UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2014

¨ TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to ______________

Commission file number 1-33377

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 check mark 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 ý      No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý     No ¨

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

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨      No ý

The number of shares outstanding, net of treasury stock, of the Registrant’s Common Stock, no par value, as of May 7, 2014 was 5,999,022.

Stewardship Financial Corporation

INDEX

	PAGE
	NUMBER
PART I  -  FINANCIAL INFORMATION
ITEM 1  -   FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition at March 31, 2014 (Unaudited) and December 31, 2013	1
Consolidated Statements of Income for the Three Months ended March 31, 2014 and 2013 (Unaudited)	2
Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2014 and 2013 (Unaudited)	3
Consolidated Statement of Changes in Shareholders’ Equity for the Three Months ended March 31, 2014 and 2013 (Unaudited)	4
Consolidated Statements of Cash Flows for the Three Months ended March 31, 2014 and 2013 (Unaudited)	5 - 6
Notes to Consolidated Financial Statements (Unaudited)	7 - 27
ITEM 2  - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28 - 35
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	36
ITEM 4 - CONTROLS AND PROCEDURES	36
PART II  -  OTHER INFORMATION
ITEM 6 - EXHIBITS	37
SIGNATURES	38
EXHIBIT INDEX	39

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Financial Condition

	March 31,			December 31,
	2014			2013
	(Unaudited)
Assets
Cash and due from banks	$	26,690,000		$	17,024,000
Other interest-earning assets		486,000			381,000
Cash and cash equivalents		27,176,000			17,405,000
Securities available for sale		171,692,000			168,411,000
Securities held to maturity; estimated fair value of $25,843,000 (at
March 31, 2014) and $27,221,000 (at December 31, 2013)		24,685,000			25,964,000
FHLB-NY stock, at cost		2,133,000			2,133,000
Loans held for sale		186,000			2,800,000
Loans, net of allowance for loan losses of $9,792,000 (at March 31, 2014)
and $9,915,000 (at December 31, 2013)		413,784,000			424,262,000
Premises and equipment, net		5,951,000			5,739,000
Accrued interest receivable		1,909,000			2,066,000
Other real estate owned, net		1,789,000			451,000
Bank owned life insurance		13,399,000			13,303,000
Other assets		9,899,000			10,974,000
Total assets	$	672,603,000		$	673,508,000
Liabilities and shareholders' equity
Liabilities
Deposits:
Noninterest-bearing	$	137,687,000		$	133,565,000
Interest-bearing		437,729,000			444,026,000
Total deposits		575,416,000			577,591,000
Federal Home Loan Bank of New York advances		25,000,000			25,000,000
Securities sold under agreements to repurchase		7,601,000			7,300,000
Subordinated debentures		7,217,000			7,217,000
Accrued interest payable		320,000			401,000
Accrued expenses and other liabilities		1,889,000			2,220,000
Total liabilities		617,443,000			619,729,000
Commitments and contingencies		—			—
Shareholders' equity
Preferred stock, no par value; 2,500,000 shares authorized; 15,000 shares
issued and outstanding at March 31, 2014 and December 31, 2013.
Liquidation preference of $15,000,000		14,977,000			14,974,000
Common stock, no par value; 10,000,000 shares authorized;
5,998,857 and 5,943,767 shares issued and outstanding
at March 31, 2014 and December 31, 2013, respectively		40,963,000			40,690,000
Retained earnings		1,936,000			1,905,000
Accumulated other comprehensive loss, net		(2,716,000	)		(3,790,000	)
Total shareholders' equity		55,160,000			53,779,000
Total liabilities and shareholders' equity	$	672,603,000		$	673,508,000

See notes to unaudited consolidated financial statements.

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Income

(Unaudited)

	Three Months Ended
	March 31,
	2014			2013
Interest income:
Loans	$	5,160,000		$	5,924,000
Securities held to maturity
Taxable		65,000			76,000
Non-taxable		174,000			196,000
Securities available for sale
Taxable		706,000			566,000
Non-taxable		6,000			77,000
FHLB dividends		26,000			25,000
Other interest-earning assets		8,000			6,000
Total interest income		6,145,000			6,870,000
Interest expense:
Deposits		476,000			641,000
Borrowed money		363,000			363,000
Total interest expense		839,000			1,004,000
Net interest income before provision for loan losses		5,306,000			5,866,000
Provision for loan losses		—			1,600,000
Net interest income after provision for loan losses		5,306,000			4,266,000
Noninterest income:
Fees and service charges		421,000			456,000
Bank owned life insurance		96,000			76,000
Gain on calls and sales of securities		—			2,000
Gain on sales of mortgage loans		12,000			162,000
Loss on sale of loans		(241,000	)		—
Gain on sale of other real estate owned		—			126,000
Gain on life insurance proceeds		—			537,000
Miscellaneous		111,000			115,000
Total noninterest income		399,000			1,474,000
Noninterest expenses:
Salaries and employee benefits		2,678,000			2,696,000
Occupancy, net		555,000			517,000
Equipment		188,000			184,000
Data processing		387,000			328,000
Advertising		130,000			111,000
FDIC insurance premium		211,000			150,000
Charitable contributions		45,000			60,000
Miscellaneous		900,000			886,000
Total noninterest expenses		5,094,000			4,932,000
Income before income tax expense (benefit)		611,000			808,000
Income tax expense (benefit)		105,000			(14,000	)
Net income		506,000			822,000
Dividends on preferred stock		171,000			166,000
Net income available to common shareholders	$	335,000		$	656,000
Basic and diluted earnings per common share	$	0.06		$	0.11
Weighted average number of basic and diluted common shares outstanding		5,956,887			5,930,981

See notes to unaudited consolidated financial statements.

2

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended
	March 31,
	2014			2013
Net income	$	506,000		$	822,000
Other comprehensive (loss) income:
Change in unrealized holding gains (losses) on
securities available for sale arising during the period		1,698,000			(548,000	)
Reclassification adjustment for gains in net income		—			(2,000	)
Net unrealized gains (losses)		1,698,000			(550,000	)
Tax effect		(659,000	)		210,000
Net unrealized gains (losses), net of tax amount		1,039,000			(340,000	)
Change in fair value of interest rate swap		58,000			65,000
Tax effect		(23,000	)		(26,000	)
Change in fair value of interest rate swap, net of tax amount		35,000			39,000
Total other comprehensive income (loss)		1,074,000			(301,000	)
Total comprehensive income	$	1,580,000		$	521,000

The following is a summary of the accumulated other comprehensive income balances, net of tax.

	March 31, 2014			December 31, 2013
Unrealized loss on securities available for sale	$	(2,416,000	)	$	(3,455,000	)
Unrealized loss on fair value of interest rate swap		(300,000	)		(335,000	)
Accumulated other comprehensive loss, net	$	(2,716,000	)	$	(3,790,000	)

See notes to unaudited consolidated financial statements.

3

Stewardship Financial Corporation and Subsidiary

Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited)

	Three Months Ended March 31, 2014
											Accumulated
											Other
	Preferred		Common Stock					Retained			Comprehensive
	Stock		Shares		Amount			Earnings			Income, Net			Total
Balance -- December 31, 2013	$	14,974,000		5,943,767	$	40,690,000		$	1,905,000		$	(3,790,000	)	$	53,779,000
Cash dividends paid on common stock		—		—		—			(59,000	)		—			(59,000	)
Payment of discount on dividend
reinvestment plan		—		—		(1,000	)		—			—			(1,000	)
Cash dividends declared on preferred stock		—		—		—			(171,000	)		—			(171,000	)
Common stock issued under dividend
reinvestment plan		—		1,638		8,000			—			—			8,000
Common stock issued under stock plans		—		3,791		17,000			—			—			17,000
Issuance of restricted stock		—		49,661		249,000			(249,000	)		—			—
Amortization of restricted stock		—		—		—			7,000			—			7,000
Amortization of issuance costs		3,000		—		—			(3,000	)		—			—
Net income		—		—		—			506,000			—			506,000
Other comprehensive income		—		—		—			—			1,074,000			1,074,000
Balance -- March 31, 2014	$	14,977,000		5,998,857	$	40,963,000		$	1,936,000		$	(2,716,000	)	$	55,160,000

	Three Months Ended March 31, 2013
											Accumulated
											Other
	Preferred		Common Stock					Retained			Comprehensive
	Stock		Shares		Amount			Earnings			Income, Net			Total
Balance -- December 31, 2012	$	14,964,000		5,924,865	$	40,606,000		$	316,000		$	460,000		$	56,346,000
Cash dividends declared on common stock		—		—		—			(59,000	)		—			(59,000	)
Payment of discount on dividend
reinvestment plan		—		—		(1,000	)		—			—			(1,000	)
Cash dividends declared on preferred stock		—		—		—			(166,000	)		—			(166,000	)
Common stock issued under dividend
reinvestment plan		—		2,275		10,000			—			—			10,000
Common stock issued under stock plans		—		5,888		24,000			—			—			24,000
Amortization of issuance costs		3,000		—		—			(3,000	)					—
Net income		—		—		—			822,000			—			822,000
Other comprehensive loss		—		—		—						(301,000	)		(301,000	)
Balance -- March 31, 2013	$	14,967,000		5,933,028	$	40,639,000		$	910,000		$	159,000		$	56,675,000

See notes to unaudited consolidated financial statements.

4

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

	Three Months Ended
	March 31,
	2014			2013
Cash flows from operating activities:
Net income	$	506,000		$	822,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization of premises and equipment		118,000			111,000
Amortization of premiums and accretion of discounts, net		234,000			352,000
Amortization of restricted stock		7,000			—
Accretion (amortization) of deferred loan fees		(4,000	)		8,000
Provision for loan losses		—			1,600,000
Originations of mortgage loans held for sale		(875,000	)		(11,072,000	)
Proceeds from sale of mortgage loans		701,000			9,917,000
Proceeds from sale of loans		2,559,000			—
Gain on sales of mortgage loans		(12,000	)		(162,000	)
Loss on sale of loans		241,000			—
Gain on sales and calls of securities		—			(2,000	)
Gain on sale of other real estate owned		—			(126,000	)
Deferred income tax benefit		(48,000	)		(375,000	)
Decrease in accrued interest receivable		157,000			153,000
Decrease in accrued interest payable		(81,000	)		(110,000	)
Earnings on bank owned life insurance		(96,000	)		(76,000	)
Gain on life insurance proceeds		—			(537,000	)
Decrease in other assets		489,000			522,000
Increase (decrease) in other liabilities		(296,000	)		74,000
Net cash provided by operating activities		3,600,000			1,099,000
Cash flows from investing activities:
Purchase of securities available-for-sale		(6,228,000	)		(13,311,000	)
Proceeds from maturities and principal repayments on securities available-for-sale		4,432,000			9,143,000
Proceeds from sales and calls on securities available-for-sale		—			2,500,000
Proceeds from maturities and principal repayments on securities held to maturity		1,259,000			895,000
Proceeds from sales and calls on securities held to maturity		—			250,000
Net (increase) decrease in loans		9,118,000			(2,012,000	)
Proceeds from sale of other real estate owned		—			461,000
Life insurance proceeds		—			1,055,000
Additions to premises and equipment		(330,000	)		(45,000	)
Net cash provided by (used in) investing activities		8,251,000			(1,064,000	)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits		4,122,000			8,674,000
Net decrease in interest-bearing deposits		(6,297,000	)		(3,390,000	)
Net increase in securities sold under agreements to repurchase		301,000			1,000
Cash dividends paid on common stock		(59,000	)		(59,000	)
Cash dividends paid on preferred stock		(171,000	)		(166,000	)
Payment of discount on dividend reinvestment plan		(1,000	)		(1,000	)
Issuance of common stock		25,000			34,000
Net cash provided by (used in) financing activities		(2,080,000	)		5,093,000
Net increase in cash and cash equivalents		9,771,000			5,128,000
Cash and cash equivalents - beginning		17,405,000			21,016,000
Cash and cash equivalents - ending	$	27,176,000		$	26,144,000

5

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Cash Flows (continued)

(Unaudited)

	Three Months Ended
	March 31,
	2014		2013
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	920,000	$	1,114,000
Transfers from loans to other real estate owned	$	1,364,000	$	153,000

See notes to unaudited consolidated financial statements.

6

Stewardship Financial Corporation and Subsidiary

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Certain information and note disclosures normally included in the unaudited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Stewardship Financial Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 26, 2014 (the “2013 Annual Report”).

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 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 GAAP. However, all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of the interim consolidated financial statements, have been included. The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results which may be expected for the entire year.

Principles of consolidation

The consolidated financial statements include the accounts of Stewardship Financial Corporation and its wholly-owned subsidiary, Atlantic Stewardship Bank (the “Bank”), together referred to as “the Corporation”. The Bank includes its wholly-owned subsidiaries, Stewardship Investment Corporation, Stewardship Realty LLC, Atlantic Stewardship Insurance Company, LLC and several other subsidiaries formed to hold title to properties acquired through foreclosure or deed in lieu of foreclosure. The Bank’s subsidiaries have an insignificant impact on the Bank’s daily operations. All 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 GAAP. In preparing the consolidated financial statements, management is required to make estimates and assumptions, based on available information, that affect the amounts reported in the consolidated financial statements and disclosures provided. Actual results could differ significantly from those estimates.

Material 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 probable incurred losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions in the market area.

Adoption of New Accounting Standards

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, "Income Taxes, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists". This ASU requires that an unrecognized tax benefit, or a portion thereof, should be presented in the consolidated financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The standard is effective for reporting periods, including interim periods, beginning after December 15, 2013. The adoption of the standard did not have a material effect on the Corporation’s consolidated financial statements.

7

Note 2. Securities – Available-for-sale and Held to Maturity

The fair value of the available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

	March 31, 2014
	Amortized		Gross Unrealized				Fair
	Cost		Gains		Losses		Value
U.S. government-sponsored agencies	$	42,848,000	$	18,000	$	1,836,000	$	41,030,000
Obligations of state and political
subdivisions		1,427,000		—		41,000		1,386,000
Mortgage-backed securities - residential		114,906,000		441,000		2,321,000		113,026,000
Asset-backed securities (a)		9,873,000		18,000		9,000		9,882,000
Corporate debt		2,996,000		4,000		82,000		2,918,000
Total debt securities		172,050,000		481,000		4,289,000		168,242,000
Other equity investments		3,573,000		—		123,000		3,450,000
	$	175,623,000	$	481,000	$	4,412,000	$	171,692,000

	December 31, 2013
	Amortized		Gross Unrealized				Fair
	Cost		Gains		Losses		Value
U.S. government-sponsored agencies		41,066,000		15,000		2,389,000		38,692,000
Obligations of state and political
subdivisions		1,429,000		—		71,000		1,358,000
Mortgage-backed securities - residential		115,134,000		244,000		3,143,000		112,235,000
Asset-backed securities (a)		9,874,000		11,000		49,000		9,836,000
Corporate debt		2,995,000		5,000		115,000		2,885,000
Total debt securities		170,498,000		275,000		5,767,000		165,006,000
Other equity investments		3,543,000		—		138,000		3,405,000
	$	174,041,000	$	275,000	$	5,905,000	$	168,411,000

(a) Collateralized by student loans

There were no cash proceeds realized from sales and calls of securities available-for-sale for the three months ended March 31, 2014. Cash proceeds realized from sales and calls of securities available-for-sale for the three months ended March 31, 2013 were $2,500,000. There were no gross gains and no gross losses realized on sales or calls during the three months ended March 31, 2014. There were gross gains totaling $2,000 and no gross losses realized on sales or calls during the three months ended March 31, 2013.

8

The following is a summary of the held to maturity securities and related unrecognized gains and losses:

	March 31, 2014
	Amortized		Gross Unrecognized				Fair
	Cost		Gains		Losses		Value
U.S. government-sponsored agencies	$	258,000	$	30,000		—	$	288,000
Obligations of state and political
subdivisions		19,584,000		770,000		—		20,354,000
Mortgage-backed securities - residential		4,843,000		358,000		—		5,201,000
	$	24,685,000	$	1,158,000	$	—	$	25,843,000

	December 31, 2013
	Amortized		Gross Unrecognized				Fair
	Cost		Gains		Losses		Value
U.S. government-sponsored agencies	$	258,000	$	31,000	$	—	$	289,000
Obligations of state and political
subdivisions		20,642,000		838,000		—		21,480,000
Mortgage-backed securities - residential		5,064,000		388,000		—		5,452,000
	$	25,964,000	$	1,257,000	$	—	$	27,221,000

There were no cash proceeds realized from calls of securities held to maturity for the three months ended March 31, 2014. Cash proceeds realized from calls of securities held to maturity for the three months ended March 31, 2013 were $250,000. There were no gross gains and no gross losses realized on calls during the three months ended March 31, 2014 or 2013.

Issuers may have the right to call or prepay obligations with or without call or prepayment penalties. This might cause actual maturities to differ from the contractual maturities.

Mortgage-backed securities are a type of asset-backed security secured by a mortgage or collection of mortgages, purchased by government agencies such as the Government National Mortgage Association and government sponsored agencies such as the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation, which then issue securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool.

9

The following table presents the amortized cost and fair value of the debt securities portfolio by contractual maturity. As issuers may have the right to call or prepay obligations with or without call or prepayment premiums, the actual maturities may differ from contractual maturities. Securities not due at a single maturity date, such as mortgage-backed securities and asset-backed securities, are shown separately.

	March 31, 2014
	Amortized		Fair
	Cost		Value
Available-for-sale
Within one year	$	—	$	—
After one year, but within five years		5,045,000		4,980,000
After five years, but within ten years		23,418,000		22,568,000
After ten years		18,808,000		17,786,000
Mortgage-backed securities - residential		114,906,000		113,026,000
Asset-backed securities		9,873,000		9,882,000
Total	$	172,050,000	$	168,242,000
Held to maturity
Within one year	$	6,324,000	$	6,418,000
After one year, but within five years		9,422,000		9,917,000
After five years, but within ten years		3,919,000		4,120,000
After ten years		177,000		187,000
Mortgage-backed securities - residential		4,843,000		5,201,000
Total	$	24,685,000	$	25,843,000

10

The following tables summarize the fair value and unrealized losses in the available-for-sale securities portfolio of those investment securities which reported an unrealized loss at March 31, 2014 and December 31, 2013, and if the unrealized loss position was continuous for the twelve months prior to March 31, 2014 and December 31, 2013. There were no investment securities in the held to maturity portfolio which reported an unrealized loss at March 31, 2014 or December 31, 2013.

Available-for-Sale
March 31, 2014	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
U.S. government-
sponsored agencies	$	25,064,000	$	(976,000	)	$	10,885,000	$	(860,000	)	$	35,949,000	$	(1,836,000	)
Obligations of state and
political subdivisions		967,000		(25,000	)		419,000		(16,000	)		1,386,000		(41,000	)
Mortgage-backed
securities - residential		50,757,000		(1,093,000	)		21,225,000		(1,228,000	)		71,982,000		(2,321,000	)
Asset-backed securities		8,832,000		(9,000	)		—		—			8,832,000		(9,000	)
Corporate debt		2,418,000		(82,000	)		—		—			2,418,000		(82,000	)
Other equity investments		3,390,000		(123,000	)		—		—			3,390,000		(123,000	)
Total temporarily
impaired securities	$	91,428,000	$	(2,308,000	)	$	32,529,000	$	(2,104,000	)	$	123,957,000	$	(4,412,000	)

December 31, 2013	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
U.S. government-
sponsored agencies	$	24,517,000	$	(1,531,000	)	$	8,987,000	$	(858,000	)	$	33,504,000	$	(2,389,000	)
Obligations of state and
political subdivisions		949,000		(43,000	)		409,000		(28,000	)		1,358,000		(71,000	)
Mortgage-backed
securities - residential		75,183,000		(2,304,000	)		13,334,000		(839,000	)		88,517,000		(3,143,000	)
Asset-backed securities		8,791,000		(49,000	)		—		—			8,791,000		(49,000	)
Corporate debt		2,385,000		(115,000	)		—		—			2,385,000		(115,000	)
Other equity investments		3,346,000		(138,000	)		—		—			3,346,000		(138,000	)
Total temporarily
impaired securities	$	115,171,000	$	(4,180,000	)	$	22,730,000	$	(1,725,000	)	$	137,901,000	$	(5,905,000	)

Other-Than-Temporary-Impairment

At March 31, 2014, there were seven U.S. government-sponsored agency securities, one obligation of state and political subdivisions security, and nineteen mortgage-backed securities in a continuous loss position for 12 months or longer. Management has assessed the securities that were in an unrealized loss position at March 31, 2014 and December 31, 2013 and has determined that any decline in fair value below amortized cost primarily relate to changes in interest rates and market spreads and was temporary.

In making this determination management considered the following factors in estimating the cash flows expected to be collected from the security: the period of time the securities were in an unrealized loss position; the percentage decline in comparison to the securities’ amortized cost; any adverse conditions specifically related to the security, an industry or a geographic area; the rating or changes to the rating by a credit rating agency; the financial condition of the issuer and guarantor and any recoveries or additional declines in fair value subsequent to the balance sheet date. Management expects to collect all amounts contractually due and none of the debt securities can be prepaid at less than the par value.

Management does not intend to sell these securities in an unrealized loss position and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost bases, which may be at maturity.

11

Note 3. Loans and Nonperforming Loans

At March 31, 2014 and December 31, 2013, respectively, the loan portfolio consisted of the following:

		March 31,			December 31,
		2014			2013
Commercial:
	Secured by real estate	$	48,379,000		$	46,162,000
	Other		23,344,000			27,728,000
Commercial real estate			246,402,000			253,035,000
Commercial construction			3,451,000			3,445,000
Residential real estate			76,292,000			77,540,000
Consumer:
	Secured by real estate		25,043,000			25,458,000
	Other		495,000			534,000
Other			65,000			107,000
	Total gross loans		423,471,000			434,009,000
Less:	Deferred loan fees, net of costs		(105,000	)		(168,000	)
	Allowance for loan losses		9,792,000			9,915,000
			9,687,000			9,747,000
Loans, net		$	413,784,000		$	424,262,000

At March 31, 2014 and December 31, 2013, loan participations sold by the Corporation to other lending institutions totaled approximately $12,563,000 and $12,725,000, respectively. These amounts are not included in the totals presented above.

Activity in the allowance for loan losses is summarized as follows:

	For the three months ended March 31, 2014
	Balance,		Provision						Recoveries		Balance,
	beginning		charged			Loans			of loans		end
	of period		to operations			charged off			charged off		of period
Commercial	$	3,373,000	$	(156,000	)	$	(181,000	)	$	90,000	$	3,126,000
Commercial real estate		5,665,000		(231,000	)		(24,000	)		3,000		5,413,000
Commercial construction		117,000		18,000			—			—		135,000
Residential real estate		460,000		21,000			(8,000	)		—		473,000
Consumer		288,000		(32,000	)		(3,000	)		—		253,000
Other loans		3,000		(2,000	)		—			—		1,000
Unallocated		9,000		382,000			—			—		391,000
Total	$	9,915,000	$	—		$	(216,000	)	$	93,000	$	9,792,000

12

	For the three months ended March 31, 2013
	Balance,		Provision						Recoveries		Balance,
	beginning		charged			Loans			of loans		end
	of period		to operations			charged off			charged off		of period
Commercial	$	4,832,000	$	805,000		$	(387,000	)	$	35,000	$	5,285,000
Commercial real estate		4,936,000		969,000			(356,000	)		—		5,549,000
Commercial construction		169,000		(128,000	)		(24,000	)		3,000		20,000
Residential real estate		308,000		26,000			—			—		334,000
Consumer		352,000		(58,000	)		(4,000	)		—		290,000
Other loans		3,000		(4,000	)		—			2,000		1,000
Unallocated		41,000		(10,000	)		—			2,000		33,000
Total	$	10,641,000	$	1,600,000		$	(771,000	)	$	42,000	$	11,512,000

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of March 31, 2014 and December 31, 2013.

	March 31, 2014
			Commercial		Commercial		Residential				Other
	Commercial		Real Estate		Construction		Real Estate		Consumer		Loans		Unallocated		Total
Allowance for loan
losses:
Ending allowance
balance attributable
to loans
Individually
evaluated for
impairment	$	145,000	$	133,000	$	27,000	$	—	$	—	$	—	$	—	$	305,000
Collectively
evaluated for
impairment		2,981,000		5,280,000		108,000		473,000		253,000		1,000		391,000		9,487,000
Total ending
allowance
balance	$	3,126,000	$	5,413,000	$	135,000	$	473,000	$	253,000	$	1,000	$	391,000	$	9,792,000
Loans:
Loans
individually
evaluated for
impairment	$	6,813,000	$	10,711,000	$	1,431,000	$	734,000	$	612,000	$	—	$	—	$	20,301,000
Loans
collectively
evaluated for
impairment		64,910,000		235,691,000		2,020,000		75,558,000		24,926,000		65,000		—		403,170,000
Total ending
loan balance	$	71,723,000	$	246,402,000	$	3,451,000	$	76,292,000	$	25,538,000	$	65,000	$	—	$	423,471,000

13

	December 31, 2013
			Commercial		Commercial		Residential				Other
	Commercial		Real Estate		Construction		Real Estate		Consumer		Loans		Unallocated		Total
Allowance for loan
losses:
Ending allowance
balance attributable
to loans
Individually
evaluated for
impairment	$	300,000	$	72,000	$	—	$	—	$	—	$	—	$	—	$	372,000
Collectively
evaluated for
impairment		3,073,000		5,593,000		117,000		460,000		288,000		3,000		9,000		9,543,000
Total ending
allowance
balance	$	3,373,000	$	5,665,000	$	117,000	$	460,000	$	288,000	$	3,000	$	9,000	$	9,915,000
Loans:
Loans
individually
evaluated for
impairment	$	7,261,000	$	12,821,000	$	1,196,000	$	755,000	$	617,000	$	—	$	—	$	22,650,000
Loans
collectively
evaluated for
impairment		66,629,000		240,214,000		2,249,000		76,785,000		25,375,000		107,000		—		411,359,000
Total ending
loan balance	$	73,890,000	$	253,035,000	$	3,445,000	$	77,540,000	$	25,992,000	$	107,000	$	—	$	434,009,000

The following table presents the recorded investment in nonaccrual loans at the dates indicated:

	March 31,		December 31,
	2014		2013
Commercial:
Secured by real estate	$	1,932,000	$	2,182,000
Other		69,000		73,000
Commercial real estate		1,725,000		6,592,000
Residential real estate		735,000		755,000
Consumer:
Secured by real estate		612,000		617,000
Total nonaccrual loans	$	5,073,000	$	10,219,000

At December 31, 2013, there was one relationship, which included four nonaccrual commercial real estate loans totaling $2.8 million, which was classified as held for sale and included in the table above. There were no nonaccrual loans classified as held for sale at March 31, 2014.

At March 31, 2014 and December 31, 2013, there were no loans that were past due 90 days and still accruing.

14

The following table presents loans individually evaluated for impairment by class of loan at and for the periods indicated:

	At and for the three months ended March 31, 2014
	Unpaid				Allowance for		Average		Interest
	Principal		Recorded		Loan Losses		Recorded		Income
	Balance		Investment		Allocated		Investment		Recognized
With no related allowance recorded:
Commercial:
Secured by real estate	$	7,106,000	$	5,611,000			$	5,683,000	$	60,000
Other		76,000		69,000				71,000		—
Commercial real estate		10,576,000		8,297,000				9,385,000		69,000
Commercial construction		—		—				264,000		20,000
Residential real estate		822,000		734,000				744,000		—
Consumer:
Secured by real estate		626,000		612,000				614,000		—
With an allowance recorded:
Commercial:
Secured by real estate		403,000		403,000	$	134,000		481,000		2,000
Other		734,000		730,000		11,000		802,000		13,000
Commercial real estate		2,427,000		2,414,000		133,000		2,381,000		31,000
Commercial construction		1,845,000		1,431,000		27,000		1,050,000		—
	$	24,615,000	$	20,301,000	$	305,000	$	21,475,000	$	195,000

During the three months ended March 31, 2014, no interest income was recognized on a cash basis.

	At and for the year ended December 31, 2013
	Unpaid				Allowance for		Average		Interest
	Principal		Recorded		Loan Losses		Recorded		Income
	Balance		Investment		Allocated		Investment		Recognized
With no related allowance recorded:
Commercial:
Secured by real estate	$	7,204,000	$	5,756,000			$	6,286,000	$	239,000
Other		80,000		73,000				98,000		1,000
Commercial real estate		12,920,000		10,474,000				9,952,000		118,000
Commercial construction		567,000		528,000				2,753,000		52,000
Residential real estate		826,000		755,000				529,000		—
Consumer:
Secured by real estate		630,000		617,000				730,000		—
With an allowance recorded:
Commercial:
Secured by real estate		686,000		559,000	$	269,000		900,000		28,000
Other		877,000		873,000		31,000		1,067,000		52,000
Commercial real estate		2,356,000		2,347,000		72,000		3,174,000		47,000
Commercial construction		1,043,000		668,000		—		430,000		43,000
Residential real estate		—		—		—		36,000		—
Consumer:
Secured by real estate		—		—		—		68,000		—
	$	27,189,000	$	22,650,000	$	372,000	$	26,023,000	$	580,000

During the year ended December 31, 2013, no interest income was recognized on a cash basis.

15

The following table presents the aging of the recorded investment in past due loans by class of loans as of March 31, 2014 and December 31, 2013. Nonaccrual loans are included in the disclosure by payment status.

	March 31, 2014
					Greater than				Loans
	30-59 Days		60-89 Days		90 Days		Total		Not
	Past Due		Past Due		Past Due		Past Due		Past Due		Total
Commercial:
Secured by real estate	$	229,000	$	56,000	$	869,000	$	1,154,000	$	47,225,000	$	48,379,000
Other		124,000		—		—		124,000		23,220,000		23,344,000
Commercial real estate		—		—		1,293,000		1,293,000		245,109,000		246,402,000
Commercial construction		—		—		—		—		3,451,000		3,451,000
Residential real estate		147,000		—		404,000		551,000		75,741,000		76,292,000
Consumer:
Secured by real estate		—		—		479,000		479,000		24,564,000		25,043,000
Other		2,000		3,000		—		5,000		490,000		495,000
Other		—		—		—		—		65,000		65,000
Total	$	502,000	$	59,000	$	3,045,000	$	3,606,000	$	419,865,000	$	423,471,000

	December 31, 2013
					Greater than				Loans
	30-59 Days		60-89 Days		90 Days		Total		Not
	Past Due		Past Due		Past Due		Past Due		Past Due		Total
Commercial:
Secured by real estate	$	866,000	$	—	$	499,000	$	1,365,000	$	44,797,000	$	46,162,000
Other		—		—		—		—		27,728,000		27,728,000
Commercial real estate		1,043,000		—		5,100,000		6,143,000		246,892,000		253,035,000
Commercial construction		—		—		—		—		3,445,000		3,445,000
Residential real estate		—		—		523,000		523,000		77,017,000		77,540,000
Consumer:
Secured by real estate		—		—		479,000		479,000		24,979,000		25,458,000
Other		—		3,000		—		3,000		531,000		534,000
Other		—		—		—		—		107,000		107,000
Total	$	1,909,000	$	3,000	$	6,601,000	$	8,513,000	$	425,496,000	$	434,009,000

Troubled Debt Restructurings

At March 31, 2014 and December 31, 2013, the Corporation had $16.5 million and $16.6 million, respectively, of loans whose terms have been modified in troubled debt restructurings. Of these loans, $15.2 million were performing in accordance with their new terms at March 31, 2014 and December 31, 2013, respectively. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $179,000 and $281,000 have been allocated for the troubled debt restructurings at March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014 and December 31, 2013, the Corporation has committed $21,000 and $257,000, respectively, of additional funds to a single customer with an outstanding construction loan that is classified as a troubled debt restructuring.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Corporation’s internal underwriting policy.

There were no new loans classified as a trouble debt restructuring during the three months ended March 31, 2014. During the three months ended March 31, 2013, one loan was modified as troubled debt restructuring. The modification of the terms of this loan represented a term out of a remaining balance on a matured loan. The following table presents loans by class that were modified as troubled debt restructurings that occurred during the three months ended March 31, 2013:

16

	For the three months ended March 31,
	2014						2013
			Pre-		Post-				Pre-		Post-
	Number		Modification		Modification		Number		Modification		Modification
	of		Recorded		Recorded		of		Recorded		Recorded
	Loans		Investment		Investment		Loans		Investment		Investment
Commercial:
Other		—		—		—		1		17,000		17,000
Total		—	$	—	$	—		1	$	17,000	$	17,000

For the three months ended March 31, 2013, the troubled debt restructuring described above resulted in no change to the allowance for loan losses. There were no charge-offs during the three months ended March 31, 2013 related to this troubled debt restructuring.

A loan is considered to be in payment default once it is contractually 90 days past due under the modified terms. There are no troubled debt restructurings for which there was a payment default within twelve months following the modification.

Credit Quality Indicators

The Corporation categorizes certain loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial, commercial real estate and commercial construction loans. This analysis is performed at the time the loan is originated and annually thereafter. The Corporation uses the following definitions for risk ratings.

Special Mention – A Special Mention asset has potential weaknesses that deserve management’s close attention, which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or the Bank’s credit position at some future date. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

Substandard – Substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or by the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful – A Doubtful loan has all of the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable or improbable. The likelihood of loss is extremely high, but because of certain important and reasonably specific factors, an estimated loss is deferred until a more exact status can be determined.

Loss – A loan classified Loss is considered uncollectible and of such little value that its continuance as an asset is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off a basically worthless asset even though partial recovery may be effected in the future.

17

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2014 and December 31, 2013, and based on the most recent analysis performed at those times, the risk category of loans by class is as follows:

	March 31, 2014
			Special
	Pass		Mention		Substandard		Doubtful		Loss		Total
Commercial:
Secured by real estate	$	40,848,000	$	4,519,000	$	3,012,000	$	—	$	—	$	48,379,000
Other		21,581,000		1,245,000		518,000		—		—		23,344,000
Commercial real estate		237,304,000		7,373,000		1,725,000		—		—		246,402,000
Commercial construction		2,166,000		1,285,000		—		—		—		3,451,000
Total	$	301,899,000	$	14,422,000	$	5,255,000	$	—	$	—	$	321,576,000

	December 31, 2013
			Special
	Pass		Mention		Substandard		Doubtful		Loss		Total
Commercial:
Secured by real estate	$	39,114,000	$	3,387,000	$	3,661,000	$	—	$	—	$	46,162,000
Other		25,604,000		1,325,000		799,000		—		—		27,728,000
Commercial real estate		241,488,000		7,326,000		4,221,000		—		—		253,035,000
Commercial construction		2,164,000		1,281,000		—		—		—		3,445,000
Total	$	308,370,000	$	13,319,000	$	8,681,000	$	—	$	—	$	330,370,000

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loans losses. For residential real estate and consumer loan segments, the Corporation also evaluates credit quality based on payment activity. The following table presents the recorded investment in residential real estate and consumer loans based on payment activity as of March 31, 2014 and December 31, 2013.

	March 31, 2014
			Past Due and
	Current		Nonaccrual		Total
Residential real estate	$	75,888,000	$	404,000	$	76,292,000
Consumer:
Secured by real estate		24,564,000		479,000		25,043,000
Other		495,000		—		495,000
Total	$	100,947,000	$	883,000	$	101,830,000

	December 31, 2013
			Past Due and
	Current		Nonaccrual		Total
Residential real estate	$	77,017,000	$	523,000	$	77,540,000
Consumer:
Secured by real estate		24,979,000		479,000		25,458,000
Other		534,000		—		534,000
Total	$	102,530,000	$	1,002,000	$	103,532,000

18

Note 4. Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values of investment securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). As the Corporation is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Corporation compares the prices received from the pricing service to a secondary pricing source. The Corporation’s internal price verification procedures have not historically resulted in adjustment in the prices obtained from the pricing service.

The interest rate swaps are reported at fair values obtained from brokers who utilize internal models with observable market data inputs to estimate the values of these instruments (Level 2 inputs).

The Corporation measures impairment of collateralized loans and other real estate owned (“OREO”) based on the estimated fair value of the collateral less estimated costs to sell the collateral, incorporating assumptions that experienced parties might use in estimating the value of such collateral (Level 3 inputs). At the time a loan or OREO is considered impaired, it is valued at the lower of cost or fair value. Generally, impaired loans carried at fair value have been partially charged-off or receive specific allocations of the allowance for loan losses. OREO is initially recorded at fair value less estimated selling costs. For collateral dependent loans and OREO, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, the net book value recorded for the collateral on the borrower’s financial statements, or aging reports. Collateral is then adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the borrower and borrower’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals are generally obtained to support the fair value of collateral. Appraisals for both collateral-dependent impaired loans and OREO are performed by licensed appraisers whose qualifications and licenses have been reviewed and verified by the Corporation. The Corporation utilizes a third party to order appraisals and, once received, reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.

Real estate appraisals typically incorporate measures such as recent sales prices for comparable properties. In addition, appraisers may make adjustments to the sales price of the comparable properties as deemed appropriate based on the age, condition or general characteristics of the subject property. Management generally applies a 12% discount to real estate appraised values to cover disposition / selling costs and to reflect the potential price reductions in the market necessary to complete an expedient transaction and to factor in the impact of the perception that a transaction being completed by a bank may result in further price reduction pressure.

19

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

			Fair Value Measurements Using:
			Quoted Prices in		Significant
			Active Markets		Other		Significant
			for Identical		Observable		Unobservable
	Carrying		Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	At March 31, 2014
Assets:
Available for sale securities
U.S. government -
sponsored agencies	$	41,030,000	$	—	$	41,030,000	$	—
Obligations of state and
political subdivisions		1,386,000		—		1,386,000		—
Mortgage-backed
securities - residential		113,026,000		—		113,026,000		—
Asset-backed securities		9,882,000		—		9,882,000		—
Corporate debt		2,918,000		—		2,918,000		—
Other equity investments		3,450,000		3,390,000		60,000		—
Total available for
sale securities	$	171,692,000	$	3,390,000	$	168,302,000	$	—
Liabilities:
Interest rate swap	$	501,000	$	—	$	501,000	$	—

	At December 31, 2013
Assets:
Available for sale securities
U.S. government -
sponsored agencies	$	38,692,000	$	—	$	38,692,000	$	—
Obligations of state and
political subdivisions		1,358,000		—		1,358,000		—
Mortgage-backed
securities - residential		112,235,000		—		112,235,000		—
Asset-backed securities		9,836,000		—		9,836,000		—
Corporate debt		2,885,000		—		2,885,000		—
Other equity investments		3,405,000		3,345,000		60,000		—
Total available for
sale securities	$	168,411,000	$	3,345,000	$	165,066,000	$	—
Liabilities:
Interest rate swap	$	559,000	$	—	$	559,000	$	—

There were no transfers of assets between Level 1 and Level 2 during the three months ended March 31, 2014 or during the year ended December 31, 2013. There were no changes to the valuation techniques for fair value measurements as of March 31, 2014 and December 31, 2013.

20

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements Using:
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	At March 31, 2014
Assets:
Impaired loans
Commercial:
Secured by real estate	$	5,745,000	$	—	$	—	$	5,745,000
Commercial real estate		7,207,000		—		—		7,207,000
Commercial construction		1,404,000		—		—		1,404,000
Residential real estate		734,000		—		—		734,000
Consumer
Secured by real estate		612,000		—		—		612,000
Other Real Estate Owned		1,789,000		—		—		1,789,000
	$	17,491,000	$	—	$	—	$	17,491,000

	At December 31, 2013
Assets:
Impaired loans
Commercial:
Secured by real estate	$	5,861,000	$	—	$	—	$	5,861,000
Commercial real estate		8,483,000		—		—		8,483,000
Commercial construction		1,196,000		—		—		1,196,000
Residential real estate		755,000		—		—		755,000
Consumer
Secured by real estate		617,000		—		—		617,000
Other Real Estate Owned		451,000		—		—		451,000
	$	17,363,000	$	—	$	—	$	17,363,000

Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment of $15,931,000, with a valuation allowance of $229,000, resulting in an increase of the allocation for loan losses of $174,000 for the three months ended March 31, 2014.

Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment of $17,180,000, with a valuation allowance of $268,000, resulting in an increase of the provision for loan losses of $3,975,000 for the year ended December 31, 2013.

Other real estate owned had a recorded investment value of $1,843,000 with a $54,000 valuation allowance at March 31, 2014. At December 31, 2013, other real estate owned had a recorded investment of $480,000 with a $29,000 valuation allowance. Additional valuation allowances of $26,000 were recorded during the three months ended March 31, 2014. No additional valuation allowances were recorded during the three months ended March 31, 2013.

21

For the Level 3 assets measured at fair value on a non-recurring basis at March 31, 2014 and December 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

March 31, 2014
	Fair
Assets	Value		Valuation Technique	Unobservable Inputs	Range
Impaired loans	$	15,702,000	Comparable real estate sales	Adjustments for differences	5% - 10%
			and / or the income approach.	between comparable sales
				and income data available.
				Estimated selling costs.	7%
Other real estate owned	$	1,789,000	Comparable real estate sales	Adjustments for differences	3% - 16%
			and / or the income approach.	between comparable sales
				and income data available.
				Estimated selling costs.	7%

December 31, 2013
	Fair
Assets	Value		Valuation Technique	Unobservable Inputs	Range
Impaired loans	$	16,912,000	Comparable real estate sales	Adjustments for differences	1% - 25%
			and / or the income approach.	between comparable sales
				and income data available.
				Estimated selling costs.	7%
Other real estate owned	$	451,000	Comparable real estate sales	Adjustments for differences	5% - 8%
			and / or the income approach.	between comparable sales
				and income data available.
				Estimated selling costs.	7%

22

Fair value estimates for the Corporation’s financial instruments are summarized below:

			Fair Value Measurements Using:
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	At March 31, 2014
Financial assets:
Cash and cash equivalents	$	27,176,000	$	27,176,000	$	—	$	—
Securities available for sale		171,692,000		3,390,000		168,302,000		—
Securities held to maturity		24,865,000		—		25,843,000		—
Mortgage loans held for sale		186,000		—		186,000		—
Loans, net		413,784,000		—		—		432,757,000
Accrued interest receivable		1,909,000		1,000		618,000		1,290,000
Financial liabilities:
Deposits		575,416,000		446,241,000		129,451,000		—
FHLB-NY advances		25,000,000		—		25,742,000		—
Securities sold under
agreements to repurchase		7,601,000		—		7,747,000		—
Subordinated debentures		7,217,000		—		—		7,213,000
Accrued interest payable		320,000		1,000		300,000		19,000
Interest rate swap		501,000		—		501,000		—

			Fair Value Measurements Using:
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	At December 31, 2013
Financial assets:
Cash and cash equivalents	$	17,405,000	$	17,405,000	$	—	$	—
Securities available for sale		168,411,000		3,345,000		165,066,000		—
Securities held to maturity		25,964,000		—		27,221,000		—
Loans held for sale		2,800,000		—		—		2,800,000
Loans, net		424,262,000		—		—		434,126,000
Accrued interest receivable		2,066,000		—		735,000		1,331,000
Financial liabilities:
Deposits		577,591,000		441,790,000		136,268,000		—
FHLB-NY advances		25,000,000		—		25,404,000		—
Securities sold under
agreements to repurchase		7,300,000		—		7,525,000		—
Subordinated debentures		7,217,000		—		—		7,213,000
Accrued interest payable		401,000		1,000		380,000		20,000
Interest rate swap		559,000		—		559,000		—

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and cash equivalents – The carrying amount approximates fair value and is classified as Level 1.

Securities available-for-sale and held to maturity – The methods for determining fair values were described previously.

23

Mortgage loans held for sale – Loans in this category have been committed for sale to third party investors at the current carrying amount resulting in a Level 2 classification.

Loans held for sale – Loans in this category include loans that have been committed for sale to third party investors at the current carrying amount resulting in a Level 2 classification. In addition, the amount at December 31, 2013 represents the estimated fair value of a group of nonperforming loans to a single borrower that are being marketed for sale. The estimated fair value is based on the fair value of the note resulting in a Level 3 classification.

Loans, net – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as residential and commercial mortgages, commercial and other installment loans. The fair value of loans is estimated by discounting cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans resulting in a Level 3 classification. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable – The carrying amount approximates fair value.

Deposits – The fair value of deposits, with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of certificates of deposit is based on the discounted value of cash flows resulting in a Level 2 classification. The discount rate is estimated using market discount rates which reflect interest rate risk inherent in the certificates of deposit. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable deposits.

FHLB-NY advances – With respect to FHLB-NY borrowings, the fair value is based on the discounted value of cash flows. The discount rate is estimated using market discount rates which reflect the interest rate risk and credit risk inherent in the term borrowings resulting in a Level 2 classification.

Securities sold under agreements to repurchase – The carrying value approximates fair value due to the relatively short time before maturity resulting in a Level 2 classification.

Subordinated debentures – The fair value of the debentures is based on the discounted value of the cash flows. The discount rate is estimated using market rates which reflect the interest rate and credit risk inherent in the debentures resulting in a Level 3 classification.

Accrued interest payable – The carrying amount approximates fair value.

Interest rate swap – The fair value of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

Commitments to extend credit – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. At March 31, 2014 and December 31, 2013 the fair value of such commitments were not material.

Limitations

The preceding fair value estimates were made at March 31, 2014 and December 31, 2013 based on pertinent market data and relevant information concerning the financial instruments. These estimates do not include any premiums or discounts that could result from an offer to sell at one time the Corporation's entire holdings of a particular financial instrument or category thereof. Since no market exists for a substantial portion of the Corporation's financial instruments, fair value estimates were necessarily based on judgments with respect to future expected loss experience, current economic conditions, risk assessments of various financial instruments, and other factors. Given the subjective nature of these estimates, the uncertainties surrounding them and the matters of significant judgment that must be applied, these fair value estimates cannot be calculated with precision. Modifications in such assumptions could meaningfully alter these estimates.

Since these fair value approximations were made solely for on- and off-balance sheet financial instruments at March 31, 2014 and December 31, 2013, no attempt was made to estimate the value of anticipated future business. Furthermore, certain tax implications related to the realization of unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into the estimates.

24

Note 5. Earnings Per Share

Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average 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 reconciles the income available to common shareholders (numerator) and the weighted average common stock outstanding (denominator) for both basic and diluted earnings per share.

	Three Months Ended
	March 31,
	2014		2013
Net income	$	506,000	$	822,000
Dividends on preferred stock		171,000		166,000
Net income available to common stockholders	$	335,000	$	656,000
Weighted average common shares outstanding - basic		5,956,887		5,930,981
Effect of dilutive securities - stock options		N/A		N/A
Weighted average common shares outstanding - diluted		5,956,887		5,930,981
Basic earnings per common share	$	0.06	$	0.11
Diluted earnings per common share	$	0.06	$	0.11

There were no stock options to purchase shares of common stock for the three months ended March 31, 2014. For the three months ended March 31, 2013, stock options to purchase 6,754 shares of common stock were not considered in computing diluted earnings per share of common stock because they were antidilutive.

25

Note 6. Preferred Stock

In connection with the Corporation’s participation in the U.S. Department of the Treasury’s Small Business Lending Fund program (“SBLF”), a $30 billion fund established under the Small Business Jobs Act of 2010 that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion, on September 1, 2011, pursuant to a Securities Purchase Agreement between the Corporation and the Secretary of the Treasury, the Corporation issued 15,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Shares”) to the Treasury for an aggregate purchase price of $15 million, in cash.

The terms of the Series B Preferred Shares provide for a liquidation preference of $1,000 per share and impose restrictions on the Corporation’s ability to declare or pay dividends or purchase, redeem or otherwise acquire for consideration, shares of the Corporation’s Common Stock and any class or series of stock of the Corporation the terms of which do not expressly provide that such class or series will rank senior or junior to the Series B Preferred Shares as to dividend rights and/or rights on liquidation, dissolution or winding up of the Corporation. Specifically, the terms provide for the payment of a non-cumulative quarterly dividend, payable in arrears, which the Corporation accrues as earned over the period that the Series B Preferred Shares are outstanding. The dividend rate could fluctuate on a quarterly basis during the first ten quarters during which the Series B Preferred Shares are outstanding, based upon changes in the level of Qualified Small Business Lending (“QSBL” as defined in the Securities Purchase Agreement) from 1% to 5% per annum and, thereafter, for the eleventh through the first half of the nineteenth dividend periods, from 1% to 7%. In general, the dividend rate decreases as the level of the Bank’s QSBL increases. In the event that the Series B Preferred Shares remain outstanding for more than four and one half years, the dividend rate will be fixed at 9%. During 2013, the dividend quarterly rate ranged between 3.38% and 4.56%, and fixed at 4.56% beginning with the quarter ended December 31, 2013. Such dividends are not cumulative but the Corporation may only declare and pay dividends on its Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Tier 1 capital on the date of entering into the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of the issuance and ending on the tenth anniversary, by 10% for each 1% increase in QSBL over the baseline level.

The Series B Preferred Shares are non-voting except in limited circumstances. In the event that the Corporation has not timely declared and paid dividends on the Series B Preferred Shares for six dividend periods or more, whether or not consecutive, and Series B Preferred Shares with an aggregate liquidation preference of at least $25,000,000 are still outstanding, the Treasury may designate two additional directors to be elected to the Corporation’s Board of Directors. Subject to the approval of the Bank’s federal banking regulator, the Federal Reserve, the Corporation may redeem the Series B Preferred Shares at any time at the Corporation’s option, at a redemption price equal to the liquidation preference per share plus the per share amount of any unpaid dividends for the then-current period through the date of the redemption. The Series B Preferred Shares are includable in Tier I capital for regulatory capital.

26

Note 7. Accumulated Other Comprehensive Income

The following table presents the after-tax changes in the balances of each component of accumulated other comprehensive income for the three months ended March 31, 2014 and 2013.

	Three Months Ended March 31, 2014
	Components of Accumlated
	Other Comprehensive Income (Loss)						Total
	Unrealized Gains						Accumulated
	and Losses on			Unrealized Gains			Other
	Available for Sale			and Losses on			Comprehensive
	(AFS) Securities			Derivatives			Income (Loss)
Balance at December 31, 2013	$	(3,455,000	)	$	(335,000	)	$	(3,790,000	)
Other comprehensive income before
reclassifications		1,039,000			35,000			1,074,000
Other comprehensive income, net		1,039,000			35,000			1,074,000
Balance at March 31, 2014	$	(2,416,000	)	$	(300,000	)	$	(2,716,000	)

	Three Months Ended March 31, 2013
	Components of Accumlated
	Other Comprehensive Income (Loss)						Total
	Unrealized Gains						Accumulated
	and Losses on			Unrealized Gains			Other
	Available for Sale			and Losses on			Comprehensive
	(AFS) Securities			Derivatives			Income (Loss)
Balance at December 31, 2012	$	947,000		$	(487,000	)	$	460,000
Other comprehensive income (loss)
before reclassifications		(339,000	)		39,000			(300,000	)
Amounts reclassified from other
comprehensive income (loss)		(1,000	)		—			(1,000	)
Other comprehensive income (loss), net		(340,000	)		39,000			(301,000	)
Balance at March 31, 2013	$	607,000		$	(448,000	)	$	159,000

The following table presents amounts reclassified from each component of accumulated other comprehensive income on a gross and net of tax basis for the three months ended March 31, 2014 and 2013.

	Three Months Ended					Income
Components of Accumulated Other	March 31,					Statement
Comprehensive Income (Loss)	2014		2013			Line Item
Unrealized gains on AFS securities before tax	$	—	$	2,000		Gains on securities transactions, net
Tax effect		—		(1,000	)
Total net of tax		—		1,000
Total reclassifications, net of tax	$	—	$	1,000

27

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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” with respect to Stewardship Financial Corporation (the “Corporation”) within the meaning of the Private Securities Litigation Reform Act of 1995, which forward looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “plan,” “estimate,” 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”, “us” and “our” refer to the 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 Quarterly Report on Form 10-Q, are based upon the Corporation’s consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”). 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, 2013 included in the Corporation’s 2013 Annual Report contains a summary of the Corporation’s significant accounting policies. Management 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. This critical accounting policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.

Allowance for Loan Losses. 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 loan 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 collectability 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, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the 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 collectability 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 adverse economic changes. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.

Deferred Income Taxes. The Corporation records income taxes in accordance with ASC 740, “Income Taxes,” as amended, using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant.

Financial Condition

Total assets were relatively unchanged, decreasing just $905,000 to $672.6 million at March 31, 2014 from $673.5 million at December 31, 2013. Cash and cash equivalents increased $9.8 million to $27.2 million at March 31, 2014 from $17.4 million at December 31, 2013, reflecting additional liquidity at quarter end. Securities available-for-sale increased $3.3 million to $171.7 million while securities held to maturity decreased $229,000 to $24.7 million. In late 2013, the Corporation sold $12.0 million of obligations of state and political subdivisions from the available-for-sale portfolio. The transaction lowered the impact of tax-free income on the portfolio and helped fund the purchase of loan participations. Net loans decreased $10.5 million to $413.8 million at March 31, 2014 compared to $424.3 million at December 31, 2013. Decreases due to regular principal payments and payoffs in the first three months of fiscal year 2014 were partially offset by new loans originated. Loans held for sale totaled $186,000 at March 31, 2014, a decrease of $2,614,000 from $2.8 million at December 31, 2013. The $2.8 million represented the fair value of a small group of nonperforming loans that, at December 31, 2013, the Corporation had categorized as held for sale at the lower of cost or fair value of the underlying collateral, less cost to sell. This loan group was sold during the three months ended March 31, 2014 and resulted in a net loss to the Corporation of $241,000, reflecting further declines in fair value. Other real estate owned (OREO) increased $1.3 million to $1.8 million at March 31, 2014 compared to $451,000 at December 31, 2013 reflecting the foreclosure or deed-in-lieu of foreclosure on several properties.

28

Deposits totaled $575.4 million at March 31, 2014, a slight decrease of $2.2 million from $577.6 million at December 31, 2013. The decline in deposits consisted of a $6.3 million decrease in interest-bearing accounts partially offset by a $4.1 million increase in noninterest-bearing accounts.

In accordance with a notice received by the Corporation from the Federal Reserve Bank of New York (“FRB-NY”) under which the Corporation is required to obtain the prior written approval of FRB-NY in order to issue dividends, the Corporation solicited and received written approval in April 2014 from FRB-NY regarding (i) the payment of a cash dividend on preferred stock held by the U.S. Treasury under the Small Business Lending Fund program of approximately $171,000 (payable on July 1, 2014), (ii) the payment of a cash dividend to common shareholders of $0.01 per share, totaling approximately $60,000 (payable on May 15, 2014); and (iii) the payment of quarterly interest on Trust Preferred Securities totaling approximately $125,000 (payable on June 17, 2014).

Results of Operations

General

The Corporation reported net income of $506,000, or $0.06 diluted earnings per common share for the three months ended March 31, 2014, compared to net income of $822,000, or $0.11 diluted earnings per common share for the comparable prior year period.

Net Interest Income

Net interest income, on a tax equivalent basis, for the three months ended March 31, 2014 was $5.4 million compared to $6.0 million recorded in the prior year period. The net interest rate spread and net yield on interest-earning assets for the three months ended March 31, 2014 were 3.26% and 3.44%, respectively, compared to 3.52% and 3.72% for the three months ended March 31, 2013. The net interest rate spread and net yield on interest-earning assets for the current year period reflects a decline in loan interest rates and an increase in yields on securities as well as a decline in the interest rates on deposits. The increase in yields on securities partially reflects the above noted sale of lower yielding obligations of state and political subdivisions. In addition, due to a slowdown in mortgage refinance activity, a reduction in premium amortization contributed to an increase in the yields on securities. The Corporation continues in its efforts to proactively manage deposit costs in an effort to mitigate the lower asset yields earned. The reduced yields on assets primarily reflect lower yields on loans reflective of the historically low market rates in the current environment partially offset by increased yields on investment securities.

The following table reflects the components of the Corporation’s net interest income for the three months ended March 31, 2014 and 2013 including: (1) average assets, liabilities and shareholders’ equity based on average daily balances, (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% for the periods presented. 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.

29

Analysis of Net Interest Income (Unaudited)

For the Three Months Ended March 31,

	2014									2013
							Average									Average
				Interest			Rates						Interest			Rates
	Average			Income/			Earned/			Average			Income/			Earned/
	Balance			Expense			Paid			Balance			Expense			Paid
	(Dollars in thousands)									(Dollars in thousands)
Assets
Interest-earning assets:
Loans (1) (2)	$	430,923		$	5,170			4.87	%	$	442,519		$	5,935			5.44	%
Taxable investment securities (1)		175,039			797			1.85			168,521			667			1.61
Tax-exempt investment securities (1) (2)		21,423			270			5.13			36,475			407			4.53
Other interest-earning assets		9,945			8			0.33			7,289			6			0.33
Total interest-earning assets		637,330			6,245			3.97			654,804			7,015			4.34
Non-interest-earning assets:
Allowance for loan losses		(10,174	)								(11,074	)
Other assets		42,702									40,547
Total assets	$	669,858								$	684,277
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	228,164		$	161			0.29	%	$	238,891		$	185			0.31	%
Savings deposits		79,182			21			0.11			68,966			18			0.11
Time deposits		132,357			294			0.90			149,132			438			1.19
Repurchase agreements		7,510			90			4.86			7,343			90			4.97
FHLB-NY borrowing		25,567			149			2.36			25,416			148			2.36
Subordinated debenture		7,217			124			6.97			7,217			125			7.02
Total interest-bearing liabilities		479,997			839			0.71			496,965			1,004			0.82
Non-interest-bearing liabilities:
Demand deposits		132,536									128,144
Other liabilities		2,521									2,537
Stockholders' equity		54,804									56,631
Total liabilities and stockholders' equity	$	669,858								$	684,277
Net interest income (taxable equivalent basis)					5,406									6,011
Tax equivalent adjustment					(100	)								(145	)
Net interest income				$	5,306								$	5,866
Net interest spread (taxable equivalent basis)								3.26	%								3.52	%
Net yield on interest-earning
assets (taxable equivalent basis) (3)								3.44	%								3.72	%

(1) For purpose of these calculations, nonaccruing loans are included in the average balance. 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.

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For the three months ended March 31, 2014, total interest income, on a tax equivalent basis, decreased $769,000 to $6.2 million, or 12.3%, when compared to the same prior year period. The decrease was due to both a decrease in the average balance of interest-earning assets and a decrease in yields on interest-earning assets. The average rate earned on interest-earning assets was 3.97% for the three months ended March 31, 2014, compared to an average rate of 4.34% for the three months ended March 31, 2013. The decline in the asset yield reflects the effect of a prolonged low interest rate environment. Average interest-earning assets decreased $7.5 million for the three months ended March 31, 2014 compared to the prior year period. The change in average interest-earning assets primarily reflects a decrease from the comparable prior year period in average loans, which decreased $11.6 million for the three months ended March 31, 2014.

Interest paid on deposits and borrowed money decreased $165,000 for the three months ended March 31, 2014, compared to the same period for 2013. The decline is due to general decreases in rates paid on deposits and borrowings coupled with decreases in average interest-bearing liabilities. For the three months ended March 31, 2014, the total cost for interest-bearing liabilities declined to 0.71% representing an 11 basis point decline when compared to the same prior year period. The average balance of total interest-bearing deposits and borrowings decreased $17.0 million for the three months ended March 31, 2014, from the comparable 2013 period. Average interest-bearing deposits decreased $17.3 million for the three months ended March 31, 2014 when compared to the same prior year period.

Provision for Loan Losses

The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable incurred losses associated with its loan portfolio. On an ongoing basis, management analyzes the adequacy of this allowance by considering the nature and volume of the Corporation’s loan activity, financial condition of the borrower, fair value of underlying collateral, and changes in general market conditions. Additions to the allowance for loan losses are charged to operations in the appropriate period. Actual loan losses, net of recoveries, reduce the allowance. The appropriate level of the allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates.

For the three months ended March 31, 2014, the Corporation recorded no provision for loan losses compared to $1.6 million for the three months ended March 31, 2013. The lack of a provision for loan losses is partially reflective of improvement in the Corporation’s credit quality metrics. Nonperforming loans of $5.1 million at March 31, 2014, or 1.20% of total gross loans, reflected a significant decrease from $10.2 million of nonperforming loans, or 2.34% of total gross loans, at December 31, 2013.

The allowance for loan losses was $9.8 million, or 2.31% of total gross loans, as of March 31, 2014 compared to $9.9 million or 2.28% of total gross loans as of December 31, 2013. The allowance for loan losses related to the impaired loans decreased from $372,000 at December 31, 2013 to $305,000 at March 31, 2014. During the three months ended March 31, 2014, the Corporation charged off $216,000 of loan balances and recovered $93,000 in previously charged off loans compared to $771,000 and $42,000, respectively, during the same period in 2013.

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, charge-off activity and general market conditions. There can be no assurances that the current level of no provision will continue in the future

See “Asset Quality” section below for a summary of the allowance for loan losses and nonperforming assets.

Noninterest Income

Noninterest income was $399,000 for the three months ended March 31, 2014, compared to $1.5 million for the prior year period. The three months ended March 31, 2014 includes a $241,000 loss from the sale of nonperforming loans as well as reduced gains on sales of mortgage loans. Gains on sales of mortgage loans totaled $12,000 for the three months ended March 31, 2014, a decrease from $162,000 for the three months ended March 31, 2013 reflective of a rise in mortgage rates which reduced application volume. For the prior year three months ended March 31, 2013, there were $126,000 of gains on sales of other real estate owned and a $537,000 payment received as a result of an insurance death benefit.

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Noninterest Expense

Noninterest expenses for the three months ended March 31, 2014 was $5.1 million, compared to $4.9 million in the comparable prior year period. Occupancy expense increased $38,000 to $555,000 for the three months ended March 31, 2014, from $517,000 for the three months ended March 31, 2013, primarily due to increased snow removal expense.

Income Tax Expense

Income tax expense totaled $105,000 for the three months ended March 31, 2014, for an effective tax rate of 17.2%. For the three months ended March 31, 2013, income taxes represents a benefit of $14,000. The 2014 tax expense includes the impact of tax exempt income. The tax benefit for 2013 reflects a decrease in our overall projected effective tax rate as a result of our tax exempt income, including the gain on life insurance proceeds, representing a larger percentage of pretax income.

Asset Quality

The Corporation’s principal earning asset is its loan portfolio. Inherent in the lending function is the risk of deterioration in the borrowers’ ability to repay loans under existing loan agreements. The Corporation manages this risk by maintaining reserves to absorb probable incurred loan losses. In determining the adequacy of the allowance for loan losses, management considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with general economic and real estate market conditions. Although management endeavors to establish a reserve sufficient to offset probable incurred losses in the portfolio, changes in economic conditions, regulatory policies and borrowers’ performance could require future changes to the allowance.

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 each of the last four quarters:

	March 31,			December 31,			September 30,			June 30,
	2014			2013			2013			2013
	(Dollars in thousands)
Nonaccrual loans (1)	$	5,073		$	10,219		$	15,269		$	14,716
Loans past due 90 days or more and accruing (2)		—			—			—			—
Total nonperforming loans		5,073			10,219			15,269			14,716
Other real estate owned		1,789			451			470			1,072
Total nonperforming assets	$	6,862		$	10,670		$	15,739		$	15,788
Performing restructured loans (3)	$	15,228		$	15,231		$	10,986		$	10,235
Allowance for loan losses	$	9,792		$	9,915		$	10,704		$	10,787
Nonperforming loans to total gross loans (4)		1.20	%		2.34	%		3.48	%		3.33	%
Nonperforming assets to total assets		1.02	%		1.58	%		2.28	%		2.29	%
Allowance for loan losses to total gross loans		2.31	%		2.28	%		2.44	%		2.44	%
Allowance for loan losses to
nonperforming loans		193.02	%		97.03	%		70.10	%		73.30	%

(1) Generally represents loans as to which the payment of principal or interest is 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. Interest earned thereafter is only included in income to the extent that it is received in cash.

(2) Represents loans as to which payment of principal or interest is contractually 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.

(3) Any restructured loans that are on nonaccrual status are only reported in nonaccrual loans and not also in restructured loans.

(4) Gross loans includes $2.8 million of loans held for sale at December 31, 2013.

A loan is generally placed on nonaccrual when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The identification of nonaccrual loans reflects careful monitoring of the loan portfolio. The Corporation is focused on resolving nonperforming loans and mitigating future losses in the portfolio. All delinquent loans continue to be reviewed by management.

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At March 31, 2014, the nonaccrual loans were comprised of 27 loans, primarily commercial real estate loans, commercial loans and construction loans. While the Corporation maintains strong underwriting requirements, the number and amount of nonaccrual loans is a reflection of the prolonged weakened economic conditions and the corresponding effects it has had on our commercial borrowers and the current real estate environment. Certain loans, including restructured loans, are current, but in accordance with applicable guidance and other weakness concerns, management has continued to keep these loans on nonaccrual status.

During the three months ended March 31, 2014, nonaccrual loans have decreased approximately 50% since December 31, 2013 to $5.1 million. The decrease reflects payments received, payoffs, charge-offs and loans returned to an accrual status partially offset by a small number of new nonaccrual loans. The ratio of allowance for loan losses to nonperforming loans increased to 193.02% at March 31, 2014 from 97.03% at December 31, 2013. The ratio of allowance for loan losses to nonperforming loans is reflective of a detailed analysis and the probable losses to be incurred that we have identified with these nonperforming loans. This metric reflects both the effect of an increase in the allowance for loan losses and the decrease in nonaccrual loans.

Evaluation of all nonperforming loans includes the updating of appraisals and specific evaluation of such loans to determine estimated cash flows from business and/or collateral. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable losses to be incurred. The majority of our nonperforming loans are secured by real estate collateral. While we have continued to record appropriate charge-offs, the existing underlying collateral coverage for a considerable portion of the nonperforming loans currently supports collection of a significant portion of our remaining principal.

For loans not included in nonperforming loans, at March 31, 2014, the level of loans past due 30-89 days was only $351,000 compared to $1.9 million at December 31, 2013. We will continue to monitor delinquencies for early identification of new problem loans. While not comprising a significantly large portion of the loan portfolio, a number of problem loans are commercial construction loans which have been affected by the struggling construction industry. As such, the entire commercial construction portfolio is being actively monitored.

The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable losses to be incurred associated with its loan portfolio. The Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity and requires management to make difficult and subjective judgments.

The adequacy of the allowance for loan losses is based upon management’s evaluation of the known and inherent risks in the portfolio, consideration to the size and composition of the loan portfolio, actual loan loss experience, the level of delinquencies, detailed analysis of individual loans for which full collectability 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.

In establishing the allowance for loan losses, the Corporation utilizes a two-tier approach by (1) identifying problem loans and allocating specific loss allowances on such loans and (2) establishing a general loan loss allowance on the remainder of its loan portfolio. The Corporation maintains a loan review system that allows for a periodic review of its loan portfolio and the early identification of potential problem loans. Such a system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers.

Allocations of specific loan loss allowances are established for identified loans based on a review of various information including appraisals of underlying collateral. Appraisals are performed by independent licensed appraisers to determine the value of impaired, collateral-dependent loans. Appraisals are periodically updated to ascertain any further decline in value. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loss experience, composition of the loan portfolio, current economic conditions and management’s judgment.

For the three ended March 31, 2014, no provision for loan losses was recorded compared to $1.6 million for the three months ended March 31, 2013. The total allowance for loan losses of 2.31% of total loans was comparable to a ratio of 2.28% at December 31, 2013.

When management expects that some portion or all of a loan balance will not be collected, that amount is charged-off as a loss against the allowance for loan losses. For the three months ended March 31, 2014 and 2013, net charge-offs were $123,000 and $729,000, respectively, reflecting partial writedowns or full charge-offs on nonaccrual loans due to the initial and ongoing evaluations of market values of the underlying real estate collateral in accordance with Accounting Standards Codification (“ASC”) 310-40. Regardless of our actions of recording partial and full charge-offs on loans, we continue to aggressively pursue collection, including legal action.

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While regular monthly payments continue to be made on many of the nonaccrual loans, certain charge-offs result, nevertheless, from the borrowers’ inability to provide adequate documentation evidencing their ability to continue to service their debt. Therefore, consideration has been given to any underlying collateral and appropriate charge-offs recorded based, in general, on the deficiency of such collateral. In general, the charge-offs reflect partial writedowns and full charge-offs on nonaccrual loans due to the initial evaluation of market values of the underlying real estate collateral in accordance with ASC 310-40. Management believes the charge-off of these reserves provides a clearer indication of the value of nonaccrual loans.

At March 31, 2014 and December 31, 2013, the Corporation had $16.5 million and $16.6 million, respectively, of loans the terms of which have been modified in troubled debt restructurings. Of these loans, $15.2 million were performing in accordance with their new terms at both March 31, 2014 and December 31, 2013. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $179,000 and $281,000 have been allocated for the troubled debt restructurings at March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014 and December 31, 2013, the Corporation has committed $21,000 and $257,000, respectively, of additional funds to a single customer with an outstanding construction loan that is classified as a troubled debt restructuring.

As of March 31, 2014, there were $12.6 million of other loans not included in the preceding table where credit conditions of borrowers, including real estate tax delinquencies, caused management to have concerns about the possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in disclosure of such loans as nonperforming loans at a future date. These loans have been considered by management in conjunction with the analysis of the adequacy of the allowance for loan losses.

The Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey.

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 of the ratio is risk-based capital. Under the regulations, risk-based capital has been classified into two categories. Tier 1 capital consists of common and qualifying perpetual preferred shareholders’ equity less goodwill and other intangibles. Tier 2 capital consists of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) the excess of qualifying preferred stock, (c) hybrid capital instruments, (d) debt, (e) mandatory convertible securities and (f) qualifying subordinated debt. Total qualifying capital consists of Tier 1 capital and Tier 2 capital less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the FRB (determined on a case-by-case basis or as a matter of policy after formal rule-making). However, the amount of Tier 2 capital may not exceed the amount of Tier 1 capital. At March 31, 2014, 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 under which a bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of at least 3% (in the case of a bank holding company that has the highest regulatory examination rating and is not contemplating significant growth or expansion) is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non-risk-adjusted) for the preceding three months. At March 31, 2014 the minimum leverage ratio requirement to be considered well capitalized was 4%. The following table summarizes the capital ratios for the Corporation and the Bank at March 31, 2014.

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							To Be Well
							Capitalized
				Required for			Under Prompt
				Capital			Corrective
				Adequacy			Action
	Actual			Purposes			Regulations
Leverage ratio
Corporation		9.22	%		4.00	%		N/A
Bank		8.97	%		4.00	%		5.00	%
Risk-based capital
Tier I
Corporation		13.87	%		4.00	%		N/A
Bank		13.47	%		4.00	%		6.00	%
Total
Corporation		15.13	%		8.00	%		N/A
Bank		14.74	%		8.00	%		10.00	%

Liquidity and Capital Resources

The Corporation’s primary sources of funds are deposits, amortization and prepayments 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 interest-earning cash accounts or short-term investments, such as federal funds sold.

Cash and cash equivalents increased $9.8 million during the first three months of 2014. Net operating and investing activities provided $3.6 million and $8.3 million, respectively, and financing activities used $2.1 million.

We anticipate that the Corporation will have sufficient funds available to meet its current contractual commitments. Should we need temporary funding, the Corporation has the ability to borrow overnight with the Federal Home Loan Bank-NY (“FHLB-NY”). The overall borrowing capacity is contingent on available collateral to secure borrowings and the ability to purchase additional activity-based capital stock of the FHLB-NY. The Corporation may also borrow from the Discount Window of the Federal Reserve Bank of New York based on the market value of collateral pledged. In addition, the Corporation has available overnight variable repricing lines of credit with other correspondent banks totaling $21.0 million on an unsecured basis.

With respect to the payment of dividends on common stock, the Corporation has historically paid a quarterly cash dividend; however, management recognizes that the payment of future dividends could be impacted by losses or reduced earnings and the Corporation cannot assure the payment of future dividends. In addition, due to its participation in the United States Treasury’s Small Business Lending Fund (the “SBLF”) program, pursuant to which the Corporation issued 15,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Shares”) to the Treasury for a purchase price of $15.0 million in cash, the Corporation may only declare and pay dividends on its common stock (or any other equity security junior to the Series B Preferred Stock) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and, if after payment of such dividend, the dollar amount of the Corporation’s Tier 1 Capital would be at least 90% of the Tier 1 Capital at the date of entering into the SBLF program excluding any subsequent charge-offs and any redemption of the Series B Preferred Shares. On April 15, 2014, the Corporation announced that its Board of Directors had declared a $0.01 per share cash dividend payable on its common stock to shareholders of record as of May 1, 2014. The dividend is to be paid on May 15, 2014.

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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable to smaller reporting companies.

ITEM 4. Controls and Procedures

Evaluation of internal controls and procedures

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have concluded that our internal disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

Changes in Internal Controls over Financial Reporting

Pursuant to Rule 13a-15(d) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated our internal controls over financial reporting and based upon such evaluation concluded that there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II -- Other Information

Item 6. Exhibits

See Exhibit Index following this report.

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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: May 12, 2014	By:	/s/ Paul Van Ostenbridge
		Paul Van Ostenbridge
		President and Chief Executive Officer
		(Principal Executive Officer)
Date: May 12, 2014	By:	/s/ Claire M. Chadwick
		Claire M. Chadwick
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit Number	Description of Exhibits
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	The following material from Stewardship Financial Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text[1]

¹ This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Corporation specifically incorporates it by reference.

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