponsored agencies such as the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). Note 4. Securities Held to Maturity The following table sets forth the carrying value and estimated market value of the Corporation's securities held to maturity as of September 30, 2005 and December 31, 2004. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts.
September 30, 2005 ----------------------------------------------------------- Gross Gross Estimated Carring Unrealized Unrealized Market Value Gains Losses Value ----------------------------------------------------------- U.S. Treasury securities $ 1,004,000 $ 10,000 $ -- $ 1,014,000 U.S. government-sponsored agencies 11,873,000 7,000 119,000 11,761,000 Obligations of state and political subdivisions 16,686,000 66,000 78,000 16,674,000 Mortgage-backed securities 10,046,000 93,000 64,000 10,075,000 ----------------------------------------------------------- $39,609,000 $ 176,000 $ 261,000 $39,524,000 =========================================================== December 31, 2004 ----------------------------------------------------------- Gross Gross Estimated Carring Unrealized Unrealized Fair Value Gains Losses Value ----------------------------------------------------------- U.S. Treasury securities $ 1,007,000 $ 30,000 $ -- $ 1,037,000 U.S. government-sponsored agencies 8,655,000 22,000 76,000 8,601,000 Obligations of state and political subdivisions 17,688,000 246,000 17,000 17,917,000 Mortgage-backed securities 12,761,000 208,000 23,000 12,946,000 ----------------------------------------------------------- $40,111,000 $ 506,000 $ 116,000 $40,501,000 ===========================================================
On a quarterly basis, the Corporation makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security is impaired on an other-than-temporary basis. The Corporation considers many factors including the length of time the security has had a market value less than the cost basis; the intent and ability of the Corporation to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Management considers the impairment of these securities to be temporary. Mortgage-backed securities are comprised primarily of government agencies such as the Government National Mortgage Association ("GNMA") and government-sponsored agencies such as the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). 8 Stewardship Financial Corporation and Subsidiary Notes to Consolidated Financial Statements Continued (Unaudited) Note 5. Loans The Corporation's primary market area for lending is the small and medium sized business and professional community, as well as the individuals residing, working and shopping in Bergen, Passaic and Morris counties, New Jersey. The following table sets forth the composition of loans as of the periods indicated. September 30, December 31, 2005 2004 -------------------------------- Mortgage Residential $ 46,456,000 $ 41,569,000 Commercial 152,315,000 130,762,000 Commercial 57,394,000 55,252,000 Equity 21,649,000 21,484,000 Installment 48,009,000 47,218,000 Other 119,000 260,000 -------------------------------- Total loans 325,942,000 296,545,000 -------------------------------- Less: Deferred loan fees 385,000 337,000 Allowance for loan losses 3,714,000 3,299,000 -------------------------------- 4,099,000 3,636,000 -------------------------------- Loans, net $321,843,000 $292,909,000 ================================ Note 6. Allowance for loan losses Nine Months Ended September 30, 2005 2004 ------------------------------- Balance, beginning of period $ 3,299,000 $ 2,888,000 Provision charged to operations 450,000 390,000 Recoveries of loans charged off 4,000 5,000 Loans charged off (39,000) (128,000) ------------------------------- Balance, end of period $ 3,714,000 $ 3,155,000 =============================== 9 Stewardship Financial Corporation and Subsidiary Notes to Consolidated Financial Statements Continued (Unaudited) Note 7. Loan Impairment The Corporation has defined the population of impaired loans to include all nonaccrual loans, loans considered more than 90 days past due and restructured loans. The following table sets forth information regarding the impaired loans as of the periods indicated. September 30, December 31, 2005 2004 ---------------------------- Impaired loans With related allowance for loan losses $ 316,000 $ 477,000 Without related allowance for loan losses 26,000 947,000 ---------- ---------- Total impaired loans $ 342,000 $1,424,000 ========== ========== Related allowance for loan losses $ 35,000 $ 44,000 ========== ========== 10 Stewardship Financial Corporation and Subsidiary Notes to Consolidated Financial Statements Continued (Unaudited) Note 8. Recent Accounting Pronouncements In December 2004, the FASB issued Statement 123 (revised 2004) ("SFAS No. 123R"), Share-Based Payment. Among other items, SFAS No. 123R eliminates the use of APB 25 and the intrinsic value method of accounting and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the fair value of those awards on the grant date, in the financial statements. On April 14, 2005, the Securities and Exchange Commission announced that the effective date for SFAS No. 123R would be delayed until January 1, 2006, for calendar year companies. The Corporation plans to adopt this standard as of January 1, 2006, and will begin expensing any unvested stock options at that time. The Corporation does not anticipate the adoption of this standard will have any material effect on the Corporation's financial condition or results of operations. In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, "Accounting Changes and Error Corrections: a replacement of APB Opinion No. 20 and FASB Statement 3," (SFAS No. 154) which requires a company to apply voluntary changes in accounting principles retrospectively whenever it is practicable. The retrospective application requirement replaces the requirement in APB 20 to recognize most voluntary changes in accounting principles by including the cumulative effect of the change in net income during the period the change occurs. Retrospective application will be the required transition method for new accounting pronouncements in the event that a newly-issued pronouncement does not specify transition guidance. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. 11 Note 9. Earnings Per Share Basic earnings per share is calculated by dividing net income by the average daily number of common shares outstanding during the period. Common stock equivalents are not included in the calculation. Diluted earnings per share is computed similar to that of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potential dilutive common shares were issued. The following is a reconciliation of the calculation of basic and diluted earnings per share. Three Months Ended Nine Months Ended September 30, September 30, 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Net income $1,159,000 $1,014,000 $3,302,000 $2,818,000 Weighted average shares 4,770,405 4,696,805 4,745,751 4,666,979 Effect of dilutive stock options 59,542 68,401 56,278 67,868 ---------- ---------- ---------- ---------- Total weighted average dilutive shares 4,829,947 4,765,206 4,802,029 4,734,847 Basic earnings per share $ 0.24 $ 0.21 $ 0.69 $ 0.60 Diluted earnings per share $ 0.24 $ 0.21 $ 0.69 $ 0.59
All share and per share amounts have been restated to reflect a 5% stock dividend paid November 15, 2004 and a 4 for 3 stock split issued July 1, 2005 and a 5% stock dividend payable November 15, 2005. Note 10. Comprehensive Income Total comprehensive income includes net income and other comprehensive income which is comprised of unrealized holding gains and losses on securities available for sale, net of taxes. The Corporation's total comprehensive income for the nine months ended September 30, 2005 and 2004 was $3.0 million and $2.8 million, respectively. The difference between the Corporation's net income and total comprehensive income for these periods relates to the change in the net unrealized holding gains and losses on securities available for sale during the applicable period of time. 12 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Form 10-Q contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, and may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of the Corporation that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects the Corporation's interest rate spread or other income anticipated from operations and investments. As used in this Form 10-Q, "we" and "us" and "our" refer to Stewardship Financial Corporation and its consolidated subsidiary, Atlantic Stewardship Bank, depending on the context. Critical Accounting Policies and Estimates ------------------------------------------ "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as disclosures found elsewhere in this Form 10-Q, are based upon the Corporation's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Corporation's Audited Consolidated Financial Statements for the year ended December 31, 2004 included in our Annual Report on Form 10-K for the year ended December 31, 2004, as supplemented by this report, contains a summary of the Corporation's significant accounting policies. Management also believes the Corporation's policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. The Audit Committee and the Board of Directors periodically review this critical policy and its application. The allowance for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectibility may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the 13 Corporation's allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Corporation's loans are secured by real estate in the State of New Jersey. Accordingly, the collectibility of a substantial portion of the carrying value of the Corporation's loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the northern New Jersey area experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation's control. Financial Condition ------------------- Total assets increased by $49.3 million, or 11.6%, from $424.3 million at December 31, 2004 to $473.6 million at September 30, 2005. Net loans increased by $28.9 million, securities available for sale increased by $8.4 million, bank owned life insurance increased by $8.1 million, mortgage loans held for sale increased by $3.2 million and premises and equipment increased by $2.4 million, partially offset by a $1.9 million decrease in cash and cash equivalents. The composition of the loan portfolio is basically unchanged at September 30, 2005 when compared with the portfolio at December 31, 2004. In the second quarter of 2005, the Corporation deployed a deposit reclassification software that allows the balances needed to be held at the Federal Reserve to maintain required reserve balances to be held at a minimum. This improved the levels of earning assets and provided funds to support continued loan growth. The Corporation has also purchased bank owned life insurance on key management personnel in the second quarter of 2005. The increase in the cash surrender value of the insurance policies is included in non-interest income and is considered tax exempt. Deposits totaled $409.6 million at September 30, 2005, an increase of $52.7 million, or 14.8%, from $356.9 million at December 31, 2004. Interest-bearing deposits increased by $50.5 million, or 18.9%, to $317.2 million at September 30, 2005 and noninterest-bearing deposits increased by $2.2 million, or 2.4%, to $92.4 million at September 30, 2005. The Corporation continued to see the success of two new deposit products developed in the fourth quarter of 2004. The Ideal Checking Product is offered to consumers and provides a low minimum balance checking product for consumers. The Sterling Lifestyle Package of Services was designed to serve the needs of consumers who are age 55 and older. It offers an interest-bearing checking account with three balance tiers. A minimum balance must be maintained in the account or in linked accounts in order to avoid a service fee. In addition to many free services, this product provides for premium rates on Certificates of Deposit. During April of 2005, the Corporation introduced a new Certificate of Deposit product that continues to bring new customers to our organization and provide a competitive product to help satisfy the investment needs of our existing customers. Our new Power Flex CD is offered with terms of 20 or 30 months and provides for monthly deposits and withdrawals and the ability to increase the interest rate once during the term, should interest rates rise. 14 The Corporation is nearing completion of it newest branch facility at 64 Franklin Turnpike, Waldwick, Bergen County, New Jersey and the opening of a new branch at 2 Changebridge Road, Montville, Morris County, New Jersey and anticipates relocating our current Waldwick branch in early November. A new branch at 2 Changebridge Road, Montville, Morris County, New Jersey has received approvals and has begun construction. It is anticipated that this branch will be open in late December. Both branch locations will allow for safe deposit boxes, drive-up facilities, and drive-up ATMs. In addition, the Corporation has begun the preliminary analysis for another new branch which would be opened in 2006. Management believes that the new products and branch locations complement the existing services offered to consumer and business customers and will allow us to expand our presence in our existing market area. In September 2005, the Corporation approved the formation of Stewardship Realty LLC as a subsidiary of Atlantic Stewardship Bank. On September 30, 2005, Stewardship Realty LLC closed on the purchase of property adjacent from the main office at 612 Godwin Avenue, Midland Park, Bergen County, New Jersey. Upon obtaining all appropriate approvals, this property will eventually provide a new office building and will allow for future office expansion needs of the Corporation. Results of Operations --------------------- Nine Months Ended September 30, 2005 and 2004 --------------------------------------------- General ------- The Corporation reported net income of $3.3 million, or $0.69 diluted earnings per share for the nine months ended September 30, 2005, compared to $2.8 million, or $0.59 diluted earnings per share for the same period in 2004. The $484,000 increase was primarily due to increases in net interest income and noninterest income, partially offset by an increase in noninterest expense and provision for loan loss. Net interest income ------------------- Net interest income increased by $1.4 million, or 11.9%, for the nine months ended September 30, 2005 as compared with the corresponding period in 2004. The increase was primarily due to an increase in average net interest-earning assets and an increase in the net interest margin. Total interest income on a tax equivalent basis increased by $2.5 million, or 15.9%, primarily due to an increase in the average earning assets and an increase in yields on interest-earning assets. An increase in yields in the loan portfolio and continued growth in loans helped attribute to tax equivalent yields on interest earning assets increasing 32 basis points from 5.57% for the nine months ended September 30, 2004 to 5.89% for the same period in 2005. The average balance of interest-earning assets increased by $36.5 million, or 9.6%, from $380.8 million for the nine months ended September 30, 2004 to $417.3 million for the same period in 2005. The Corporation continued to experience an increase in loan demand which caused loans on average to increase by $38.9 million to an average of $309.7 million for the nine months ended September 30, 2005, from an average of $270.8 million for the comparable period in 2004. Taxable investment 15 securities decreased by $6.6 million to an average of $79.3 million as the Corporation redeployed payments on these assets into its lending portfolio. Interest paid on deposits and borrowed money increased by $1.1 million, or 30.8%, due to an increase in deposits, an increase in rates paid on certain deposit products, and a shift into higher yielding deposit products. The average balance of total interest-bearing deposits and borrowed money increased to $320.1 million for the nine months ended September 30, 2005 from $292.5 million for the comparable 2004 period, primarily as a result of the Corporation's expanding customer base and new product offerings. Yields on deposits and borrowed money increased from 1.63% for the nine month period ended September 30, 2004 to 1.96% for the comparable period in 2005. The following table reflects the components of the Corporation's net interest income for the nine months ended September 30, 2005 and 2004 including: (1) average assets, liabilities, and stockholders' equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, and (4) net yield on interest-earning assets. Nontaxable income from investment securities and loans is presented on a tax-equivalent basis assuming a statutory tax rate of 34%. This was accomplished by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes. 16 Analysis of Net Interest Income (Unaudited) For the Nine Months Ended September 30,
2005 2004 -------------------------------------- ------------------------------------- Average Average Interest Rates Interest Rates Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid ------- ------- ---- ------- ------- ---- (Dollars in thousands) Assets Interest-earning assets: Loans (1) $309,682 $ 15,268 6.59% $270,824 $ 12,741 6.28% Taxable investment securities (1) 79,347 2,259 3.81 85,936 2,365 3.68 Tax-exempt investment securities (1) (2) 19,349 658 4.55 20,301 726 4.78 Other interest-earning assets 8,923 202 3.03 3,737 36 1.29 -------- -------- -------- -------- Total interest-earning assets 417,301 18,387 5.89 380,798 15,868 5.57 -------- -------- Non-interest-earning assets: Allowance for loan losses (3,530) (3,031) Other assets 27,276 23,842 -------- -------- Total assets $441,047 $401,609 ======== ======== Liabilities and Stockholders' Equity Interest-bearing liabilities: Interest-bearing demand deposits $135,276 $ 1,128 1.11% $121,918 $ 571 0.63% Savings deposits 49,039 217 0.59 49,085 268 0.73 Time deposits 108,454 2,457 3.03 92,265 1,860 2.69 Repurchase agreements 2,784 53 2.55 2,974 26 1.17 FHLB Borrowing 17,293 461 3.56 18,964 488 3.44 Subordinated debenture 7,258 365 6.72 7,260 365 6.72 -------- -------- -------- -------- Total interest-bearing liabilities 320,104 4,681 1.96 292,466 3,578 1.63 -------- -------- Non-interest-bearing liabilities: Demand deposits 86,769 79,117 Other liabilities 2,260 1,991 Stockholders' equity 31,914 28,035 -------- -------- Total liabilities and stockholders' equity $441,047 $401,609 ======== ======== Net interest income (taxable equivalent basis) $ 13,706 $ 12,290 Tax equivalent adjustment (211) (225) -------- -------- Net interest income 13,495 12,065 ======== ======== Net interest spread (taxable equivalent basis) 3.94% 3.93% ==== ==== Net yield on interest-earning assets (taxable equivalent basis) (3) 4.39% 4.31% ==== ====
---------- (1) For purpose of these calculations, nonaccruing loans are included in the average balance. Fees are included in loan interest. Loans and total interest-earning assets are net of unearned income. Securities are included at amortized cost. (2) The tax equivalent adjustments are based on a marginal tax rate of 34%. (3) Net interest income (taxable equivalent basis) divided by average interest-earning assets. 17 Provision for loan losses ------------------------- The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the inherent losses associated with its loan portfolio, after giving consideration to changes in general market conditions and in the nature and volume of the Corporation's loan activity. The allowance for loan losses is based on estimates, and provisions are charged to operations during the period in which such additions are deemed necessary. The provision charged to operations totaled $450,000 and $390,000 during the nine months ended September 30, 2005 and 2004, respectively. The increase in the provision was primarily due to the continued growth in the loan portfolio. See "Asset Quality" section for summary of allowance for loan losses and nonperforming assets. The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio and general market conditions. Noninterest income ------------------ Noninterest income increased by $371,000, or 18.3%, from $2.0 million for the nine month period ended September 30, 2004 to $2.4 million for the comparable period in 2005. Deposit related fees increased by $157,000 for the nine month period ended September 30, 2005 due to increases in income derived from the merchant credit card processing program, overdraft and return item fees and ATM interchange income. Gains on sales of mortgage loans improved by $70,000 compared to the first nine months of 2004 due to an increase in the volume of loans originated for sale. An increase in the cash surrender value of bank owned life insurance, purchased in the second quarter of 2005, provided $132,000 in noninterest income for the nine month period ended September 30, 2005. Noninterest expense ------------------- Noninterest expense increased by approximately $1.0 million, or 11.1%, to $10.3 million for the nine months ended September 30, 2005, compared to $9.3 million in 2004. Salaries and employee benefits, the major component of noninterest expense, increased by $405,000, or 9.7%, during the nine months ended September 30, 2005. This increase was due to general increases for merit and performance and increases in benefit related expenses. Advertising expense increased by $123,000 to support the new product offerings and the Bank's 20 year anniversary celebration. Merchant processing and bank-card related services increased by $142,000, or 18.1%, due to growth in the number of merchants being processed and due to increases in the number of outstanding debit and credit cards. Miscellaneous expenses increased by $117,000, or 8.4% as a result of the general growth of the Corporation and an increase in consulting expenses. The Corporation hired an outside consulting firm to work with management in the documentation of internal controls. This will help in the future compliance with Sarbanes Oxley Section 404 which requires management to document and assess the adequacy of internal controls. 18 Income taxes ------------ Income tax expense totaled $1.8 million for the nine months ended September 30, 2005, for an effective tax rate of 35.6%. For the nine months ended September 30, 2004, income tax expense totaled $1.6 million, for an effective tax rate of 36.3%. Results of Operations --------------------- Three Months Ended September 30, 2005 and 2004 ---------------------------------------------- General ------- The Corporation reported net income of $1.2 million, or $0.24 diluted earnings per share for the three months ended September 30, 2005, compared to $1.0 million, or $0.21 diluted earnings per share for the same period in 2004. The $145,000 increase was primarily caused by increases in net interest income and noninterest income, partially offset by an increase in noninterest expense. Net interest income ------------------- Net interest income increased by $443,000, or 10.6%, for the three months ended September 30, 2005 as compared with the corresponding period in 2004. The increase was primarily due to an increase in average net interest-earning assets, partially offset by a decrease in the net interest margin. Total interest income on a tax equivalent basis increased by $1.1 million, or 21.3%, primarily due to an increase in the average earning assets and an increase in yields on interest-earning assets. Due to an increase in yields in the loan and investment portfolio and a shift in assets into loans, tax equivalent yields on interest earning assets increased by 35 basis points from 5.58% for the three months ended September 30, 2004 to 5.93% for the same period in 2005. The average balance of interest-earning assets increased by $53.1 million, or 13.8%, from $383.3 million for the three months ended September 30, 2004 to $436.4 million for the same period in 2005, primarily caused by strong loan demand. The Corporation continued to experience an increase in loan demand which caused loans on average to increase by $43.5 million to an average of $321.2 million for the three months ended September 30, 2005, from an average of $277.7 million for the comparable period in 2004. Other interest-earning assets increased from an average of $9.6 million to $12.1 million for the period ended September 30, 2005. Interest paid on deposits and borrowed money increased by $709,000, or 62.4%, due primarily to an increase in deposits, increases in rates paid on deposits and a shift in deposit mix toward higher yield term deposits. The effects of the rising interest rate environment and the flattening yield curve has required the Corporation to provide a competitive time deposit product. The Power Flex Certificate of Deposit has allowed the organization to remain competitive with its peers and maintain adequate funding for the loan portfolio. The average balance of total interest-bearing deposits and borrowed money increased to $337.7 million for the three months ended September 30, 2005 from $291.6 million for the comparable 2004 period, primarily as a result of the Corporation's expanding customer base and new product offerings. Yields on 19 deposits and borrowed money increased from 1.55% for the three month period ended September 30, 2004 to 2.17% for the comparable period in 2005. The following table reflects the components of the Corporation's net interest income for the three months ended September 30, 2005 and 2004 including: (1) average assets, liabilities, and stockholders' equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, and (4) net yield on interest-earning assets. Nontaxable income from investment securities and loans is presented on a tax-equivalent basis assuming a statutory tax rate of 34%. This was accomplished by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes. 20 Analysis of Net Interest Income (Unaudited) For the Three Months Ended September 30,
2005 2004 -------------------------------------- ------------------------------------- Average Average Interest Rates Interest Rates Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid ------- ------- ---- ------- ------- ---- (Dollars in thousands) Assets Interest-earning assets: Loans (1) $321,177 $ 5,399 6.67% $277,675 $ 4,358 6.24% Taxable investment securities (1) 84,136 817 3.85 83,117 778 3.72 Tax-exempt investment securities (1) (2) 18,999 210 4.39 20,000 232 4.61 Other interest-earning assets 12,081 101 3.32 2,524 11 1.73 -------- -------- -------- -------- Total interest-earning assets 436,393 6,527 5.93 383,316 5,379 5.58 -------- -------- Non-interest-earning assets: Allowance for loan losses (3,670) (3,112) Other assets 28,572 24,237 -------- -------- Total assets $461,295 $404,441 ======== ======== Liabilities and Stockholders' Equity Interest-bearing liabilities: Interest-bearing demand deposits $136,384 $ 411 1.20% $122,578 $ 182 0.59% Savings deposits 47,732 71 0.59 50,606 77 0.61 Time deposits 128,201 1,079 3.34 91,168 590 2.57 Repurchase agreements 2,480 20 3.20 2,431 9 1.47 FHLB Borrowing 15,648 143 3.63 17,563 158 3.58 Subordinated debenture 7,258 122 6.67 7,259 121 6.63 -------- -------- -------- -------- Total interest-bearing liabilities 337,703 1,846 2.17 291,605 1,137 1.55 -------- -------- Non-interest-bearing liabilities: Demand deposits 88,206 82,072 Other liabilities 2,512 2,063 Stockholders' equity 32,874 28,701 -------- -------- Total liabilities and stockholders' equity $461,295 $404,441 ======== ======== Net interest income (taxable equivalent basis) $ 4,681 $ 4,242 Tax equivalent adjustment (67) (71) -------- -------- Net interest income 4,614 4,171 ======== ======== Net interest spread (taxable equivalent basis) 3.77% 4.03% ==== ==== Net yield on interest-earning assets (taxable equivalent basis) (3) 4.27% 4.40% ==== ====
---------- (1) For purpose of these calculations, nonaccruing loans are included in the average balance. Fees are included in loan interest. Loans and total interest-earning assets are net of unearned income. Securities are included at amortized cost. (2) The tax equivalent adjustments are based on a marginal tax rate of 34%. (3) Net interest income (taxable equivalent basis) divided by average interest-earning assets. 21 Provision for loan losses ------------------------- The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the inherent losses associated with its loan portfolio, after giving consideration to changes in general market conditions and in the nature and volume of the Corporation's loan activity. The allowance for loan losses is based on estimates, and provisions are charged to operations during the period in which such additions are deemed necessary. The provision charged to operations totaled $150,000 for both of the three months ended September 30, 2005 and 2004. See "Asset Quality" section for summary of allowance for loan losses and nonperforming assets. The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio and general market conditions. Noninterest income ------------------ Noninterest income increased by $180,000, or 26.7%, from $674,000 for the three month period ended September 30, 2004 to $854,000 for the comparable period in 2005. Deposit related fees increased by $68,000 for the three month period ended September 30, 2005 compared to the same period for 2004 due to an increase in overdraft fee income and income derived from the merchant credit card processing program. Gains on sales of mortgage loans increased by $36,000 due to the increase in the volume of loans originated and sold during the quarter ended September 30, 2005. Income on bank owned life insurance in the amount of $77,000 was earned for the three months ended September 30, 2005. Noninterest expense ------------------- Noninterest expense increased by approximately $455,000, or 14.7%, to $3.6 million for the three months ended September 30, 2005, compared to $3.1 million for the same 2004 period. Salaries and employee benefits, the major component of noninterest expense, increased by $163,000, or 11.4%, during the three months ended September 30, 2005. This increase was due to general increases for merit and performance and increases in benefit related expenses. Charitable contributions increased by $75,000 due to the Bank's tithing program. The tithing program commits the Bank to donate 10% of taxable income to charities during each year. Miscellaneous expenses increased $72,000, or 16.4% as a result of the general growth of the Corporation and increases in consulting expense due to compliance with Sarbanes Oxley. Income taxes ------------ Income tax expense totaled $607,000 for the three months ended September 30, 2005, for an effective tax rate of 34.4%. For the three months ended September 30, 2004, income tax expense 22 totaled $584,000, for an effective tax rate of 36.5%. The effective tax rate has decreased due to a slight change in the mix of taxable versus nontaxable earning assets and the income derived from the bank owned life insurance that is earned on a tax exempt basis. Asset Quality ------------- The Corporation's principal earning assets are its loans to businesses and individuals located in northern New Jersey. Inherent in the lending function is the risk of deterioration in the borrowers' ability to repay their loans under their existing loan agreements. Risk elements include nonaccrual loans, past due and restructured loans, potential problem loans, loan concentrations and other real estate owned. The following table shows the composition of nonperforming assets at the end of the last four quarters:
09/30/05 06/30/05 03/31/05 12/31/04 -------- -------- -------- -------- (Dollars in Thousands) Nonaccrual loans: (1) $ 316 $ 202 $ 270 $ 262 Loans past due 90 days or more: (2) 26 7 7 947 Restructured loans: -- -- -- 215 ------ ------ ------ ------ Total nonperforming loans $ 342 $ 209 $ 277 $1,424 ====== ====== ====== ====== Allowance for loan losses $3,714 $3,570 $3,438 $3,299 ====== ====== ====== ====== Nonaccrual loans to total loans 0.10% 0.06% 0.09% 0.09% Nonperforming loans to total loans 0.10% 0.07% 0.09% 0.48% Nonperforming loans to total assets 0.07% 0.05% 0.07% 0.34% Allowance for loan losses to total loans 1.14% 1.13% 1.13% 1.11%
(1) Generally represents loans to which the payments of interest or principal are in arrears for a period of more than 90 days. Interest previously accrued on these loans and not yet paid is reversed and charged against income during the current period. (2) Represents loans to which payments of interest or principal are contractually considered past due 90 days or more but which are currently accruing income at the contractually stated rates. A determination is made to continue accruing income on those loans which are sufficiently collateralized and on which management believes all interest and principal owed will be collected. There were no loans at September 30, 2005 other than those included in the above table, where the Corporation was aware of any credit conditions of any borrowers that would indicate a strong possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in such loans being included as non-accrual, past due or restructured at a future date. The Corporation's lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectibility of a substantial portion of the Corporation's loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey. 23 Market Risk ----------- The Corporation's primary exposure to market risk arises from changes in market interest rates ("interest rate risk"). The Corporation's profitability is largely dependent upon its ability to manage interest rate risk. Interest rate risk can be defined as the exposure of the Corporation's net interest income to adverse movements in interest rates. Although the Corporation manages other risks, such as credit and liquidity risk, in the normal course of its business, management considers interest rate risk to be its most significant market risk and it could potentially have the largest material effect on the Corporation's financial condition. The Corporation manages its interest rate risk by utilizing an asset/liability simulation model and by measuring and managing its interest sensitivity gap. Interest sensitivity gap is determined by analyzing the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within the same period of time. The Asset Liability Committee reviews and discusses these measurements on a monthly basis. The Corporation does not have any material exposure to foreign currency exchange rate risk or commodity price risk. The Corporation did not enter into any market sensitive instruments for trading purposes nor did it engage in any hedging transactions utilizing derivative financial instruments during the nine months ended September 30, 2005. The Corporation is, however, 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 instruments, which include commitments to extend credit and standby letters of credit, involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statement of condition. 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 and may require collateral from the borrower if deemed necessary by the Corporation. Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions. Commitments to extend credit and standby letters of credit are not recorded on the Corporation's consolidated balance sheet until the instrument is exercised. Capital Adequacy ---------------- The Corporation is subject to capital adequacy guidelines promulgated by the Board of Governors of the Federal Reserve System ("FRB"). The Bank is subject to similar capital adequacy requirements imposed by the Federal Deposit Insurance Corporation. The FRB has issued regulations to define the adequacy of capital based upon the sensitivity of assets and off-balance sheet exposures to risk factors. Four categories of risk weights (0%, 20%, 50%, and 100%) were established to be applied to different types of balance sheet assets and off-balance sheet exposures. The aggregate of the risk-weighted items (risk-based assets) is the denominator of the ratio, the numerator is risk-based capital. Under the regulations, risk-based capital has been classified into two categories. Tier 1 capital includes common and qualifying perpetual 24 preferred stockholders' equity less goodwill. Tier 2 capital includes mandatory convertible debt, allowance for loan losses, subject to certain limitations, and certain subordinated and term debt securities. Total qualifying capital consists of Tier 1 capital and Tier 2 capital, however, the amount of Tier 2 capital may not exceed the amount of Tier 1 capital. At September 30, 2005, the minimum risk-based capital requirements to be considered adequately capitalized were 4% for Tier 1 capital and 8% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non risk-adjusted) for the preceding quarter. At September 30, 2005 the minimum leverage ratio requirement to be considered well capitalized was 4%. The following table reflects the Corporation's capital ratios at September 30, 2005. Required Actual Excess -------- ------ ------ Risk-based Capital Tier 1 4.00% 11.58% 7.58% Total 8.00% 12.64% 4.64% Leverage Ratio 4.00% 8.81% 4.81% Liquidity and Capital Resources ------------------------------- The Corporation's primary sources of funds are deposits, repayments of loans and mortgage-backed securities, maturities of investment securities and funds provided from operations. While scheduled loan and mortgage-backed securities amortization and maturities of investment securities are a relatively predictable source of funds, deposit flow and prepayments on loans and mortgage-backed securities are greatly influenced by market interest rates, economic conditions and competition. The Corporation's liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities. The primary source of cash from operating activities is net income. Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments, such as federal funds sold. The Corporation anticipates that it will have sufficient funds available to meet its current loan commitments. At September 30, 2005, the Corporation has outstanding loan commitments of $31.4 million and unused lines and letters of credit totaling $96.8 million. Certificates of deposit scheduled to mature in one year or less, at September 30, 2005, totaled $43.3 million. Management believes that a significant portion of such deposits will remain with the Corporation. Cash and cash equivalents decreased by $1.9 million during the first nine months of 2005. Net investing activities used $48.9 million, partially offset by operating and financing activities providing $1.3 million and $45.7 million, respectively. 25 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk Disclosure about quantitative and qualitative market risk is located in the Market Risk section of Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 4. Controls and Procedures The Corporation's management, with the participation of the Corporation's chief executive officer and principal accounting officer, has evaluated the effectiveness of the Corporation's disclosure controls and procedures as of September 30, 2005. Based on this evaluation, the Corporation's chief executive officer and principal accounting officer concluded that the Corporation disclosure controls and procedures are effective for recording, processing, summarizing and reporting the information the Corporation is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC's rules and forms. Such evaluation did not identify any change in the Corporation's internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting. 26 Stewardship Financial Corporation Part II -- Other Information ITEM 6. Exhibits -------- (a) Exhibits See Exhibit Index following this report. 27 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. Stewardship Financial Corporation Date: November 14, 2005 By: /s/ Paul Van Ostenbridge ----------------- ------------------------------------ Paul Van Ostenbridge President and Chief Executive Officer (authorized officer on behalf of registrant) Date: November 14, 2005 By: /s/ Julie E. Holland ----------------- ------------------------------------ Julie E. Holland Vice President and Treasurer (principal accounting officer) 28 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION 31.1 Certification of Paul Van Ostenbridge required by Rule 13a-14(a) or Rule 15d-14(a) 31.2 Certification of Julie Holland required by Rule 13a-14(a) or Rule 15d-14(a) 32.1 Certification of Paul Van Ostenbridge and Julie Holland required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 29