UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
(_) 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 check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]
The number of shares outstanding, net of treasury stock, of the
registrant's Common Stock, no par value, as of August 3, 2006 was 4,802,310.
Stewardship Financial Corporation
INDEX
PAGE
NUMBER
------
PART I - CONSOLIDATED FINANCIAL INFORMATION
-------------------------------------------
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition
at June 30, 2006 (Unaudited) and December 31, 2005 ...............1
Consolidated Statements of Income for the Six
Months ended June 30, 2006 and 2005 (Unaudited) ..................2
Consolidated Statements of Income for the Three
Months ended June 30, 2006 and 2005 (Unaudited) ..................3
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2006 and 2005 (Unaudited) ..................4
Consolidated Statement of Changes in Stockholders'
Equity for the Six Months ended June 30, 2006 and
2005 (Unaudited) .................................................5
Notes to Consolidated Financial Statements (Unaudited) .........6 - 15
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS ..................................................16 - 26
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK .............................................26
ITEM 4 - CONTROLS AND PROCEDURES ........................................27
PART II - OTHER INFORMATION
---------------------------
ITEM 1A. RISK FACTORS ...................................................28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS ................................................28
ITEM 6 - EXHIBITS ........................................................28
SIGNATURES ...............................................................29
----------
EXHIBIT INDEX ............................................................30
-------------
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Financial Condition
(Unaudited)
June 30, December 31,
2006 2005
------------------------------
Assets
Cash and due from banks $ 13,454,000 $ 13,158,000
Other interest-earning assets 477,000 870,000
------------------------------
Cash and cash equivalents 13,931,000 14,028,000
Securities available for sale 62,269,000 64,166,000
Securities held to maturity; fair value
of $38,186,000 (2006) and $37,459,000 (2005) 38,856,000 37,801,000
FHLB-NY stock, at cost 1,715,000 1,939,000
Loans, net of allowance for loan losses of
of $ 4,011,000 (2006) and $3,847,000 (2005) 355,793,000 341,976,000
Mortgage loans held for sale 1,338,000 2,041,000
Premises and equipment, net 6,538,000 6,464,000
Accrued interest receivable 2,579,000 2,432,000
Intangible assets, net of accumulated amortization of
$629,000 (2006) and $610,000 (2005) 121,000 140,000
Bank owned life insurance 8,365,000 8,210,000
Other assets 3,862,000 3,530,000
------------------------------
Total assets $ 495,367,000 $ 482,727,000
==============================
Liabilities and stockholders' equity
Liabilities
Deposits:
Noninterest-bearing $ 90,193,000 $ 94,331,000
Interest-bearing 328,763,000 309,135,000
------------------------------
Total deposits 418,956,000 403,466,000
Other borrowings 23,796,000 30,486,000
Subordinated debentures 7,217,000 7,217,000
Securities sold under agreements to repurchase 7,420,000 4,731,000
Accrued interest payable 1,322,000 1,086,000
Accrued expenses and other liabilities 1,627,000 2,357,000
------------------------------
Total liabilities 460,338,000 449,343,000
------------------------------
Stockholders' equity
Common stock, no par value; 10,000,000 shares authorized;
4,823,625 and 4,787,889 shares issued and outstanding
at June 30, 2006 and December 31, 2005, respectively 28,642,000 28,211,000
Treasury stock, 22,802 and 39,581 shares outstanding at
June 30, 2006 and December 31, 2005, respectively (330,000) (556,000)
Retained earnings 8,163,000 6,647,000
Accumulated other comprehensive loss (1,446,000) (918,000)
------------------------------
Total stockholders' equity 35,029,000 33,384,000
------------------------------
Total liabilities and stockholders' equity $ 495,367,000 $ 482,727,000
==============================
See notes to unaudited consolidated financial statements.
1
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Income
(Unaudited)
Six Months Ended
June 30,
-------------------------
2006 2005
-------------------------
Interest income:
Loans $12,278,000 $ 9,869,000
Securities held to maturity
Taxable 440,000 416,000
Non-taxable 237,000 286,000
Securities available for sale
Taxable 1,285,000 994,000
Non-taxable 13,000 17,000
FHLB-NY stock 47,000 32,000
Other interest-earning assets 18,000 101,000
-------------------------
Total interest income 14,318,000 11,715,000
-------------------------
Interest expense:
Deposits 3,792,000 2,240,000
Borrowed money 1,087,000 594,000
-------------------------
Total interest expense 4,879,000 2,834,000
-------------------------
Net interest income before provision for loan losses 9,439,000 8,881,000
Provision for loan losses 160,000 300,000
-------------------------
Net interest income after provision for loan losses 9,279,000 8,581,000
-------------------------
Noninterest income:
Fees and service charges 828,000 716,000
Bank owned life insurance 154,000 55,000
Merchant processing 562,000 433,000
Gain on sales of mortgage loans 95,000 101,000
Miscellaneous 263,000 240,000
-------------------------
Total noninterest income 1,902,000 1,545,000
-------------------------
Noninterest expenses:
Salaries and employee benefits 3,332,000 2,978,000
Occupancy, net 607,000 488,000
Equipment 489,000 379,000
Data processing 571,000 552,000
Advertising 201,000 228,000
FDIC insurance premium 26,000 24,000
Amortization of intangible assets 19,000 19,000
Charitable contributions 362,000 370,000
Stationery and supplies 153,000 137,000
Merchant processing 514,000 384,000
Bank-card related services 244,000 213,000
Miscellaneous 1,123,000 994,000
-------------------------
Total noninterest expenses 7,641,000 6,766,000
-------------------------
Income before income tax expense 3,540,000 3,360,000
Income tax expense 1,264,000 1,217,000
-------------------------
Net income $ 2,276,000 $ 2,143,000
=========================
Basic earnings per share $ 0.48 $ 0.45
=========================
Diluted earnings per share $ 0.47 $ 0.45
=========================
Weighted average number of common shares outstanding 4,769,751 4,733,215
=========================
Weighted average number of diluted common
shares outstanding 4,819,994 4,787,570
=========================
Share data has been restated to reflect a 4 for 3 stock split issued July 1,
2005 and a 5% stock dividend paid November 15, 2005.
See notes to unaudited consolidated financial statements.
2
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Income
(Unaudited)
Three Months Ended
June 30,
-----------------------
2006 2005
-----------------------
Interest income:
Loans $6,304,000 $5,082,000
Securities held to maturity
Taxable 219,000 205,000
Non-taxable 119,000 142,000
Securities available for sale
Taxable 648,000 494,000
Non-taxable 6,000 9,000
FHLB-NY stock 27,000 19,000
Other interest-earning assets 11,000 75,000
-----------------------
Total interest income 7,334,000 6,026,000
-----------------------
Interest expense:
Deposits 2,015,000 1,265,000
Borrowed money 557,000 282,000
-----------------------
Total interest expense 2,572,000 1,547,000
-----------------------
Net interest income before provision for loan losses 4,762,000 4,479,000
Provision for loan losses 110,000 150,000
-----------------------
Net interest income after provision for loan losses 4,652,000 4,329,000
-----------------------
Noninterest income:
Fees and service charges 449,000 365,000
Bank owned life insurance 74,000 55,000
Merchant processing 296,000 242,000
Gain on sales of mortgage loans 45,000 83,000
Miscellaneous 168,000 151,000
-----------------------
Total noninterest income 1,032,000 896,000
-----------------------
Noninterest expenses:
Salaries and employee benefits 1,711,000 1,540,000
Occupancy, net 293,000 237,000
Equipment 247,000 186,000
Data processing 277,000 281,000
Advertising 114,000 97,000
FDIC insurance premium 13,000 12,000
Amortization of intangible assets 9,000 9,000
Charitable contributions 181,000 205,000
Stationery and supplies 77,000 67,000
Merchant processing 272,000 193,000
Bank-card related services 123,000 108,000
Miscellaneous 546,000 516,000
-----------------------
Total noninterest expenses 3,863,000 3,451,000
-----------------------
Income before income tax expense 1,821,000 1,774,000
Income tax expense 654,000 635,000
-----------------------
Net income $1,167,000 $1,139,000
=======================
Basic earnings per share $ 0.25 $ 0.24
=======================
Diluted earnings per share $ 0.24 $ 0.24
=======================
Weighted average number of common shares outstanding 4,784,483 4,743,870
=======================
Weighted average number of diluted common
shares outstanding 4,825,252 4,798,734
=======================
Share data has been restated to reflect a 4 for 3 stock split issued July 1,
2005 and a 5% stock dividend paid November 15, 2005.
See notes to unaudited consolidated financial statements.
3
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
----------------------------
2006 2005
----------------------------
Cash flows from operating activities:
Net income $ 2,276,000 $ 2,143,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization of premises and equipment 379,000 304,000
Amortization of premiums and accretion of discounts, net 146,000 226,000
Accretion of deferred loan fees (58,000) (78,000)
Provision for loan losses 160,000 300,000
Originations of mortgage loans held for sale (9,383,000) (9,725,000)
Proceeds from sale of mortgage loans 10,181,000 10,054,000
Gain on sale of loans (95,000) (101,000)
Deferred income tax benefit (49,000) (117,000)
Amortization of intangible assets 19,000 19,000
Nonqualified stock option expense 24,000 --
Purchase of bank owned life insurance -- (8,000,000)
increase in bank owned life insurance (155,000) (55,000)
Increase in accrued interest receivable (147,000) (89,000)
Decrease in accrued interest payable 236,000 193,000
Decrease (increase) in other assets 48,000 (27,000)
(Decrease) increase in other liabilities (556,000) 227,000
------------ ------------
Net cash provided (used) by operating activities 3,026,000 (4,726,000)
------------ ------------
Cash flows from investing activities:
Purchase of securities available for sale (5,613,000) (2,321,000)
Proceeds from maturities and principal repayments
on securities available for sale 6,595,000 3,234,000
Proceeds from sales and calls on securities available for sale -- 500,000
Purchase of securities held to maturity (6,813,000) (1,288,000)
Proceeds from maturities and principal repayments on
securities held to maturity 5,668,000 2,644,000
Purchase (Redemption) of FHLB-NY stock 224,000 (3,000)
Net increase in loans (13,919,000) (18,528,000)
Additions to premises and equipment (453,000) (940,000)
------------ ------------
Net cash provided by investing activities (14,311,000) (16,702,000)
------------ ------------
Cash flows from financing activities:
Net decrease in noninterest-bearing deposits (4,138,000) (1,248,000)
Net increase in interest-bearing deposits 19,628,000 45,077,000
Net increase (decrease) in securities sold under agreements
to repurchase 2,689,000 (1,259,000)
Net decrease in short term borrowings (5,900,000) (7,500,000)
Payments on long term borrowings (790,000) (765,000)
Cash dividends paid on common stock (348,000) (261,000)
Purchase of treasury stock (103,000) --
Exercise of stock options 101,000 143,000
Issuance of common stock 49,000 28,000
------------ ------------
Net cash used in financing activities 11,188,000 34,215,000
------------ ------------
Net (decrease) increase in cash and cash equivalents (97,000) 12,787,000
Cash and cash equivalents - beginning 14,028,000 24,792,000
------------ ------------
Cash and cash equivalents - ending $ 13,931,000 $ 37,579,000
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the year for interest 4,643,000 2,650,000
Cash paid during the year for income taxes 1,500,000 1,505,000
Noncash financing activity - issuance of
common stock under dividend reinvestment plan 412,000 346,000
See notes to unaudited consolidated financial statements.
4
Stewardship Financial Corporation and Subsidiary
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)
For the Period Ended June 30, 2006
--------------------------------------------------------------------------------------------
Accumulated
Other
Comprehensive
Common Stock Treasury Stock Retained Loss,
Shares Amount Shares Amount Earnings Net Total
--------------------------------------------------------------------------------------------
Balance -- December 31, 2005 4,787,889 $28,211,000 (39,581) $ (556,000) $ 6,647,000 $ (918,000) $ 33,384,000
Dividends Paid -- -- -- -- (760,000) -- (760,000)
Common stock issued under
stock plans 33,149 461,000 -- -- 461,000
Repurchase common stock -- -- (16,370) (235,000) -- -- (235,000)
Exercise of stock options 35,736 233,000 -- -- -- -- 233,000
Stock options earned -- 24,000 -- -- -- -- 24,000
Tax benefit on stock options
exercised -- 174,000 -- -- -- -- 174,000
Comprehensive income:
Net income for the six months
ended June 30, 2006 -- -- -- -- 2,276,000 -- 2,276,000
Unrealized holding losses on
securities available for sale
arising during the period
(net tax benefit of $331,000) -- -- -- -- -- (528,000) (528,000)
------------
Total comprehensive income,
net of tax 1,748,000
--------------------------------------------------------------------------------------------
Balance -- June 30, 2006 4,823,625 $28,642,000 (22,802) $ (330,000) $ 8,163,000 $(1,446,000) $ 35,029,000
============================================================================================
For the Period Ended June 30, 2005
-------------------------------------------------------------------
Accumulated
Other
Comprehensive
Common Stock Retained Loss,
Shares Amount Earnings Net Total
-------------------------------------------------------------------
Balance -- December 31, 2004 4,487,977 $ 23,893,000 $ 6,746,000 $ (179,000) $ 30,460,000
Dividends Paid -- -- (607,000) -- (607,000)
Common stock issued under stock plans 26,150 374,000 -- -- 374,000
Exercise of stock options 20,920 143,000 -- -- 143,000
Tax benefit on stock options exercised -- 70,000 -- -- 70,000
Comprehensive income:
Net income for the three months
ended June 30, 2005 -- -- 2,143,000 -- 2,143,000
Unrealized holding losses on securities
available for sale arising during the period
(net tax benefit of $80,000) -- -- -- (129,000) (129,000)
------------
Total comprehensive income, net of tax 2,014,000
-------------------------------------------------------------------
Balance -- June 30, 2005 4,535,047 $ 24,480,000 $ 8,282,000 $ (308,000) $ 32,454,000
===================================================================
See notes to unaudited consolidated financial statements.
5
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
June 30, 2006
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Certain information and footnote disclosures normally included in the unaudited
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the Securities and
Exchange Commission. These unaudited 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, 2005.
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
subsidiary, Stewardship Investment Corp. All significant intercompany accounts
and transactions have been eliminated in the consolidated financial statements.
Certain prior period amounts have been reclassified to conform to the current
presentation. The consolidated financial statements of the Corporation have been
prepared in conformity with accounting principles generally accepted in the
United States of America. In preparing the financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the statements of financial condition
and revenues and expenses during the reporting periods. Actual results could
differ significantly from those estimates.
Material estimates that are particularly susceptible to significant changes
relate to the determination of the allowance for loan losses. Management
believes that the allowance for loan losses is adequate. While management uses
available information to recognize losses on loans, future additions to the
allowance for loan losses may be necessary based on changes in economic
conditions in the market area.
Share-based Payment Cost
On January 1, 2006, the Corporation adopted Statement of Financial Accounting
Standards No. 123 (revised 2004) "Share-Based Payment" ("SFAS No. 123(R)") under
the applied modified perspective method. With limited exceptions, SFAS No.
123(R) requires public companies to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant date
fair value of the award and to recognize such cost over the period during which
an employee is required to provide service in exchange for the award (usually
the vesting period).
Prior to the adoption of SFAS No. 123(R), and in accordance with the provisions
of Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS No.
6
123"), the Corporation accounted for share-based payments under the recognition
and measurement principles of Accounting Principle Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB Opinion No. 25") and related
interpretations.
At June 30, 2006, the Corporation had five types of stock award programs
referred to as the Employee Stock Bonus Plan, the Director Stock Plan, the
Employee Stock Option Plan and the 2001 and 2006 Stock Option Plan for
Non-Employee Directors. The Employee Stock Bonus Plan is intended to provide
incentives which will retain highly competent key management by providing them
with a bonus in the form of shares of common stock of the Corporation. The
Corporation did not grant shares under this plan during the first six months of
2005 or 2006.
The Director Stock Plan permits members of the Board of Directors of the Bank to
receive any monthly Board of Directors' fees in shares of the Corporation's
common stock, rather than in cash. The Corporation recorded $34,000 and $10,000
in directors expense for the six months ended June 30, 2006 and 2005,
respectively, and $17,000 and $5,000 in directors expense for the quarters ended
June 30, 2006 and 2005, respectively, relating to this plan.
The Employee Stock Option Plan provides for options to purchase shares of Common
Stock to be issued to employees of the Corporation at the discretion of the
Compensation Committee of the Board of Directors. The following table represents
the stock activity for the six months ended June 30, 2006 and 2005:
2006 2005
---------------------------- --------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
Outstanding at beginning of year 72,370 $ 6.33 74,688 $ 6.41
Granted -- -- -- --
Exercised -- -- 1,546 6.52
Forfeited 463 13.61 540 19.05
------------ ------------ ------------ ------------
Outstanding at end of period 71,907 $ 6.29 72,602 $ 6.32
============ ============
Options exercisable 71,907 65,886
============ ============
Weighted-average fair value of
options granted during the period -- --
Options outstanding as of June 30, 2006 had a weighted average remaining
contractual life of 2.21 years. The intrinsic value for stock options is
calculated based on the exercise price of the underlying awards and the market
price of our common stock as of the reporting date. The intrinsic value of the
options at June 30, 2006 was $519,000.
The 2001 Stock Option Plan for Non-Employee Directors provided for options to
purchase shares of common stock to be issued to non-employee Directors of the
Corporation. In accordance with the provisions of SFAS No. 123(R), the
Corporation recorded $24,000 of director's compensation expense for share-based
payments for the six months ended June 30, 2006 with a related income tax
benefit of $10,000 and expense of $7,000 for the quarter ended June 30, 2006,
with related income tax benefit of $3,000. This
7
expense relates to non-qualified stock options that were outstanding but not yet
vested as of January 1, 2006. Due to the relatively small amount of compensation
expense, basic and diluted earnings per share, income from continuing
operations, income before taxes, net income, cash flow from operations and cash
flow from financing activities were not significantly impacted.
The 2006 Stock Option Plan for Non-Employee Directors which provides for options
to purchase shares of common stock to be issued to non-employee Directors, was
adopted by the shareholders at the Annual Meeting in May, 2006. Options were
granted on June 30, 2006.
The following table represents the stock activity for non-employee Directors for
the six months ended June 30, 2006 and 2005:
2006 2005
---------------------------- --------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
Outstanding at beginning of year 43,398 $ 7.47 66,371 $ 7.33
Granted 50,000 13.50 -- --
Exercised 35,736 6.51 20,420 6.51
Expired 2,557 6.51 7,658 19.05
------------ ------------ ------------ ------------
Outstanding at end of period 55,105 $ 13.61 38,293 $ 6.51
============ ============
Options exercisable 5,105 17,872
============ ============
Weighted-average fair value of
options granted during the period $ 4.78 --
Of the 35,736 options exercised under the 2001 Stock Option Plan for
Non-Employee Directors, 20,240 shares were exercised by tendering 9,000 shares
of common stock.
Options outstanding as of June 30, 2006 had a weighted average remaining
contractual life of 5.45 years. The intrinsic value for stock options is
calculated based on the exercise price of the underlying awards and the market
price of our common stock as of the reporting date. There was no intrinsic value
of the options at June 30, 2006 because the exercise price equaled or exceeded
the market value of the stock at June 30, 2006. As of June 30, 2006, there was
approximately $239,000 of total unrecognized compensation costs related to
nonvested stock options. These costs are expected to be recognized over the next
five years.
8
The following table sets forth the pro forma net income and earnings per share
for the three months and six months of 2005 as if the fair value based method
set forth in SFAS No. 123(R) had been applied to all share-based arrangements.
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
------------- -------------
Net Income:
Net income as reported $ 1,139,000 $ 2,143,000
Stock-based compensation expense included in net
Income, net of related tax effects 3,000 6,000
Total stock-based compensation expense determined
Under fair value based method for all awards,
Net of related tax effects (18,000) (36,000)
------------- -------------
Pro forma net income $ 1,124,000 $ 2,113,000
============= =============
Earnings per share:
As reported basic earnings per share $ 0.24 $ 0.45
As reported diluted earnings per share 0.24 0.45
Pro forma basic earnings per share 0.24 0.45
Pro form diluted earnings per share 0.23 0.44
Share data has been restated to reflect a 4 for 3 stock dividend issued July,
2005 and a 5% stock dividend paid November 15, 2005.
There were stock options awarded under the 2006 Stock Option Plan for
Non-Employee Directors on June 30, 2006. The fair value of options granted for
Directors is estimated on the date of the grant using the Black-Scholes option
pricing model with the following assumptions used:
Director Director Director
Stock Options Stock Options Stock Options
2001 2005 2006
---- ---- ----
Dividend yield 1.62% 1.79% 2.25%
Expected volatility 39.76% 33.19% 36.72%
Risk-free interest rate 6.65% 4.34% 5.21%
Expected life 7 years 5 years 6 years
Fair value at grant date $2.94 $4.50 $4.78
9
Note 2. Basis of presentation
The interim unaudited consolidated financial statements included herein have
been prepared in accordance with instructions for Form 10-Q and the rules and
regulations of the Securities and Exchange Commission ("SEC") and, therefore, do
not include information or footnotes necessary for a complete presentation of
consolidated financial condition, results of operations, and cash flows in
conformity with accounting principles generally accepted in the United States of
America. However, all adjustments, consisting only of normal recurring
adjustments, which in the opinion of management are necessary for a fair
presentation of the consolidated financial statements, have been included. The
results of operations for the three months and six months ended June 30, 2006
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.
10
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements Continued
(Unaudited)
Note 3. Securities Available for Sale
The following table sets forth the amortized cost and fair value of the
Corporation's securities available for sale as of June 30, 2006 and December 31,
2005. In accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", securities
available for sale are carried at fair value.
June 30, 2006
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Holding Gains Holding Losses Value
--------------------------------------------------------
U.S. government-sponsored agencies 33,987,000 -- 931,000 33,056,000
Obligations of state and political
subdivisions 1,362,000 -- 39,000 1,323,000
Mortgage-backed securities 28,176,000 3,000 1,333,000 26,846,000
Community Reinvestment Act Fund 1,095,000 -- 51,000 1,044,000
--------------------------------------------------------
$64,620,000 $ 3,000 $ 2,354,000 $62,269,000
========================================================
December 31, 2005
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Holding Gains Holding Losses Value
--------------------------------------------------------
U.S. Treasury securities $ 501,000 $ -- $ 5,000 $ 496,000
U.S. government-sponsored agencies 33,140,000 -- 662,000 32,478,000
Obligations of state and political
subdivisions 2,068,000 -- 37,000 2,031,000
Mortgage-backed securities 28,879,000 8,000 777,000 28,110,000
Community Reinvestment Act Fund 1,071,000 -- 20,000 1,051,000
--------------------------------------------------------
$65,659,000 $ 8,000 $ 1,501,000 $64,166,000
========================================================
On a quarterly basis, the Corporation makes an assessment to determine whether
there have been any events or economic circumstances to indicate that a security
is impaired on an other-than-temporary basis. The Corporation considers many
factors including the length of time the security has had a market value less
than the cost basis; the intent and ability of the Corporation to hold the
security for a period of time sufficient for a recovery in value; and recent
events specific to the issuer or industry. Management considers the 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") and the Federal Home Loan Mortgage Corporation ("FHLMC").
Note 4. Securities Held to Maturity
The following table sets forth the amortized cost and fair value of the
Corporation's securities held to maturity as of June 30, 2006 and December 31,
2005. Securities held to maturity are stated at cost, adjusted for amortization
of premiums and accretion of discounts.
June 30, 2006
----------------------------------------------------------
Gross Gross
Carrying Unrecognized Unrecognized Fair
Value Holding Gains Holding Losses Value
----------------------------------------------------------
U.S. Treasury securities $ 502,000 $ -- $ 7,000 $ 495,000
U.S. government-sponsored agencies 12,546,000 -- 229,000 12,317,000
Obligations of state and political
subdivisions 17,962,000 6,000 214,000 17,754,000
Mortgage-backed securities 7,846,000 10,000 236,000 7,620,000
----------------------------------------------------------
$ 38,856,000 $ 16,000 $ 686,000 $ 38,186,000
==========================================================
December 31, 2005
----------------------------------------------------------
Gross Gross
Carrying Unrecognized Unrecognized Fair
Value Holding Gains Holding Losses Value
----------------------------------------------------------
U.S. Treasury securities $ 1,004,000 $ 2,000 $ 1,000 $ 1,005,000
U.S. government-sponsored agencies 12,113,000 1,000 180,000 11,934,000
Obligations of state and political
subdivisions 15,747,000 27,000 128,000 15,646,000
Mortgage-backed securities 8,937,000 60,000 123,000 8,874,000
----------------------------------------------------------
$ 37,801,000 $ 90,000 $ 432,000 $ 37,459,000
==========================================================
On a quarterly basis, the Corporation makes an assessment to determine whether
there have been any events or economic circumstances to indicate that a security
is impaired on an other-than-temporary basis. The Corporation considers many
factors including the length of time the security has had a market value less
than the cost basis; the intent and ability of the Corporation to hold the
security for a period of time sufficient for a recovery in value; and recent
events specific to the issuer or industry. Management considers the 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") and the Federal Home Loan Mortgage Corporation ("FHLMC").
11
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements Continued
(Unaudited)
Note 5. Loans
The Corporation's primary market area for lending is the small and
medium sized business and professional community, as well as the individuals
residing, working and shopping in Bergen, Passaic and Morris counties, New
Jersey. The following table sets forth the composition of loans as of the
periods indicated.
June 30, December 31,
2006 2005
------------------------------
Mortgage
Residential $ 45,037,000 $ 45,604,000
Commercial 167,882,000 163,309,000
Commercial 73,149,000 65,011,000
Equity 20,006,000 20,271,000
Installment 53,832,000 51,540,000
Other 334,000 506,000
------------------------------
Total loans 360,240,000 346,241,000
------------------------------
Less: Deferred loan fees 436,000 418,000
Allowance for loan losses 4,011,000 3,847,000
------------------------------
4,447,000 4,265,000
------------------------------
Loans, net $355,793,000 $341,976,000
==============================
Note 6. Allowance for loan losses
Six Months Ended June 30,
2006 2005
------------------------------
Balance, beginning of period $ 3,847,000 $ 3,299,000
Provision charged to operations 160,000 300,000
Recoveries of loans charged off 24,000 3,000
Loans charged off (20,000) (32,000)
------------------------------
Balance, end of period $ 4,011,000 $ 3,570,000
==============================
12
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements Continued
(Unaudited)
Note 7. Loan Impairment
The Corporation has defined the population of impaired loans to include all
nonaccrual loans. The following table sets forth information regarding the
impaired loans as of the periods indicated.
June 30, December 31,
2006 2005
------------ ------------
Impaired loans
With related allowance for loan losses $ 80,000 $ 152,000
Without related allowance for loan losses 177,000 320,000
------------ ------------
Total impaired loans $ 257,000 $ 472,000
============ ============
Related allowance for loan losses $ 7,000 $ 29,000
============ ============
13
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements Continued
(Unaudited)
Note 8. Recent Accounting Pronouncements
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments"
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments" (SFAS No. 155), an amendment to SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133) and SFAS No
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (SFAS No. 140). SFAS No. 155 provides the
framework for fair value remeasurement of any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation as well
as establishes a requirement to evaluate interests in securitized financial
assets to identify interests. SFAS No. 155 further amends SFAS No. 140 to
eliminate the prohibition on a qualifying special-purpose entity from holding a
derivative financial instrument that pertains to a beneficial interest other
than another derivative financial instrument. The SFAS No. 155 guidance also
clarifies which interest-only strips and principal-only strips are not subject
to the requirement of SFAS No. 133 and which concentrations of credit risk in
the form of subordination are not embedded derivatives. This statement is
effective for all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. SFAS No.
155 is not expected to have a material impact on the Corporation's financial
statements.
SFAS No. 156, "Accounting for Servicing of Financial Assets"
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140." (SFAS No. 156). SFAS
No. 156 requires the recognition of servicing assets or servicing liabilities
each time an entity undertakes an obligation to service a financial asset;
requires all separately recognized servicing assets and servicing liabilities to
be initially measured at fair value, if practicable; and, permits an entity to
choose either to (1) amortize servicing assets or servicing liabilities in
proportion to and over the period of estimated net servicing income or net
servicing loss and assess servicing assets or servicing liabilities for
impairment or increased obligation based on fair value at each reporting date;
or, (2) measure servicing assets or servicing liabilities at fair value at each
reporting date and report changes in fair value in earnings in the period in
which the changes occur. At its initial adoption, SFAS No. 156 permits a
one-time reclassification of available for sale securities to trading securities
provided that the available for sale securities are identified in some manner as
offsetting exposure to changes in fair value of servicing assets or servicing
liabilities subsequently being measured at fair value. SFAS No. 156 requires
separate financial statement presentation of servicing assets and servicing
liabilities subsequently measured at fair value and requires additional
disclosures for all separately recognized servicing assets and servicing
liabilities. SFAS No. 156 is effective for the Corporation on January 1, 2007.
The Corporation does not expect adoption to have a significant impact on the
consolidated financial statements, results of operation or liquidity of the
Corporation.
14
FIN 48, "Accounting for Uncertainty in Income Taxes"
In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes - an Interpretation of FASB Statement No. 109." (FIN 48). FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. It requires the recognition and measurement of uncertain
tax positions using a "more-likely-than-not" approach. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Management has not completed its
evaluation of the impact of the adoption of FIN48.
Note 9. Earnings Per Share
Basic earnings per share is calculated by dividing net income by the average
daily number of common shares outstanding during the period. Common stock
equivalents are not included in the calculation. Diluted earnings per share is
computed similar to that of basic earnings per share except that the denominator
is increased to include the number of additional common shares that would have
been outstanding if all potential dilutive common shares were issued.
The following is a reconciliation of the calculation of basic and diluted
earnings per share.
Three Months Six Months
Ended June 30, Ended June 30,
2006 2005 2006 2005
------ ------ ------ ------
Net income $1,167 $1,139 $2,276 $2,143
Weighted average shares 4,784 4,744 4,770 4,733
Effect of dilutive stock options 50 55 50 55
------ ------ ------ ------
Total weighted average dilutive shares 4,834 4,799 4,820 4,788
Basic earnings per share $ 0.25 $ 0.24 $ 0.48 $ 0.45
Diluted earnings per share $ 0.24 $ 0.24 $ 0.47 $ 0.45
All share and per share amounts have been restated to reflect a 4 for 3 stock
split issued July 2005 and a 5% stock dividend paid November 15, 2005.
Note 10. Comprehensive Income
Total comprehensive income includes net income and other comprehensive income
which is comprised of unrealized holding gains and losses on securities
available for sale, net of taxes. The Corporation's total comprehensive income
for the six months ended June 30, 2006 and 2005 was $1.7 million and $2.0
million, respectively, and for the three months ended June 30, 2006 and 2005 was
$764,000 and $1.5 million, respectively. The difference between the
Corporation's net income and total comprehensive income for these periods
relates to the change in the net unrealized holding gains and losses on
securities available for sale during the applicable period of time.
15
Stewardship Financial Corporation
Management's Discussion and Analysis of
Financial Condition and Results of Operations
This Form 10-Q contains certain "forward looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995, and may be identified
by the use of such words as "believe," "expect," "anticipate," "should,"
"planned," "estimated," and "potential." Examples of forward looking statements
include, but are not limited to, estimates with respect to the financial
condition, results of operations and business of the Corporation that are
subject to various factors which could cause actual results to differ materially
from these estimates. These factors include: changes in general, economic, and
market conditions, legislative and regulatory conditions, or the development of
an interest rate environment that adversely affects the Corporation's interest
rate spread or other income anticipated from operations and investments. As used
in this Form 10-Q, "we" and "us" and "our" refer to Stewardship Financial
Corporation and its consolidated subsidiary, Atlantic Stewardship Bank,
depending on the context.
Critical Accounting Policies and Estimates
------------------------------------------
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as disclosures found elsewhere in this Form 10-Q, are based
upon the Corporation's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management 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, 2005 included
in our Annual Report on Form 10-K for the year ended December 31, 2005, as
supplemented by this report, contains a summary of the Corporation's significant
accounting policies. Management also believes the Corporation's policy with
respect to the methodology for the determination of the allowance for loan
losses involves a higher degree of complexity and requires management to make
difficult and subjective judgments which often require assumptions or estimates
about highly uncertain matters. Changes in these judgments, assumptions or
estimates could materially impact results of operations. The Audit Committee and
the Board of Directors periodically review this critical policy and its
application.
The allowance for loan losses is based upon management's evaluation of the
adequacy of the allowance, including an assessment of known and inherent risks
in the portfolio, giving consideration to the size and composition of the loan
portfolio, actual loan loss experience, level of delinquencies, detailed
analysis of individual loans for which full collectibility may not be assured,
the existence and estimated net realizable value of any underlying collateral
and guarantees securing the loans, and current economic and market conditions.
Although management uses the best information available, the level of the
allowance for loan losses remains an estimate that is subject to significant
judgment and short-term change. Various regulatory agencies, as an integral part
of their examination process, periodically review the
16
Corporation's allowance for loan losses. Such agencies may require the
Corporation to make additional provisions for loan losses based upon information
available to them at the time of their examination. Furthermore, the majority of
the Corporation's loans are secured by real estate in the State of New Jersey.
Accordingly, the collectibility of a substantial portion of the carrying value
of the Corporation's loan portfolio is susceptible to changes in local market
conditions and may be adversely affected should real estate values decline or
the northern New Jersey area experience an adverse economic shock. Future
adjustments to the allowance for loan losses may be necessary due to economic,
operating, regulatory and other conditions beyond the Corporation's control.
Financial Condition
-------------------
Total assets increased by $12.6 million, or 2.6%, from $482.7 million at
December 31, 2005 to $495.4 million at June 30, 2006. Net loans increased by
$13.8 million, or 4.0%, despite the Corporation participating approximately $7.1
million of commercial mortgages during the first quarter of 2006. Securities
available for sale decreased $1.9 million, partially offset by an increase in
securities held to maturity of $1.1 million. The composition of the loan
portfolio is basically unchanged at June 30, 2006 when compared with the
portfolio at December 31, 2005.
Deposits totaled $419.0 million at June 30, 2006, an increase of $15.5 million,
or 3.8%, from $403.5 million at December 31, 2005. Interest-bearing deposits
increased by $19.6 million, or 6.3%, to $328.8 million, partially offset by
noninterest-bearing deposits decreasing by $4.1 million, or 4.4%, to $90.2
million at June 30, 2006. The Corporation is experiencing strong competition in
attracting deposits due to the current interest environment and flat yield
curve. The Corporation opened its tenth branch in Montville, Morris County, New
Jersey in February 2006 and this new market has helped to obtain a strong core
deposit base. In addition, the Corporation entered the brokered certificate of
deposit market which provided $15.6 million in certificates of deposit with
average remaining maturities of 4.5 months and average yields of 4.94%.
The Corporation has received approvals to begin the building of our new Wyckoff
branch, anticipated to open in the second quarter of 2007. The Corporation is
also looking at several new deposit products for introduction during this year
to help provide attractive services to existing and new customers that will fund
the loan growth anticipated for the remainder of the year. The challenges of the
rising interest rate environment and the strong competitive market for deposits
is expected to continue for the remainder of the year and will require the
Corporation to continue to look at a blend of new deposit products and
borrowings in order to fund the balance sheet.
17
Results of Operations
---------------------
Six Months Ended June 30, 2006 and 2005
---------------------------------------
General
-------
The Corporation reported net income of $2.28 million, or $0.47 diluted earnings
per share for the six months ended June 30, 2006, compared to $2.14 million, or
$0.45 diluted earnings per share for the same period in 2005. The $133,000
increase was primarily due to increases in net interest income and noninterest
income and a decrease in the provision for loan loss, partially offset by an
increase in noninterest expense.
Net interest income
-------------------
Net interest income increased by $558,000, or 6.3%, for the six months ended
June 30, 2006 as compared with the corresponding period in 2005. The increase
was primarily due to an increase in average net interest-earning assets,
partially offset by a decrease in the net interest margin.
The following table reflects the components of the Corporation's net interest
income for the six months ended June 30, 2006 and 2005 including, (1) average
assets, liabilities, and stockholders' equity, (2) interest income earned on
interest-earning assets and interest expense paid on interest-bearing
liabilities, (3) average yields earned on interest-earning assets and average
rates paid on interest-bearing liabilities, and (4) net yield on
interest-earning assets. Nontaxable income from investment securities and loans
is presented on a tax-equivalent basis assuming a statutory tax rate of 34%.
This was accomplished by adjusting non-taxable income upward to make it
equivalent to the level of taxable income required to earn the same amount after
taxes.
Analysis of Net Interest Income (Unaudited)
For the Six Months Ended June 30,
2006 2005
----------------------------------- -----------------------------------
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) $ 352,037 $ 12,278 7.03% $ 303,839 $ 9,870 6.55%
Taxable investment securities (1) 85,874 1,772 4.16 76,912 1,442 3.78
Tax-exempt investment securities (1) (2) 16,614 364 4.38 19,526 447 4.58
Other interest-earning assets 432 18 8.40 7,318 101 2.78
--------- --------- --------- ---------
Total interest-earning assets 454,957 14,432 6.40 407,595 11,860 5.87
--------- ---------
Non-interest-earning assets:
Allowance for loan losses (3,959) (3,459)
Other assets 31,517 26,620
--------- ---------
Total assets $ 482,515 $ 430,756
========= =========
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits $ 116,764 $ 887 1.53% $ 134,656 $ 716 1.07%
Savings deposits 43,858 127 0.58 49,667 147 0.60
Time deposits 147,764 2,778 3.79 97,853 1,377 2.84
Repurchase agreements 6,068 125 4.15 2,929 33 2.27
FHLB Borrowing 33,286 719 4.36 18,091 318 3.54
Subordinated debenture 7,217 243 6.79 7,217 244 6.82
--------- --------- --------- ---------
Total interest-bearing liabilities 354,957 4,879 2.77 310,413 2,835 1.84
--------- ---------
Non-interest-bearing liabilities:
Demand deposits 89,375 86,390
Other liabilities 3,828 2,527
Stockholders' equity 34,355 31,426
--------- ---------
Total liabilities and stockholders' equity $ 482,515 $ 430,756
========= =========
Net interest income (taxable equivalent basis) $ 9,553 $ 9,025
Tax equivalent adjustment (114) (144)
--------- ---------
Net interest income 9,439 8,881
Net interest spread (taxable equivalent basis) 3.63% 4.03%
========= =========
Net yield on interest-earning
assets (taxable equivalent basis) (3) 4.23% 4.47%
========= =========
--------------------------
(1) For purpose of these calculations, nonaccruing loans are included in
the average balance. Fees are included in loan interest. Loans and
total interest-earning assets are net of unearned income. Securities
are included at amortized cost.
(2) The tax equivalent adjustments are based on a marginal tax rate of
34%.
(3) Net interest income (taxable equivalent basis) divided by average
interest-earning assets.
18
Total interest income on a tax equivalent basis increased by $2.6 million, or
21.7%, primarily due to an increase in the average earning assets and an
increase in yields on interest-earning assets. An increase in the yields in the
loan and investment portfolio and a shift of assets into loans provided an
increase in tax equivalent yields on interest earning assets of 53 basis points
from 5.87% for the six months ended June 30, 2005 to 6.40% for the same period
in 2006. The average balance of interest-earning assets increased by $47.4
million, or 11.6%, from $407.6 million for the six months ended June 30, 2005 to
$455.0 million for the same period in 2006, primarily due to strong loan demand
and an increase in taxable investment securities. The Corporation continued to
experience an increase in loan demand which caused loans on average to increase
by $48.2 million to an average of $352.0 million for the six months ended June
30, 2006, from an average of $303.8 million for the comparable period in 2005.
Taxable investment securities increased by $9.0 million to an average of $85.9
million as the Corporation deployed short-term assets into securities.
Interest paid on deposits and borrowed money increased by $2.0 million, or
72.1%, due to an increase in deposits and an increase in rates paid on deposits.
The average balance of total interest-bearing deposits and borrowed money
increased to $355.0 million for the six months ended June 30, 2006 from $310.4
million for the comparable 2005 period, primarily as a result of the
Corporation's expanding customer base, issuance of brokered certificates of
deposit and new product offerings. Yields on deposits and borrowed money
increased from 1.84% for the six month period ended June 30, 2005 to 2.77% for
the comparable period in 2006. Rising short-term interest rates and an extremely
competitive market has caused the Corporation to raise yields on deposits in
order to fund the asset base.
Provision for loan losses
-------------------------
The Corporation maintains an allowance for loan losses at a level considered by
management to be adequate to cover the inherent losses associated with its loan
portfolio, after giving consideration to changes in general market conditions,
current charge-off experience, level of nonperforming loans and in the nature
and volume of the Corporation's loan activity. The allowance for loan losses is
based on estimates, and provisions are charged to operations during the period
in which such additions are deemed necessary.
The provision charged to operations totaled $160,000 and $300,000 during the six
months ended June 30, 2006 and 2005, respectively. The decrease in the provision
was primarily due to lower loan growth in 2006 than observed in 2005 and an
improvement in nonperforming loans since December 31, 2005. See the "Asset
Quality" section for a summary of allowance for loan losses and nonperforming
assets. The Corporation monitors its loan portfolio and intends to continue to
provide for loan loss reserves based on its ongoing periodic review of the loan
portfolio and general market conditions.
19
Noninterest income
------------------
Noninterest income increased by $357,000, or 23.1%, from $1.55 million for the
six month period ended June 30, 2005 to $1.90 million for the comparable period
in 2006. Income derived from the merchant credit card processing program
increased by $129,000 due to an expanding merchant base and deposit related fees
increased by $112,000 for the six month period ended June 30, 2006 compared to
the same period for 2005 primarily due to the implementation of an overdraft
protection program which was offered to customers beginning March 1, 2006. This
program allows eligible customers with an overdraft line available for check
writing and ATM, ACH, and Debit card transactions. The Bank purchased bank owned
life insurance in April, 2005 which contributed $154,000 to noninterest income
during the six month period ended June 30, 2006, compared with $55,000 for the
comparable period in 2005.
Noninterest expense
-------------------
Noninterest expense increased by approximately $875,000, or 12.9%, to $7.64
million for the six months ended June 30, 2006, compared to $6.77 million for
the same period in 2005. Salaries and employee benefits, the major component of
noninterest expense, increased by $354,000, or 11.9%, during the six months
ended June 30, 2006. This increase was due to general increases for merit and
performance and increases in staffing to support the new Montville branch, the
lending department and the executive administration. Occupancy and equipment
expense increased by $229,000, or 26.4%, primarily to support the new Montville
branch and the newly relocated Waldwick branch which opened in the fall of 2005.
The increase in the merchant card processing business caused merchant processing
expense to increase by $130,000 in the six months ended June 30, 2006.
Income taxes
------------
Income tax expense totaled $1.26 million for the three months ended June 30,
2006, for an effective tax rate of 35.7%. For the three months ended June 30,
2005, income tax expense totaled $1.22 million, for an effective tax rate of
36.2%. The effective tax rate has decreased due to the effect of the tax
deferred status of the bank owned life insurance income.
Results of Operations
---------------------
Three Months Ended June 30, 2006 and 2005
-----------------------------------------
General
-------
The Corporation reported net income of $1.17 million, or $0.24 diluted earnings
per share for the three months ended June 30, 2006, compared to $1.14 million,
or $0.24 diluted earnings per share for the same period in 2005. The $28,000
increase was primarily due to increases in net interest income and noninterest
income and a decrease in the provision for loan loss, partially offset by an
increase in noninterest expense.
20
Net interest income
-------------------
Net interest income increased by $283,000, or 6.3%, for the three months ended
June 30, 2006 as compared with the corresponding period in 2005. The increase
was primarily due to an increase in average net interest-earning assets and a
decrease in the net interest margin.
The following table reflects the components of the Corporation's net interest
income for the quarters ended June 30, 2006 and 2005 including, (1) average
assets, liabilities, and stockholders' equity, (2) interest income earned on
interest-earning assets and interest expense paid on interest-bearing
liabilities, (3) average yields earned on interest-earning assets and average
rates paid on interest-bearing liabilities, and (4) net yield on
interest-earning assets. Nontaxable income from investment securities and loans
is presented on a tax-equivalent basis assuming a statutory tax rate of 34%.
This was accomplished by adjusting non-taxable income upward to make it
equivalent to the level of taxable income required to earn the same amount after
taxes.
Analysis of Net Interest Income (Unaudited)
For the Three Months Ended June 30,
2006 2005
------------------------------------- -------------------------------------
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) $ 355,341 $ 6,304 7.12% $ 310,836 $ 5,082 6.56%
Taxable investment securities (1) 85,118 894 4.21 75,807 718 3.80
Tax-exempt investment securities (1) (2) 16,413 182 4.44 19,581 223 4.56
Other interest-earning assets 597 11 7.39 10,542 76 2.89
---------- ---------- ---------- ----------
Total interest-earning assets 457,469 7,391 6.48 416,766 6,099 5.87
---------- ----------
Non-interest-earning assets:
Allowance for loan losses (3,986) (3,526)
Other assets 32,761 26,589
---------- ----------
Total assets $ 486,244 $ 439,829
========== ==========
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits $ 114,840 $ 481 1.68% $ 137,536 $ 396 1.15%
Savings deposits 43,084 63 0.59 49,247 73 0.59
Time deposits 151,860 1,471 3.89 105,701 796 3.02
Repurchase agreements 6,515 70 4.31 2,466 15 2.44
FHLB Borrowing 32,842 365 4.46 16,040 146 3.65
Subordinated debenture 7,217 122 6.78 7,217 122 6.78
---------- ---------- ---------- ----------
Total interest-bearing liabilities 356,358 2,572 2.89 318,207 1,548 1.95
---------- ----------
Non-interest-bearing liabilities:
Demand deposits 91,370 87,111
Other liabilities 3,851 2,755
Stockholders' equity 34,665 31,756
---------- ----------
Total liabilities and stockholders' equity $ 486,244 $ 439,829
========== ==========
Net interest income (taxable equivalent basis) $ 4,819 $ 4,551
Tax equivalent adjustment (57) (72)
---------- ----------
Net interest income 4,762 4,479
========== ==========
Net interest spread (taxable equivalent basis) 3.59% 3.92%
========== ==========
Net yield on interest-earning
assets (taxable equivalent basis) (3) 4.23% 4.38%
========== ==========
----------------------------
(1) For purpose of these calculations, nonaccruing loans are included in
the average balance. Fees are included in loan interest. Loans and
total interest-earning assets are net of unearned income. Securities
are included at amortized cost.
(2) The tax equivalent adjustments are based on a marginal tax rate of
34%.
(3) Net interest income (taxable equivalent basis) divided by average
interest-earning assets.
21
Total interest income on a tax equivalent basis increased by $1.3 million, or
21.2%, primarily due to an increase in the average earning assets and an
increase in yields on interest-earning assets. The average balance of
interest-earning assets increased by $40.7 million, or 9.8%, from $416.8 million
for the three months ended June 30, 2005 to $457.5 million for the same period
in 2006, primarily caused by strong loan demand and an increase in taxable
investment securities. The Corporation continued to experience an increase in
loan demand which caused loans on average to increase by $44.5 million to an
average of $355.3 million for the three months ended June 30, 2006, from an
average of $310.8 million for the comparable period in 2005. Taxable investment
securities increased by $9.3 million to an average of $85.1 million.
Interest paid on deposits and borrowed money increased by $1.0 million, or
66.2%, due to an increase in deposits and an increase in rates paid on deposits.
The average balance of total interest-bearing deposits and borrowed money
increased to $356.4 million for the three months ended June 30, 2006 from $318.2
million for the comparable period in 2005, primarily as a result of the
Corporation's expanding customer base, issuance of brokered certificates of
deposit and new product offerings. Yields on deposits and borrowed money
increased from 1.95% for the three month period ended June 30, 2005 to 2.89% for
the comparable period in 2006. Rising short-term interest rates and an extremely
competitive market has caused the Corporation to raise yields on deposits in
order to fund the asset base.
22
Provision for loan losses
-------------------------
The Corporation maintains an allowance for loan losses at a level considered by
management to be adequate to cover the inherent losses associated with its loan
portfolio, after giving consideration to changes in general market conditions,
current charge-off experience, level of nonperforming loans and in the nature
and volume of the Corporation's loan activity. The allowance for loan losses is
based on estimates, and provisions are charged to operations during the period
in which such additions are deemed necessary.
The provision charged to operations totaled $110,000 and $150,000 during the
three months ended June 30, 2006 and 2005, respectively. See the "Asset Quality"
section for a summary of allowance for loan losses and nonperforming assets. The
Corporation monitors its loan portfolio and intends to continue to provide for
loan loss reserves based on its ongoing periodic review of the loan portfolio
and general market conditions.
Noninterest income
------------------
Noninterest income increased by $136,000, or 15.2%, from $896,000 for the three
month period ended June 30, 2005 to $1.0 million for the comparable period in
2006. Income derived from the merchant credit card processing program increased
by $54,000 due to an expanding merchant base and deposit related fees increased
by $84,000 for the three month period ended June 30, 2006 compared to the same
period for 2005 due to the implementation of an overdraft protection program.
Offsetting these increases was a decrease in gain on mortgages sold of $38,000,
caused by lower volume of loans originated for sale during the quarter ended
June 30, 2006 when compared with the quarter ended June 30, 2005.
Noninterest expense
-------------------
Noninterest expense increased by approximately $412,000, or 11.9%, to $3.9
million for the three months ended June 30, 2006, compared to $3.5 million for
the same period in 2005. Salaries and employee benefits, the major component of
noninterest expense, increased by $171,000, or 11.1%, during the three months
ended June 30, 2006. This increase was due to general increases for merit and
performance and increases in staffing to support the new Montville branch, the
lending department and the executive administration. Occupancy and equipment
expense increased by $117,000, or 27.7%, primarily to support the new Montville
branch and the newly relocated Waldwick branch which opened in the fall of 2005.
The increase in the merchant card processing business caused merchant processing
expense to increase by $79,000 for the quarter ended June 30, 2006.
Income taxes
------------
Income tax expense totaled $654,000 for the three months ended June 30, 2006,
for an effective tax rate of 35.9%. For the three months ended June 30, 2005,
income tax expense totaled $635,000, for an effective tax rate of 35.8%.
23
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:
06/30/06 03/31/06 12/31/05 09/30/05
-------- -------- -------- --------
(Dollars in Thousands)
Nonaccrual loans: (1) $ 258 $ 184 $ 472 $ 316
Loans past due 90 days or more: (2) 11 5 55 26
Restructured loans: -- -- -- --
--------- --------- --------- ---------
Total nonperforming loans $ 269 $ 189 $ 527 $ 342
========= ========= ========= =========
Allowance for loan losses $ 4,011 $ 3,920 $ 3,299 $ 3,714
========= ========= ========= =========
Nonaccrual loans to total loans 0.07% 0.05% 0.14% 0.09%
Nonperforming loans to total loans 0.08% 0.06% 0.15% 0.10%
Nonperforming loans to total assets 0.05% 0.04% 0.11% 0.07%
Allowance for loan losses to total loans 1.11% 1.13% 1.11% 1.14%
(1) Generally represents loans to which the payments of interest or principal
are in arrears for a period of more than 90 days. Interest previously accrued on
these loans and not yet paid is reversed and charged against income during the
current period. Interest earned thereafter is only included in income to the
extent that it is received in cash.
(2) Represents loans to which payments of interest or principal 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.
There were no loans at June 30, 2006 other than those included in the above
table, where the Corporation was aware of any credit conditions of any borrowers
that would indicate a strong possibility of the borrowers not complying with the
present terms and conditions of repayment and which may result in such loans
being included as non-accrual, past due or restructured at a future date.
The Corporation's lending activities are concentrated in loans secured by real
estate located in northern New Jersey. Accordingly, the collectibility of a
substantial portion of the Corporation's loan portfolio is susceptible to
changes in real estate market conditions in northern New Jersey.
Market Risk
-----------
The Corporation's primary exposure to market risk arises from changes in market
interest rates ("interest rate risk"). The Corporation's profitability is
largely dependent upon its ability to manage interest rate risk. Interest rate
risk can be defined as the exposure of the Corporation's
24
net interest income to adverse movements in interest rates. Although the
Corporation manages other risks, such as credit and liquidity risk, in the
normal course of its business, management considers interest rate risk to be its
most significant market risk and it could potentially have the largest material
effect on the Corporation's financial condition. The Corporation manages its
interest rate risk by utilizing an asset/liability simulation model and by
measuring and managing its interest sensitivity gap. Interest sensitivity gap is
determined by analyzing the difference between the amount of interest-earning
assets maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within the same period of
time. The Asset Liability Committee reviews and discusses these measurements on
a monthly basis.
The Corporation does not have any material exposure to foreign currency exchange
rate risk or commodity price risk. The Corporation did not enter into any market
sensitive instruments for trading purposes nor did it engage in any hedging
transactions utilizing derivative financial instruments during the six months
ended June 30, 2006.
The Corporation is, however, a party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financing needs of its
customers. These instruments, which include commitments to extend credit and
standby letters of credit, involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the consolidated
statement of condition. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates and may require
collateral from the borrower if deemed necessary by the Corporation. Standby
letters of credit are conditional commitments issued by the Corporation to
guarantee the performance of a customer to a third party up to a stipulated
amount and with specified terms and conditions. Commitments to extend credit and
standby letters of credit are not recorded on the Corporation's consolidated
balance sheet until the instrument is exercised.
Capital Adequacy
----------------
The Corporation is subject to capital adequacy guidelines promulgated by the
Board of Governors of the Federal Reserve System ("FRB"). The Bank is subject to
similar capital adequacy requirements imposed by the Federal Deposit Insurance
Corporation. The FRB has issued regulations to define the adequacy of capital
based upon the sensitivity of assets and off-balance sheet exposures to risk
factors. Four categories of risk weights (0%, 20%, 50%, and 100%) were
established to be applied to different types of balance sheet assets and
off-balance sheet exposures. The aggregate of the risk-weighted items
(risk-based assets) is the denominator of the ratio, the numerator is risk-based
capital. Under the regulations, risk-based capital has been classified into two
categories. Tier 1 capital includes common and qualifying perpetual 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 June 30, 2006, the
25
minimum risk-based capital requirements to be considered adequately capitalized
were 4% for Tier 1 capital and 8% for total capital.
Federal banking regulators have also adopted leverage capital guidelines to
supplement the risk-based measures. The leverage ratio is determined by dividing
Tier 1 capital as defined under the risk-based guidelines by average total
assets (non risk-adjusted) for the preceding quarter. At June 30, 2006 the
minimum leverage ratio requirement to be considered well capitalized was 4%. The
following table reflects the Corporation's capital ratios at June 30, 2006.
Required Actual Excess
-------- ------ ------
Risk-based Capital
Tier 1 4.00% 11.27% 7.27%
Total 8.00% 12.31% 4.31%
Leverage Ratio 4.00% 8.97% 4.97%
Liquidity and Capital Resources
-------------------------------
The Corporation's primary sources of funds are deposits, repayments of loans and
mortgage-backed securities, maturities of investment securities and funds
provided from operations. While scheduled loan and mortgage-backed securities
amortization and maturities of investment securities are a relatively
predictable source of funds, deposit flow and prepayments on loans and
mortgage-backed securities are greatly influenced by market interest rates,
economic conditions and competition. The Corporation's liquidity, represented by
cash and cash equivalents, is a product of its operating, investing and
financing activities.
The primary source of cash from operating activities is net income. Liquidity
management is both a daily and long-term function of business management. Excess
liquidity is generally invested in short-term investments, such as federal funds
sold. The Corporation anticipates that it will have sufficient funds available
to meet its current loan commitments. At June 30, 2006, the Corporation has
outstanding loan commitments of $30.1 million and unused lines and letters of
credit totaling $96.6 million. Certificates of deposit scheduled to mature in
one year or less, at June 30, 2006, totaled $76.3 million. Management believes
that a significant portion of such deposits will remain with the Corporation.
Cash and cash equivalents decreased $97,000 during the first six months of 2006.
Net operating and financing activities provided $3.0 million and $11.2 million,
respectively, and investing activities used $14.3 million.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Disclosure about quantitative and qualitative market risk is located in the
Market Risk section of Management's Discussion and Analysis of Financial
Condition and Results of Operations.
26
ITEM 4. Controls and Procedures
The Corporation's management, with the participation of the Corporation's chief
executive officer and principal accounting officer, has evaluated the
effectiveness of the Corporation's disclosure controls and procedures as of June
30, 2006. Based on this evaluation, the Corporation's chief executive officer
and principal accounting officer concluded that the Corporation disclosure
controls and procedures are effective for recording, processing, summarizing and
reporting the information the Corporation is required to disclose in the reports
it files under the Securities Exchange Act of 1934, within the time periods
specified in the SEC's rules and forms. Such evaluation did not identify any
change in the Corporation's internal control over financial reporting that
occurred during the period ended June 30, 2006 that has materially affected, or
is reasonably likely to materially affect, the Corporation's internal control
over financial reporting.
27
Stewardship Financial Corporation
Part II -- Other Information
Item 1A. Risk Factors
------------
There have been no material changes in risk factors described
in the Corporation's Annual Report on Form 10-K for the year ended December 31,
2005.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Corporation held an Annual Meeting of Shareholders on May 9, 2006. At that
meeting, the Corporation's shareholders elected three directors for a three year
term that will expire in May 2009, or until their successors are duly elected
and qualified. The voting results were as follows:
Votes for Votes Withheld
--------- --------------
Election of Director
Robert J. Turner 3,529,228 17,992
William J. Vander Eems 3,539,680 7,539
Paul Van Ostenbridge 3,540,771 6,449
There were no broker non-votes on any of the above matters. The following
individuals whose terms expire in either 2007 or 2008, or until their successors
are duly elected and qualified, continue to serve as directors: William C.
Hanse, Margo Lane, Arie Leegwater, John L. Steen, Harold Dyer, Abe Van
Wingerden, Michael Westra and Howard Yeaton.
The shareholders reviewed and voted on the 2006 Director Stock Option Plan for
Nonemployee Directors with 2,660,804 shares voting for, 357,351 shares voting
against, 56,858 shares abstaining, and 463,206 broker non-votes.
The shareholders ratified the appointment of Crowe Chizek and Company LLC as the
Corporation's independent auditors for the fiscal year ending December 31, 2006
with 3,530,062 shares voting for, 755 shares voting against, and 16,401 shares
abstaining.
Item 6. Exhibits
--------
(a) Exhibits
See Exhibit Index following this report.
28
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: August 14, 2006 By: /s/ Paul Van Ostenbridge
--------------- ---------------------------------------
Paul Van Ostenbridge
President and Chief Executive
Officer
(authorized officer on behalf
of registrant)
Date: August 14, 2006 By: /s/ Julie E. Holland
--------------- ---------------------------------------
Julie E. Holland
Senior Vice President and Treasurer
(principal accounting officer)
29
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
31.1 Certification of Paul Van Ostenbridge required by Rule 13a-14(a) or
Rule 15d-14(a)
31.2 Certification of Julie Holland required by Rule 13a-14(a) or Rule
15d-14(a)
32.1 Certification of Paul Van Ostenbridge and Julie Holland required by
Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
30