form10q-10074_ssfn.htm

 
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, 2009

 
o
TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________

Commission file number 0-21855

Stewardship Financial Corporation
(Exact name of registrant as specified in its charter)
   
New Jersey
22-3351447
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
  
   
630 Godwin Avenue, Midland Park,  NJ
07432
(Address of principal executive offices)
(Zip Code)
   
(201)  444-7100
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by a checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý     No o
 
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 fies). Yes o     No o
 
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o (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 o     No ý

The number of shares outstanding, net of treasury stock, of the Issuer’s Common Stock, no par value, as of May 8, 2009 was 5,536,645.



 
 
 

Stewardship Financial Corporation

INDEX


 
PAGE
 
NUMBER
 
   
 
   
1
   
2
   
3
   
4 - 5
   
6 - 12
   
13 - 19
   
20
   
20
   
21
   
22
   
23



 


Stewardship Financial Corporation and Subsidiary
  
Consolidated Statements of Financial Condition
  
(Unaudited)
  
             
   
March 31,
    
December 31,
  
   
2009
    
2008
  
Assets
            
             
Cash and due from banks
   $ 11,669,000     $ 12,719,000  
Other interest-earning assets
     151,000       95,000  
       Cash and cash equivalents
     11,820,000       12,814,000  
                 
Securities available for sale
     106,577,000       90,023,000  
Securities held to maturity; estimated fair value of $71,784,000 (2009) and
                
    $49,150,000 (2008)
     70,842,000       48,856,000  
FHLB-NY stock, at cost
     3,032,000       2,420,000  
Loans, net of allowance for loan losses of $5,324,000 (2009) and $5,166,000 (2008)
     431,467,000       434,103,000  
Mortgage loans held for sale
     1,968,000       394,000  
Premises and equipment, net
     7,331,000       7,470,000  
Accrued interest receivable
     3,334,000       3,371,000  
Bank owned life insurance
     8,682,000       8,599,000  
Other assets
     3,963,000       3,766,000  
       Total assets
   $ 649,016,000     $ 611,816,000  
                 
Liabilities and stockholders' equity
                
                 
Liabilities
                
Deposits:
                
    Noninterest-bearing
   $ 87,376,000     $ 99,099,000  
    Interest-bearing
     428,094,000       407,432,000  
        Total deposits
     515,470,000       506,531,000  
                 
Other borrowings
     50,500,000       36,900,000  
Subordinated debentures
     7,217,000       7,217,000  
Securities sold under agreements to repurchase
     15,162,000       15,160,000  
Accrued interest payable
     1,747,000       1,582,000  
Accrued expenses and other liabilities
     5,340,000       1,630,000  
        Total liabilities
     595,436,000       569,020,000  
                 
Commitments and contingencies
     -       -  
                 
Stockholders' equity
                
Preferred stock, no par value; 2,500,000 shares authorized; 10,000 shares
                
    issued and outstanding at March 31, 2009.  Liquidation preference of $10,000,000.
     9,692,000       -  
Common stock, no par value; 10,000,000 shares authorized;
                
    5,584,713 and 5,575,095 shares issued: 5,553,645 and 5,555,095 shares
                
    outstanding at March 31, 2009 and December 31, 2008, respectively
     38,294,000       37,962,000  
Treasury stock, 31,068 and 20,000 shares outstanding at March 31, 2009 and
                
    December 31, 2008, respectively
     (379,000 )     (272,000 )
Retained earnings
     4,951,000       4,383,000  
Accumulated other comprehensive income
     1,022,000       723,000  
        Total stockholders' equity
     53,580,000       42,796,000  
                 
        Total liabilities and stockholders' equity
   $ 649,016,000     $ 611,816,000  
                 
                 
See notes to unaudited consolidated financial statements.
                

1

Stewardship Financial Corporation and Subsidiary
  
Consolidated Statements of Income
  
(Unaudited)
  
       
   
Three Months Ended
  
   
March 31,
  
   
2009
    
2008
  
Interest income:
            
Loans
   $ 6,608,000     $ 7,185,000  
Securities held to maturity
                
Taxable
     441,000       204,000  
Non-taxable
     213,000       207,000  
     Securities available for sale
                
Taxable
     1,137,000       994,000  
Non-taxable
     52,000       27,000  
FHLB dividends
     19,000       34,000  
Other interest-earning assets
     3,000       6,000  
Total interest income
     8,473,000       8,657,000  
                 
Interest expense:
                
Deposits
     2,372,000       2,910,000  
Borrowed money
     503,000       585,000  
Total interest expense
     2,875,000       3,495,000  
                 
Net interest income before provision for loan losses
     5,598,000       5,162,000  
Provision for loan losses
     150,000       100,000  
Net interest income after provision for loan losses
     5,448,000       5,062,000  
                 
Noninterest income:
                
Fees and service charges
     396,000       295,000  
Bank owned life insurance
     83,000       81,000  
Gain on sales of mortgage loans
     11,000       55,000  
Gain on calls and sales of securities
     39,000       41,000  
Merchant processing
     118,000       369,000  
Other
     60,000       135,000  
Total noninterest income
     707,000       976,000  
                 
Noninterest expenses:
                
Salaries and employee benefits
     2,059,000       2,016,000  
Occupancy, net
     472,000       449,000  
Equipment
     265,000       273,000  
Data processing
     305,000       308,000  
FDIC insurance premium
     170,000       73,000  
Charitable contributions
     171,000       162,000  
Stationery and supplies
     59,000       111,000  
Merchant processing
     108,000       325,000  
Other
     799,000       762,000  
Total noninterest expenses
     4,408,000       4,479,000  
                 
Income before income tax expense
     1,747,000       1,559,000  
Income tax expense
     560,000       498,000  
Net income
     1,187,000       1,061,000  
Dividends on preferred stock and accretion
     92,000       -  
Net income available to common stockholders
   $ 1,095,000     $ 1,061,000  
                 
Basic earnings per common share
   $ 0.20     $ 0.19  
Diluted earnings per common share
   $ 0.20     $ 0.19  
                 
Weighted average number of common shares outstanding
     5,551,734       5,576,090  
Weighted average number of diluted common
                
     shares outstanding
     5,557,098       5,591,517  
                 
Share data has been restated to reflect a 5% stock dividend paid November 17, 2008.
                
                 
                 
See notes to unaudited consolidated financial statements.
                

2


Stewardship Financial Corporation and Subsidiary
  
Consolidated Statement of Changes in Stockholders' Equity
  
(Unaudited)
  
                                           
                                           
   
Three Months Ended March 31, 2009
  
                                 
Accumulated
        
                                 
Other
        
                                 
Comprehensive
        
   
Preferred
    
Common Stock
    
Treasury
    
Retained
    
Gain (Loss),
        
   
Stock
    
Shares
    
Amount
    
Stock
    
Earnings
    
Net
    
Total
  
                                           
Balance -- December 31, 2008
   $ -       5,575,095     $ 37,962,000     $ (272,000 )   $ 4,383,000     $ 723,000     $ 42,796,000  
Proceeds from issuance of preferred
                                                        
    stock and a warrant
     9,731,000               269,000                               10,000,000  
Preferred stock issuance costs
     (49,000 )                                             (49,000 )
Cash dividends paid on common stock
     -       -       -       -       (527,000 )     -       (527,000 )
Payment of discount on dividend
                                                        
    reinvestment plan
     -       -       (11,000 )     -       -       -       (11,000 )
Cash dividends accrued on preferred
                                                        
    stock
     -       -       -       -       (84,000 )     -       (84,000 )
Common stock issued under stock plans
     -       2,288       22,000       -       -       -       22,000  
Stock option compensation expense
     -       -       12,000       -       -       -       12,000  
Stock options exercised
     -       7,330       40,000       (32,000 )     -       -       8,000  
Repurchase of common stock
     -       -       -       (75,000 )     -       -       (75,000 )
Accretion of discount on preferred
                                                        
    stock
     8,000       -       -       -       (8,000 )             -  
Amortization of issuance costs
     2,000       -       -       -       -               2,000  
Comprehensive income:
                                                        
Net income
     -       -       -       -       1,187,000       -       1,187,000  
   Change in unrealized holding gains on
                                                        
     securities available for sale arising during
                                                        
     the period (net tax expense of $177,000)
     -       -       -       -       -       275,000       275,000  
   Reclassification adjustment for gains in
                                                        
     net income (net of taxes of $15,000)
     -       -       -       -       -       24,000       24,000  
Total comprehensive income
                                                     1,486,000  
                                                         
Balance -- March 31, 2009
   $ 9,692,000       5,584,713     $ 38,294,000     $ (379,000 )   $ 4,951,000     $ 1,022,000     $ 53,580,000  
                                                         
   
Three Months Ended March 31, 2008
  
                                           
Accumulated
          
                                           
Other
          
                                           
Comprehensive
          
           
Common Stock
    
Treasury
    
Retained
    
Gain (Loss),
          
   
Amount
    
Shares
    
Amount
    
Stock
    
Earnings
    
Net
    
Total
  
                                                         
Balance -- December 31, 2007
   $ -       5,306,828     $ 34,871,000     $ -     $ 5,943,000     $ 276,000     $ 41,090,000  
Cash dividends paid on common stock
     -       -       -       -       (478,000 )     -       (478,000 )
Payment of discount on dividend
                                                        
    reinvestment plan
     -       -       (11,000 )     -       -       -       (11,000 )
Common stock issued under stock plans
     -       1,667       21,000       -       -       -       21,000  
Stock option compensation expense
     -       -       12,000       -       -       -       12,000  
Stock options exercised
     -       8,976       43,000       (21,000 )     -       -       22,000  
Comprehensive income:
                                                        
   Net income
     -       -       -       -       1,061,000       -       1,061,000  
   Change in unrealized holding gains on
                                                        
     securities available for sale arising during
                                                        
     the period (net tax benefit of $249,000)
     -       -       -       -       -       397,000       397,000  
   Reclassification adjustment for gains
                                                        
     in net income (net taxes of $17,000)
     -       -       -       -       -       24,000       24,000  
Total comprehensive income
                                                     1,482,000  
                                                         
Balance -- March 31, 2008
   $ -       5,317,471     $ 34,936,000     $ (21,000 )   $ 6,526,000     $ 697,000     $ 42,138,000  
                                                         
See notes to unaudited consolidated financial statements.
                                                  

3


Stewardship Financial Corporation and Subsidiary
  
Consolidated Statements of Cash Flows
  
(Unaudited)
  
       
   
Three Months Ended
  
   
March 31,
  
   
2009
  
2008
  
Cash flows from operating activities:
            
Net income
   $ 1,187,000     $ 1,061,000  
Adjustments to reconcile net income to
                
net cash provided by operating activities:
                
Depreciation and amortization of premises and equipment
     210,000       240,000  
Amortization of premiums and accretion of discounts, net
     123,000       30,000  
Accretion of deferred loan fees
     (56,000 )     (59,000 )
Provision for loan losses
     150,000       100,000  
Originations of mortgage loans held for sale
     (2,948,000 )     (5,642,000 )
Proceeds from sale of mortgage loans
     1,385,000       4,736,000  
Gain on sale of loans
     (11,000 )     (55,000 )
Gain on calls and sales of securities
     (39,000 )     (41,000 )
Loss on sale of equipment
     -       12,000  
Deferred income tax benefit
     (69,000 )     (50,000 )
Amortization of intangible assets
     8,000       8,000  
Nonqualified stock option expense
     12,000       12,000  
Amortization of stock issuance costs
     2,000       -  
Increase in bank owned life insurance
     (83,000 )     (81,000 )
Decrease in accrued interest receivable
     37,000       99,000  
(Increase) decrease in other assets
     (328,000 )     86,000  
Increase (decrease) in accrued interest payable
     165,000       (235,000 )
Increase in other liabilities
     615,000       33,000  
Net cash provided by operating activities
     360,000       254,000  
                 
Cash flows from investing activities:
                
Purchase of securities available for sale
     (30,248,000 )     (18,442,000 )
Proceeds from maturities and principal repayments on securities available for sale
     2,730,000       1,746,000  
Proceeds from calls and sales on securities available for sale
     11,417,000       7,316,000  
Purchase of securities held to maturity
     (24,289,000 )     (404,000 )
Proceeds from maturities and principal repayments on securities held to maturity
     1,018,000       412,000  
Proceeds from calls on securities held to maturity
     4,250,000       3,770,000  
Purchase of FHLB-NY stock
     (612,000 )     (575,000 )
Net decrease (increase) in loans
     2,542,000       (5,137,000 )
Additions to premises and equipment
     (71,000 )     (170,000 )
Sale of equipment
     -       4,000  
                 Net cash used in investing activities
     (33,263,000 )     (11,480,000 )
                 
Cash flows from financing activities:
                
Net decrease in noninterest-bearing deposits
     (11,723,000 )     (6,496,000 )
Net increase in interest-bearing deposits
     20,662,000       10,764,000  
Net increase (decrease) in securities sold under agreements to repurchase
     2,000       (775,000 )
Proceeds from term borrowings
     6,000,000       30,000,000  
Net increase (decrease) in short term borrowings
     7,600,000       (16,800,000 )
Payments on long term borrowings
     -       (420,000 )
Proceeds from issuance of preferred stock and warrants
     9,951,000       -  
Cash dividends paid on common stock
     (527,000 )     (478,000 )
Payment of discount on dividend reinvestment plan
     (11,000 )     (11,000 )
Purchase of treasury stock
     (75,000 )     -  
Options exercised
     8,000       22,000  
Issuance of common stock
     22,000       21,000  
Net cash provided by financing activities
     31,909,000       15,827,000  
                 
Net (decrease) increase in cash and cash equivalents
     (994,000 )     4,601,000  
Cash and cash equivalents - beginning
     12,814,000       11,932,000  
Cash and cash equivalents - ending
   $ 11,820,000     $ 16,533,000  

4


Stewardship Financial Corporation and Subsidiary
  
Consolidated Statements of Cash Flows (continued)
  
(Unaudited)
  
     
   
  Three Months Ended
  
   
  March 31,
  
   
2009
  
2008
  
Supplemental disclosures of cash flow information:
            
Cash paid during the period for interest
   $ 2,710,000     $ 3,729,000  
Cash paid during the period for income taxes
   $ -     $ -  
Noncash investing activities - security purchases due brokers
   $ 3,010,000     $ 1,209,000  
                 
                 
See notes to unaudited consolidated financial statements.
                

5

Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
March 31, 2009
(Unaudited)


Note 1.   Summary of Significant Accounting Policies

Certain information and footnote disclosures normally included in the unaudited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

Principles of consolidation

The consolidated financial statements include the accounts of Stewardship Financial Corporation (the “Corporation”) and its wholly owned subsidiary, Atlantic Stewardship Bank (the “Bank”).  The Bank includes its wholly owned subsidiaries, Stewardship Investment Corp., Stewardship Realty, LLC and Atlantic Stewardship Insurance Company, LLC.  All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.  Certain prior period amounts have been reclassified to conform to the current presentation.  The consolidated financial statements of the Corporation have been prepared in conformity with accounting principles generally accepted in the United States of America.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the statements of financial condition and revenues and expenses during the reporting periods.  Actual results could differ significantly from those estimates.

Material estimates

Material estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses and fair value of financial instruments.  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.

Basis of presentation

The interim unaudited consolidated financial statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the SEC and, therefore, do not include information or footnotes necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America.  However, all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of the consolidated financial statements, have been included.  The results of operations for the three months ended March 31, 2009 are not necessarily indicative of the results which may be expected for the entire year.  All share and per share amounts have been restated for stock splits and stock dividends.

Adoption of New Accounting Standards

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination.  The adoption SFAS 141(R) did not have a material effect on the Corporation’s results of operations or financial position.

In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51”  (“SFAS 160”), which changes the accounting and reporting for minority interests, which are now re-characterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheet.  The adoption of SFAS No. 160 did not have a significant impact on the Corporation’s results of operations or financial position.

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133” (“SFAS 161”).   SFAS 161 amends and expands the disclosure requirements of SFAS 133 for derivative instruments and hedging activities.  SFAS 161 requires qualitative disclosure about objectives and strategies

6

for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements.  The adoption of SFAS 161 did not have a material effect on the Corporation’s results of operations or financial position.

Recently Issued But Not Yet Effective Accounting Standards

In April 2009, the FASB issued Staff Position No. 107-1 and APB 28-1 (“FSP 107-1”), Interim Disclosures about Fair Value of Financial Instruments. FSP 107-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required in annual financial statements. FSP 107-1 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  The Corporation plans to adopt this FSP in the second quarter.  The adoption of FSP 107-1 is not expected to have a material effect on the Corporation’s results of operations or financial position.

In April 2009, the FASB issued Staff Position No. 115-2 and FAS 124-2(“FSP 115-2 / 124-2”), Recognition and presentation of Other-Than-Temporary Impairments, which amends existing guidance for determining whether impairment is other-than-temporary for debt securities.  FSP 115-2 / 124-2 requires an entity to access whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis.  If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings.  For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.    Additionally, this FSP expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities.  FSP 115-2 / 124-2 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  The Corporation plans to adopt this FSP in the second quarter.  The adoption of FSP 115-2 / 124-2 is not expected to have a material effect on the Corporation’s results of operations or financial position.

In April 2009, the FASB issued Staff Position 157-4 (“FSP 157-4”), Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.  FSP 157-4 emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants.  The FSP provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity.   In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value.  The FSP also requires increased disclosures.  FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009 and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009.  The Corporation plans to adopt this FSP in the second quarter.  The adoption of FSP 157-4 is not expected to have a material effect on the Corporation’s results of operations or financial position.


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, 2009
  
         
Gross
    
Gross
  
   
Fair
    
Unrealized
    
Unrealized
  
   
Value
    
Holding Gains
    
Holding Losses
  
                   
U.S. government-sponsored agencies
   $ 42,884,000     $ 498,000     $ 133,000  
Obligations of state and political
                        
  subdivisions
     5,722,000       47,000       76,000  
Mortgage-backed securities
     55,004,000       1,329,000       2,000  
Other securities
     2,967,000       25,000       4,000  
    $ 106,577,000     $ 1,899,000     $ 215,000  
                         
   
December 31, 2008
  
           
Gross
    
Gross
  
   
Fair
    
Unrealized
    
Unrealized
  
   
Value
    
Holding Gains
    
Holding Losses
  
                         
U.S. government-sponsored agencies
   $ 49,660,000     $ 741,000     $ 30,000  
Obligations of state and political
                        
  subdivisions
     5,820,000       6,000       190,000  
Mortgage-backed securities
     31,670,000       716,000       15,000  
Other securities
     2,873,000       -       35,000  
    $ 90,023,000     $ 1,463,000     $ 270,000  

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

   
March 31, 2009
  
         
Gross
    
Gross
        
   
Carrying
    
Unrecognized
    
Unrecognized
    
Fair
  
   
Value
    
Holding Gains
    
Holding Losses
    
Value
  
                         
U.S. government-sponsored agencies
   $ 28,753,000     $ 157,000     $ 163,000     $ 28,747,000  
Obligations of state and political
                                
  subdivisions
     23,617,000       545,000       131,000       24,031,000  
Mortgage-backed securities
     18,472,000       535,000     $ 1,000       19,006,000  
    $ 70,842,000     $ 1,237,000     $ 295,000     $ 71,784,000  
                                 
   
December 31, 2008
  
           
Gross
    
Gross
          
   
Carrying
    
Unrecognized
    
Unrecognized
    
Fair
  
   
Value
    
Holding Gains
    
Holding Losses
    
Value
  
                                 
U.S. government-sponsored agencies
   $ 10,290,000     $ 217,000     $ -     $ 10,507,000  
Obligations of state and political
                                
  subdivisions
     23,048,000       110,000       301,000       22,857,000  
Mortgage-backed securities
     15,518,000       271,000       3,000       15,786,000  
    $ 48,856,000     $ 598,000     $ 304,000     $ 49,150,000  

On a quarterly basis, the Corporation makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security is impaired on an other-than-temporary basis.  The Corporation considers many factors including the length of time the security has had a market value less than the cost basis; the intent

8

and ability of the Corporation to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry.  Management considers the decline in market value of these securities to be temporary.

Mortgage-backed securities are comprised primarily of government agencies such as the Government National Mortgage Association ("GNMA") and government-sponsored agencies such as the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Banks ("FHLB") and the Federal Home Loan Mortgage Corporation (“FHLMC”).

Note 3.   Loans

The following table sets forth the composition of loans:


   
March 31,
    
December 31,
  
   
2009
    
2008
  
             
Mortgage
            
  Residential
   $ 39,690,000     $ 40,337,000  
  Commercial
     229,333,000       226,183,000  
Commercial
     96,587,000       100,282,000  
Equity
     22,803,000       21,208,000  
Installment
     48,398,000       51,290,000  
Other
     385,000       356,000  
       Total loans
     437,196,000       439,656,000  
                 
Less:    Deferred loan fees     405,000       387,000  
  Allowance for loan losses
     5,324,000       5,166,000  
      5,729,000       5,553,000  
                 
  Loans, net
   $ 431,467,000     $ 434,103,000  

Note 4.   Allowance for Loan Losses

   
Three Months Ended March 31,
  
   
2009
    
2008
  
             
Balance, beginning of period
   $ 5,166,000     $ 4,457,000  
Provision charged to operations
     150,000       100,000  
Recoveries of loans charged off
     87,000       18,000  
Loans charged off
     (79,000 )     (4,000 )
                 
Balance, end of period
   $ 5,324,000     $ 4,571,000  

Note 5.   Loan Impairment

The Corporation has defined the population of impaired loans to include all nonaccrual loans.  The following table sets forth information regarding the impaired loans as of the periods indicated.

 
   
March 31,
    
December 31,
  
   
2009
    
2008
  
             
Impaired loans
            
    With related allowance for loan losses
   $ 2,981,000     $ 2,762,000  
    Without related allowance for loan losses
     3,611,000       1,468,000  
Total impaired loans
   $ 6,592,000     $ 4,230,000  
                 
Related allowance for loan losses
   $ 655,000     $ 481,000  


9

Note 6.   Fair Value

Statement of Financial Accounting Standard No. 157, “Fair Value Measurements“, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes 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 securities available for sale 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).

The Company measures impairment of collateralized loans based on the estimated fair value of the collateral less estimated costs to sell, incorporating assumptions that experienced parties might use in estimating the value of such collateral (Level 3 inputs).

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 at Using:
  
   
Carrying
Value
    
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs (Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
  
   
At March 31, 2009
  
Assets:
                        
Available for sale securities
   $ 106,577,000     $ -     $ 106,577,000     $ -  
               
   
At December 31, 2008
  
Assets:
                                
Available for sale securities
   $ 90,023,000     $ -     $ 90,023,000     $ -  

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:
  
   
Carrying
Value
    
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
  
   
At March 31, 2009
  
Assets:
                        
Impaired loans
   $ 2,326,000     $ -     $ -     $ 2,326,000  
                                 
   
At December 31, 2008
  
Assets:
                                
Impaired loans
   $ 2,281,000     $ -     $ -     $ 2,281,000  


10

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2,981,000 at March 31, 2009, with a valuation allowance of $655,000, resulting in an additional provision for loan losses of $174,000 for the three months ended March 31, 2009.

Note 7.   Earnings Per Share

Basic earnings per share is calculated by dividing net income available to common stockholders by the average daily number of common shares outstanding during the period.  Common stock equivalents are not included in the calculation.  Diluted earnings per share is computed similar to that of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potential dilutive common shares were issued.

The following is a reconciliation of the calculation of basic and diluted earnings per share.

 
   
Three Months Ended
  
   
March 31,
  
   
2009
    
2008
  
   
(in thousands, except per share data)
  
             
Net income
   $ 1,187     $ 1,061  
Dividends on preferred stock and accretion
     92       -  
Net income available to common stockholders
   $ 1,095     $ 1,061  
                 
Weighted average shares
     5,552       5,576  
Effect of dilutive stock options
     5       16  
Total weighted average dilutive shares
     5,557       5,592  
                 
Basic earnings per common share
   $ 0.20     $ 0.19  
                 
Diluted earnings per common share
   $ 0.20     $ 0.19  

Stock options to purchase 67,295 and 54,408 average shares of common stock were not considered in computing diluted earnings per share for the three months ended March 31, 2009 and 2008, respectively, because they were antidilutive.   A common stock warrant to purchase 84,746 average shares of common stock was not considered in computing diluted earnings per share for the three months ended March 31, 2009 because it was antidilutive.

All share and per share amounts have been restated to reflect a 5% stock dividend declared on September 16, 2008 and payable November 17, 2008.

Note 8.   Preferred Stock

On January 30, 2009, in exchange for issuing 10,000 shares of Series A Preferred Stock (the “Senior Preferred Shares”) and a warrant to purchase 127,119 shares of common stock, the Corporation received $10.0 million as part of the United States Treasury Department’s Capital Purchase Program (“CPP”).  

The Senior Preferred Shares pay a cumulative dividend of 5% per annum for the first five years and 9% per annum thereafter.  Dividends are payable quarterly in arrears and the Corporation accrues the preferred dividends as earned over the period the Senior Preferred Shares are outstanding.

The warrant to purchase 127,119 of common shares has an exercise price of $11.80 per share.  The exercise price for the warrant was calculated based on the average of the closing prices of the Corporation’s common stock on the 20 trading days ending on the last trading day prior to the date of the Treasury’s approval of the Corporation’s application under the program.

Of the $10 million of proceeds, $9.7 million was allocated to the Senior Preferred Shares and $269,000 was allocated to the warrant based on their estimated relative fair values as of January 30, 2009.  The resulting discount on the Senior Preferred Shares of $269,000 is being accreted through a charge to retained earnings over an estimated five year life using an effective yield method.  The Senior Preferred Shares and warrant issued under the CPP are includable in Tier I capital for regulatory capital.

11


The Corporation may repay the funds provided under the CPP without regard to whether the Corporation has replaced such funds from any other source or to any waiting period, subject to regulatory approval.  Until the earlier of the third anniversary of the Treasury’s investment in the Senior Preferred Shares or when all of the Senior Preferred Shares have been redeemed by the Corporation or transferred by the Treasury to third parties, the Corporation may not, without the consent of the Treasury, increase the common stock cash dividend.




12

Stewardship Financial Corporation
Management’s Discussion and Analysis of
Financial Condition and Results of Operations


Cautionary Note Regarding Forward-Looking Statements

This Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, and may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “plan,” “estimated,” and “potential.”  Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of the Corporation that are subject to various factors which could cause actual results to differ materially from these estimates.  These factors include: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects the Corporation’s interest rate spread or other income anticipated from operations and investments.  As used in this Form 10-Q, “we” and “us” and “our” refer to Stewardship Financial Corporation and its consolidated subsidiary, Atlantic Stewardship Bank, depending on the context.

Critical Accounting Policies and Estimates

“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures found elsewhere in this Form 10-Q, are based upon the Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.  Note 1 to the Corporation’s Audited Consolidated Financial Statements for the year ended December 31, 2008 included in our Annual Report on Form 10-K for the year ended December 31, 2008, as supplemented by this 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 policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.

The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full 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 an adverse economic shock.  Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.

Financial Condition

Total assets increased by $37.2 million, or 6.1%, from $611.8 million at December 31, 2008 to $649.0 million at March 31, 2009.  Securities available for sale and securities held to maturity increased $16.6 million and $22.0 million, respectively.  The overall increase in securities was primarily attributable to the initial investing and leveraging of the $10.0 million of funds received under the Capital Purchase Program principally in mortgage-backed securities.  The cash flows from the amortization of the mortgage-backed securities will be utilized to continue to fund loan growth.  Net loans decreased $2.6 million due, in part, to the sale of $2.0 million of loan participations.

Deposits totaled $515.5 million at March 31, 2009, an increase of $8.9 million, or 1.8%, from $506.5 million at December 31, 2008.  The Corporation introduced its Power Rate Checking to customers during the first quarter of 2009.  This free checking account rewards customers with a high rate of interest for meeting three simple qualifications that assist the Bank in reducing our account related expenses.  A new online business product is being rolled out in the second quarter of 2009.

13

These products and services will allow us to continue to attract new personal and business core deposits.  A $13.6 million increase in other borrowings reflects funds utilized to accomplish the leveraging of the $10 million of CPP funds.

Results of Operations for the Three Months Ended March 31, 2009 and 2008

General

The Corporation reported net income of $1.2 million, or $0.20 diluted earnings per common share for the three months ended March 31, 2009, compared to $1.1 million, or $0.19 diluted earnings per common share for the comparable prior year period.

Net Interest Income

Net interest income for the three months ended March 31, 2009 was $5.6 million compared to $5.2 million recorded in the prior year period.  The increase in the current year period is primarily attributable to a decline in the cost of interest bearing liabilities.  The net interest rate spread and net yield on interest earning assets for the three months ended March 31, 2009 were 3.42% and 3.87%, respectively, compared to 3.23% and 3.94% for the three months ended March 31, 2008.  The  net yield on interest earning assets during the current year period reflects both a decline in loan interest rates and yields on securities as well as a decline in the interest rates on deposits and borrowings.

The following table reflects the components of the Corporation’s net interest income for the three months ended March 31, 2009 and 2008 including, (1) average assets, liabilities, and stockholders’ 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.

14



Analysis of Net Interest Income (Unaudited)
  
For the Three Months Ended March 31,
  
                                     
 
2009
    
2008
  
               
Average
                
Average
  
         
Interest
    
Rates
          
Interest
    
Rates
  
 
Average
    
Income/
    
Earned/
    
Average
    
Income/
    
Earned/
  
 
Balance
    
Expense
    
Paid
    
Balance
    
Expense
    
Paid
  
 
(Dollars in thousands)
  
                                     
Assets
                                    
                                     
Interest-earning assets:
                                    
Loans (1) (2)
   $ 436,926     $ 6,619       6.14 %   $ 424,449     $ 7,196       6.88 %
Taxable investment securities (1)
     134,749       1,597       4.81       95,002       1,232       5.26  
Tax-exempt investment securities (1) (2)
     28,938       390       5.47       25,698       341       5.38  
Other interest-earning assets
     84       3       9.66       222       6       10.96  
Total interest-earning assets
     600,697       8,609       5.81       545,371       8,775       6.52  
                                                 
Non-interest-earning assets:
                                                
Allowance for loan losses
     (5,214 )                     (4,488 )                
Other assets
     35,413                       33,062                  
Total assets
   $ 630,896                     $ 573,945                  
                                                 
                                                 
Liabilities and Stockholders' Equity
                                                
                                                 
Interest-bearing liabilities:
                                                
Interest-bearing demand deposits
   $ 167,280     $ 517       1.25 %   $ 155,341     $ 870       2.27 %
Savings deposits
     40,377       58       0.58       36,398       69       0.77  
Time deposits
     211,891       1,797       3.44       175,882       1,971       4.54  
Repurchase agreements
     15,162       189       5.06       16,683       143       3.48  
FHLB borrowing
     46,139       230       2.02       38,958       318       3.31  
Subordinated debenture
     7,217       84       4.72       7,217       124       6.97  
Total interest-bearing liabilities
     488,066       2,875       2.39       430,479       3,495       3.29  
Non-interest-bearing liabilities:
                                                
Demand deposits
     88,792                       97,183                  
Other liabilities
     4,562                       4,838                  
Stockholders' equity
     49,476                       41,445                  
Total liabilities and stockholders' equity
   $ 630,896                     $ 573,945                  
                                                 
Net interest income (taxable equivalent basis)
       5,734                       5,280          
Tax Equivalent adjustment
             (136 )                     (118 )        
Net interest income
           $ 5,598                     $ 5,162          
                                                 
Net interest spread (taxable equivalent basis)
               3.42 %                     3.23 %
                                                 
Net yield on interest-earning
                                                
  assets (taxable equivalent basis) (3)
                     3.87 %                     3.94 %
                                                 
_______________________                                                 
                                                 
(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.
                  


15

For the three months ended March 31, 2009, total interest income on a tax equivalent basis decreased $166,000, or 1.9%, when compared to the three months ended March 31, 2008 primarily due to a decrease in the total yield on interest-earning assets, partially offset by an increase in the average earning assets.  The average rate earned on interest-earning assets was 5.81% for the three months ended March 31, 2009 compared to an average rate of 6.52% for the same prior year period.  The average yield on the loan portfolio decreased 74 basis points when comparing the three months ended March 31, 2009 to the three months ended March 31, 2008.  The decline in short-term interest rates during 2008 resulted in a Prime rate of 3.25% at March 31, 2009 compared to a Prime rate of 5.25% a year earlier.  The decline in short-term rates resulted in loans resetting during the past year at lower interest rates, thereby contributing to the decline in yields on earning assets.  Average interest-earning assets increased $55.3 million for the three months ended March 31, 2009 when compared to the prior year period.  The increase is primarily attributable to an increase in loans due to demand and an increase in taxable investment securities as a result of the previously mentioned leverage strategy.  Average loans increased $12.5 million to an average of $436.9 million for the three months ended March 31, 2009, from an average of $424.4 million for the comparable period in 2008.  Taxable investment securities of $134.7 million for the three months ended March 31, 2009 represent an increase of $39.7 million when compared to the same prior year period.

Interest paid on deposits and borrowed money decreased $620,000, or 17.7% for the three months ended March 31, 2009 compared to the same period for 2008.  The decline is due to a decrease in rates paid on deposits and borrowings, partially offset by an increase in average interest-bearing liabilities.  The average balance of total interest-bearing deposits and borrowings increased $57.6 million for the three months ended March 31, 2009 from the comparable 2008 period.  In addition to the Corporation’s expanding customer base, the increase in average interest-bearing liabilities was a result of increased borrowings to complete the leveraging of the $10 million of CPP funds.  For the three months ended March 31, 2009, the total cost for interest-bearing liabilities declined to 2.39% representing a 90 basis point decline 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 market value of the 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, serve to reduce the allowance.  The appropriate level of the allowance for loan losses is based on estimates, and ultimate losses may vary from the current estimates.

The loan loss provision totaled $150,000 for the three months ended March 31, 2009.  For the three months ended March 31, 2008 the provision for loan losses was $100,000.  Nonaccrual loans increased from $4.2 million at December 31, 2008 to $6.6 million at March 31, 2009.  The allowance for loan losses related to the impaired loans increased from $481,000 at December 31, 2008 to $655,000 million at March 31, 2009.  The current period loan loss provision primarily reflects the increase in impaired loans.  The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio and general market conditions.

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

Noninterest Income

For the three ended March 31, 2009, noninterest income was $707,000 compared to $976,000 for the prior year period.  As previously reported, on December 31, 2008, the Corporation sold its merchant servicing portfolio and, as a result, a decline of $251,000 in noninterest income as well as a $217,000 decline in noninterest expense is reflected for the three months ended March 31, 2009. Gains on sales of mortgage loans were $11,000 for the three months ended March 31, 2009, a decrease when compared to $55,000 for the three months ended March 31, 2008.  When compared to the prior year, the three months ended March 31, 2009 reflects a decrease in mortgage activity due to the challenging real estate market.  This decrease in activity resulted in a decline in the volume of loans sold and ultimately, a decline in gains on mortgages sold.  Mortgage loan application activity increased during the first quarter of 2009 and such activity should ultimately translate into additional gain on sales of mortgage loans.

Noninterest Expense

Noninterest expenses for the three months ended March 31, 2009 was $4.4 million and $4.5 million for the comparable prior year period.  As previously reported, on December 31, 2008, the Corporation sold its merchant servicing portfolio and, as a result, a $217,000 decline in noninterest expense as well as a decline of $251,000 in noninterest income is reflected for the three months ended March 31, 2009. FDIC insurance premiums increased $97,000 for the three months

16

ended March 31, 2009 when compared to the three months ended March 31, 2008, reflecting a general increase in the assessment of insurance as well as in increase in deposits.

Income Tax Expense

Income tax expense totaled $560,000 for the three months ended March 31, 2009 compared to an income tax expense of $498,000 for the three months ended March 31, 2008.  The effective tax rate for the three months ended March 31, 2009 was 32.1% compared to 31.9% for the three months ended March 31, 2008.

Asset Quality

The Corporation’s principal earning assets are its loans to businesses and individuals located in northern New Jersey.  Inherent in the lending function is the risk of deterioration in the borrowers’ ability to repay their loans under their existing loan agreements.  Risk elements include nonaccrual loans, past due and restructured loans, potential problem loans, loan concentrations and other real estate owned.  The following table shows the composition of nonperforming assets at the end of the last four quarters:


   
March 31,
    
December 31,
    
September 30,
    
June 30,
  
   
2009
    
2008
    
2008
    
2008
  
                         
Nonaccrual loans (1)
   $ 6,592     $ 4,230     $ 6,884     $ 451  
Loans past due 90 days or more and accruing (2)
     414       353       268       840  
Total nonperforming loans
     7,006       4,583       7,152       1,291  
                                 
Restructured loans
     2,375       1,855       -       -  
                                 
Total nonperforming loans
   $ 9,381     $ 6,438     $ 7,152     $ 1,291  
                                 
Allowance for loan losses
   $ 5,324     $ 5,166     $ 5,930     $ 4,768  
                                 
Nonperforming loans to total loans
     2.15 %     1.46 %     1.61 %     0.29 %
Nonperforming loans to total assets
     1.45 %     1.05 %     1.17 %     0.21 %
Allowance for loan losses to total loans
     1.22 %     1.18 %     1.34 %     1.09 %
Allowance for loan losses to
                                
nonperforming loans
     56.75 %     80.24 %     82.91 %     369.33 %


(1)  Generally represents loans to which the payments of principal or interest are in arrears for a period of more than 90 days.  Interest previously accrued on these loans and not yet paid is reversed and charged against income during the current period.  Interest earned thereafter is only included in income to the extent that it is received in cash.

(2)  Represents loans to which payments of principal or interest are 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.

The nonaccrual loans are comprised of 24 loans, primarily commercial mortgage, residential mortgage and commercial loans.  While the Corporation maintains strong underwriting requirements, the increase is reflective of the current economic and real estate environment.

As of March 31, 2009, there were $17.8 million of other loans not included in the above table, where credit conditions of borrowers 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 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.

17

Interest Rate Sensitivity
 
The Corporation’s primary exposure to market risk arises from changes in market interest rates (“interest rate risk”).  The Corporation’s profitability is largely dependent upon its ability to manage interest rate risk.  Interest rate risk can be defined as the exposure of the Corporation’s net interest income to adverse movements in interest rates.

The Corporation manages its interest rate risk by utilizing an asset/liability simulation model and by measuring and managing its interest sensitivity gap.  The simulation model analyzes the sensitivity of net interest income to movements in interest rates.  The simulation model projects net interest income, net income, net margin, and capital to asset ratios based on various interest rate scenarios over a twelve-month period.  The model is based on the actual maturity and repricing characteristics of all rate sensitive assets and liabilities.  Management incorporates into the model certain assumptions regarding prepayments of certain assets and liabilities.  Assumptions have been built into the model for prepayments for assets and decay rates for nonmaturity deposits such as savings and interest bearing demand.  The model assumes an immediate rate shock to interest rates without management’s ability to proactively change the mix of assets or liabilities.  According to reports generated for the quarter ended March 31, 2009, an immediate interest rate increase of 200 basis points would have resulted in a decrease in net interest income of 8.5%, or $2.1 million, while an immediate decrease of 200 basis points would have resulted in a decrease in net interest income of 2.5%, or $626,000.  Management has a goal to maintain a percentage change of no more than 17.5% given a 200 basis point change in interest rates.  Management cannot provide any assurance about the actual effect of changes in interest rates on the Corporation’s net interest income.

The Corporation does not have any material exposure to foreign currency exchange rate risk or commodity price risk.  The Corporation did not enter into any market sensitive instruments for trading purposes nor did it engage in any hedging transactions utilizing derivative financial instruments during the three months ended March 31, 2009.

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These instruments include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statement of condition.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The Corporation evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the counter-party.  Standby letters of credit are conditional commitments issued by the Corporation to guarantee payment or performance of a customer to a third party up to a stipulated amount and with specified terms and conditions.  Commitments to extend credit and standby letters of credit are not recorded on the Corporation’s consolidated balance sheet until the instrument is exercised.
 
Capital Adequacy
 
The Corporation is subject to capital adequacy guidelines promulgated by the Board of Governors of the Federal Reserve System (“FRB”).  The Bank is subject to similar capital adequacy requirements imposed by the Federal Deposit Insurance Corporation.  The FRB has issued regulations to define the adequacy of capital based upon the sensitivity of assets and off-balance sheet exposures to risk factors.   Four categories of risk weights (0%, 20%, 50%, and 100%) were established to be applied to different types of balance sheet assets and off-balance sheet exposures.  The aggregate of the risk-weighted items (risk-based assets) is the denominator of the ratio, the numerator is risk-based capital.  Under the regulations, risk-based capital has been classified into two categories.  Tier 1 capital includes common and qualifying perpetual preferred stockholders’ equity less goodwill.  Tier 2 capital includes mandatory convertible debt, allowance for loan losses, subject to certain limitations, and certain subordinated and term debt securities.  Total qualifying capital consists of Tier 1 capital and Tier 2 capital; however; the amount of Tier 2 capital may not exceed the amount of Tier 1 capital.  At March 31, 2009, the minimum risk-based capital requirements to be considered adequately capitalized were 4% for Tier 1 capital and 8% for total capital.


18

Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures.  The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non risk-adjusted) for the preceding quarter.  At March 31, 2009 the minimum leverage ratio requirement to be considered well capitalized was 4%.  The following table reflects the Corporation’s capital ratios at March 31, 2009.

 
Required
Actual
Excess
       
Leverage Ratio
4.00%
9.44%
5.44%
Risk-based Capital
      
Tier 1
4.00%
12.52%
8.52%
Total
8.00%
13.64%
5.64%

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 short-term investments, such as federal funds sold.

Cash and cash equivalents decreased $1.0 million during the first three months of 2009.  Net operating and financing activities provided $361,000 and $31.9 million, respectively, and investing activities used $33.3 million.

19

ITEM 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable to smaller reporting companies.

ITEM 4T.  Controls and Procedures

 
(a)
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 controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) 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.

 
(b)
Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and can only provide reasonable assurance with respect to financial statement preparation.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

We assessed the effectiveness of our internal control over financial reporting as of March 31, 2009.  In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework. Based on our assessment using those criteria, our management (including our Chief Executive Officer and Chief Financial Officer) concluded that our internal control over financial reporting was effective as of March 31, 2009.

 
(c)
Changes in internal controls.
There were no significant changes in our internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses during the quarter ended March 31, 2009 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



20

Stewardship Financial Corporation
Part II -- Other Information


Item 1.
  
Legal Proceedings
   
None.
     
Item 1A.
  
Risk Factors
   
Not applicable to smaller reporting companies.
     
Item 2.
  
Unregistered Sales of Equity Securities and Use of Proceeds
 
  
None. 
     
Item 3.
  
Defaults Upon Senior Securities
 
  
None. 
     
Item 4.
  
Submission of Matters to a Vote of Security Holders
   
None.
     
Item 5.
  
Other Information
   
None.
     
Item 6.
  
Exhibits
   
See Exhibit Index following this report.
     

21


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 15, 2009
By:
/s/ Paul Van Ostenbridge
   
Paul Van Ostenbridge
   
President and Chief Executive Officer
   
(Principal Executive Officer)
     
     
     
     
Date:   May 15, 2009
By:
/s/ Claire M. Chadwick
   
Claire M. Chadwick
   
Senior Vice President and Chief Financial Officer
   
(Principal Financial and Accounting Officer)



22


EXHIBIT INDEX


Exhibit
Number
  
 
Description of Exhibits
     
 
Restated Certificate of Incorporation of Stewardship Financial Corporation
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Certification of Chief Financial pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
23