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SSFN > SEC Filings for SSFN > Form 10-Q on 13-Nov-2013All Recent SEC Filings

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Form 10-Q for STEWARDSHIP FINANCIAL CORP


13-Nov-2013

Quarterly Report


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, 2012 included in the 2012 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.

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.

Financial Condition

Total assets were relatively unchanged, increasing only $840,000 to $689.2 million at September 30, 2013 from $688.4 million at December 31, 2012. Cash and cash equivalents decreased $5.6 million to $15.4 million at September 30, 2013 from $21.0 million at December 31, 2012, reflecting growth in the securities portfolio. Securities available-for-sale increased $8.7 million to $183.4 million while securities held to maturity decreased $3.6 million to $26.2 million. Net loans decreased $1.0 million to $428.8 million at September 30, 2013 compared to $429.8 million at December 31, 2012. Increases due to new loans originated were partially offset by regular principal payments and payoffs in the first nine months of fiscal year 2013 as well as a $63,000 net increase in the allowance for loan losses. Loans held for sale totaled $910,000 at September 30, 2013, an increase of $126,000 from $784,000 at December 31, 2012. Bank owned life insurance increased $2.7 million to $13.2 million reflecting a $3.0 million purchase partially offset by a death benefit insurance payment received in the first quarter of 2013.

Deposits totaled $577.2 million at September 30, 2013, a decrease of $13.1 million from $590.3 million at December 31, 2012. The decline in deposits consisted of a $28.7 million decrease in interest-bearing accounts partially offset by a $15.6 million increase in noninterest-bearing accounts.

Index

FHLB - NY advances were $40.1 million at September 30, 2013 compared to $25.0 million at December 31, 2012. The increase in these borrowings was the result of a decrease in deposits.

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 October 2013 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 $170,000 (payable on January 2, 2014), (ii) the payment of a cash dividend to common shareholders of $0.01 per share, totaling approximately $59,000 (payable on November 15, 2013); and (iii) the payment of quarterly interest on Trust Preferred Securities totaling approximately $125,000 (payable on December 17, 2013).

Results of Operations

General

The Corporation reported net income of $522,000, or $0.06 diluted earnings per common share for the three months ended September 30, 2013, compared to net income of $328,000, or $0.04 diluted earnings per common share for the three months ended September 30, 2012. For the nine months ended September 30, 2013, the Corporation reported net income of $1.8 million, or $0.23 diluted earnings per common share compared to net income of $780,000, or $0.09 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 and nine months ended September 30, 2013 was $5.6 million and $17.1 million, respectively, compared to $5.9 million and $17.9 million recorded in the prior year periods. The net interest rate spread and net yield on interest-earning assets for the three months ended September 30, 2013 were 3.31% and 3.49%, respectively, compared to 3.40% and 3.62% for the three months ended September 30, 2012. For the nine months ended September 30, 2013, the net interest rate spread and net yield on interest-earning assets were 3.41% and 3.60%, respectively, compared to 3.45% and 3.67% for the nine months ended September 30, 2012. The net interest rate spread and net yield on interest-earning assets for the current year periods reflect a decline in loan interest rates and yields on securities as well as a decline in the interest rates on deposits. 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 as well as on investment securities, reflective of the historically low market rates in the current environment.

The following table reflects the components of the Corporation's net interest income for the three and nine months ended September 30, 2013 and 2012 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.

Index

                  Analysis of Net Interest Income (Unaudited)

                    For the Three Months Ended September 30,



                                                                 2013                                   2012
                                                                             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)                                    $ 439,283     $  5,544        5.01 %   $ 445,722     $  5,962        5.31 %
Taxable investment securities (1)                  176,540          733        1.65       176,773          882        1.98
Tax-exempt investment securities (1) (2)            34,787          390        4.44        35,670          410        4.56
Other interest-earning assets                          407            8        7.80           658           11        6.63
Total interest-earning assets                      651,017        6,675        4.07       658,823        7,265        4.37

Non-interest-earning assets:
Allowance for loan losses                          (11,282 )                              (12,351 )
Other assets                                        51,306                                 55,923
Total assets                                     $ 691,041                              $ 702,395


Liabilities and Stockholders' Equity

Interest-bearing liabilities:
Interest-bearing demand deposits                 $ 230,406     $    188        0.32 %   $ 243,105     $    236        0.39 %
Savings deposits                                    75,539           20        0.11        64,532           23        0.14
Time deposits                                      141,037          359        1.01       161,551          543        1.33
Repurchase agreements                                7,684           93        4.80        13,885          179        5.11
FHLB-NY borrowing                                   26,662          153        2.28        25,096          151        2.39
Subordinated debenture                               7,217          127        6.98         7,217          127        6.98
Total interest-bearing liabilities                 488,545          940        0.76       515,386        1,259        0.97
Non-interest-bearing liabilities:
Demand deposits                                    145,668                                125,443
Other liabilities                                    2,939                                  3,105
Stockholders' equity                                53,889                                 58,461
Total liabilities and stockholders' equity       $ 691,041                              $ 702,395

Net interest income (taxable equivalent basis)                    5,735                                  6,006
Tax Equivalent adjustment                                          (139 )                                 (145 )
Net interest income                                            $  5,596                               $  5,861

Net interest spread (taxable equivalent basis)                                 3.31 %                                 3.40 %

Net yield on interest-earning
 assets (taxable equivalent basis) (3)                                         3.49 %                                 3.62 %

(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.

Index

                  Analysis of Net Interest Income (Unaudited)

                    For the Nine Months Ended September 30,



                                                                 2013                                   2012
                                                                             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)                                    $ 443,316     $ 17,169        5.18 %   $ 452,664     $ 18,328        5.39 %
Taxable investment securities (1)                  172,482        2,076        1.61       176,088        2,816        2.13
Tax-exempt investment securities (1) (2)            35,970        1,202        4.47        34,030        1,210        4.74
Other interest-earning assets                          413           22        7.12           998           28        3.87
Total interest-earning assets                      652,181       20,469        4.20       663,780       22,382        4.49

Non-interest-earning assets:
Allowance for loan losses                          (11,432 )                              (12,574 )
Other assets                                        49,333                                 54,286
Total assets                                     $ 690,082                              $ 705,492


Liabilities and Stockholders' Equity

Interest-bearing liabilities:
Interest-bearing demand deposits                 $ 234,478     $    562        0.32 %   $ 248,095     $    847        0.45 %
Savings deposits                                    72,300           58        0.11        61,674           84        0.18
Time deposits                                      145,745        1,180        1.08       163,954        1,748        1.42
Repurchase agreements                                7,458          274        4.91        14,188          543        5.10
FHLB-NY borrowing                                   25,744          451        2.34        27,428          480        2.33
Subordinated debenture                               7,217          377        6.98         7,217          379        7.00
Total interest-bearing liabilities                 492,942        2,902        0.79       522,556        4,081        1.04
Non-interest-bearing liabilities:
Demand deposits                                    138,328                                121,320
Other liabilities                                    3,093                                  3,027
Stockholders' equity                                55,719                                 58,589
Total liabilities and stockholders' equity       $ 690,082                              $ 705,492

Net interest income (taxable equivalent basis)                   17,567                                 18,301
Tax Equivalent adjustment                                          (427 )                                 (429 )
Net interest income                                            $ 17,140                               $ 17,872

Net interest spread (taxable equivalent basis)                                 3.41 %                                 3.45 %

Net yield on interest-earning
 assets (taxable equivalent basis) (3)                                         3.60 %                                 3.67 %

(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.

Index

For the three months ended September 30, 2013, total interest income, on a tax equivalent basis, decreased $590,000 to $6.7 million, or 8.1%, 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. Total interest income on a tax equivalent basis decreased $1.9 million to $20.5 million for the nine months ended September 30, 2013, or 8.5%, compared to the same period for 2012. Consistent with the three month period, the decrease in the current nine month period is due to a decrease in the overall yield on interest-earning assets and a decrease in the average interest-earning assets. The average rate earned on interest-earning assets was 4.07% and 4.20% for the three and nine months ended September 30, 2013, respectively, compared to an average rate of 4.37% and 4.49% for the three and nine months ended September 30, 2012. The decline in the asset yield reflects the effect of a prolonged low interest rate environment. Average interest-earning assets decreased $7.8 million and $11.6 million for the three and nine months ended September 30, 2013 compared to the same prior year periods. The change in average interest-earning assets primarily reflects a decrease from the comparable prior year periods in average loans, which decreased $6.4 million and $9.3 million for the three and nine months ended September 30, 2013, respectively.

Interest paid on deposits and borrowed money decreased $319,000 and $1.2 million for the three and nine months ended September 30, 2013, respectively, compared to the same periods for 2012. 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 September 30, 2013, the total cost for interest-bearing liabilities declined to 0.76% representing a 21 basis point decline when compared to the same prior year period. The cost for deposits and borrowed money decreased 25 basis points from 1.04% for the nine month period ended September 30, 2012 to 0.79% for the comparable period in 2013. The average balance of total interest-bearing deposits and borrowings decreased $26.8 million and $29.6 million for the three and nine months ended September 30, 2013, respectively, from the comparable 2012 period. Average interest-bearing deposits decreased $22.2 million and average borrowings decreased $4.6 million for the three months ended September 30, 2013 when compared to the same prior year period. Likewise, for the nine months ended September 30, 2013 the change in interest-bearing deposits and borrowings was comprised of a $21.2 million decrease in average interest-bearing deposits and a $8.4 million decrease in average borrowings.

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 current estimates.

The loan loss provision totaled $900,000 and $3.4 million for the three and nine months ended September 30, 2013, respectively, compared to $2.0 million and $6.7 million for the three and nine months ended September 30, 2012, respectively. Nonaccrual loans of $15.3 million at September 30, 2013 reflected a decrease from $18.0 million of nonaccrual loans at December 31, 2012. The allowance for loan losses related to the impaired loans increased from $266,000 at December 31, 2012 to $363,000 at September 30, 2013. During the nine months ended September 30, 2013, the Corporation charged off $3.6 million of loan balances and recovered $292,000 in previously charged off loans compared to $5.9 million and $224,000, respectively, during the same period in 2012.

The current period loan loss provision considers economic conditions that have contributed to loan delinquencies and the softness in the real estate market. 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.

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

Noninterest Income

Noninterest income was $971,000 and $3.4 million for the three and nine months ended September 30, 2013, respectively, compared to $1.7 million and $4.6 million for the prior year periods. For the three months ended September 30, 2013, there was $156,000 of gains on sales of other real estate owned while noninterest income included a net loss of $37,000 related to sales of other real estate owned for the three months ended September 30, 2012. Gains on sales of other real estate owned were $282,000 for the nine months ended September 30, 2013 compared to $432,000 for the comparable prior year period. Gains on sales of mortgage loans totaled $150,000 and $610,000 for the three and nine months ended September 30, 2013, respectively, compared to $162,000 and $727,000 for the three and nine months ended September 30, 2012, respectively. There were no gains on calls and sales of securities included in noninterest income for the three months ended September 30, 2013 and for the nine months ended September 30, 2013, noninterest income included just $2,000 from gains on calls and sales of securities. This compares to $891,000 and $1.3 million for the three and nine months ended September 31, 2012, respectively. The gain for the three months ended September 30, 2012 reflected a transaction executed to lower the Corporation's risk exposure to rising interest rates and delever the balance sheet through the partial repayment of a higher costing wholesale repurchase agreement. A resulting gain was partially offset by a prepayment penalty discussed below. Noninterest income of $537,000 was recorded as a result of a death benefit insurance payment received in early 2013.

Index

Noninterest Expense

Noninterest expenses for the three and nine months ended September 30, 2013 was $4.9 million and $14.9 million, respectively, compared to $5.2 million and $14.8 million, respectively, in the comparable prior year periods. The majority of the increase in noninterest expenses has occurred in higher salary and employee benefits expense, reflective of increasing regulatory compliance and the attendant staffing necessary to oversee all compliance-related issues. In addition, the increase in salary and employee benefits expense is the result of an increased focus on commercial lending opportunities as well as costs associated with an enhanced credit review function. Included in noninterest expense for the prior year periods is a $691,000 prepayment premium resulting from the Corporation's repayment of $7 million of a wholesale repurchase agreement.

Income Tax Expense

For the three months ended September 30, 2013, the Corporation recorded income tax expense of $271,000 compared to income tax expense of $46,000 for the three months ended September 30, 2012. For the nine months ended September 30, 2013, income tax expense totaled $488,000 representing an effective tax rate of 21.3% compared to income tax expense of $193,000, or an effective tax rate of 19.8%, for the nine months ended September 30, 2012.

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:

Index

                                                   September 30,      June 30,       March 31,       December 31,
                                                       2013             2013           2013              2012
                                                                       (Dollars in thousands)

Nonaccrual loans (1)                              $        15,269     $  14,716     $    17,479     $       18,011
Loans past due 90 days or more and accruing (2)                 -             -              50                237
Total nonperforming loans                                  15,269        14,716          17,529             18,248

Other real estate owned                                       470         1,072             876              1,058
Total nonperforming assets                        $        15,739     $  15,788     $    18,405     $       19,306

Performing restructured loans (3)                 $        10,986     $  10,235     $    10,134     $       10,373

Allowance for loan losses                         $        10,704     $  10,787     $    11,512     $       10,641

Nonperforming loans to total gross loans                     3.48 %        3.33 %          3.97 %             4.14 %
Nonperforming assets to total assets                         2.28 %        2.29 %          2.65 %             2.80 %
Allowance for loan losses to total gross loans               2.44 %        2.44 %          2.61 %             2.42 %
Allowance for loan losses to
nonperforming loans                                         70.10 %       73.30 %         65.67 %            58.31 %

(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 . . .

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