STEWARDSHIP FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED FINANCIAL SUMMARY OF SELECTED FINANCIAL DATA
December 31,
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2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(Dollars in thousands, except per share amounts)
Earnings Summary:
Net interest income ...................................... $ 14,324 $ 12,507 $ 10,866 $ 10,349 $ 8,881
Provision for loan losses ................................ (425) (160) (420) (410) (340)
-------- -------- -------- -------- --------
Net interest income after
provision for loan losses ............................. 13,899 12,347 10,446 9,939 8,541
Noninterest income ....................................... 2,894 2,250 1,695 1,279 1,091
Noninterest expense ...................................... 11,394 9,847 8,279 7,558 6,679
-------- -------- -------- -------- --------
Income before income tax expense ......................... 5,399 4,750 3,862 3,660 2,953
Income tax expense ....................................... 1,908 1,634 1,304 1,240 972
-------- -------- -------- -------- --------
Net income ............................................... $ 3,491 $ 3,116 $ 2,558 $ 2,420 $ 1,981
======== ======== ======== ======== ========
Common Share Data:(1)
Basic net income ......................................... $ 1.11 $ 1.01 $ 0.85 $ 0.81 $ 0.69
Diluted net income ....................................... 1.10 1.00 0.84 0.81 0.68
Cash dividends declared .................................. 0.26 0.22 0.18 0.15 0.13
Book value at year end ................................... 8.58 7.66 6.80 6.07 5.24
Average shares outstanding ............................... 3,140 3,077 3,020 2,974 2,878
Shares outstanding at year end ........................... 3,165 3,111 3,025 3,002 2,917
Dividend payout ratio .................................... 23.37% 21.41% 21.81% 18.84% 18.53%
Selected Consolidated Ratios:
Return on average assets ................................. 0.97% 1.03% 1.01% 1.11% 1.03%
Return on average stockholders' equity ................... 13.68% 14.01% 13.09% 14.52% 13.77%
Average stockholders' equity as
a percentage of average total assets .................. 7.12% 7.36% 7.74% 7.67% 7.49%
Tier-I capital leverage (2) .............................. 8.89% 7.02% 7.45% 7.87% 7.52%
Tier-I risk based capital (3) ............................ 12.93% 10.53% 10.65% 11.01% 11.16%
Total risk based capital (3) ............................. 14.03% 11.74% 11.90% 12.26% 12.41%
Allowance for loan loss total to total loans ............. 1.10% 1.24% 1.40% 1.30% 1.30%
Nonperforming loans to total loans ....................... 0.42% 0.62% 0.52% 0.45% 0.02%
Selected Year-end Balances:
Total assets ............................................. $401,768 $331,087 $278,523 $231,159 $203,072
Total loans, net of allowance
for loan loss ......................................... 258,776 213,579 182,930 169,052 142,196
Total deposits ........................................... 341,538 302,735 255,684 210,135 185,167
Stockholders' equity ..................................... 27,149 23,817 20,553 18,208 15,286
- ----------
(1) All share and per share amounts have been restated to reflect a 5% stock
dividend paid November 2000, 2001, 2002 and 2003 and a 3 for 2 stock split
that occurred in July 2003.
(2) As a percentage of average quarterly assets.
(3) As a percentage of total risk-weighted assets.
A-1
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This section provides an analysis of the Stewardship Financial Corporation's
(the "Corporation") consolidated financial condition and results of operations
for the years ended December 31, 2003, 2002 and 2001. The analysis should be
read in conjunction with the related audited consolidated financial statements
and the accompanying notes presented elsewhere herein.
This annual report contains certain "forward looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995, and may be
identified by the use of such words as "believe," "expect," "anticipate,"
"should," "plan," "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 annual report, "we" and "us" and "our" refer to
Stewardship Financial Corporation and its consolidated subsidiary, Atlantic
Stewardship Bank, depending on the context.
Introduction
The Corporation, organized in January 1995, as a business corporation under the
laws of the State of New Jersey, was established by the Board of Directors of
Atlantic Stewardship Bank (the "Bank") to become a holding company for the Bank.
The shareholders of the Bank approved the holding company formation at the
annual meeting in 1996. After obtaining approval and submitting appropriate
applications, the Corporation, on November 22, 1996, acquired all of the shares
of the Bank in exchange for its own shares, on a share per share basis. The
Bank, and its subsidiary, Stewardship Investment Corp., is now the wholly-owned
subsidiary of the Corporation. The Corporation also formed a second subsidiary
in 2003, Stewardship Statutory Trust I (the "Trust"). The Trust was formed to
issue Trust Preferred Securities to enhance the capital position of the
Corporation.
The Corporation conducts a general commercial and retail banking business
encompassing a wide range of traditional deposit and lending functions along
with the other customary banking services. Stewardship Investment Corporation is
a wholly-owned nonbank subsidiary of Atlantic Stewardship Bank, whose primary
business is to own and manage the Bank's investment portfolio. The Corporation
earns income and generates cash primarily through the deposit gathering
activities of the branch network These deposits are then utilized to fund the
Corporation's lending and investing activities.
The Corporation is affected by the overall economic conditions in northern New
Jersey, interest rate and yield curve environment, and the national economy.
These factors are relevant because they will affect the Corporation's ability to
attract specific deposit products, invest in loan and investment products, and
earn acceptable profits without incurring increased risks.
When evaluating the financial condition and operating performance of the
organization, management reviews historical trends and peer comparisons of the
growth of the organization, asset and deposit concentrations, interest margin
analysis, adequacy of loan loss reserve and loan quality performance, adequacy
of capital under current positions as well as to support future expansion,
adequacy of liquidity, and overall quality of earnings performance.
The Corporation has developed a strong deposit base with good franchise value.
Our challenges are to continue to grow the deposit base of existing branches,
explore new branch opportunities, provide adequate technological enhancements to
achieve efficiencies and deliver strong products, and provide the highest level
of customer service.
The Corporation implemented a strategy to raise capital during 2003 to support
the future growth of the organization. In September 2003, the Corporation formed
a new subsidiary, Stewardship Statutory Trust I (the "Trust"). The Trust, a
statutory business trust, issued $7.0 million Fixed/Floating Rate Capital
Securities ("Capital Securities") due September 17, 2033. The proceeds from this
issuance were used to purchase from the Corporation, $7.0 million of
Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures
("Debentures") also maturing September 17, 2033. The Capital Securities and the
Debentures both bear a fixed interest rate of 6.75% until September 17, 2008 and
thereafter shall float quarterly at a rate of 3-Month LIBOR plus 2.95%. Both the
Capital Securities and the Debentures are redeemable quarterly beginning
September 17, 2008.
The proceeds from the Debentures were use to provide a capital infusion into the
Bank and to purchase investment securities. The Corporation purchased 1.5
million shares of common stock of the Bank at $20.00 per share. In December
2003, the Corporation entered into a $20.0 million leveraging strategy to help
cover the cost of raising capital. The leveraging strategy consisted of $20.0
million in Federal Home Loan Bank ("FHLB") borrowings, the proceeds of which
were utilized to purchase agency and mortgage-backed securities.
A-2
Critical Accounting Policies And Estimates
"Management's Discussion and Analysis of Financial Condition and Results of
Operation," is based upon the Corporation's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires the Corporation to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses. Note 1 to
the Corporation's Audited Consolidated Financial Statements for the year ended
December 31, 2003 contains a summary of the Corporation's significant accounting
policies. Management believes the Corporation's policy with respect to the
methodology for the determination of the allowance for loan losses involves a
higher degree of complexity and requires management to make difficult and
subjective judgments, which often require assumptions or estimates about highly
uncertain matters. Changes in these judgments, assumptions or estimates could
materially impact results of operations. This critical policy and its
application are periodically reviewed with the Audit Committee and the Board of
Directors.
The allowance for loan losses is based upon management's evaluation of the
adequacy of the allowance, including an assessment of known and inherent risks
in the portfolio, giving consideration to the size and composition of the loan
portfolio, actual loan loss experience, level of delinquencies, detailed
analysis of individual loans for which full 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, 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
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.
Earnings Summary
The Corporation reported net income of $3.5 million, or $1.10 diluted earnings
per share, for the year ended December 31, 2003, an increase of $375,000, or
12.0%, above the $3.1 million recorded for 2002. Earnings for 2002 had increased
$558,000, or 21.8%, over the 2001 earnings of $2.6 million. Earnings have
increased in both years as a result of increases in net interest income and
noninterest income offset by increases in noninterest expense.
Although interest rates continued to decline in 2003, the Corporation's net
interest income increased $1.8 million, contributing to the increased earnings
per share. An increase in the average loan and investment volume helped to
offset the decline in interest rates.
The return on average assets decreased in 2003 to 0.97% from 1.03% in 2002. The
return on average equity decreased to 13.68% in 2003 from 14.01% in 2002. These
decreases were due to the pressure on net interest margin and the increase in
the provision for loan loss.
Results of Operations
Net Interest Income
The Corporation's principal source of revenue is the net interest income derived
from the Bank, which represents the difference between the interest earned on
assets and interest paid on funds acquired to support those assets. Net interest
income is affected by the balances and mix of interest-earning assets and
interest-bearing liabilities, changes in their corresponding yields and costs,
and by the volume of interest-earning assets funded by noninterest-bearing
deposits. The Corporation's principal interest-earning assets are loans made to
businesses and individuals, investment securities, and federal funds sold.
In 2003, net interest income, on a tax equivalent basis, increased to $14.6
million from $12.8 million in 2002, an increase of $1.8 million, or 14.2%. This
was caused by an increase of $14.0 million, or 20.9%, in net average
interest-earning assets (average interest-earning assets less average
interest-bearing liabilities).
Interest income, on a tax equivalent basis, increased $1.1 million, or 6.3%,
during 2003 to $19.2 million from $18.1 million earned during 2002. The increase
was due to an increase in the average volume of interest-earning assets
partially offset by a decrease in yields on interest-earning assets. Average
interest-earning assets increased $54.1 million in 2003, or 18.9%, over the 2002
amount with average loans attributing to $43.8 million of the increase due
primarily to the Corporation's increased competitiveness within the marketplace
and the attractive level of interest rates.
A-3
Interest expense decreased $680,000, or 12.9%, during 2003 to $4.6 million. The
decrease was due to a declining rate environment partially offset by an increase
in average interest-bearing liabilities of $40.0 million, or 18.3%, to $258.3
million during 2003. Yields on interest-bearing liabilities decreased to 1.78%
during 2003 from 2.41% during 2002. Despite customer movements to interest
bearing deposits, average noninterest-bearing demand deposits increased $12.9
million, or 21.6%, to $72.7 million during 2003.
In 2002, net interest income, on a tax equivalent basis, increased to $12.8
million from $11.1 million in 2001, an increase of $1.7 million, or 15.4%.
Interest income, on a tax equivalent basis, increased $252,000, or 1.4%, during
2002 to $18.1 million from $17.8 million earned in 2001. The increase was due to
an increase in the average volume of interest-earning assets offset by a
decrease in yields on interest-earning assets. Average interest-earning assets
increased $47.3 million in 2002, or 19.9%, over the 2001 amount. Interest
expense decreased $1.5 million or 21.7%, during 2002. The decrease was due to
the decline in interest rates from 3.72% in 2001 to 2.41% in 2002, partially
offset by an increase in average interest-bearing liabilities. Average
noninterest-bearing demand deposits increased $9.1 million, or 17.9%, to $59.8
million during 2002.
The following table reflects the components of the Corporation's net interest
income for the years ended December 31, 2003, 2002 and 2001 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 is
presented on a tax-equivalent basis assuming a statutory tax rate of 34% and
compliance with Section 291 of the Internal Revenue Code for 2003, 2002 and
2001. This was accomplished by adjusting this income upward to make it
equivalent to the level of taxable income required to earn the same amount after
taxes.
A-4
2003 2002 2001
---------------------------- --------------------------- -----------------------------
Average Average Average
Interest Rates Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid Balance Expense Paid
------- -------- ------- ------- -------- ------- ------- -------- --------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans(1) ........................... $242,530 $16,091 6.63% $198,737 $14,673 7.38% $180,926 $14,836 8.20%
Taxable investment securities(1) ... 59,097 1,929 3.26 41,026 1,970 4.80 26,328 1,616 6.14
Tax-exempt investment
securities(1)(2) ................. 20,385 1,051 5.16 19,766 1,075 5.44 16,007 904 5.65
Other interest-earning assets ...... 17,680 168 0.95 26,106 380 1.46 15,036 490 3.26
-------- ------- -------- ------- -------- -------
Total interest-earning assets ...... 339,692 19,239 5.66 285,635 18,098 6.34 238,297 17,846 7.49
------- ------- -------
Non-interest-earning assets:
Allowance for loan losses .......... (2,839) (2,663) (2,423)
Other assets ....................... 21,816 19,424 16,572
-------- -------- --------
Total assets ....................... $358,669 $302,396 $252,446
======== ======== ========
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Interest-bearing
demand deposits .................. $115,383 $ 1,058 0.92% $ 98,503 $ 1,314 1.33% $ 79,965 $ 2,038 2.55%
Savings deposits ................... 41,767 325 0.78 31,486 336 1.07 22,704 319 1.41
Time deposits ...................... 94,047 2,975 3.16 87,296 3,592 4.11 77,180 4,323 5.60
Repurchase agreements .............. 3,998 57 1.43 1,030 29 2.82 1,107 49 4.43
FHLB borrowings .................... 1,041 35 3.36 -- -- -- -- -- --
Subordinated debenture ............. 2,097 141 6.72 -- -- -- -- -- --
-------- ------- -------- ------- -------- -------
Total interest-bearing
liabilities ...................... 258,333 4,591 1.78 218,315 5,271 2.41 180,956 6,729 3.72
------- ------- -------
Non-interest-bearing liabilities:
Demand deposits .................... 72,687 59,784 50,702
Other liabilities .................. 2,126 2,047 1,256
Stockholders' equity ............... 25,523 22,250 19,532
-------- -------- --------
Total liabilities and
stockholders' equity ............. $358,669 $302,396 $252,446
======== ======== ========
Net interest income
(taxable equivalent basis) ........ 14,648 12,827 11,117
Tax equivalent adjustment .......... (324) (320) (251)
------- ------- -------
Net interest income ................ $14,324 $12,507 $10,866
======= ======= =======
Net interest spread
(taxable equivalent basis) ........ 3.88% 3.93% 3.77%
==== ==== ====
Net yield on interest-earning assets
(taxable equivalent basis)(3) ..... 4.31% 4.49% 4.67%
==== ==== ====
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(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% and
the provisions of Section 291 of the Internal Revenue Code.
(3) Net interest income (taxable equivalent basis) divided by average
interest-earning assets.
A-5
The following table analyzes net interest income in terms of changes in the
volume of interest-earning assets and interest-bearing liabilities and changes
in yields earned and rates paid on such assets and liabilities on a tax
equivalent basis. The table reflects the extent to which changes in the
Corporation's interest income and interest expense are attributable to changes
in volume (changes in volume multiplied by prior year rate) and changes in rate
(changes in rate multiplied by prior year volume). Changes attributable to the
combined impact of volume and rate have been allocated proportionately to
changes due to volume and changes due to rate.
2003 Versus 2002 2002 Versus 2001
----------------------------------- -----------------------------------
(In thousands)
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
----------------------------------- -----------------------------------
Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------- -------
Interest income:
Loans ........................................ $ 3,009 $(1,591) $ 1,418 $ 2,050 $ (632) $ 1,418
Taxable investment securities ................ 707 (748) (41) 75 (93) (18)
Tax-exempt investment securities ............. 33 (57) (24) 101 (24) 77
Other interest-earning assets ................ (102) (110) (212) 246 (382) (136)
------- ------- ------- ------- ------- -------
Total interest-earning assets .............. 3,647 (2,506) 1,141 2,472 (1,131) 1,341
------- ------- ------- ------- ------- -------
Interest expense:
Interest-bearing demand deposits ............. $ 200 $ (456) $ (256) $ 268 $ (460) $ (192)
Savings deposits ............................. 93 (104) (11) 20 (29) (9)
Time deposits ................................ 262 (879) (617) 913 114 1,027
Repurchase agreements ........................ 48 (20) 28 (11) (10) (21)
FHLB borrowings .............................. 35 -- 35 -- -- --
Subordinated debenture ....................... 141 -- 141 -- -- --
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities ......... 779 (1,459) (680) 1,190 (385) 805
------- ------- ------- ------- ------- -------
Net change in net interest income ............ $ 2,868 $(1,047) $ 1,821 $ 1,282 $ (746) $ 536
======= ======= ======= ======= ======= =======
Provision for Loan Losses
The Corporation maintains an allowance for loan losses considered by management
to be adequate to cover the inherent risk of loss 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 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 $425,000 in 2003 representing a 165.6% increase
from the 2002 provision of $160,000. This increase was due to the strong growth
in the loan portfolio in 2003. The 2002 provision decreased 61.9% from the 2001
provision of $420,000.
Noninterest Income
Noninterest income consists of all income other than interest income and is
principally derived from service charges on deposits, gains on sales of mortgage
loans, fees on safe deposit boxes, credit card merchant income and income
derived from debit cards and ATM usage.
Noninterest income increased $644,000, or 28.6%, to $2.9 million during the year
ended December 31, 2003, when compared with $2.3 million during the 2002 period.
The increase in noninterest income resulted primarily from an increase in fees
and service charges on deposit accounts of $317,000 to $2.1 million for the year
ended December 31, 2003 due to an increase in the deposit base and income
derived from merchant card processing. Gain on sales of mortgage loans increased
$203,000 to $451,000 for 2003 due to an increase in the volume of loans
originated for sale brought about by the high refinancing activity associated
with the low mortgage interest rate environment. Also contributing to the strong
increase in noninterest income was the gain on
A-6
sales of securities of $49,000 and a gain on the sale of a real estate property
of $54,000. This property had been purchased in 2001 for a potential branch
site. During 2002, the Corporation made the decision to locate the branch in an
alternative location and sell the property. The sale was consummated during the
first quarter of 2003.
Noninterest income increased by $555,000, or 32.7%, to $2.3 million during the
year ended December 31, 2002, when compared with $1.7 million during the 2001
period. The increase resulted primarily from an increase in fees and service
charges and a volume related increase in gain on sales of mortgage loans.
Noninterest Expense
Although management is committed to containing noninterest expense, the
continued growth of the Corporation has caused noninterest expense to increase
by $1.5 million, or 15.7%, to $11.4 million for the year ended December 31,
2003, compared to $9.8 million for the same period in 2002. Salaries and
employee benefits, the major component of noninterest expense, increased
$727,000, or 15.6%. The increase was due primarily to additions to staff for the
lending, branch administration and deposit operations departments, staffing for
the new branch office opened in November 2003 in Wayne, New Jersey and general
merit and salary increases. Occupancy and equipment increased $141,000, or
10.9%, primarily due to the increase in our branch facilities. Data processing
expense increased $236,000, or 34.6%, due to the increase in our deposit base,
the conversion to a check imaging platform, the outsourcing of our statement
rendering function and the enhancements to our online banking product. Although
management believes that data processing expense will continue to increase, the
check imaging conversion will allow the Corporation to more efficiently provide
research and customer service to our customer base. Miscellaneous expenses
increased $345,000, or 15.7%, due to increased activity in credit card merchant
processing and overall support of the general growth of the Corporation.
In accordance with its By-laws to tithe 10% of its pre-tax profits to various
charities, the Corporation had charitable contributions totaling $512,000 for
the year ended December 31, 2003, an increase of $87,000, or 20.4%, over the
same period in 2002.
Noninterest expense increased $1.6 million, or 18.9%, to $9.8 million for the
year ended December 31, 2002, compared to $8.3 million for the same period in
2001. Increases in salaries and employee benefits were primarily a result of new
personnel hires in lending, deposit operations, and branches. Data processing
expense increased due to the upgrading of our online banking and billpay product
and servicing a new consumer debit card product.
Income Taxes
Income tax expense totaled $1.9 million for the year ended December 31, 2003,
for an effective tax rate of 35.3%, compared to an effective tax rate of 34.4%
for the year ended December 31, 2002. The increase in the effective tax rate can
be attributed to less income being generated through the investment subsidiary.
Income tax expense totaled $1.3 million for the year ended December 31, 2001,
for an effective tax rate of 33.8%.
Financial Condition
Total assets at December 31, 2003 were $401.8 million, an increase of $70.7
million, or 21.3%, over the $331.1 million at December 31, 2002. This increase
in assets reflects, among other things, a $45.2 million increase in net loans
held for portfolio and an increase of $48.5 million in securities available for
sale, partially offset by a decrease in cash and cash equivalents of $14.3
million and in securities held to maturity of $8.5 million. Despite principal
repayments and refinancings, the Corporation showed strong growth in loan
generation. The leveraging transaction, entered into in December, accounted for
$20.0 million in new investment purchases in securities available for sale.
During the second half of the year, management redeployed Federal funds sold and
other interest earning assets into the securities available for sale portfolio
in order to improve earnings on these funds.
Loan Portfolio
The Corporation's loan portfolio at December 31, 2003, net of allowance for loan
losses, totaled $258.8 million, an increase of $45.2 million, or 21.2%, over the
$213.6 million at December 31, 2002. Commercial real estate mortgage loans
consisting of $109.7 million, or 41.9% of the total portfolio, comprised the
largest portion of the loan portfolio. This represented an increase of $21.1
million, or 23.8%, from $88.6 million at December 31, 2002. Commercial loans
increased $10.7 million and residential mortgages increased $5.1 million. The
residential real estate market in northern New Jersey was strong due to the
declining rate environment and the Corporation continued its policy of selling
the majority of its fixed rate residential real estate loans in the secondary
market.
A-7
The Corporation's lending activities are concentrated in loans secured by real
estate located in northern New Jersey and therefore collectibility of the loan
portfolio is susceptible to changes in real estate market conditions in the
northern New Jersey market. The Corporation has not made loans to borrowers
outside the United States.
At December 31, 2003, there were no concentrations of loans exceeding 10% of
total loans outstanding. Loan concentrations are considered to exist when there
are amounts loaned to a multiple number of borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
related conditions.
The following table sets forth the classification of the Corporation's loans by
major category at the end of the last five years:
December 31,
---------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands)
Real estate mortgage:
Residential ................................ $ 44,835 $ 39,705 $ 36,394 $ 34,652 $ 31,716
Commercial ................................. 109,708 88,593 72,262 64,473 53,609
Commercial loans ............................. 48,950 38,228 32,871 30,326 21,838
Consumer loans:
Installment(1) ............................. 41,067 37,293 35,961 35,011 32,110
Home equity ................................ 17,181 12,471 7,944 6,699 4,742
Other ...................................... 238 241 243 234 175
-------- -------- -------- -------- --------
Total loans .................................. 261,979 216,531 185,675 171,395 144,190
Less: Allowance for loan losses .............. 2,888 2,689 2,602 2,223 1,874
Deferred loan fees ....................... 315 263 143 120 120
-------- -------- -------- -------- --------
Net loans .................................... $258,776 $213,579 $182,930 $169,052 $142,196
======== ======== ======== ======== ========
- ----------
(1) Includes automobile, home improvement, second mortgages and unsecured
loans.
The following table sets forth certain categories of gross loans as of December
31, 2003 by contractual maturity. Borrowers may have the right to prepay
obligations with or without prepayment penalties. This might cause actual
maturities to differ from the contractual maturities summarized below.
After 1 Year
Within But Within After
1 Year 5 Years 5 Years Total
-------- ------------ -------- --------
(In thousands)
Real estate mortgage ......................... $ 14,984 $ 21,123 $118,436 $154,543
Commercial ................................... 22,446 24,207 2,297 48,950
Consumer ..................................... 2,458 11,762 44,266 58,486
-------- -------- -------- --------
Total gross loans ............................ $ 39,888 $ 57,092 $164,999 $261,979
======== ======== ======== ========
The following table sets forth the dollar amount of all gross loans due one year
or more after December 31, 2003, which have predetermined interest rates or
floating or adjustable interest rates:
Floating or
Predetermined Adjustable
Rates Rates Total
------------- ----------- --------
(In thousands)
Real estate mortgage ................................. $ 71,473 $ 68,086 $139,559
Commercial ........................................... 13,212 13,292 26,504
Consumer ............................................. 35,307 20,721 56,028
-------- -------- --------
$119,992 $102,099 $222,091
======== ======== ========
A-8
Asset Quality
The Corporation's principal earning asset is its loan portfolio. Inherent in the
lending function is the risk of deterioration in a borrower's ability to repay
loans under existing loan agreements. Management realizes that because of this
risk, reserves are maintained to absorb potential loan losses. In determining
the adequacy of the allowance for loan losses, management of the Corporation
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 attempts to establish a reserve
sufficient to offset potential losses in the portfolio, changes in economic
conditions, regulatory policies and borrower's performance could require future
changes to the allowance.
The Corporation utilizes a two tier approach by (1) identifying problem loans
and allocating specific loss allowances on such loans and (2) establishing a
general valuation allowance on the remainder of its loan portfolio. The
Corporation maintains a loan review system that allows for a periodic review of
its loan portfolio and the early identification of potential problem loans. Such
a system takes into consideration, among other things, delinquency status, size
of loans, type of collateral and financial condition of the borrowers.
Allocations of specific loan loss allowances are established for identified
loans based on a review of such information and/or appraisals of underlying
collateral. General loan loss allowances are based upon a combination of factors
including, but not limited to, actual loss experience, composition of loan
portfolio, current economic conditions and management's judgment.
The Corporation's accounting policies are set forth in Note 1 to the audited
financial statements. The application of certain of these policies require
significant management judgment and the utilization of estimates. Actual results
could differ from these judgments and estimates resulting in a significant
impact on the financial statements. A critical accounting policy for the
Corporation is the policy utilized in determining the adequacy of the allowance
for loan losses. 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 collectibility of a substantial portion of the carrying value
of the Corporation's loan portfolio is susceptible to changes in the 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 may be necessary due to economic, operating,
regulatory, and other conditions beyond the Corporation's control. The allowance
for loan losses represents 1.1% of total loans, or 2.6 times non-performing
loans at December 31, 2003, compared with 1.2% of total loans or 2.0 times
non-performing loans at December 31, 2002. In management's opinion, the
allowance for loan losses totaling $2.9 million is adequate to cover losses
inherent in the portfolio at December 31, 2003.
Nonperforming Assets
Nonperforming assets include nonaccrual loans, restructured loans, loans past
due 90 days or more and accruing, and other real estate owned. The Corporation's
loans are generally placed in a nonaccrual status when they become past due in
excess of 90 days as to payment of principal and interest. Interest previously
accrued on these loans and not yet paid is charged against income during the
current period. Interest earned thereafter is only included in income to the
extent that it is received in cash. Loans past due 90 days or more and accruing
represent those loans which are sufficiently collateralized and management
believes all interest and principal owed will be collected. Restructured loans
are loans that have been renegotiated to permit a borrower, who has incurred
adverse financial circumstances, to continue to perform. Management can reduce
the contractual interest rates to below market rates or make significant
concessions to the terms of the loan in order for the borrower to continue to
make payments.
A-9
The following table sets forth certain information regarding the Corporation's
nonperforming loans as of December 31 of each of the preceding five years:
December 31,
---------------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ---------
(Dollars in thousands)
Nonaccrual loans:(1)
Commercial real estate ............................................ $ 83 $ 80 $ 77 $ -- $ --
Commercial ........................................................ 163 326 -- 728 --
Consumer .......................................................... 11 89 86 -- --
------ ------ ------ ------ ---------
Total nonaccrual loans .......................................... 257 495 163 728 --
------ ------ ------ ------ ---------
Loans past due ninety days or more and accruing:(2)
Commercial ........................................................ 314 -- 14 18 --
Consumer .......................................................... 6 4 8 -- --
------ ------ ------ ------ ---------
Total loans past due ninety days or more and
accruing ...................................................... 320 4 22 18 --
------ ------ ------ ------ ---------
Restructured loans:
Commercial ........................................................ 269 451 357 19 25
Consumer .......................................................... 244 397 430 -- --
------ ------ ------ ------ ---------
Total restructured loans ........................................ 513 848 787 19 25
------ ------ ------ ------ ---------
Total nonperforming loans ........................................... $1,090 $1,347 $ 972 $ 765 $ 25
====== ====== ====== ====== =========
Nonaccrual loans to total gross loans ............................... 0.10% 0.23% 0.09% 0.42% 0.00%
Nonperforming loans to total gross loans ............................ 0.42% 0.62% 0.52% 0.45% 0.02%
Nonperforming loans to total assets ................................. 0.27% 0.41% 0.35% 0.33% 0.01%
Allowance for loan losses to nonperforming loans .................... 264.95% 199.63% 267.70% 290.59% 7,493.62%
- ----------
(1) Restructured loans classified as nonaccrual for the years ended December
31, 2003 and 2002 were $174,000 and $329,000, respectively.
(2) There were approximately $150,000 restructured loans classified as loans
past due ninety days or more and accruing at December 31, 2003.
Restructured loans classified as loans past due ninety days or more and
accruing at December 31, 2001 totaled $14,000.
There were no loans, 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 nonaccrual, past due or restructured at a future date.
A-10
The following table sets forth, for the years ended December 31, 2003, 2002,
2001, 2000 and 1999, the historical relationships among the allowance for loan
losses, the provision for loan losses, the amount of loans charged off and the
amount of loan recoveries:
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of period ............................... $2,689 $2,602 $2,223 $1,874 $1,542
Loans charged off:
Commercial ................................................. 173 65 -- 37 11
Consumer ................................................... 56 25 49 29 26
------ ------ ------ ------ ------
Total loans charged off .................................. 229 90 49 66 37
------ ------ ------ ------ ------
Recoveries of loans previously charged off:
Commercial real estate ..................................... -- -- -- -- 12
Commercial ................................................. 1 9 5 5 5
Consumer ................................................... 2 8 3 -- 12
------ ------ ------ ------ ------
Total recoveries of loans previously charged off ......... 3 17 8 5 29
------ ------ ------ ------ ------
Net loans charged off ........................................ 226 73 41 61 8
Provisions charged to operations ............................. 425 160 420 410 340
------ ------ ------ ------ ------
Balance at end of period ..................................... $2,888 $2,689 $2,602 $2,223 $1,874
====== ====== ====== ====== ======
Net charge offs during the period to average
loans outstanding during the period ........................ 0.10% 0.04% 0.02% 0.04% 0.01%
====== ====== ====== ====== ======
Balance of allowance for loan losses at the
end of year to gross year end loans ........................ 1.10% 1.24% 1.40% 1.30% 1.30%
====== ====== ====== ====== ======
The following table sets forth the allocation of the allowance for loan losses
at the dates indicated by category loans:
2003 2002 2001 2000 1999
------------------ ------------------- ------------------ ------------------ ------------------
Percent to Percent to Percent to Percent to Percent to
Amount Total(1) Amount Total(1) Amount Total(1) Amount Total(1) Amount Total(1)
------------------ ------------------- ------------------ ------------------ ------------------
(Dollars in thousands)
Real estate - residential ... $ 306 17.1% $ 289 18.3% $ 316 19.6% $ 278 20.2% $ 246 22.0%
Real estate - commercial .... 1038 41.9% 911 40.9% 857 38.9% 699 37.6% 562 37.2%
Commercial .................. 910 18.7% 906 17.7% 849 17.7% 741 17.7% 623 15.1%
Consumer .................... 634 22.3% 583 23.1% 580 23.8% 505 24.5% 443 25.7%
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total allowance for
loan losses ........... $2,888 100.0% $2,689 100.0% $2,602 100.0% $2,223 100.0% $1,874 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
(1) Represents percentage of loan balance in category to total gross loans.
Investment Portfolio
The Corporation maintains an investment portfolio to enhance its yields and to
provide a secondary source of liquidity. The portfolio is comprised of U.S.
Treasury securities, U.S. government and agency obligations, mortgage-backed
securities, and state and political subdivision obligations and has been
classified as held to maturity or available for sale. Investments in debt
securities that the Corporation has the positive intent and the ability to hold
to maturity are classified as held to maturity securities and reported at
amortized cost. All other securities are classified as available for sale
securities and reported at fair value, with unrealized holding gains or losses
reported in a separate component of stockholders' equity. Securities in the
available for sale category may be held for indefinite periods of time and
include securities that management intends to use as part of its Asset/Liability
strategy or that may be sold in response to changes in interest rates, changes
in prepayment risks, the need to provide liquidity, the need to increase
regulatory capital or similar factors. Securities available for sale increased
to $61.3 million at December 31, 2003, from $12.8 million at December 31, 2002,
an increase of $48.5 million, or 378.5%. The large increase can be attributable
to $20.0 million in purchases to fund the leveraging strategy and remaining
purchases to redeploy liquid investments. Securities held to maturity decreased
$8.5 million, or 14.0%, to $52.4 million at December 31, 2003 from $60.9 million
at December 31, 2002. Maturities and principal paydowns were reinvested in the
lending portfolio.
A-11
The following table sets forth the classification of the Corporation's
investment securities by major category at the end of the last three years:
December 31,
---------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
(Dollars in thousands)
Securities available for sale:
U.S. Treasury ..................................... $ 500 0.8% $ -- 0.0% $ 514 4.1%
U.S. government agencies .......................... 22,144 36.1% 2,733 21.3% 4,169 33.2%
Obligations of state and
political subdivisions ......................... 1,406 2.3% 821 6.4% 1,081 8.6%
Mortgage-backed securities ........................ 37,255 60.8% 9,258 72.3% 6,785 54.1%
------- ----- ------- ----- ------- -----
Total ............................................... $61,305 100.0% $12,812 100.0% $12,549 100.0%
======= ===== ======= ===== ======= =====
Securities held to maturity:
U.S. Treasury ..................................... $ 1,011 1.9% $ 1,514 2.5% $ 1,517 4.0%
U.S. government agencies .......................... 12,756 24.4% 13,125 21.6% 7,894 20.8%
Obligations of state and
political subdivisions .......................... 19,686 37.6% 20,060 32.9% 16,470 43.5%
Mortgage-backed securities ........................ 18,907 36.1% 26,188 43.0% 11,991 31.7%
------- ----- ------- ----- ------- -----
Total ............................................... $52,360 100.0% $60,887 100.0% $37,872 100.0%
======= ===== ======= ===== ======= =====
The following table sets forth the maturity distribution and weighted average
yields (calculated on the basis of stated yields to maturity, considering
applicable premium or discount) of the Corporation's securities available for
sale as of December 31, 2003. Issuers may have the right to call or prepay
obligations with or without call or prepayment penalties. This might cause
actual maturities to differ from the contractual maturities.
After 1 Year After 5 Years
Within But Within But Within After
1 Year 5 Years 10 Years 10 Years Total
------ ------------ ------------- -------- -----
(Dollars in thousands)
U.S. Treasury:
Carrying value ...................................... $ -- $ 500 $ -- $ -- $ 500
Yield ............................................... -- 1.61% -- -- 1.61%
U.S. government agencies:
Carrying value ...................................... -- 20,146 1,998 -- 22,144
Yield ............................................... -- 2.76% 3.50% -- 2.82%
Obligations of state and political subdivisions:
Carrying value ...................................... 179 1,227 -- -- 1,406
Yield ............................................... 4.23% 1.95% -- -- 2.24%
Mortgage-backed securities:
Carrying value ...................................... -- 746 10,252 26,257 37,255
Yield ............................................... -- 4.38% 3.80% 4.70% 4.44%
----- ------- ------- ------- -------
Total carrying value .................................. $ 179 $22,619 $12,250 $26,257 $61,305
===== ======= ======= ======= =======
Weighted average yield ................................ 4.23% 2.71% 3.75% 4.70% 3.78%
===== ======= ======= ======= =======
A-12
The following table sets forth the maturity distribution and weighted average
yields (calculated on the basis of stated yields to maturity, considering
applicable premium or discount) of the Corporation's securities held to maturity
as of December 31, 2003. Issuers may have the right to call or prepay
obligations with or without call or prepayment penalties. This might cause
actual maturities to differ from contractual maturities.
After 1 Year After 5 Years
Within But Within But Within After
1 Year 5 Years 10 Years 10 Years Total
------ ------------ -------------- -------- -----
(Dollars in thousands)
U.S. Treasury:
Carrying value ..................................... $ -- $ 1,011 $ -- $ -- $ 1,011
Yield .............................................. -- 4.28% -- -- 4.28%
U.S. government agencies:
Carrying value ..................................... 250 12,506 -- -- 12,756
Yield .............................................. 6.78% 2.94% -- -- 3.02%
Obligations of state and political subdivisions:
Carrying value ..................................... 3,725 15,961 -- -- 19,686
Yield .............................................. 4.02% 3.36% -- -- 3.49%
Mortgage-backed securities:
Carrying value ..................................... 81 461 3,491 14,874 18,907
Yield .............................................. 6.19% 5.08% 4.25% 4.94% 4.82%
---------- ---------- ---------- ---------- ----------
Total carrying value ................................. $ 4,056 $ 29,939 $ 3,491 $ 14,874 $ 52,360
========== ========== ========== ========== ==========
Weighted average yield ............................... 4.23% 3.24% 4.25% 4.94% 3.87%
========== ========== ========== ========== ==========
Deposits
Corporation deposits at December 31, 2003 totaled $341.5 million, an increase of
$38.8 million, or 12.8%, over the comparable period of 2002, when deposits
totaled $302.7 million. The Corporation attributes this increase to competitive
products and services being offered to our customer base as well as newer branch
locations expanding our market area.
The following table sets forth the classification of the Corporation's deposits
by major category as of December 31 of each of the preceding years:
December 31,
------------------------------------------------------------------------
2003 2002 2001
-------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent
------- ------- ------ ------- ------ -------
(Dollars in thousands)
Noninterest-bearing demand ....................... $ 80,845 23.7% $ 69,344 22.9% $ 57,581 22.5%
Interest-bearing demand .......................... 119,663 35.0% 101,191 33.5% 91,694 35.9%
Saving deposits .................................. 45,051 13.2% 38,242 12.6% 25,748 10.1%
Time deposits .................................... 95,979 28.1% 93,958 31.0% 80,661 31.5%
-------- ----- -------- ----- -------- -----
Total ............................................ $341,538 100.0% $302,735 100.0% $255,684 100.0%
======== ===== ======== ===== ======== =====
As of December 31, 2003, the aggregate amount of outstanding time deposits
issued in amounts of $100,000 or more, broken down by time remaining to
maturity, was as follows (in thousands):
Three months or less ............................ $ 9,608
Four months through six months .................. 4,191
Seven months through twelve months .............. 4,898
Over twelve months .............................. 10,658
-------
Total ....................................... $29,355
=======
A-13
Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates.
The Corporation's market risk arises primarily from interest rate risk inherent
in its lending and deposit taking activities. Management actively monitors and
manages its interest rate risk exposure.
The Corporation's profitability is affected by fluctuations in interest rates. A
sudden and substantial increase in interest rates may adversely impact the
Corporation's earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the same
basis. The Corporation monitors the impact of changes in interest rates on its
net interest income using several tools. One measure of the Corporation's
exposure to differential changes in interest rates between assets and
liabilities is shown in the Corporation's Maturity and Repricing Analysis under
the Interest Rate Sensitivity caption below.
The Corporation's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Corporation's
net interest income and capital, while structuring the asset-liability structure
to obtain the maximum yield-cost spread on that structure. The Corporation
relies primarily on its asset-liability structure to control interest rate risk.
The Corporation continually evaluates interest rate risk management
opportunities, including the use of derivative financial instruments. Management
believes that hedging instruments currently available are not cost effective,
and therefore, has focused its efforts on increasing the Corporation's
yield-cost spread through retail growth opportunities.
The following table shows the Corporation's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 2003. Market rate sensitive
instruments are generally defined as on and off balance sheet derivatives and
other financial instruments. Expected maturities are contractual maturities
adjusted for projected payments of principal. The actual maturities of these
instruments could vary substantially if future prepayments differ from the
projections. For non-maturity deposit liabilities, in accordance with standard
industry practice, "decay factors" were used to estimate deposit runoff.
Average
Interest
Rate 2004 2005 2006 2007
-------- ---- ---- ---- ----
(Dollars in thousands)
Interest-Sensitive Assets:
Federal funds sold .................. 0.52% $ 1,300 $ -- $ -- $ --
Interest-bearing due from banks ..... 0.69% 1,680 -- -- --
Other interest-earning assets ....... 0.89% 517 -- -- --
Loans:
Real estate mortgage .............. 6.57% 21,475 8,920 8,718 17,340
Commercial ....................... 5.97% 25,549 10,295 6,159 2,594
Consumer ......................... 5.78% 10,831 5,089 5,179 5,374
Mortgage loans held for sale ........ 5.17% 576 -- -- --
Investment securities (1) ........... 3.78% 18,490 15,456 16,975 9,006
---- -------- -------- ------- -------
5.47% $ 80,418 $ 39,760 $37,031 $34,314
Interest-Sensitive Liabilities:
Savings ............................. 0.75% $ 9,232 $ 8,977 $ 8,977 $ 8,977
Interest-bearing .................... 0.71% 23,987 23,979 23,979 23,979
Time deposits ....................... 2.85% 54,654 25,451 10,635 3,924
Securites under agreement
to repurchase ..................... 1.05% 3,547 -- -- --
FHLB borrowings ..................... 3.33% 3,501 1,549 1,598 1,650
Subordinated debentures ............. 6.75% -- -- -- --
---- -------- -------- ------- -------
1.75% $ 94,921 $ 59,956 $45,189 $38,530
-------- -------- ------- -------
Net Interest-Sensitive
Assets (Liabilities) ................ $(14,503) $(20,196) $(8,158) $(4,216)
======== ======== ======= =======
2008 Thereafter Balance Fair Value
---- ---------- ------- ----------
(Dollars in thousands)
Interest-Sensitive Assets:
Federal funds sold .................. $ -- $ -- $ 1,300 $ 1,300
Interest-bearing due from banks ..... -- -- 1,680 1,680
Other interest-earning assets ....... -- -- 517 517
Loans:
Real estate mortgage .............. 9,826 88,264 154,543 155,018
Commercial ....................... 3,350 1,004 48,951 48,675
Consumer ......................... 4,720 27,292 58,485 58,972
Mortgage loans held for sale ........ -- -- 576 576
Investment securities (1) ........... 6,542 48,518 114,987 115,997
-------- -------- -------- ---------
$ 24,438 $165,078 $381,039 $ 382,735
Interest-Sensitive Liabilities:
Savings ............................. $ 8,888 $ -- $ 45,051 $ 45,055
Interest-bearing .................... 23,740 -- 119,664 119,664
Time deposits ....................... 427 888 95,979 97,121
Securites under agreement
to repurchase ..................... -- -- 3,547 3,547
FHLB borrowings ..................... 1,702 10,000 20,000 19,483
Subordinated debentures ............. -- 7,217 7,217 7,264
-------- -------- -------- ---------
$ 34,757 $ 18,105 $291,458 $ 292,134
-------- -------- -------- ---------
Net Interest-Sensitive
Assets (Liabilities) ................ $(10,319) $146,973 $ 89,581 $ 90,601
======== ======== ======== =========
- ----------
(1) Includes securities held to maturity, securities available for sale and
FHLB-NY stock.
A-14
Interest Rate Sensitivity
Interest rate movements and deregulation of interest rates have made managing
the Corporation's interest rate sensitivity increasingly important. The
Corporation attempts to maintain stable net interest margins by generally
matching the volume of assets and liabilities maturing, or subject to repricing,
by adjusting interest rates to market conditions, and by developing new
products. One method of measuring the Corporation's exposure to changes in
interest rates is the maturity and repricing gap analysis. The difference
between the volume of assets and liabilities that reprice in a given period is
the interest sensitivity gap. A "positive" gap results when more assets than
liabilities mature or are repricing in a given time frame. Conversely, a
"negative" gap results when there are more liabilities than assets maturing or
repricing in a given period of time. The smaller the gap, the less the effect of
the market volatility on net interest income. During a period of rising interest
rates, an institution with a negative gap position would not be in as favorable
a position, as compared to an institution with a positive gap, to invest in
higher yielding assets. This may result in yields on its assets increasing at a
slower rate than the increase in its costs of interest-bearing liabilities than
if it had a positive gap. During a period of falling interest rates, an
institution with a negative gap would experience a repricing of its assets at a
slower rate than its interest-bearing liabilities, which consequently may result
in its net interest income growing at a faster rate than an institution with a
positive gap position.
The following tables sets forth the estimated maturity/repricing structure of
the Corporation's interest-earning assets and interest-bearing liabilities as of
December 31, 2003. The amounts of assets or liabilities shown which reprice or
mature during a particular period were determined in accordance with the
contractual terms of each asset or liability and adjusted for prepayment
assumptions where applicable. The table does not necessarily indicate the impact
of general interest rate movements on the Corporation's net interest income
because the repricing of certain categories of assets and liabilities, for
example, prepayments of loans and withdrawal of deposits, is beyond the
Corporation's control. As a result, certain assets and liabilities indicated as
repricing within a period may in fact reprice at different times and at
different rate levels.
More than
Three Months
Three Months Through After Noninterest
or Less One Year One Year Sensitive Total
------------ ------------- --------- ----------- ---------
(Dollars in thousands)
Assets:
Loans:
Real estate mortgage .................. $ 7,114 $ 17,713 $ 129,716 $ -- $ 154,543
Commercial ............................ 15,874 14,285 18,791 -- 48,950
Consumer .............................. 21,414 5,491 31,581 -- 58,486
Mortgage loans held for sale ............ 576 -- -- -- 576
Investment securities(1) ................ 13,486 21,083 80,418 -- 114,987
Federal funds sold ...................... 1,300 -- -- -- 1,300
Other assets ............................ 2,198 -- -- 20,728 22,926
--------- --------- --------- --------- ---------
Total assets ....................... $ 61,962 $ 58,572 $ 260,506 $ 20,728 $ 401,768
--------- --------- --------- --------- ---------
Source of funds:
Savings ................................. $ -- $ 45,051 $ -- $ -- $ 45,051
Interest-bearing ........................ 41,429 78,234 -- -- 119,663
Time deposits ........................... 20,676 34,223 41,080 -- 95,979
Repurchase agreements ................... 2,848 699 -- -- 3,547
Borrowings .............................. 2,371 1,130 16,499 -- 20,000
Subordinated debenture .................. -- -- 7,217 -- 7,217
Other liabilities ....................... -- -- -- 83,162 83,162
Stockholders' equity .................... -- -- -- 27,149 27,149
--------- --------- --------- --------- ---------
Total source of funds ............... $ 67,324 $ 159,337 $ 64,796 $ 110,311 $ 401,768
--------- --------- --------- --------- ---------
Interest rate sensitivity gap ............. $ (5,362) $(100,765) $ 195,710 $ (89,583)
========= ========= ========= =========
Cumulative interest rate
sensitivity gap ......................... $ (5,362) $(106,127) $ 89,583 $ --
========= ========= ========= =========
Ratio of GAP to total assets .............. -1.3% -25.1% 48.6% -22.3%
========= ========= ========= =========
Ratio of cumulative GAP assets to
total assets ............................ -1.3% -26.3% 22.3% --
========= ========= ========= =========
- ----------
(1) Includes securities held to maturity, securities available for sale and
FHLB-NY stock.
A-15
The Corporation also uses a simulation model to analyze the sensitivity of net
interest income to movements in interest rates. The simulation model projects
net interest income, net income, net interest margin, and capital to asset
ratios based on various interest rate scenarios over a twelve month period. The
model is based on the actual maturity and repricing characteristics of all rate
sensitive assets and liabilities. Management incorporates into the model certain
assumptions regarding prepayments of certain assets and liabilities. The model
assumes an immediate rate shock to interest rates without management's ability
to proactively change the mix of assets or liabilities. According to the reports
generated for year end 2003, an immediate interest rate increase of 100 basis
points resulted in a decrease in net interest income of 6.3%, or $1.1 million,
while an immediate interest rate decrease of 100 basis points resulted in an
increase in net interest income of 3.0% or $540,000. Management has a goal to
maintain a % change of no more than 10% given a 100 basis point change in
interest rates. Management cannot provide any assurance about the actual effect
of changes in interest rates on the Corporation's net interest income.
Assumptions have been built into the model for prepayments for assets and decay
rates for nonmaturity deposits such as savings and interest bearing demand.
Liquidity
The Corporation's primary sources of funds are deposits, amortization and
prepayments of loans and mortgage-backed securities, maturities of investment
securities and funds provided by 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
loan 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. These activities
are summarized below:
Year Ended December 31,
--------------------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Cash and cash equivalents - beginning ................... $ 33,418 $ 34,074 $ 13,696
Operating activities:
Net income ............................................ 3,491 3,116 2,558
Adjustments to reconcile net income
to net cash provided by operating
activities .......................................... 2,582 2,429 (1,961)
-------- -------- --------
Net cash provided by operating activities ............... 6,073 5,545 597
Net cash used in investing activities ................... (87,362) (55,050) (24,727)
Net cash provided by financing activities ............... 67,009 48,849 44,508
-------- -------- --------
Net (decrease) increase in cash and cash equivalents .... (14,280) (656) 20,378
-------- -------- --------
Cash and cash equivalents - ending ...................... $ 19,138 $ 33,418 $ 34,074
======== ======== ========
Cash was generated by operating activities in each of the above periods. The
primary source of cash from operating activities during each period was 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 enters into commitments to extend credit, such as letters of
credit, which are not reflected in the consolidated financial statements.
A-16
The Corporation has various contractual obligations that may require future cash
payments. The following table summarizes the Corporation's contractual
obligations at December 31, 2003 and the effect of such obligations is expected
to have on our liquidity and cash flows in future periods.
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
------- ------- ------- ------- -------
(In thousands)
Contractual obligations
Operating lease obligations ........................ $ 3,372 $ 413 $ 837 $ 710 $ 1,412
------- ------- ------- ------- -------
Total contracted cost obligations .................... $ 3,372 $ 413 $ 837 $ 710 $ 1,412
======= ======= ======= ======= =======
Other long-term liabilities/long-term debt
Time deposits ...................................... $95,979 $55,542 $36,087 $ 4,350 $ --
Federal Home Loan Bank advances .................... 20,000 3,371 3,137 3,492 10,000
Subordinated debentures ............................ 7,217 -- -- -- 7,217
------- ------- ------- ------- -------
Total other long-term liabilities/long-term debt ..... $27,217 $ 3,371 $ 3,137 $ 3,492 $17,217
======= ======= ======= ======= =======
Other commitments - off balance sheet
Letter of credit ................................... $ 609 $ 609 $ -- $ -- $ --
Other commitments - off balance sheet .............. 16,964 16,964 -- -- --
Unused lines of credit ............................. 59,171 59,171 -- -- --
------- ------- ------- ------- -------
Total off balance sheet arrangements and
contractual obligations ............................ $76,744 $76,744 $ -- $ -- $ --
======= ======= ======= ======= =======
- ----------
For further information, see Note 15 of Notes to Consolidated Financial
Statements.
Management believes that a significant portion of the time deposits will remain
with the Corporation. In addition, management does not believe that all of the
unused lines of credit will be exercised. The Corporation anticipates that it
will have sufficient funds available to meet its current contractual
commitments.
Capital
The Corporation is subject to capital adequacy guidelines promulgated by the
Board of Governors of the Federal Reserve System ("FRB"). 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 for application 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. The FRB
has also issued leverage capital adequacy standards. Under these standards, in
addition to the risk-based capital ratios, a corporation must also compute a
ratio of Tier 1 capital (using the risk-based capital definition) to total
quarterly average assets. The following table reflects the Corporation's capital
ratios at December 31, 2003. The Bank Federal regulator has promulgated
substantially similar capital regulations applicable to the Bank.
Required Actual Excess
----------------------------------
Risk-based capital:
Tier 1 .............................. 4.00% 12.93% 8.93%
Total ............................... 8.00% 14.03% 6.03%
Leverage ratio* ...................... 4.00% 8.89% 4.89%
- ----------
* The minimum leverage ratio set by the FRB is 3.00%. Institutions, which
are not "top-rated", will be expected to maintain a ratio of approximately
100 to 200 basis points above this ratio.
A-17
KPMG
KPMG LLP
New Jersey Headquarters
150 John F. Kennedy Parkway
Short Hills, NJ 07078
Independent Auditors' Report
The Board of Directors and Stockholders
Stewardship Financial Corporation:
We have audited the accompanying consolidated statements of financial condition
of Stewardship Financial Corporation and subsidiary as of December 31, 2003 and
2002, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2003. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Stewardship
Financial Corporation and subsidiary as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
KPMG LLP
Short Hills, New Jersey
January 30, 2004
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Financial Condition
December 31,
----------------------------------
2003 2002
----------------------------------
Assets
Cash and due from banks ...................................................... $ 15,640,000 $ 14,039,000
Other interest-earning assets ................................................ 2,198,000 9,854,000
Federal funds sold ........................................................... 1,300,000 9,525,000
----------------------------------
Cash and cash equivalents .................................................. 19,138,000 33,418,000
Securities available for sale (note 2) ....................................... 61,305,000 12,812,000
Securities held to maturity; estimated fair value
of $53,370,000 (2003) and $62,273,000 (2002) (note 3) ...................... 52,360,000 60,887,000
FHLB-NY stock, at cost ....................................................... 1,322,000 1,059,000
Loans, net of allowance for loan losses of $2,888,000 (2003)
and $2,689,000 (2002) (notes 4 and 5) ...................................... 258,776,000 213,579,000
Mortgage loans held for sale ................................................. 576,000 2,099,000
Premises and equipment, net (note 6) ......................................... 3,637,000 3,733,000
Accrued interest receivable .................................................. 1,863,000 1,640,000
Intangible assets, net of accumulated amortization of $530,000 and
$486,000 at December 31, 2003 and 2002 respectively ........................ 220,000 264,000
Other assets (note 14) ....................................................... 2,571,000 1,596,000
----------------------------------
Total assets ........................................................... $401,768,000 $331,087,000
==================================
Liabilities and Stockholders' equity
Liabilities
Deposits: (note 7)
Noninterest-bearing ........................................................ $ 80,845,000 $ 69,344,000
Interest-bearing ........................................................... 260,693,000 233,391,000
----------------------------------
Total deposits ......................................................... 341,538,000 302,735,000
Other borrowings (note 8) .................................................... 20,000,000 --
Subordinated debenture (note 9) .............................................. 7,217,000 --
Securities sold under agreements to repurchase (note 8) ...................... 3,547,000 2,435,000
Accrued expenses and other liabilities ....................................... 2,317,000 2,100,000
----------------------------------
Total liabilities ...................................................... 374,619,000 307,270,000
----------------------------------
Commitments and contingencies (note 15) ...................................... -- --
Stockholders' equity (notes 10 and 16)
Common stock, no par value; 5,000,000 shares authorized;
3,165,233 and 2,972,566 shares issued and outstanding at
December 31, 2003 and 2002, respectively ................................... 19,552,000 15,058,000
Retained earnings ............................................................ 7,593,000 8,600,000
Accumulated other comprehensive income, net .................................. 4,000 159,000
----------------------------------
Total Stockholders' equity ............................................... 27,149,000 23,817,000
----------------------------------
Total liabilities and Stockholders' equity ............................... $401,768,000 $331,087,000
==================================
See accompanying notes to consolidated financial statements.
A-20
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Income
Year Ended December 31,
-----------------------------------------------------
2003 2002 2001
-----------------------------------------------------
Interest income:
Loans ............................................................ $ 16,091,000 $ 14,673,000 $ 14,836,000
Securities held to maturity:
Taxable ....................................................... 1,248,000 1,379,000 765,000
Nontaxable .................................................... 700,000 713,000 609,000
Securities available for sale .................................... 708,000 633,000 895,000
Other interest-earning assets .................................... 168,000 380,000 490,000
-----------------------------------------------------
Total interest income ................................ 18,915,000 17,778,000 17,595,000
-----------------------------------------------------
Interest expense:
Deposits (note 7) ................................................ 4,358,000 5,242,000 6,680,000
Borrowed money ................................................... 233,000 29,000 49,000
-----------------------------------------------------
Total interest expense ............................... 4,591,000 5,271,000 6,729,000
-----------------------------------------------------
Net interest income before provision for loan losses ............. 14,324,000 12,507,000 10,866,000
Provision for loan losses (note 4) ............................... 425,000 160,000 420,000
-----------------------------------------------------
Net interest income after provision for loan losses .............. 13,899,000 12,347,000 10,446,000
-----------------------------------------------------
Noninterest income:
Fees and service charges ......................................... 2,106,000 1,789,000 1,345,000
Gain/(loss) on calls and sales of securities,
net (notes 2 and 3) .......................................... 49,000 (4,000) 3,000
Gain on sales of mortgage loans .................................. 451,000 248,000 178,000
Miscellaneous .................................................... 288,000 217,000 169,000
-----------------------------------------------------
Total noninterest income ............................. 2,894,000 2,250,000 1,695,000
-----------------------------------------------------
Noninterest expense:
Salaries and employee benefits (note 11) ......................... 5,377,000 4,650,000 4,061,000
Occupancy, net (note 15) ......................................... 758,000 657,000 586,000
Equipment ........................................................ 680,000 640,000 523,000
Data processing .................................................. 918,000 682,000 560,000
Advertising ...................................................... 270,000 269,000 154,000
FDIC insurance premium ........................................... 48,000 43,000 39,000
Amortization of intangible assets ................................ 44,000 45,000 48,000
Charitable contributions ......................................... 512,000 425,000 351,000
Stationery and supplies .......................................... 241,000 235,000 188,000
Miscellaneous .................................................... 2,546,000 2,201,000 1,769,000
-----------------------------------------------------
Total noninterest expenses ........................... 11,394,000 9,847,000 8,279,000
-----------------------------------------------------
Income before income tax expense ................................. 5,399,000 4,750,000 3,862,000
Income tax expense (note 14) ..................................... 1,908,000 1,634,000 1,304,000
-----------------------------------------------------
Net income ....................................................... $ 3,491,000 $ 3,116,000 $ 2,558,000
=====================================================
Basic earnings per share (note 13) ............................... $ 1.11 $ 1.01 $ 0.85
=====================================================
Diluted earnings per share (note 13) ............................. $ 1.10 $ 1.00 $ 0.84
=====================================================
Cash dividends per share ......................................... $ 0.26 $ 0.22 $ 0.18
=====================================================
Weighted average number of common shares
outstanding (note 13) ........................................ 3,140,444 3,076,763 3,020,361
=====================================================
Weighted average number of diluted common
shares outstanding (note 13) ................................. 3,185,057 3,101,121 3,053,960
=====================================================
See accompanying notes to consolidated financial statements.
A-21
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2003, 2002, and 2001
---------------------------------------------------------------------------------------------
Accumulated
Other
Common Stock Treasury Stock Comprehensive
------------------------ Retained --------------------- Income/(Loss),
Shares Amount Earnings Shares Amount Net Total
---------------------------------------------------------------------------------------------
Balance -- December 31, 2000 ...... 2,725,821 $10,863,000 $ 7,457,000 -- $ -- $(112,000) $ 18,208,000
Cash dividends paid ($0.18 per
share) ....................... -- -- (556,000) -- -- -- (556,000)
5% Stock dividend ............... 72,621 1,332,000 (1,573,000) 14,059 239,000 -- (2,000)
Common stock issued under
stock plans ................... 22,436 370,000 -- 5,941 101,000 -- 471,000
Issuance of stock options
at a discount ................. -- 6,000 -- -- -- -- 6,000
Stock options exercised ......... 5,482 67,000 -- -- -- -- 67,000
Repurchase common stock ......... -- -- -- (20,000) (340,000) -- (340,000)
Comprehensive income:
Net income for the year
ended December 31, 2001 ....... -- -- 2,558,000 -- -- -- 2,558,000
Unrealized holding gains on
securities available for sale
arising during the period
(net tax of $87,000) .......... -- -- -- -- -- 141,000 141,000
------------
Total comprehensive income ...... 2,699,000
---------------------------------------------------------------------------------------------
Balance -- December 31, 2001 ...... 2,826,360 $12,638,000 $ 7,886,000 -- $ -- $ 29,000 $ 20,553,000
Cash dividends paid ($0.22 per
share) ........................ -- -- (667,000) -- -- -- (667,000)
5% Stock dividend ............... 93,654 1,734,000 (1,735,000) -- -- -- (1,000)
Common stock issued under
stock plans ................... 18,467 315,000 -- 8,832 164,000 -- 479,000
Stock options exercised ......... 34,085 371,000 -- -- -- -- 371,000
Repurchase common stock ......... -- -- -- (8,832) (164,000) -- (164,000)
Comprehensive income:
Net income for the year
ended December 31, 2002 ....... -- -- 3,116,000 -- -- -- 3,116,000
Unrealized holding gains on
securities available for sale
arising during the period
(net tax of $83,000) .......... -- -- -- -- -- 130,000 130,000
------------
Total comprehensive income ...... 3,246,000
---------------------------------------------------------------------------------------------
Balance -- December 31, 2002 ...... 2,972,566 $15,058,000 $ 8,600,000 -- $ -- $ 159,000 $ 23,817,000
Cash dividends paid ($0.26 per
share) . ..................... -- -- (817,000) -- -- -- (817,000)
5% Stock dividend ............... 150,162 3,679,000 (3,681,000) -- -- -- (2,000)
Common stock issued
under stock plans ............. 30,216 570,000 -- -- -- -- 570,000
Stock options exercised ......... 12,289 126,000 -- -- -- -- 126,000
Tax benefit on stock options
exercised ..................... -- 119,000 -- -- -- -- 119,000
Comprehensive income:
Net income for the year
ended December 31, 2003 ....... -- -- 3,491,000 -- -- -- 3,491,000
Unrealized holding losses on
securities available for sale
arising during the period
(net tax benefit of $98,000) .. -- -- -- -- -- (155,000) (155,000)
------------
Total comprehensive income ........ 3,336,000
---------------------------------------------------------------------------------------------
Balance -- December 31, 2003 ...... 3,165,233 $19,552,000 $ 7,593,000 -- $ -- $ 4,000 $ 27,149,000
=============================================================================================
See accompanying notes to consolidated financial statements
A-22
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------------------------------------------
Cash flows from operating activities:
Net income ................................................................ $ 3,491,000 $ 3,116,000 $ 2,558,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of premises and equipment .............. 619,000 561,000 481,000
Amortization of premiums and accretion of discounts, net ............. 791,000 424,000 56,000
Accretion of deferred loan fees ...................................... (172,000) (53,000) (50,000)
Provision for loan losses ............................................ 425,000 160,000 420,000
Originations of mortgage loans held for sale ......................... (37,063,000) (23,102,000) (18,007,000)
Proceeds from sale of mortgage loans ................................. 39,037,000 24,490,000 15,249,000
Gain on sale of loans ................................................ (451,000) (248,000) (178,000)
(Gain) loss on sale of securities available for sale ................. (49,000) (4,000) 3,000
Gain on sale of fixed assets ......................................... (54,000) -- --
Issuance of stock options at a discount ............................. -- -- 6,000
Deferred income tax benefit .......................................... (44,000) (71,000) (258,000)
Amortization of intangible assets .................................... 44,000 45,000 48,000
(Increase) decrease in accrued interest receivable ................... (223,000) (132,000) 66,000
(Increase) decrease in other assets .................................. (614,000) (111,000) 52,000
Increase in other liabilities ........................................ 336,000 470,000 151,000
--------------------------------------------------
Net cash provided by operating activities .......................... 6,073,000 5,545,000 597,000
--------------------------------------------------
Cash flows from investing activities:
Purchase of securities available for sale ............................ (58,690,000) (7,185,000) (5,675,000)
Proceeds from maturities and principal repayments
on securities available for sale ................................... 5,552,000 3,431,000 3,083,000
Proceeds from sales and calls on securities
available for sale ................................................. 4,270,000 3,653,000 8,005,000
Purchase of securities held to maturity .............................. (24,317,000) (44,427,000) (24,173,000)
Proceeds from maturities and principal repayments on
securities held to maturity ........................................ 17,097,000 9,206,000 3,159,000
Proceeds from calls of securities held to maurity .................... 15,125,000 11,830,000 6,440,000
Purchase of FHLB-NY stock ............................................ (263,000) (173,000) (115,000)
Investment in special purpose subsidiary ............................. (217,000) -- --
Net increase in loans ................................................ (45,450,000) (30,757,000) (14,248,000)
Sales of premises and equipment ...................................... 227,000 -- --
Additions to premises and equipment .................................. (696,000) (628,000) (1,203,000)
--------------------------------------------------
Net cash used in investing activities .............................. (87,362,000) (55,050,000) (24,727,000)
--------------------------------------------------
Cash flows from financing activities:
Net increase in noninterest-bearing deposits ......................... 11,501,000 11,763,000 8,813,000
Net increase in interest-bearing deposits ............................ 27,302,000 35,288,000 36,737,000
Net increase (decrease) in securities sold
under agreement to repurchase ...................................... 1,112,000 1,780,000 (682,000)
Net increase in borrowings ........................................... 20,000,000 -- --
Issuance of subordinated debentures .................................. 7,217,000 -- --
Cash dividends paid on common stock .................................. (819,000) (668,000) (558,000)
Purchase of treasury stock ........................................... -- (164,000) (340,000)
Exercise of stock options ............................................ 126,000 371,000 67,000
Issuance of common stock ............................................. 570,000 479,000 471,000
--------------------------------------------------
Net cash provided by financing activities .......................... 67,009,000 48,849,000 44,508,000
--------------------------------------------------
Net (decrease) increase in cash and cash equivalents ................. (14,280,000) (656,000) 20,378,000
Cash and cash equivalents - beginning ................................ 33,418,000 34,074,000 13,696,000
--------------------------------------------------
Cash and cash equivalents - ending ................................... $ 19,138,000 $ 33,418,000 $ 34,074,000
==================================================
Supplemental disclosures of cash flow information:
Cash paid during the year for interest ............................... 4,676,000 5,487,000 6,697,000
Cash paid during the year for income taxes ........................... 1,934,000 1,698,000 1,164,000
See accompanying notes to consolidated financial statements.
A-23
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
Note 1. SIGNIFICANT ACCOUNTING POLICIES
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"). Atlantic Stewardship 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.
Basis of consolidated financial statements presentation
The consolidated financial statements of the Corporation have been prepared in
conformity with generally accepted accounting principles. 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.
Cash and cash equivalents
Cash and cash equivalents include cash and due from banks, commercial paper,
interest-bearing deposits in other banks, money market funds and federal funds
sold. Generally, federal funds are sold for one-day periods.
Securities available for sale and held to maturity
The Corporation classifies its securities as securities held to maturity or
securities available for sale. Investments in debt securities that the
Corporation has the positive intent and ability to hold to maturity are
classified as securities held to maturity and are carried at cost, adjusted for
amortization of premium and accretion of discount, which are recognized as
adjustments to income, on a level yield basis. All other securities are
classified as securities available for sale. Securities available for sale may
be sold prior to maturity in response to changes in interest rates or prepayment
risk, for asset/liability management purposes, or other similar factors. These
securities are carried at fair value with unrealized holding gains or losses
reported in a separate component of stockholders' equity, net of the related tax
effects. Realized gains or losses on sales of securities are based upon the
specific identification method. Management evaluates securities for other than
temporary impairment and records such adjustments as necessary.
Federal Home Loan Bank of New York Stock
As a condition of membership, the Corporation is required to maintain shares of
stock in the Federal Home Loan Bank of New York (FHLB-NY) based on the
Corporation's level of residential mortgage loans and mortgage-backed securities
or outstanding advances from the FHLB-NY, whichever is larger. Such shares are
carried at cost.
Mortgage loans held for sale
Mortgage loans held for sale are reported at the lower of cost or market on an
aggregate basis. Mortgage loans held for sale are carried net of deferred fees,
which are recognized as income at the time the loans are sold to permanent
investors. Gains or losses on the sale of mortgage loans held for sale are
recognized at the settlement date and are determined by the difference between
the net proceeds and the amortized cost.
Loans
Loans are carried at the principal amount outstanding, net of unearned discounts
and deferred loan fees and costs. Interest on loans is accrued and credited to
interest income as earned.
A-24
The accrual of interest income is discontinued on a loan when certain factors
indicate reasonable doubt as to the collectibility of principal and interest. At
the time a loan is placed on nonaccrual status, previously accrued and
uncollected interest is reversed against interest income in the current period.
Interest collections on nonaccrual loans are generally credited to interest
income when received. Such loans are restored to an accrual status only if the
loan is brought contractually current and the borrower has demonstrated an
ability to make future payments of principal and interest.
The Corporation defined the population of impaired loans to include nonaccrual
loans, loans more than 90 days past due and restructured loans. Impaired loans
are individually assessed to determine that the loan's carrying value is not in
excess of the fair value of the collateral or the present value of the loan's
expected future cash flows.
Loan fees collected and certain costs incurred related to loan originations are
deferred and amortized as an adjustment to interest income over the life of the
related loans. The deferred fees and costs are recorded as an adjustment to
loans outstanding.
Allowance for loan losses
An allowance for loan losses is maintained at a level considered adequate to
absorb inherent loan losses. Management of the Corporation, in determining the
provision for loan losses, 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.
The Corporation utilizes a two tier approach: (1) identification of problem
loans and the establishment of specific loss allowances on such loans; and (2)
establishment of general allowances on the remainder of its loan portfolio based
on historical loss experience and other economic data management believes
relevant. The Corporation maintains a loan review system, which allows for a
periodic review of its loan portfolio and the early identification of potential
problem loans. Such system takes into consideration, among other things,
delinquency status, size of loans, types of collateral and financial condition
of the borrowers. Specific loan loss allowances are established for identified
loans based on a review of such information and/or appraisals of the underlying
collateral. General loan loss allowances are based upon a combination of factors
including, but not limited to, actual loan loss experience, composition of loan
portfolio, current economic conditions and management's judgment.
Although management believes that adequate specific and general loan losses are
established, actual losses are dependent upon future events and, as such,
further additions to the level of the specific and general loan loss allowance
may be necessary.
In addition, 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 recognize additions to the
allowance for loan losses based on their judgments about information available
to them at the time of their examination.
Premises and equipment
Land is stated at cost. Buildings and improvements and furniture, fixtures and
equipment are stated at cost, less accumulated depreciation computed on the
straight-line method over the estimated lives of each type of asset. Estimated
useful lives are three to forty years for buildings and improvements and three
to twenty-five years for furniture, fixtures and equipment. Leasehold
improvements are stated at cost less accumulated amortization computed on the
straight-line method over the shorter of the term of the lease or useful life.
Significant renewals and improvements are capitalized. Maintenance and repairs
are charged to operations as incurred. Rental income is netted against occupancy
costs in the consolidated statements of income.
Other real estate owned
Other real estate owned (OREO) consists of foreclosed property and is carried at
the lower of cost or fair value less estimated selling costs. When a property is
acquired, the excess of the carrying amount over fair value, if any, is charged
to the allowance for loan losses. Subsequent adjustments to the carrying value
are recorded in an allowance for OREO and charged to OREO expense. Operating
results for OREO, including rental income, operating expenses, and gains and
losses realized from the sale of property owned, are also recorded in OREO
expense. The Corporation sold its OREO during 1998.
A-25
Income taxes
The Corporation accounts for taxes under the asset/liability method. Under this
method, deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Other comprehensive income
The Corporation's other comprehensive income is comprised of unrealized gains
and losses on securities available for sale. Disclosure of comprehensive income
for the years end 2003, 2002 and 2001 is presented in the accompanying
consolidated statements of changes in Stockholders' Equity.
Stock plans
At December 31, 2003, the Corporation has two stock-based employee compensation
plans and two director compensation plans, which are described more fully in
Note 12. The Corporation accounts for those plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Corporation had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation",
to stock-based compensation.
2003 2002 2001
---------- ---------- ----------
Net Income:
Net income as reported ................................................. $3,491,000 $3,116,000 $2,558,000
Total stock-based compensation expense determined
under fair value based method for all awards,
net of related tax effects ........................................... (50,000) (59,000) (67,000)
---------- ---------- ----------
Pro forma net income ................................................... $3,441,000 $3,057,000 $2,491,000
========== ========== ==========
Earnings per share:
As reported basic earnings per share ................................... $ 1.11 $ 1.01 $ 0.85
As reported diluted earnings per share ................................. 1.10 1.00 0.84
Pro forma basic earnings per share ..................................... 1.10 0.99 0.82
Pro forma diluted earnings per share ................................... 1.08 0.99 0.82
Weighted average fair value of options granted during year ............. $ 9.19 $ -- $ 4.04
The fair value of options granted for employees and directors is estimated on
the date of the grant using the Black-Scholes option pricing model with the
following assumptions used:
Employee Director Employee Employee Employee Employee
Stock Options Stock Options Stock Options Stock Options Stock Options Stock Options
------------- ------------- ------------- ------------- ------------- -------------
2003 2001 2000 1999 1998 1997
------------- ------------- ------------- ------------- ------------- -------------
Dividend yield .................... 2.02% 1.62% 1.57% 1.25% 1.12% 1.15%
Expected volatility ............... 51.65% 39.76% 20.27% 23.63% 16.24% 14.07%
Risk-free interest rate ........... 3.40% 5.07% 5.16% 6.65% 5.58% 6.64%
Expected life ..................... 7 years 7 years 7 years 7 years 7 years 7 years
Fair value at grant date .......... $ 9.19 $ 4.04 $ 2.96 $ 3.46 $ 2.03 $ 1.92
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 the 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.
A-26
All share and per share amounts have been restated to reflect a 5% stock
dividend paid November 2000, 2001, 2002 and 2003 and a 3 for 2 stock split that
occurred in July 2003.
Intangible assets
Intangible assets are comprised of other intangible assets and core deposit
intangibles. Other intangible assets represent the excess of the fair value of
liabilities assumed over the fair value of tangible assets acquired through a
branch acquisition, completed in 1995, which did not qualify as a business
combination. Other intangible assets amounted to $198,000 and $231,000 at
December 31, 2003 and December 31, 2002, respectively, and are amortized on a
straight-line method over a period of fifteen years.
The core deposit intangible represents the intangible value of depositor
relationships resulting from deposit liabilities assumed in the same
acquisition. The core deposit intangible amounted to $22,000 and $33,000 at
December 31, 2003 and December 31, 2002, respectively, and is amortized on an
accelerated basis over a period of twelve years.
Note 2. SECURITIES AVAILABLE FOR SALE
The following is a summary of the contractual maturities of securities available
for sale:
December 31, 2003
-----------------------------------------------------------------
Gross Unrealized
Amortized --------------------------- Carrying
Cost Gains Losses Value
-----------------------------------------------------------------
U.S. Treasury:
After one but within five years ......................... $ 505,000 $ -- $ 5,000 $ 500,000
U.S. government agencies:
After one but within five years ......................... 20,210,000 48,000 112,000 20,146,000
After five years ........................................ 2,000,000 3,000 5,000 1,998,000
-----------------------------------------------------------------
22,210,000 51,000 117,000 22,144,000
-----------------------------------------------------------------
Obligations of state and political subdivisions:
Within one year ......................................... 176,000 3,000 -- 179,000
After one but within five years ......................... 1,224,000 8,000 5,000 1,227,000
-----------------------------------------------------------------
1,400,000 11,000 5,000 1,406,000
-----------------------------------------------------------------
Mortgage-backed securities:
After one but within five years ......................... 736,000 11,000 1,000 746,000
After five years ........................................ 36,449,000 201,000 141,000 36,509,000
-----------------------------------------------------------------
37,185,000 212,000 142,000 37,255,000
-----------------------------------------------------------------
$61,300,000 $274,000 $ 269,000 $61,305,000
=================================================================
December 31, 2002
-----------------------------------------------------------------
Gross Unrealized
Amortized --------------------------- Carrying
Cost Gains Losses Value
-----------------------------------------------------------------
U.S. government agencies:
Within one year ........................................... $ 300,000 $ 10,000 $ -- $ 310,000
After one but within five years ......................... 1,906,000 12,000 -- 1,918,000
After five years ........................................ 500,000 5,000 -- 505,000
-----------------------------------------------------------------
2,706,000 27,000 -- 2,733,000
-----------------------------------------------------------------
Obligations of state and political subdivisions:
Within one year ......................................... 462,000 6,000 -- 468,000
After one but within five years ......................... 335,000 18,000 -- 353,000
-----------------------------------------------------------------
797,000 24,000 -- 821,000
-----------------------------------------------------------------
Mortgage-backed securities:
After one but within five years ......................... 133,000 7,000 -- 140,000
After five years ........................................ 8,917,000 201,000 -- 9,118,000
-----------------------------------------------------------------
9,050,000 208,000 -- 9,258,000
-----------------------------------------------------------------
$12,553,000 $259,000 $ -- $12,812,000
=================================================================
A-27
Issuers may have the right to call or prepay obligations with or without call or
prepayment penalties. This might cause actual maturities to differ from the
contractual maturities summarized above.
The table below provides information about securities available for sale with
unrealized losses at December 31, 2003. These unrealized losses were in a
continuous unrealized loss position for less than 12 months and were caused by
changes in market interest rates and volatility rather than changes in credit
ratings of issuers. Management considers the impairment on these securities to
be temporary.
Less than 12 Months 12 Months or Longer Total
-------------------------- ----------------------- --------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
-------------------------- ----------------------- --------------------------
U.S. Treasury .............................. $ 500,000 $ (5,000) $ -- $ -- $ 500,000 $ (5,000)
U.S. government agencies ................... 11,595,000 (117,000) -- -- 11,595,000 (117,000)
Obligations of state and
political subdivisions ................... 712,000 (5,000) -- -- 712,000 (5,000)
Mortgage-backed securities ................. 12,379,000 (142,000) -- -- 12,379,000 (142,000)
----------------------------------------------------------------------------------
Total temporarily impaired
securities ........................... $25,186,000 $(269,000) $ -- $ -- $25,186,000 $(269,000)
==================================================================================
Cash proceeds realized from sales and calls of securities available for sale for
the years ended December 31, 2003, 2002 and 2001 were $4,270,000, $3,653,000 and
$8,005,000, respectively. Gross gains totaling $49,000 and no losses were
realized on sales and calls of securities during the year ended December 31,
2003. Gross gains totaling $10,000 and gross losses totaling $14,000 were
realized on sales and calls of securities during the year ended December 31,
2002. Gross gains totaling $1,000 and no losses were realized on sales and calls
of securities during the year ended December 31, 2001.
See Note 8 to financial statements regarding securities pledged as collateral
for securities sold under agreements to repurchase.
Note 3. SECURITIES HELD TO MATURITY
The following is a summary of the contractual maturities of securities held to
maturity:
December 31, 2003
-------------------------------------------------------------
Gross Unrealized
Carrying --------------------------- Estimated
Value Gains Losses Fair Value
-------------------------------------------------------------
U.S. Treasury:
After one but within five years ....................... $ 1,011,000 $ 56,000 $ -- $ 1,067,000
U.S. government agencies:
Within one year ....................................... 250,000 10,000 -- 260,000
After one but within five years ....................... 12,506,000 64,000 26,000 12,544,000
-------------------------------------------------------------
12,756,000 74,000 26,000 12,804,000
-------------------------------------------------------------
Obligations of state and political subdivisions:
Within one year ....................................... 3,725,000 54,000 -- 3,779,000
After one but within five years ....................... 15,961,000 600,000 -- 16,561,000
-------------------------------------------------------------
19,686,000 654,000 -- 20,340,000
-------------------------------------------------------------
Mortgage-backed securities:
Within one year ....................................... 81,000 1,000 -- 82,000
After one but within five years ....................... 461,000 10,000 -- 471,000
After five years ...................................... 18,365,000 284,000 43,000 18,606,000
-------------------------------------------------------------
18,907,000 295,000 43,000 19,159,000
-------------------------------------------------------------
$52,360,000 $1,079,000 $ 69,000 $53,370,000
=============================================================
A-28
December 31, 2002
----------------------------------------------------------------
Gross Unrealized
Carrying -------------------------- Estimated
Value Gains Losses Fair Value
----------------------------------------------------------------
U.S. Treasury:
Within one year ....................................... $ 500,000 $ 6,000 $ -- $ 506,000
After one but within five years ....................... 510,000 27,000 -- 537,000
After five years ...................................... 504,000 37,000 -- 541,000
----------------------------------------------------------------
1,514,000 70,000 -- 1,584,000
----------------------------------------------------------------
U.S. government agencies:
Within one year ....................................... 300,000 5,000 -- 305,000
After one but within five years ....................... 11,401,000 170,000 -- 11,571,000
After five years ...................................... 1,424,000 7,000 -- 1,431,000
----------------------------------------------------------------
13,125,000 182,000 -- 13,307,000
----------------------------------------------------------------
Obligations of state and political subdivisions:
Within one year ....................................... 2,239,000 27,000 -- 2,266,000
After one but within five years ....................... 17,046,000 655,000 -- 17,701,000
After five years ...................................... 775,000 30,000 -- 805,000
----------------------------------------------------------------
20,060,000 712,000 -- 20,772,000
----------------------------------------------------------------
Mortgage-backed securities:
After one but within five years ....................... 891,000 9,000 -- 900,000
After five years ...................................... 25,297,000 453,000 40,000 25,710,000
----------------------------------------------------------------
26,188,000 462,000 40,000 26,610,000
----------------------------------------------------------------
$60,887,000 $1,426,000 $ 40,000 $62,273,000
================================================================
Issuers may have the right to call or prepay obligations with or without call or
prepayment penalties. This might cause actual maturities to differ from the
contractual maturities summarized above.
The table below provides information about securities held to maturity with
unrealized losses at December 31, 2003. These unrealized losses were in a
continuous unrealized loss position for less than 12 months and were caused by
changes in market interest rates and volatility rather than changes in credit
ratings of issuers. Management considers the impairment on these securities to
be temporary.
Less than 12 Months 12 Months or Longer Total
------------------------- ------------------------ -------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
------------------------- ------------------------ -------------------------
U.S. government agencies ................. $4,214,000 $(26,000) $ -- $ -- $4,214,000 $(26,000)
Obligations of state and
political subdivisions ................. 101,000 -- -- -- 101,000 --
Mortgage-backed securities ............... 3,511,000 (43,000) -- -- 3,511,000 (43,000)
-----------------------------------------------------------------------------------
Total temporarily impaired
securities ......................... $7,826,000 $(69,000) $ -- $ -- $7,826,000 $(69,000)
===================================================================================
Cash proceeds realized from calls of securities held to maturity for the years
ended December 31, 2003, 2002 and 2001 were $15,125,000, $11,830,000 and
$6,440,000, respectively. There were no gains or losses realized on calls for
the years ended December 31, 2003 and 2002. Gross gains totaling $2,000 and no
losses were realized from calls for the year ended December 31, 2001.
The carrying value of securities pledged to secure treasury tax and loan
deposits and public deposits for the years ended December 31, 2003 and 2002 were
$1,004,000. See also Note 8 to financial statements regarding securities pledged
as collateral for securities pledged as collateral for securities sold under
agreements to repurchase.
A-29
Note 4. LOANS
The loan portfolio consisted of the following:
December 31,
----------------------------------
2003 2002
----------------------------------
Mortgage:
Residential ........................................... $ 44,835,000 $ 39,705,000
Commercial ............................................ 109,708,000 88,593,000
Commercial .............................................. 48,950,000 38,228,000
Equity .................................................. 17,181,000 12,471,000
Installment ............................................. 41,067,000 37,293,000
Other ................................................... 238,000 241,000
----------------------------------
Total loans ....................................... 261,979,000 216,531,000
----------------------------------
Less: Deferred loan fees ................................ 315,000 263,000
Allowance for loan losses ......................... 2,888,000 2,689,000
----------------------------------
3,203,000 2,952,000
----------------------------------
Loans, net .............................................. $258,776,000 $213,579,000
==================================
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.
At December 31, 2003, 2002 and 2001, loans serviced by the Corporation for the
benefit of others totaled approximately $5,983,000 $2,809,000, and $4,761,000,
respectively.
Activity in the allowance for loan losses is summarized as follows:
December 31,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
Balance, beginning ...................................... $ 2,689,000 $ 2,602,000 $ 2,223,000
Provision charged to operations ......................... 425,000 160,000 420,000
Recoveries of loans charged off ......................... 3,000 17,000 8,000
Loans charged off ....................................... (229,000) (90,000) (49,000)
-----------------------------------------------
Balance, ending ......................................... $ 2,888,000 $ 2,689,000 $ 2,602,000
===============================================
The Corporation has entered into lending transactions in the ordinary course of
business with directors, executive officers and principal stockholders of the
Corporation and their affiliates on the same terms as those prevailing for
comparable transactions with other borrowers. At December 31, 2003 and 2002,
these loans aggregated approximately $436,000 and $674,000, respectively. During
the year ended December 31, 2003, new loans totaling $51,000 were granted and
repayments totaled approximately $289,000. The loans, at December 31, 2003, were
current as to principal and interest payments, and do not involve more than
normal risk of collectability.
A-30
Note 5. NONPERFORMING ASSETS
Nonperforming assets include the following:
December 31,
------------------------------------
2003 2002
------------------------------------
Nonaccrual loans ............................................................... $ 257,000 $ 495,000
Loans past due ninety days or more and accruing ................................ 320,000 4,000
Restructured loans ............................................................. 513,000 848,000
------------------------------------
Total nonperforming loans .................................................. $1,090,000 $1,347,000
====================================
Restructured loans classified as nonaccrual for the years ended December 31,
2003 and 2002 were $174,000 and $329,000, respectively.
There were approximately $150,000 restructured loans classified as loans past
due ninety days or more and accruing at December 31, 2003.
The following information is presented for loans classified as nonaccrual and
restructured:
Year ended December 31,
----------------------------------------------
2003 2002 2001
----------------------------------------------
Income that would have been recorded under
contractual terms .......................................................... $ 57,000 $ 69,000 $ 14,000
Less interest income received ................................................ 13,000 48,000 7,000
----------------------------------------------
Lost income on nonperforming loans at year end ............................... $ 44,000 $ 21,000 $ 7,000
==============================================
Impaired loans consisted of the following:
December 31,
----------------------------------------------
2003 2002 2001
----------------------------------------------
Impaired Loans
With related allowance for loan loss ....................................... $1,073,000 $ 499,000 $ 534,000
Without related allowance for loan loss .................................... 17,000 848,000 438,000
----------------------------------------------
Total impaired loans ......................................................... $1,090,000 $1,347,000 $ 972,000
==============================================
Related allowance for possible credit losses ................................. $ 100,000 $ 189,000 $ 205,000
==============================================
Average investment in impaired loans ......................................... $1,258,000 $1,370,000 $ 984,000
==============================================
Interest recognized on impaired loans ........................................ $ 44,000 $ 81,000 $ 42,000
==============================================
Note 6. PREMISES AND EQUIPMENT, NET
December 31,
------------------------------------
2003 2002
------------------------------------
Land ........................................................................... $1,116,000 $1,189,000
Buildings and improvements ..................................................... 1,899,000 2,055,000
Leasehold improvements ......................................................... 748,000 654,000
Furniture, fixtures and equipment .............................................. 3,061,000 3,449,000
------------------------------------
6,824,000 7,347,000
Less accumulated depreciation and amortization ................................. 3,187,000 3,614,000
------------------------------------
Total premises & equipment, net ................................................ $3,637,000 $3,733,000
====================================
A-31
Note 7. DEPOSITS
December 31, 2003 December 31, 2002
-----------------------------------------------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-----------------------------------------------------------
Noninterest-bearing demand ............................. 0% $ 80,845,000 0% $ 69,344,000
-----------------------------------------------------------
NOW accounts ........................................... 0.57% 41,436,000 0.77% 34,521,000
Money market accounts .................................. 0.78% 78,227,000 1.33% 66,670,000
-----------------------------------------------------------
Total interest-bearing demand .......................... 0.71% 119,663,000 1.14% 101,191,000
Statement savings and clubs ............................ 0.77% 41,258,000 1.08% 35,205,000
Business savings ....................................... 0.49% 3,793,000 0.70% 3,037,000
-----------------------------------------------------------
Total savings .......................................... 0.75% 45,051,000 1.05% 38,242,000
IRA investment and variable rate savings ............... 3.81% 19,070,000 4.38% 16,415,000
Money market certificates .............................. 2.61% 76,909,000 3.35% 77,543,000
-----------------------------------------------------------
Total certificates of deposit .......................... 2.85% 95,979,000 3.53% 93,958,000
-----------------------------------------------------------
Total interest-bearing deposits ........................ 1.50% 260,693,000 2.09% 233,391,000
-----------------------------------------------------------
Total deposits ......................................... 1.15% $341,538,000 1.61% $302,735,000
===========================================================
Certificates of deposit with balances of $100,000 or more at December 31, 2003
and 2002, totaled approximately $29,355,000 and $27,385,000, respectively.
Interest on certificates of deposit with balances of $100,000 or more totaled
$908,000, $925,000, and $808,000, for the years ended December 31, 2003, 2002
and 2001, respectively.
The scheduled maturities of certificates of deposit were as follows:
December 31,
-------------------------------
2003 2002
-------------------------------
One year or less ................................................... $55,542,000 $50,543,000
After one to three years ........................................... 36,087,000 33,858,000
After three years .................................................. 4,350,000 9,557,000
-------------------------------
$95,979,000 $93,958,000
===============================
Note 8. OTHER BORROWINGS
Federal Home Loan Bank of New York Advances
Advances from the FHLB-NY were consummated during the month of December to fund
an investment purchase. The maximum amount of FHLB-NY advances outstanding at
any month end was $20.0 million during the year ended December 31, 2003. The
average amount of advances outstanding during the year ended December 31, 2003
was $1.0 million. As of December 31, 2003, all FHLB-NY advances had fixed rates.
The advances are scheduled for repayment as follows:
December 31, 2003
-------------------------
Weighted
Average
Amount Rate
-------------------------
2004 .......... $ 2,000,000 1.19%
2008 .......... 8,000,000 3.26%
2013 .......... 10,000,000 3.82%
----------- ----
$20,000,000 3.33%
A-32
Advances totaling $10.0 million are convertible by the FHLB-NY on December 10,
2004 and quarterly thereafter into any FHLB-NY advance at the then current
market rate. This conversion feature is only available if the three month LIBOR
resets at or above 7.50%.
Advances from the FHLB-NY were secured by a blanket assignment of the
Corporation's unpledged, qualifying mortgage loans, mortgage-backed securities
and investment securities. Such loans and securities remain under the control of
the Corporation.
The Corporation had an available overnight line of credit with the FHLB-NY for a
maximum of $33.7 million at December 31, 2003.
Securities Sold Under Agreement to Repurchase
At December 31, 2003 and 2002, securities sold under agreements to repurchase
were collateralized by U.S. Treasury and agency securities having a carrying
value of approximately $5,838,000 and $3,559,000, respectively. These securities
were maintained in a separate safekeeping account within the Corporation's
control.
December 31,
-----------------------------
2003 2002
-----------------------------
Balance ..................................................... $3,547,000 $2,435,000
Weighted average interest rate .............................. 1.05% 1.98%
Weighted average length of maturity ......................... 90 days 119 days
Maximum amount outstanding at any month end
during the year ........................................... $5,155,000 $2,435,000
Average amount outstanding during the year .................. $3,998,000 $1,018,000
Average interest rate during the year ....................... 1.44% 2.83%
Note 9. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
On September 17, 2003, Stewardship Statutory Trust I (the "Trust"), a statutory
business trust, and a wholly owned subsidiary of Stewardship Financial
Corporation, issued $7,000,000 Fixed/Floating Rate Capital Securities due
September 17, 2033 ("Capital Securities"), the proceeds from which the Trust
used to purchase from the Corporation, $7,000,000 of Fixed/Floating Rate Junior
Subordinated Deferrable Interest Debentures ("Debentures") maturing September
17, 2033. The Trust is obligated to distribute all proceeds of a redemption
whether voluntary or upon maturity, to holders of the Capital Securities.
Stewardship Financial Corporation's obligation with respect to the Capital
Securities, and the subordinated debentures, when taken together, provide a full
and unconditional guarantee on a subordinated basis by Stewardship Financial
Corporation of the Trust's obligations to pay amounts when due on the Capital
Securities.
The Capital Securities and the Debentures both bear a fixed interest rate of
6.75% until September 17, 2008 and thereafter shall float quarterly at a rate of
3-Month LIBOR plus 2.95%.
The Capital Securities and the Debentures both may be redeemed at par beginning
September 17, 2008 and quarterly thereafter. In addition, the Capital Securities
and the Debentures may be redeemed prior to September 17, 2008 upon the
occurrence of a special event. A special event includes a change to laws or
regulations which would preclude the Corporation to treat the Capital Securities
as Tier 1 Capital for purposes of capital adequacy guidelines of the Federal
Reserve, subject the Trust to US federal income tax with respect to income
received or accrued, limit the deductibility of interest payable, or the Trust
would be considered an investment company that is required to be registered
under the Investment Company Act.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" was
issued in January 2003 and was reissued as FASB Interpretation No. 46R (revised
December 2003) ("FIN 46R"). FIN 46 and FIN 46R provide guidance on the
identification of entities controlled through means other than voting rights and
specify how the Corporation should evaluate its interest in a variable interest
entity for purposes of determining whether to consolidate that entity. If a
variable interest entity does not effectively disperse risk among the parties
involved, it must be consolidated by its primary beneficiary.
The Corporation adopted FIN 46R on December 31, 2003, deconsolidating its
investment in Stewardship Statutory Trust I, the subsidiary trust formed in
connection with the issuance of subordinated debentures (trust preferred
securities). In July 2003, the Board of Governors of the Federal Reserve System
instructed bank holding companies to continue to include trust preferred
securities in their Tier I capital for regulatory purposes until notice is given
to the contrary. There can be no assurance that the Federal
A-33
Reserve System will continue to allow bank holding companies to include trust
preferred securities in Tier I capital for regulatory purposes. As of December
31, 2003, assuming the Corporation was not allowed to include the $7,000,000 in
trust preferred securities issued by Stewardship Statutory Trust I in Tier I
capital, the Corporation would remain "well capitalized".
Note 10. REGULATORY CAPITAL REQUIREMENTS
Regulations of the Board of Governors of the Federal Reserve System ("FRB")
require bank holding companies to maintain minimum levels of regulatory capital.
Under the regulations in effect at December 31, 2003, the Corporation was
required to maintain (i) a minimum leverage ratio of Tier 1 capital to total
adjusted assets of 4.0% and (ii) minimum ratios of Tier 1 and total capital to
risk-weighted assets of 4.0% and 8.0%, respectively. The Bank must comply with
substantially similar capital regulations promulgated by the FDIC.
Under its prompt corrective action regulations, the FRB is required to take
certain supervisory actions (and may take additional discretionary actions) with
respect to an undercapitalized institution. Such actions could have a direct
material effect on the institution's financial statements. The regulations
establish a framework for the classification of savings institutions into five
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. Generally, an
institution is considered well capitalized if it has a leverage (Tier 1) capital
ratio of at least 5.0%; a Tier 1 risk-based capital ratio of at least 6.0%; and
a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative measures
of assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classifications are also
subject to qualitative judgments by the FRB about capital components, risk
weightings and other factors.
Management believes that, as of December 31, 2003, the Bank and the Corporation
have met all capital adequacy requirements to which they are subject.
The following is a summary of the Corporation's actual capital amounts and
ratios as of December 31, 2003 and 2002, compared to the FRB minimum capital
adequacy requirements and the FRB requirements for classification as a well
capitalized institution:
FRB Requirements
-------------------------------------------------
Minimum Capital For Classification
Actual Adequacy as Well Capitalized
----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------------------------------------------------------------------------
December 31, 2003
Leverage (Tier 1) capital ......................... $33,925,000 8.89% $15,265,000 4.00% $19,082,000 5.00%
Risk-based capital:
Tier 1 .......................................... 33,925,000 12.93% 10,497,000 4.00% 15,746,000 6.00%
Total ........................................... 36,812,000 14.03% 20,994,000 8.00% 26,243,000 10.00%
December 31, 2002
Leverage (Tier 1) capital ......................... $23,394,000 7.02% $13,336,000 4.00% $16,670,000 5.00%
Risk-based capital:
Tier 1 .......................................... 23,394,000 10.53% 8,890,000 4.00% 13,336,000 6.00%
Total ........................................... $26,083,000 11.74% $17,781,000 8.00% $22,226,000 10.00%
Note 11. BENEFIT PLANS
The Corporation has a noncontributory profit sharing plan covering all eligible
employees. Contributions are determined by the Corporation's Board of Directors
on an annual basis. Total profit sharing plan expense for the years ended
December 31, 2003, 2002 and 2001 amounted to approximately $290,000, $221,000
and $167,000, respectively.
The Corporation also has a 401(k) plan which covers all eligible employees.
Participants may elect to contribute up to 15% of their salaries, not to exceed
the applicable limitations as per the Internal Revenue Code. The Corporation, on
an annual basis, may elect to match 50% of the participant's first 5%
contribution. Total 401(k) expense for the years ended December 31, 2003, 2002
and 2001 amounted to approximately $50,000, $42,000 and $42,000, respectively.
A-34
During 1996, the Corporation adopted an Employee Stock Purchase Plan which
allows all eligible employees to authorize a specific payroll deduction from his
or her base compensation. Total stock purchases amounted to 1,720 and 2,752
shares during 2003 and 2002, respectively.
Note 12. STOCK-BASED COMPENSATION
At December 31, 2003, the Corporation had four types of stock award programs
referred to as the Employee Stock Bonus Plan, the Director Stock Plan, an
Employee Stock Option Plan and a Stock Option Plan for Non-Employee Directors.
The Employee Stock Bonus Plan is intended to provide incentives which will
retain highly competent key management employees of the Corporation by providing
them with a bonus in the form of shares of the common stock of the Corporation.
The Corporation has not granted shares during 2003 and 2002 under this plan.
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 issued 3,416 and 4,325 shares
during 2003 and 2002, respectively.
The Employee Stock Option Plan provides for options to purchase shares of Common
Stock to be issued to key employees of the Corporation at the discretion of the
Stock Option Committee. The committee has the authority to determine the terms
and conditions of the options granted, the exercise price thereof, and whether
the options are incentive or non-statutory options. The Employee Stock Option
Plan has reserved 135,685 shares of common stock for issuance. The options were
issued with an exercise price which represented market price of the stock at the
date of grant. Options are exercisable starting one year from the date of the
grant and expire between five and ten years from the date of grant and are
subject to a vesting schedule. Options were granted to all full-time employees
on July 15, 2003. There were no options granted during 2002 and 2001. A summary
of the status of the qualified stock options as of December 31, 2003 and 2002
and changes during the years then ended on those dates is presented below:
2003 2002 2001
--------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------------------------------------------------------------
Outstanding at beginning of year ......................... 51,995 $ 7.53 60,000 $ 7.38 60,000 $ 7.38
Granted .................................................. 9,135 20.00 -- -- -- --
Exercised ................................................ 6,161 7.01 8,005 6.41 -- --
Forfeited ................................................ 420 20.00 -- -- -- --
--------------------------------------------------------------------
Outstanding at end of year ............................... 54,549 $ 9.58 51,995 $ 7.53 60,000 $ 7.38
Options exercisable at year end .......................... 40,486 41,884 37,942
Weighted average fair value of
options granted during the year ........................ $ 9.19 $ -- $ --
The following table summarizes information about the qualified employee stock
options outstanding at December 31, 2003
Options Outstanding
----------------------------------------------------------------
Number Weighted Avg. Weighted Number
Outstanding Remaining Average Exercisable
at 12/31/03 Contractual Life Exercise Price 12/31/03
----------------------------------------------------------------
Range of Exercise Prices:
$ 6 - 9 ............................... 29,492 3.50 $ 6.26 29,492
$ 9 - 12 ............................... 16,342 5.06 10.01 10,942
$12 - 15 ............................... -- -- -- --
$15 - 18 ............................... -- -- -- --
$18 - 21 ............................... 8,715 9.55 20.00 52
--------------------------------------------------------------
$ 6 - 21 ............................... 54,549 4.93 $ 9.58 40,487
==============================================================
A-35
The 1995 Stock Option Plan for Non-Employee Directors had reserved 135,685
shares of common stock for issuance. During 1997 each participant was granted
the option to purchase 12,332 shares of common stock. No option could be
exercised more than five years after the date of its grant. The options were
issued with an exercise price of $5.82, 95% of the fair market value on the date
the options were granted. During 2001, an option to purchase the remaining
shares available under this plan, 12,332 shares, were granted to a new director.
The option to purchase these shares was issued with an exercise price of $9.37,
95% of the fair market value on the date the options were granted. As a result
of the discount, $6,000 was charged to noninterest expense for 2001. Options to
purchase 46,589 shares were exercised in 2002. All options to purchase shares
have been exercised under this plan.
In May 2001, the shareholders approved the 2001 Stock Option Plan for
Non-Employee Directors that would allow the Corporation to grant a maximum of
8,682 shares to each director. The plan reserved 104,186 shares of common stock
for issuance. Options would be exercisable 20% each year for five years. No
option may be exercised more than five years after the date of its grant.
Options to purchase 78,139 shares were granted in 2001 with an exercise price of
$9.57. In September 2003 options to purchase 5,209 shares were granted with an
exercise price of $20.00. Options to purchase 8,680 and 1,736 shares were
exercised during 2003 and 2002. respectively. Options to purchase 20,839 shares
were exercisable at December 31, 2003.
The Corporation applies the "intrinsic value based method" as described in
Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees," and related Interpretations in accounting for its stock-based
compensation. Accordingly, no compensation cost has been recognized for these
stock option plans. Consistent with SFAS 123, if compensation cost for the plans
was included, the Corporation's net income and earnings per share would have
been reduced to the proforma amounts as disclosed in Note 1.
Note 13: EARNINGS PER SHARE
The following reconciles the income available to common shareholders (numerator)
and the weighted average common stock outstanding (denominator) for both basic
and diluted earnings per share for 2003, 2002 and 2001:
2003 2002 2001
------------------------------------------
Net income ....................................................... $3,491,000 $3,116,000 $2,558,000
------------------------------------------
Income available to common stockholders
basic and diluted .............................................. $3,491,000 $3,116,000 $2,558,000
==========================================
Weighted average common shares
outstanding - basic ............................................ 3,140,444 3,076,763 3,020,361
Effect of dilutive securities - stock options .................... 44,613 24,358 33,599
------------------------------------------
Weighted average common shares
outstanding - diluted .......................................... 3,185,057 3,101,121 3,053,960
==========================================
Basic earnings per share ......................................... $ 1.11 $ 1.01 $ 0.85
==========================================
Dilute earnings per share ........................................ $ 1.10 $ 1.00 $ 0.84
==========================================
A-36
Note 14. INCOME TAXES
The components of income taxes (benefit) are summarized as follows:
Year ended December 31,
-----------------------------------------------------
2003 2002 2001
-----------------------------------------------------
Current tax expense:
Federal ............................................. $ 1,497,000 $ 1,321,000 $ 1,180,000
State ............................................... 455,000 384,000 295,000
-----------------------------------------------------
1,952,000 1,705,000 1,475,000
Deferred tax benefit:
Federal ............................................. (37,000) (61,000) (146,000)
State ............................................... (7,000) (10,000) (25,000)
-----------------------------------------------------
(44,000) (71,000) (171,000)
-----------------------------------------------------
$ 1,908,000 $ 1,634,000 $ 1,304,000
=====================================================
Not included in the above table is income tax (benefit) expense relating to
unrealized (losses) gains on securities available for sale recognized in
stockholders' equity amounting to ($98,000), $83,000, and $87,000 for the years
ended December 31, 2003, 2002, and 2001 respectively.
The following table presents a reconciliation between the reported income taxes
and the income taxes which would be computed by applying the normal federal
income tax rate (34%) to income before income taxes:
Year ended December 31,
-----------------------------------------------------
2003 2002 2001
-----------------------------------------------------
Federal income tax ....................................... $ 1,836,000 $ 1,615,000 $ 1,313,000
Add (deduct) effect of:
State income taxes, net of federal income tax effect .... 296,000 247,000 178,000
Nontaxable interest income .............................. (230,000) (236,000) (250,000)
Other items, net ........................................ 6,000 8,000 63,000
-----------------------------------------------------
Effective federal income taxes ........................... $ 1,908,000 $ 1,634,000 $ 1,304,000
=====================================================
The tax effects of existing temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax liabilities are
as follows:
December 31,
----------------------------
2003 2002
----------------------------
Deferred tax assets/liabilities:
Allowance for loan losses .............................. $1,153,000 $1,074,000
Allowance for other losses ............................. 36,000 28,000
Core deposit intangible amortization ................... 23,000 26,000
Nonaccrual loan interest .............................. 28,000 36,000
Depreciation .......................................... 58,000 90,000
----------------------------
$1,298,000 $1,254,000
----------------------------
Deferred tax liabilities:
Unrealized gains on securities available for sale ...... $ 2,000 $ 101,000
Other .................................................. 5,000 5,000
----------------------------
$ 7,000 $ 106,000
----------------------------
Net deferred tax assets .................................. $1,291,000 $1,148,000
============================
A-37
The Corporation has determined that it is not required to establish a valuation
reserve for the deferred tax asset, since it is more likely than not that the
deferred tax asset will be principally realized through carrybacks to taxable
income in prior years, a history of growth in earnings and the prospects for
continued growth in the future.
Note 15. COMMITMENTS AND CONTINGENCIES
The Corporation is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated financial statements. The contract or notional amounts of those
instruments reflect the extent of involvement the Corporation has in particular
classes of financial instruments.
The Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Corporation uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
At December 31, 2003, the Corporation had mortgage commitments to extend credit
aggregating approximately $2.3 million at fixed rates averaging 6.01%. Of these
loan commitments, $2.1million will be sold to investors upon closing.
Commercial, construction and home equity loan commitments of approximately $13.7
million were extended with variable rates currently averaging 5.87% and $1.0
million were extended at fixed rates averaging 6.05%. All commitments were due
to expire within approximately 90 days.
Additionally, at December 31, 2003, the Corporation was committed for
approximately $59.2 million of unused lines of credit, consisting of $19.1
million relating to a home equity line of credit program and an unsecured line
of credit program (cash reserve), $10.7 million relating to credit cards, and
$29.4 million relating to commercial and construction lines of credit. Amounts
drawn on the unused lines of credit are predominantly assessed interest at rates
which fluctuate with the base rate.
Commitments under standby and commercial letters of credit aggregated
approximately $609,000 at December 31, 2003, of which $607,000 expires within
one year. Should any letter of credit be drawn on, the interest rate charged on
the resulting note would fluctuate with the Corporation's base rate.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments may expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Corporation evaluates each customer's creditworthiness on
a case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Corporation upon extension of credit, is based on management's credit
evaluation of the counter-party. Collateral held varies, but may include
accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby and commercial letters of credit are conditional commitments issued by
the Corporation to guarantee payment or performance of a customer to a third
party. Those guarantees are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Corporation obtains collateral supporting those commitments for which
collateral is deemed necessary
Rentals under long-term operating lease for branch offices amounted to
approximately $363,000 and $273,000 during the years ended December 31, 2003 and
2002, respectively. At December 31, 2003, the minimum rental commitments on the
noncancellable leases with an initial term of one year and expiring thereafter
is as follows:
Year Ending Minimum
December 31 Rent
--------------------------------------------
2004 ..................... $ 413,000
2005 ..................... 426,000
2006 ..................... 411,000
2007 ..................... 369,000
2008 ..................... 341,000
Thereafter 1,412,000
----------
$3,372,000
==========
A-38
The Corporation is also subject to litigation which arises primarily in the
ordinary course of business. In the opinion of management the ultimate
disposition of such litigation should not have a material adverse effect on the
financial position of the Corporation.
Note 16. DIVIDEND LIMITATION
The Corporation's ability to pay cash dividends is based on its ability to
receive cash from its bank subsidiary. New Jersey law provides that no dividend
shall be paid by the Bank on its capital stock unless, following the payment of
such dividend, the capital stock of the Bank will be unimpaired, and the Bank
will have a surplus of not less than 50% of its capital stock, or if not, the
payment of such dividend will not reduce the surplus of the Bank. At December
31, 2003, this restriction did not result in any effective limitation in the
manner in which the Bank is currently operating.
Note 17. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 (SFAS No. 107) Disclosures
About Fair Value of Financial Instruments, requires that the Corporation
disclose the estimated fair value of its financial instruments whether or not
recognized in the consolidated balance sheet. Fair value estimates, methods and
assumptions are set forth below for the Corporation's financial instruments.
December 31,
--------------------------------------------------------
2003 2002
--------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------------------------------------------------------
(Dollars in thousands)
Financial assets:
Cash and cash equivalents ........................ $ 19,138 $ 19,138 $ 33,418 $ 33,418
Securities available for sale .................... 61,305 61,305 12,812 12,812
Securities held to maturity ...................... 52,360 53,370 60,887 62,273
FHLB-NY stock .................................... 1,322 1,322 1,059 1,059
Net loans ........................................ 258,776 259,463 213,579 218,219
Mortgage loans held for sale ..................... 576 576 2,099 2,099
Financial liabilities:
Deposits ......................................... 341,538 343,576 302,735 304,813
Securities sold under agreements
to repurchase .................................. 3,547 3,547 2,435 2,435
Other borrowings ................................. 20,000 19,483 -- --
Subordinated debentures .......................... 7,127 7,264 -- --
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash and cash equivalents
The carrying amount approximates fair value.
Securities available for sale
All securities available for sale are actively traded and have been valued using
quoted market prices.
Securities held to maturity
All securities held to maturity are actively traded and have been valued using
quoted market prices.
FHLB-NY stock
The carrying amount approximates fair value.
A-39
Net loans
Fair values are estimated for portfolios of loan with similar financial
characteristics. Loans are segregated by type such as residential and commercial
mortgages, commercial and other installment. The fair value of loans is
estimated by discounting cash flows using estimated market discount rates which
reflect the credit and interest rate risk inherent in the loans.
Mortgage loans held for sale
Loans in this category have been committed for sale to investors at the current
carrying amount.
Deposits
The fair value of deposits, with no stated maturity, such as noninterest-bearing
demand deposits, savings, NOW and money market accounts, is equal to the amount
payable on demand as of December 31, 2003 and 2002, respectively. The fair value
of the certificates of deposit is based on the discounted value of cash flows.
The discount rate is estimated using market discount rates which reflect
interest rate risk inherent in the certificates of deposit.
Securities sold under agreements to repurchase
The carrying value approximates fair value due to the relatively short time
before maturity.
Commitments to extend credit
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the counter parties, and at
December 31, 2003 and 2002 were not material.
Limitations
The preceding fair value estimates were made at December 31, 2003 and 2002,
based on pertinent market data and, relevant information on the financial
instruments. These estimates do not include any premium or discount that could
result from an offer to sell at one time the Corporation's entire holdings of a
particular financial instrument or category thereof. Since no market exists for
a substantial portion of the Corporation's financial instruments, fair value
estimates were necessarily based on judgments with respect to future expected
loss experience, current economic conditions, risk assessments of various
financial instruments, and other factors. Given the subjective nature of these
estimates, the uncertainties surrounding them and the matters of significant
judgment that must be applied, these fair value estimates cannot be calculated
with precision. Modifications in such assumptions could meaningfully alter these
estimates.
Since these fair value approximations were made solely for on and off balance
sheet financial instruments at December 31, 2003 and 2002, no attempt was made
to estimate the value of anticipated future business. Furthermore, certain tax
implications related to the realization of unrealized gains and losses could
have a substantial impact on these fair value estimates and have not been
incorporated into the estimates.
A-40
Note 18. PARENT COMPANY ONLY
The Corporation was formed in January 1995 to operate its subsidiary, Atlantic
Stewardship Bank. The earnings of the bank are recognized by the Corporation
using the equity method of accounting. Accordingly, the bank dividends paid
reduce the Corporation's investment in the subsidiary. In 2003, the Corporation
formed its second subsidiary, Stewardship Statutory Trust, to offer trust
preferred securities. The following information should be read in conjuction
with the other notes to the consolidated financial statements. Condensed
financial statements of the Corporation at December 31, 2003 and 2002 are
presented below:
Condensed Statements of Financial Condition Year ended December 31,
------------------------------------
2003 2002
------------------------------------
Assets
Cash and due from banks ........................................ $ 277,000 $ 1,092,000
Securities available for sale .................................. 3,812,000 --
Securities held to maturity .................................... 1,000,000 --
Investment in subsidiary ....................................... 28,961,000 22,752,000
Accrued interest receivable .................................... 44,000 --
Other assets ................................................... 314,000 22,000
------------------------------------
Total assets ............................................ $34,408,000 $23,866,000
====================================
Liabilities and Stockholders' equity
Subordinated debentures ........................................ $ 7,217,000 $ --
Other liabilities .............................................. 42,000 49,000
Stockholders' equity ........................................... 27,149,000 23,817,000
------------------------------------
Total liabilities and Stockholders' equity ............. $34,408,000 $23,866,000
====================================
Condensed Statements of Income Year ended December 31,
---------------------------------------------
2003 2002 2001
---------------------------------------------
Interest income - securities available for sale ................ $ 33,000 $ -- $ 6,000
Interest income - securities held to maturity .................. 26,000 24,000 19,000
Dividend income ................................................ 275,000 575,000 475,000
Other income ................................................... 9,000 -- --
---------------------------------------------
Total income ........................................... 343,000 599,000 500,000
Interest expense ............................................... 141,000 -- --
Other expenses ................................................. 106,000 106,000 30,000
---------------------------------------------
Total expenses ......................................... 247,000 106,000 30,000
---------------------------------------------
Income before income tax benefit ............................... 96,000 493,000 470,000
Tax benefit .................................................... (61,000) (28,000) --
---------------------------------------------
Income before equity in undistributed earnings
of subsidiary ................................................ 157,000 521,000 470,000
Equity in undistributed earnings of subsidiary ................. 3,334,000 2,595,000 2,088,000
---------------------------------------------
Net income ..................................................... $ 3,491,000 $ 3,116,000 $2,558,000
=============================================
A-41
Condensed Statements of Cash Flows Year ended December 31,
---------------------------------------------
2003 2002 2001
---------------------------------------------
Cash flows from operating activities:
Net income ................................................................. $ 3,491,000 $ 3,116,000 $ 2,558,000
---------------------------------------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in undistributed earnings of subsidiary ........................ (3,334,000) (2,595,000) (2,088,000)
Issuance of stock options at a discount ............................... -- -- 6,000
(Increase) decrease decrease in accrued interest receivable ........... (44,000) 7,000 3,000
Decrease (increase) in other assets ................................... 2,000 47,000 (5,000)
Increase (decrease) in other liabilities .............................. (7,000) 11,000 (44,000)
---------------------------------------------
Net cash provided by operating activities ........................ 108,000 586,000 430,000
---------------------------------------------
Cash flows from investing activities:
Purchase of security held to maturity ...................................... (1,000,000) (300,000) (100,000)
Purchase of securities available for sale .................................. (3,800,000) -- --
Investment in bank subsidiary .............................................. (3,000,000) -- --
Investment in special purpose subsidiary ................................... (217,000) -- --
Proceeds from calls on securities available for sale ....................... -- 650,000 100,000
---------------------------------------------
Net cash (used) provided by investing activities ................. (8,017,000) 350,000 --
---------------------------------------------
Cash flows from financing activities:
Issuance of subordinated debentures ........................................ 7,217,000 -- --
Cash dividends paid on common stock ........................................ (819,000) (669,000) (558,000)
Exercise of stock options .................................................. 126,000 371,000 67,000
Purchase of treasury stock ................................................. -- (164,000) (340,000)
Issuance of common stock ................................................... 570,000 480,000 471,000
---------------------------------------------
Net cash provided (used) by investing activities ................. 7,094,000 18,000 (360,000)
---------------------------------------------
Net (decrease) increase in cash and cash equivalents ............................ (815,000) 954,000 70,000
Cash and cash equivalents - beginning ........................................... 1,092,000 138,000 68,000
---------------------------------------------
Cash and cash equivalents - ending .............................................. $ 277,000 $ 1,092,000 $ 138,000
=============================================
NOTE 19. RECENT ACCOUNTING PRONOUNCEMENTS
FASB No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity"
On May 15, 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity,"
("SFAS No. 150"). SFAS No. 150 requires instruments within its scope to be
classified as a liability (or, in some cases, as an asset). Generally, SFAS No.
150 is effective for financial instrument arrangements entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
fiscal period beginning after December 2003. On November 7, 2003, the FASB
deferred the application of several provisions of SFAS No. 150. The adoption of
SFAS No. 150 is not expected to impact the Corporation's consolidated financial
statements.
FASB No. 149, "Amendment of Statement No. 133 on Derivative Instruments and
Hedging Activities"
Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," ("SFAS No. 149") was issued
on April 30, 2003. This statement amends financial accounting and reporting
requirements for derivative instruments and hedging activities under SFAS No.
133 to clarify the definition of a derivative, expand the nature of exemptions
from SFAS No. 133, clarify the application of hedge accounting when using
certain instruments, clarify the application of paragraph 13 of Statement No.
133 to embedded derivative instruments in which the underlying is an interest
rate and modify the cash flow presentation of derivative instruments that
contain financing elements. The adoption of SFAS No. 149 did not have a material
impact on the Corporation's consolidated financial statements.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities
FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN
No. 46") was issued in January 2003. FIN No. 46 applies immediately to
enterprises that hold a variable interest in variable interest entities created
after January 31, 2003. FIN No. 46 applies to public enterprises as of the
beginning of the applicable interim or annual period. FIN No. 46 may be applied
prospectively with a cumulative-effect adjustment as of the date on which it is
first applied or by restating previously issued financial statements for one or
more years with a cumulative-effect adjustment as of the beginning of the first
year restated. FIN No. 46 provides guidance on the identification of entities
controlled through means other than voting rights and specifies how a business
enterprise should evaluate its interest in a variable interest entity to
determine whether to consolidate that entity. A variable interest entity must be
consolidated by its primary beneficiary if the entity does not effectively
disperse risks among the parties involved.
A-42
On October 9, 2003, the effective date was deferred until the end of the first
annual period ending after December 15, 2003, for certain interests held by a
public entitiy in certain variable interest entities or potential variable
interest entities created before February 1, 2003. The adoption of this
accounting pronouncement required the Corporation to de-consolidate its
investment in Stewardship Statutory Trust I in the Corporation's consolidated
financial statements. The de-consolidation of subsidiary trusts of bank holding
companies formed in connection with the issuance of trust preferred securities,
like Stewardship Statutory Trust I, appears to be an unintended consequence of
FIN 46. In July 2003, the Board of Governors of the Federal Reserve System
instructed bank holding companies to continue to include the trust preferred
securities in their Tier 1 capital for regulatory capital purposes until notice
is given to the contrary. There can be no assurance that the Federal Reserve
will continue to allow institutions to include trust preferred securities in
Tier 1 capital for regulatory capital purposes. As of December 31, 2003,
assuming the Corporation was not allowed to include the $7.0 million in trust
preferred securities issued by Stewardship Statutory Trust I in Tier 1 capital,
the Corporation would remain "well capitalized."
Note 20. QUARTERLY FINANCIAL DATA (Unaudited)
The following table contains quarterly financial data for the years ended
December 31, 2003 and 2002 (dollars in thousands).
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-----------------------------------------------------------------------
Year ended December 31, 2003:
Interest income .................................... $ 4,604 $ 4,632 $ 4,705 $ 4,978 $18,919
Interest expense ................................... 1,180 1,175 1,070 1,166 4,591
-----------------------------------------------------------------------
Net interest income before
provision for loan losses .................... 3,424 3,457 3,635 3,812 14,328
Provision for loan losses .......................... 115 110 90 110 425
-----------------------------------------------------------------------
Net interest income after
provision for loan losses .................... 3,309 3,347 3,545 3,702 13,903
Noninterest income ................................. 696 778 777 639 2,890
Noninterest expense ................................ 2,694 2,794 2,935 2,971 11,394
-----------------------------------------------------------------------
Net income before
income tax expense ........................... 1,311 1,331 1,387 1,370 5,399
Federal and state income tax expense ............... 458 469 492 489 1,908
-----------------------------------------------------------------------
Net income ......................................... $ 853 $ 862 $ 895 $ 881 $ 3,491
=======================================================================
Basic earnings per share ........................... $ 0.27 $ 0.28 $ 0.28 $ 0.28 $ 1.11
=======================================================================
Diluted earnings per share ......................... $ 0.27 $ 0.27 $ 0.28 $ 0.28 $ 1.10
=======================================================================
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-----------------------------------------------------------------------
Year ended December 31, 2002:
Interest income .................................... $ 4,266 $ 4,374 $ 4,567 $ 4,571 $17,778
Interest expense ................................... 1,318 1,306 1,324 1,323 5,271
-----------------------------------------------------------------------
Net interest income before
provision for loan losses .................... 2,948 3,068 3,243 3,248 12,507
Provision for loan losses .......................... 40 30 30 60 160
-----------------------------------------------------------------------
Net interest income after
provision for loan losses .................... 2,908 3,038 3,213 3,188 12,347
Noninterest income ................................. 530 599 533 588 2,250
Noninterest expense ................................ 2,376 2,447 2,456 2,568 9,847
-----------------------------------------------------------------------
Net income before income tax expense ........... 1,062 1,190 1,290 1,208 4,750
Federal and state income tax expense ............... 357 406 454 417 1,634
-----------------------------------------------------------------------
Net income ......................................... $ 705 $ 784 $ 836 $ 791 $ 3,116
=======================================================================
Basic earnings per share ........................... $ 0.23 $ 0.26 $ 0.27 $ 0.25 $ 1.01
=======================================================================
Diluted earnings per share ......................... $ 0.23 $ 0.25 $ 0.27 $ 0.25 $ 1.00
=======================================================================
A-43