Item 1. Business
General
Stewardship Financial Corporation (the “Corporation” or the “Registrant”) is a one-bank holding company, which was incorporated under the laws of the State of New Jersey in January 1995 to serve as a holding company for Atlantic Stewardship Bank (the “Bank”). The Corporation was organized at the direction of the Board of Directors of the Bank for the purpose of acquiring all of the capital stock of the Bank (the “Acquisition”). Pursuant to the New Jersey Banking Act of 1948, as amended (the “New Jersey Banking Act”), and pursuant to approval of the shareholders of the Bank, the Corporation acquired the Bank and became its holding company on November 22, 1996. As part of the Acquisition, shareholders of the Bank received one share of common stock, no par value of the Corporation (“Common Stock”), for each outstanding share of the common stock of the Bank held. The only significant activity of the Corporation is ownership and supervision of the Bank.
The Bank is a commercial bank formed under the laws of the State of New Jersey on April 26, 1984. Throughout 2014 the Bank operated from its main office at 630 Godwin Avenue, Midland Park, New Jersey, and its current eleven branches located in the State of New Jersey. One branch closed in March 2014.
The Corporation is subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (the “FRB”). The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable limits. The operations of the Corporation and the Bank are subject to the supervision and regulation of the FRB, the FDIC and the New Jersey Department of Banking and Insurance (the “Department”).
Stewardship Investment Corp. is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is to own and manage an investment portfolio. Stewardship Realty, LLC is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is to own and manage property at 612 Godwin Avenue, Midland Park, New Jersey. Atlantic Stewardship Insurance Company, LLC is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is insurance. The Bank also has several other wholly-owned, non-bank subsidiaries formed to hold title to properties acquired through foreclosure or deed in lieu of foreclosure. In addition to the Bank, in 2003, the Corporation formed, Stewardship Statutory Trust I, a wholly-owned, non-bank subsidiary for the purpose of issuing trust preferred securities.
The principal executive offices of the Corporation are located at 630 Godwin Avenue, Midland Park, New Jersey 07432. Our telephone number is (201) 444-7100 and our website address is http://www.asbnow.com.
Business of the Corporation
The Corporation’s primary business is the ownership and supervision of the Bank. The Corporation, through the Bank, conducts a traditional commercial banking business, and offers deposit services including personal and business checking accounts and time deposits, money market accounts and regular savings accounts. The Corporation structures the Bank’s specific products and services in a manner designed to attract the business of the small and medium-sized business and professional community as well as that of individuals residing, working and shopping in Bergen, Morris and Passaic counties, New Jersey. The Corporation engages in a wide range of lending activities and offers commercial, consumer, residential real estate, home equity and personal loans.
In addition, in forming the Bank, the members of the Board of Directors envisioned a community-based institution which would serve the local communities surrounding its branches, while also providing a return to its shareholders. This vision has been reflected in the Bank’s tithing policy, under which the Bank tithes 10% of its pre-tax profits to worthy Christian and civic organizations in the communities where the Bank maintains branches.
Service Area
The Bank’s service area primarily consists of Bergen, Morris and Passaic Counties in New Jersey, although the Corporation makes loans throughout New Jersey. Throughout 2014, the Bank operated from its main office in Midland Park, New Jersey and eleven existing branch offices in Hawthorne (2), Ridgewood, Montville, North Haledon, Pequannock, Waldwick, Wayne (2), Westwood and Wyckoff, New Jersey. One branch in Wayne, New Jersey was closed during 2014.
Competition
The market for banking services remains highly competitive. The Bank competes for deposits and loans with commercial banks, thrifts and other financial institutions, many of which have greater financial resources than the Bank. Many large financial institutions in New York City and other parts of New Jersey compete for the business of New Jersey residents and companies located in the Bank’s service area. Certain of these institutions have significantly higher lending limits and expend greater resources on marketing and advertising than the Bank and provide services to their customers that the Bank does not offer.
Management believes the Bank is able to compete on a substantially equal basis with its competitors because it provides responsive, personalized services through management’s knowledge and awareness of the Bank’s service area, customers and business.
Employees
At December 31, 2014, the Corporation employed 123 full-time employees and 28 part-time employees. None of these employees is covered by a collective bargaining agreement and the Corporation believes that its employee relations are good.
Supervision and Regulation
General
Bank holding companies and banks are extensively regulated under both federal and state law. These laws and regulations are intended to protect depositors, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions and is not intended to be an exhaustive description of the statutes or regulations applicable to the Corporation’s business. Any change in the applicable law or regulation may have a material effect on the business and prospects of the Corporation and the Bank.
Dodd-Frank Act
On July 21, 2010, financial regulatory reform legislation entitled The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act imposes extensive changes across the financial regulatory landscape, including provisions that, among other things, have:
centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”), responsible for implementing, examining, and enforcing compliance with federal consumer financial laws;
applied to most bank holding companies, the same leverage and risk-based capital requirements applicable to insured depository institutions. The Corporation’s existing trust preferred securities will continue to be treated as Tier 1 capital;
changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling on the size of the Deposit Insurance Fund (“DIF”) and increased the floor on the size of the DIF, which generally requires an increase in the level of assessments for institutions with assets in excess of $10 billion;
implemented corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions;
made permanent the $250,000 limit for federal deposit insurance;
repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts; and
restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater.
In December 2013, regulatory agencies adopted a rule on the treatment of certain collateralized debt obligations backed by trust preferred securities to implement sections of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the Volcker Rule. In January 2014, the regulatory agencies approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities from the investment prohibitions of the Volcker rule. Under the interim final rule, the regulatory agencies
permit the retention of an interest in or sponsorship of covered funds by banking entities if certain qualifications are met. Based upon management’s review of the securities portfolio, management believes that there are no securities in their portfolio that are impacted by the Volcker Rule.
Provisions in the Dodd-Frank Act and related rules that affect deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues that those deposits may generate.
Certain aspects of the Dodd-Frank Act remain subject to implementation through rulemaking that will continue for several years, making it difficult to anticipate the overall financial impact of the legislation on the Corporation, the Bank and its customers as well as the financial industry in general.
Regulation of the Corporation
BANK HOLDING COMPANY ACT. As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”), the Corporation is subject to the regulation, supervision examination and inspection of the Board of Governors of the FRB. The Corporation is required to file with the FRB annual reports and other information showing that its business operations and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity which the FRB determines to be so closely related to banking or managing or controlling banks as to be properly incident thereto. The FRB may also make examinations of the Corporation and its subsidiaries.
The BHCA requires, among other things, the prior approval of the FRB in any case where a bank holding company proposes to (i) acquire all or substantially all of the assets of any other bank, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank (unless it owns a majority of such bank’s voting shares), or (iii) merge or consolidate with any other bank holding company. The FRB will not approve any merger, acquisition, or consolidation that would have a substantially anti-competitive effect, unless the anti-competitive impact of the proposed transaction is clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also considers capital adequacy and other financial and managerial resources and future prospects of the companies and the banks concerned, together with the convenience and needs of the community to be served.
Additionally, the BHCA prohibits, with certain limited exceptions, a bank holding company from (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company, or (ii) engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries; unless such non-banking business is determined by the FRB to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such determinations, the FRB is required to weigh the expected benefits to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.
The BHCA prohibits depository institutions whose deposits are insured by the FDIC and bank holding companies, among others, from transferring and sponsoring and investing in private equity funds and hedge funds.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance funds in the event the depository institution becomes in danger of default. Under a policy of the FRB with respect to bank holding company operations, a bank holding company is required to commit resources to support such institutions in circumstances where it might not do so absent such a policy. The FRB also has the authority under the BHCA to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES. The FRB has adopted risk-based capital guidelines for bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The risk-based guidelines apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more. The minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least 4% of the total capital is required to be “Tier 1” capital, consisting of common shareholders’ equity and certain preferred stock, less certain goodwill items and other intangible assets. The remainder, “Tier 2 Capital,” may consist of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) excess of qualifying preferred stock, (c) hybrid capital instruments, (d) debt, (e) mandatory convertible securities, and (f) qualifying subordinated debt. Total capital is the sum of Tier 1 and Tier 2 capital less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the FRB (determined on a case-by-case basis or as a matter of policy after formal rule-making).
Bank holding company assets are given risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets. Most loans are assigned to the 100% risk category, except for performing first mortgage loans fully secured by residential property which carry a 50% risk-weighting. Most investment securities (including, primarily, general obligation claims of states or other political subdivisions of the United States) are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S. Government, which have a 0% risk-weight. In converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing nonfinancial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50% risk-weighting. Short-term commercial letters of credit have a 20% risk-weighting and certain short-term unconditionally cancelable commitments have a 0% risk-weighting.
In addition to the risk-based capital guidelines, the FRB has adopted a minimum Tier 1 capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of at least 3% in the case of a bank holding company that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum.
In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that revises the leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless a one-time opt-out is exercised. Additional constraints will also be imposed on the inclusion in regulatory capital of mortgage-servicing assets and defined tax assets. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule became effective for the Corporation on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
Regulation of the Bank
As a New Jersey-chartered commercial bank, the Bank is subject to the regulation, supervision, and control of the Department. As an FDIC-insured institution, the Bank is also subject to regulation, supervision and control by the FDIC, an agency of the federal government. The regulations of the FDIC and the Department impact virtually all activities of the Bank, including the minimum level of capital the Bank must maintain, the ability of the Bank to pay dividends, the ability of the Bank to expand through new branches or acquisitions, and various other matters.
INSURANCE OF DEPOSITS. Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The Dodd-Frank Act permanently raised the standard maximum deposit insurance amount to $250,000.
The FDIC redefined its deposit insurance premium assessment base to be an institution’s average consolidated total assets minus average tangible equity as required by the Dodd-Frank Act and revised deposit insurance assessment rate schedules in light of the changes to the assessment base. The rate schedule and other revisions to the assessment rules, which were adopted by the FDIC Board of Directors on February 7, 2011, became effective April 1, 2011 and were first used to calculate the June 30, 2011 assessment. The assessment rules were further modified in November, 2014; the revisions became effective on January 1, 2015. As of December 31, 2014, the Bank’s assessment rate averaged $0.07 per $100 in assessable assets minus average tangible equity.
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation (“FICO”) in connection with the failure of certain savings and loan associations. This payment obligation is established quarterly and averaged 0.62% and 0.64% of the assessment base for the years ended December 31, 2014 and 2013, respectively. The Corporation paid $38,000 and $40,000 under this assessment for the years ended December 31, 2014 and 2013, respectively. These assessments will continue until the FICO bonds mature in 2017.
Capital Adequacy Guidelines FOR BANKS. Similar to the FRB, the FDIC has promulgated risk-based capital guidelines for banks that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. These guidelines are substantially the same as those put in place by the FRB for bank holding companies.
DIVIDEND RIGHTS. Under the New Jersey Banking Act, a bank may declare and pay dividends only if, after payment of the dividend, the capital stock of the bank will be unimpaired and either the bank will have a surplus of not less than 50% of its capital stock or the payment of the dividend will not reduce the bank’s surplus.
USA PATRIOT ACT OF 2001 (the “Patriot Act”). On October 26, 2001, the Patriot Act was signed into law. Enacted in response to the terrorist attacks in New York, Pennsylvania, and Washington, D.C. on September 11, 2001, the Patriot Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including, but not limited to: (a) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons; (b) standards for verifying customer identification at account opening; (c) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (d) reports of nonfinancial trades and business filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (e) filing of suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
Regulations promulgated under the Patriot Act impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. Failure of the Corporation or the Bank to comply with the Patriot Act’s requirements could have serious legal consequences for the institution and adversely affect our reputation.
Item 1A.
Item 1A. Risk Factors
Investments in the Common Stock of the Corporation involve risk. The following discussion highlights the risks management believes are material for our Corporation, but does not necessarily include all risks that we may face.
Our operations are subject to interest rate risk and changes in interest rates may negatively affect financial performance.
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed money. To be profitable we must earn more interest from our interest-earning assets than we pay on our interest-bearing liabilities. Changes in the general level of interest rates may have an adverse effect on our business, financial condition and results of operations. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of
governmental and regulatory agencies such as the Federal Reserve Bank. Changes in monetary policy and interest rates can also adversely affect our ability to originate loans and deposits, the fair value of financial assets and liabilities and the average duration of our assets and liabilities.
Our allowance for loan losses may be insufficient.
There are risks inherent in our lending activities, including dealing with individual borrowers, nonpayment, uncertainties as to the future value of collateral and changes in economic and industry conditions. We attempt to mitigate and manage credit risk through prudent loan underwriting and approval procedures, monitoring of loan concentrations and periodic independent review of outstanding loans. We cannot be assured that these procedures will reduce credit risk inherent in the business.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and assets serving as collateral for loan repayments. In determining the size of our allowance for loan loss, we rely on our experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient to cover probable incurred loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our portfolio. Significant additions to our allowance for loan losses would materially decrease our net income. 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.
An improving but a prolonged weak economy has adversely affected the financial services industry and, because of our geographic concentration in northern New Jersey, we could be impacted by adverse changes in local economic conditions.
Our success depends on the general economic conditions of the nation, the State of New Jersey, and the northern New Jersey area. The nation’s improving but prolonged weak economic environment has severely adversely affected the banking industry and may adversely affect our business, financial condition, results of operations and stock price. We believe recovery will continue to be slow and believe the reversal of the impact of the prolonged difficult economic conditions are likely to take time to show improvement. Unlike larger banks that are more geographically diversified, we provide financial services to customers primarily in the market areas in which we operate. The local economic conditions of these areas have a significant impact on our commercial, real estate and construction loans, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. While we did not and do not have a sub-prime lending program, any significant decline in the real estate market in our primary market area would hurt our business and mean that collateral for our loans would have less value. As a consequence, our ability to recover on defaulted loans by selling the real estate securing the loan would be diminished and we would be more likely to suffer losses on defaulted loans. Any of the foregoing events and conditions could have a material adverse effect on our business, results of operations and financial condition.
Competition within the financial services industry could adversely affect our profitability.
We face strong competition from banks, other financial institutions, money market mutual funds and brokerage firms within the New York metropolitan area. A number of these entities have substantially greater marketing and advertising resources and lending limits, larger branch systems and a wider array of banking services. Competition among depository institutions for customer deposits has increased significantly and will likely continue in the current economic environment. If we are unsuccessful in competing effectively, we will lose market share and may suffer a reduction in our margins and adverse consequences to our business, results of operations and financial condition.
Federal and State regulations could restrict our business and increase our costs and non-compliance would result in penalties, litigation and damage to our reputation.
We operate in a highly regulated environment and are subject to extensive regulation, supervision, and examination by the FDIC, the FRB and the State of New Jersey. The significant federal and state banking regulations that we are subject to are described herein under “Item 1. Business.” The regulation and supervision of the activities in which bank and bank holding companies may engage is primarily intended for the protection of the depositors and the federal deposit insurance funds. These regulations affect our lending practices, capital structure, investment practices, dividend policy and overall operations. These statutes, regulations, regulatory policies, and interpretations of policies and regulations are constantly evolving and may change significantly over time. Any such changes could subject the Corporation to additional costs, limit the types of financial services and products the Bank may offer and/or increase
the ability of non-banks to offer competing financial services and products, among other things. Due to our nation’s current economic environment and a lower level of confidence in the financial markets, new federal and/or state laws and regulations of lending and funding practices and liquidity standards continue to be implemented. Bank regulatory agencies are being very aggressive in responding to concerns and trends identified in bank examinations with respect to bank capital requirements. Any increased government oversight, including the full implementation of the Dodd-Frank Act, may increase our costs and limit our business opportunities. Our failure to comply with laws, regulations or policies applicable to our business could result in sanctions against us by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurances that such violations will not occur.
The Dodd-Frank Act requires lenders to make a reasonable, good faith determination of a borrower’s ability to repay a mortgage. The CFPB has promulgated a safe harbor rule for any loan that constitutes a “qualified mortgage.” Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including: excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans); interest-only payments; negative-amortization; and terms longer than 30 years. Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time-consuming to make these loans, all of which could limit our growth or profitability.
A breach of our information systems through a system failure, cyber-security breach, computer virus or disruption or interruption of service or a compliance breach by one of our vendors could negatively affect our reputation, our business and our earnings.
Information technology systems are critical to our business. The financial services industry has experienced an increase in both the number and severity of reported cyber-attacks aimed at gaining unauthorized access to bank systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. We rely heavily upon a variety of computing platforms and networks over the Internet for the purpose of data processing, communication and information exchange and to conduct and manage various aspects of our business and provide our customers with the ability to bank online. We have business continuity and data security systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems and controls in place to monitor vendor risks. Despite the safeguards instituted by management, our systems may be vulnerable to a breach of security through unauthorized access, phishing schemes, computer viruses and other security problems, as well as failures and disruptions of services resulting from power outages and other circumstances.
The Corporation maintains policies and procedures to prevent or limit the impact of system failures, interruptions and security breaches (including privacy breaches), but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not fully protect our systems from compromises or breaches of security.
Our information technology environment/network, including disaster recovery and business continuity planning, are outsourced to a third party hosted environment. In addition, we rely on the service of a variety of third-party vendors to meet our data processing needs. If any of these third-party providers encounters a system failure, cyber-security breach or other difficulties, or if we have difficulty communicating with any of these third-party providers, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption or breach of security involving us or our vendors could result in the compromise of our confidential information and the confidential information of our customers, employees and others. In such event, we could be exposed to claims, litigation, financial losses, costs and damages. Such damages could materially affect our earnings. In addition, any failure, interruption or breach in security could also result in failures or disruptions in our general ledger, deposit, loan and other systems and could subject us to additional regulatory
scrutiny. In addition, the negative affect on our reputation could affect our ability to deliver products and services successfully to existing customers and to attract new customers. Any of the foregoing events and conditions could have a material adverse effect on our business, results of operations and financial condition.
The trading volume of our Common Stock remains low which could impact Common Stock prices.
The trading history of our Common Stock, which trades on the Nasdaq Capital Market, has been characterized by relatively low trading volume. The value of a shareholder’s investment may be subject to decreases due to the volatility of the price of our Common Stock.
Volatility in the market price of our Common Stock may occur in response to numerous factors, including, but not limited to, the factors discussed in the other risk factors and the following:
actual or anticipated fluctuation in our operating results;
press releases, publicity, or announcements concerning us, our competitors or the banking industry;
changes in expectation of our future financial performance;
future sales of our Common Stock; and
other developments affecting us or our competitors.
These factors may adversely affect the trading price of our Common Stock, regardless of our actual operating performance, and could prevent a shareholder from selling Common Stock at or above the current market price.
Because of our participation in the Treasury’s Small Business Lending Fund, the Corporation is subject to certain restrictions including limitations on the payment of dividends.
As discussed elsewhere in this Annual Report on Form 10-K, the Series B Preferred Shares issued in connection with our participation in the SBLF program pay a non-cumulative quarterly dividend in arrears. Although such dividends are non-cumulative, the Corporation may only declare and pay dividends on its Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Corporation’s Tier 1 capital on the date of entering into the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of the issuance and ending on the tenth anniversary, by 10% for each 1% increase in QSBL over the baseline level. This restriction on declaring or paying dividends could negatively affect the value of our Common Stock.
Moreover, our ability to pay dividends is always subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Corporation’s earnings, capital requirements, financial condition and other factors considered relevant by the Corporation’s Board of Directors. Although we have historically paid cash dividends on our Common Stock, we are not required to do so and our Board of Directors could reduce or eliminate our Common Stock dividend in the future.
If we are unable to redeem the Series B Preferred Shares issued to the Treasury in connection with our participation in the Treasury’s Small Business Lending Fund and Series B Preferred Shares remain outstanding beyond February 29, 2016, the cost of the capital received will increase.
The Series B Preferred Shares pay a non-cumulative quarterly dividend in arrears. The dividend rate for the Series B Preferred Shares fluctuated from 1% to 5% per annum on a quarterly basis during the first ten dividend periods during which the Series B Preferred Shares were outstanding. Subsequently, for the eleventh dividend period through that portion of the nineteenth dividend period prior to the four and one-half year anniversary of the date of issuance of the Series B Preferred Shares (i.e., through February 29, 2016), such dividend rate became fixed at 4.56% With respect to that portion of the nineteenth dividend period that begins on the four and one-half year anniversary of the date of the issuance of the Series B Preferred Shares (i.e., beginning on March 1, 2016) and all dividend periods thereafter, the dividend rate will be fixed at 9%. This increase in the annual dividend rate on the Series B Preferred Shares could have a material adverse effect on our liquidity, net income and capital resources.
The Series B Preferred Shares issued to the Treasury in connection with our participation in the Treasury’s Small Business Lending Fund reduces our net income available to common shareholders and earnings per share of Common Stock.
As discussed elsewhere in this Annual Report on Form 10-K, the Series B Preferred Shares pay non-cumulative dividends . Although such dividends are non-cumulative, the Corporation may only declare and pay dividends on our Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and will be subject to other restrictions on its ability to repurchase or redeem other securities. These dividends will reduce our net income and earnings per share of Common Stock. The Series B Preferred Shares ranks senior to the Common Stock and, as such, will receive preferential treatment in the event of liquidation, dissolution or winding up of the Corporation.
External factors, many of which we cannot control, may result in liquidity concerns for us.
Liquidity risk is the potential that the Corporation will be unable to: meet its obligations as they come due; capitalize on growth opportunities as they arise; or pay regular dividends, because of the Corporation’s inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances.
Liquidity is required to fund various obligations, including credit commitments to borrowers, loan originations, withdrawals by depositors, repayment of borrowings, operating expenses, capital expenditures and dividends to shareholders.
Liquidity is derived primarily from deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; borrowing capacity; net cash provided from operations and access to other funding sources.
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a prolonged economic downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Corporation conducts its business through its main office located at 630 Godwin Avenue, Midland Park, New Jersey and its current eleven branch offices. The property located at 612 Godwin Avenue is used for administrative offices, primarily for commercial lending functions. The following table sets forth certain information regarding the Corporation’s properties as of December 31, 2014.
_____________________
* The property located at 121 Franklin Avenue was a remote drive-up location. This location was closed as of January 31, 2015 and the lease has been terminated.
We believe that our properties are in good condition, well maintained and adequate for the present and anticipated needs of our business.
Item 3.
Item 3. Legal Proceedings
The Corporation and the Bank are parties to or otherwise involved in legal proceedings arising in the normal course of business from time to time, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to the Bank’s business. Management does not believe that there is any pending or threatened proceeding against the Corporation or the Bank which, if determined adversely, would have a material effect on the business or financial position of the Corporation or the Bank.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
Part II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Corporation’s Common Stock trades on the Nasdaq Capital Market under the symbol “SSFN”. As of March 20, 2015, there were approximately 1,000 shareholders of record of the Common Stock.
The following table sets forth the quarterly high and low sale prices of the Common Stock as reported on the Nasdaq Capital Market for the quarterly periods presented and cash dividends declared and paid in the quarterly periods presented. The prices below reflect inter-dealer prices, without retail markup, markdown or commissions, and may not represent actual transactions.
The Corporation may pay dividends as declared from time to time by the Corporation’s Board of Directors out of funds legally available therefor, subject to certain restrictions. Since dividends paid by the Bank to the Corporation are a major source of income for the Corporation, any restriction on the Bank’s ability to pay dividends to the Corporation will act as a restriction on the Corporation’s ability to pay dividends to its shareholders. Under the New Jersey Banking Act, the Bank may not pay a cash dividend unless, following the payment of such dividend, the capital stock of the Bank will be unimpaired and (i) the Bank will have a surplus of no less than 50% of its capital stock or (ii) the payment of such dividend will not reduce the surplus of the Bank. In addition, the Bank cannot pay dividends if doing so would reduce its capital below the regulatory imposed minimums.
Also, our ability to pay future cash dividends is subject to the terms of our Series B Preferred Shares issued in connection with the Corporation’s participation in the SBLF program which provides that we may only declare and pay dividends on our Common Stock if we have declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Tier 1 capital on the date the Corporation entered the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares.
During fiscal 2014, the Corporation paid quarterly cash dividends totaling $0.05 per share compared to quarterly cash dividends totaling $0.04 per share during fiscal 2013.
We did not repurchase any shares of our Common Stock during the years ended December 31, 2014 and 2013.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data of the Corporation is qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements, including notes, thereto, included elsewhere in this document.
STEWARDSHIP FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED
FINANCIAL SUMMARY OF SELECTED FINANCIAL DATA
(1)As a percentage of average quarterly assets.
(2)As a percentage of total risk-weighted assets.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section provides an analysis of the Corporation’s consolidated financial condition and results of operations for the years ended December 31, 2014 and 2013. The analysis should be read in conjunction with the related audited consolidated financial statements and the accompanying notes presented elsewhere herein.
As used in this annual report, “we”, “us” and “our” refer to Stewardship Financial Corporation and its consolidated subsidiary, Atlantic Stewardship Bank, depending on the context.
Introduction
The Corporation’s primary business is the ownership and supervision of the Bank and, through the Bank, the Corporation has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. As of December 31, 2014, the Corporation had 12 full service branch offices located in Bergen, Passaic and Morris Counties in New Jersey; the branch office located at 121 Franklin Avenue, Ridgewood, New Jersey was subsequently closed in January 2015. The Corporation conducts a general commercial and retail banking business encompassing a wide range of traditional deposit and lending functions along with other customary banking services. The Corporation earns income and generates cash primarily through the deposit gathering activities of the branch network. These deposits gathered from the general public are then utilized to fund the Corporation’s lending and investing activities.
The Corporation has developed a strong deposit base with good franchise value. A mix of a variety of different deposit products and electronic services, along with a strong focus on customer service, is used to attract customers and build depositor relationships. Challenges facing the Corporation include our ability to continue to grow the branch deposit levels, provide adequate technology enhancements to achieve efficiencies, offer a competitive product line, and provide the highest level of customer service.
The Corporation is affected by the overall economic conditions in northern New Jersey, the interest rate and yield curve environment, and the overall national economy. Each of these factors has an impact on our ability to attract specific deposit products, our ability to invest in loan and investment products, and our ability to earn acceptable profits without incurring increased risks.
When evaluating the financial condition and operating performance of the Corporation, management reviews historical trends, peer comparisons, 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 branch network coupled with our online services provides for solid coverage in both existing and new markets in key towns in the three counties in which we operate. The Corporation continually evaluates the need to further develop the infrastructure, including electronic products and services, to enable it to continue to build franchise value and expand its existing and future customer base.
During 2014 and 2013, the Corporation, like all financial institutions, continued to experience a difficult and complicated economic and operating environment. Although substantial improvement in asset quality was achieved in 2014, the Corporation’s results have been affected by the prolonged challenging economic environment. The managing of credit risk remains a priority for the Bank. In addition, competition in the northern New Jersey market remains intense and the challenges of operating throughout these years in a flat interest rate market has continued to make it somewhat difficult to attract deposits when interest rate levels are so low. Competition for low cost, core deposits remains strong. New lending opportunities continue to be appropriately evaluated, with the level of consumers and businesses looking to borrow improving in 2014. The Corporation has not engaged in subprime lending.
In an effort to address the strong competition in attracting deposit balances, the Corporation continues to evaluate product and services offerings. Improvements and upgrades of our electronic / online banking products and services continue to be a priority. Management believes that the Corporation offers the majority of the services that our competitors offer and what today’s customers require. Electronic products and services now available to our customers include: online banking / cash management, including remote deposit capture services for businesses, mobile deposit capabilities (depositing checks remotely by taking pictures of checks and transmitting them electronically) and applications for smartphones and iPads. These electronic banking products and services continue
to provide our customers with additional means to access their accounts conveniently. Our security for online banking customers includes a multi-factor authentication sign-on. In addition, the Corporation has the technology and procedures to enable instant debit card issuance for new customers and existing customers.
For several years the Corporation experienced an increase in mortgage loan refinance activity due to the lower rate environment and the Corporation’s promotion of a “no cost closing” program. This activity allowed the Corporation to sell a larger volume of mortgage loan refinances into the secondary market resulting in increased gains. With a rise in mortgage rates in mid-2013, mortgage refinance activity was negatively impacted and the Corporation has experienced a corresponding reduction in gains on sales of mortgage loans since mid-2013.
Expense control is an ongoing focus. The Corporation continues to balance the need to control expenses with its focus on quality loan growth and an awareness of the customers’ desire for convenient banking - all being addressed while continuing to be compliant with regulations and remaining up-to-date on all levels of security.
The Corporation will continue to concentrate its efforts on the origination of loans funded with appropriate deposit growth. In addition, monitoring asset quality, capitalizing on technology and improving efficiencies will remain a focus during 2015.
Small Business Lending Fund Program
The Corporation elected to participate in the U.S. Department of the Treasury (the “Treasury”) Small Business Lending Fund program (“SBLF”), a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage small business lending by providing capital to qualified community banks with assets of less than $10 billion. Accordingly, on September 1, 2011 (the “Series B Preferred Issue Date”), pursuant to a Securities Purchase Agreement between the Corporation and the Secretary of the Treasury (the “Securities Purchase Agreement”), the Treasury purchased 15,000 shares of the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B stock (the “Series B Preferred Shares”), having a liquidation preference of $1,000 per share for an aggregate purchase price of $15 million in cash.
The terms of the Series B Preferred Shares impose restrictions on the Corporation’s ability to declare or pay dividends or purchase, redeem or otherwise acquire for consideration, shares of our Common Stock and any class or series of stock of the Corporation the terms of which do not expressly provide that such class or series will rank senior or junior to the Series B Preferred Shares as to dividend rights and/or rights on liquidation, dissolution or winding up of the Corporation. Specifically, the terms provide for the payment of a non-cumulative quarterly dividend, payable in arrears, which the Corporation accrues as earned over the period that the Series B Preferred Shares are outstanding. The dividend rate was subject to fluctuation on a quarterly basis during the first ten quarters during which the Series B Preferred Shares were outstanding or until December 31, 2013, based upon changes in the level of Qualified Small Business Lending (“QSBL” as defined in the Securities Purchase Agreement) from 1% to 5% per annum and, since then, for the eleventh dividend period through that portion of the nineteenth dividend period prior to the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., through February 29, 2016), the dividend rate became fixed at 4.56%. In general, the dividend rate decreased as the level of the Bank’s QSBL increased. With respect to that portion of the nineteenth dividend period beginning on the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., beginning on March 1, 2016) and all dividend periods thereafter, the dividend rate will be 9%. Such dividends are not cumulative but the Corporation may only declare and pay dividends on its Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Tier 1 capital on the date of entering into the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of the issuance and ending on the tenth anniversary of the issuance, by 10% for each 1% increase in QSBL over the baseline level.
In addition, the Series B Preferred Shares are non-voting except in limited circumstances and, in the event that the Corporation has not timely declared and paid dividends on the Series B Preferred Shares for six dividend periods or more, whether or not consecutive, and shares of Series B Preferred Shares with an aggregate liquidation preference of at least $25 million are still outstanding, the Treasury may designate two additional directors to be elected to the Corporation’s Board of Directors. Subject to the approval of the Bank’s federal banking regulator, the FRB, the Corporation may redeem the Series B Preferred Shares at any time at the Corporation’s option, at a redemption price equal to the liquidation preference per share plus the per share amount of any unpaid dividends for the then-current period through the date of the redemption. The Series B Preferred Shares are currently includable, and are expected to be includable in the future, in Tier I capital for regulatory capital.
The proceeds from the issuance of the Series B Preferred Shares were used to repurchase shares of the Corporation’s Series A Preferred Shares previously issued in connection with the Corporation’s participation in the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) for an aggregate purchase price of $10,022,222, in cash, including accrued but unpaid dividends through the date of repurchase. Subsequently, on October 15, 2011, the Corporation completed the repurchase of the warrant held by the Treasury in connection with the TARP participation for an aggregate purchase price of $107,398 in cash.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements and their effect on the Corporation’s Audited Consolidated Financial Statements can be found in Note 1 of the Corporation’s Audited Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures found elsewhere in this Annual Report on Form 10-K, are based upon the Corporation’s audited consolidated financial statements, which have been prepared in conformity of U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Corporation’s Audited Consolidated Financial Statements for the year ended December 31, 2014 contains a summary of the Corporation’s significant accounting policies. Management believes the Corporation’s policies with respect to the methodology for the determination of the allowance for loan losses and the evaluation of deferred income taxes 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. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors.
Allowance for Loan Losses. The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the loan portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey. Accordingly, the collectability of a substantial portion of the carrying value of the Corporation’s loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the northern New Jersey area experience adverse economic changes. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.
Deferred Income Taxes. The Corporation records income taxes in accordance with ASC 740, “Income Taxes,” as amended, using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant.
Earnings Summary
The Corporation reported net income of $3.1 million for the year ended December 31, 2014, compared to $2.5 million for 2013. After dividends on preferred stock and accretion, net income available to common shareholders was $2.4
million for 2014, or $0.40 per diluted common share, compared to $1.8 million, or $0.31 per diluted common share for the year ended December 31, 2013.
The return on average assets was 0.46% in 2014 compared to 0.36% in 2013. The return on average common equity was 5.77% for 2014 as compared to 4.54% in 2013.
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 and investment securities.
For the year ended December 31, 2014, net interest income, on a tax equivalent basis, decreased to $22.1 million from $23.3 million for the year ended December 31, 2013, reflecting a decrease of $1.2 million, or 5.2%. The net interest rate spread and net yield on interest-earning assets for the year ended December 31, 2014 were 3.28% and 3.46%, respectively, compared to 3.34% and 3.54% for the year ended December 31, 2013. The net interest rate spread and net yield on interest-earning assets for the current year reflect a decline in loan interest rates as well as a decline in the interest rates on deposits. The Corporation continues in its efforts to proactively manage deposit costs in an effort to mitigate the lower asset yields earned. The reduced yields on assets reflect historically low market rates in the current environment.
For the year ended December 31, 2014, total interest income, on a tax equivalent basis, decreased $1.8 million, or 6.7%, when compared to the prior year. The decrease was due to both a decrease in the average balance of interest-earning assets and a decrease in yields on interest-earning assets. The average rate earned on interest-earning assets decreased 16 basis points from 4.12% for the year ended December 31, 2013 to 3.96% in the 2014 fiscal year. The decline in the asset yield reflects the effect of a prolonged low interest rate environment. Average interest-earning assets decreased $19.4 million in 2014 over the 2013 amount with average loans decreasing $5.3 million and average investment securities decreasing $12.6 million.
Interest expense decreased $606,000, or 15.9%, during the year ended December 31, 2014 to $3.2 million. The decline is due to general decreases in rates paid on deposits and borrowings coupled with decreases in average interest-bearing liabilities. The cost of interest-bearing liabilities decreased to 0.68% for the year ended December 31, 2014 compared to 0.78% during 2013, primarily reflecting a general decline in rates paid on deposits. Average interest-bearing liabilities were $472.4 million for the year ended December 31, 2014, reflecting a decrease of $18.7 million, or 3.8%, when compared to $491.1 million for the year ended December 31, 2013. Average interest-bearing deposits decreased $22.2 million and average borrowings increased $3.5 million for the year ended December 31, 2014 when compared to the prior year. The net decrease in average interest-bearing liabilities reflects a decline in time deposits and an increased use of borrowings. The Corporation continues to supplement its branch deposit network with a mix of wholesale repurchase agreements and Federal Home Loan Bank borrowings. The Federal Home Loan Bank borrowings in particular provide an alternative funding source that helps provide for better management of interest rate risk. At December 31, 2014 brokered deposits totaled $10.5 million. There were no brokered certificates of deposit utilized during 2013.
The following table reflects the components of the Corporation’s net interest income for the years ended December 31, 2014, 2013 and 2012 including: (1) average assets, liabilities and shareholders’ equity based on average daily balances, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, and (4) net yield on interest-earning assets. Nontaxable income from investment securities and loans is presented on a tax-equivalent basis assuming a statutory tax rate of 34% for the years presented. This was accomplished by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes.
(1)For purpose of these calculations, nonaccruing loans are included in the average balance. Fees are included in loan interest.
(2)The tax equivalent adjustments are based on a marginal tax rate of 34%. Loans and total interest-earning assets are net of unearned income. Securities are included at amortized cost.
(3)Net interest income (taxable equivalent basis) divided by average interest-earning assets.
The following table compares net interest income for the year ended December 31, 2014 and 2013 over the respective prior years in terms of changes from the prior year 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.
Provision for Loan Losses
The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable incurred losses associated with its loan portfolio. On an ongoing basis, management analyzes the adequacy of this allowance by considering the nature and volume of the Corporation’s loan activity, financial condition of the borrower, fair value of underlying collateral, and changes in general market conditions. Additions to the allowance for loan losses are charged to operations in the appropriate period. Actual loan losses, net of recoveries, reduce the allowance. The appropriate level of the allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates.
For the year ended December 31, 2014, the Corporation recorded a $50,000 negative loan loss provision compared to a $3.8 million loan loss provision recorded for the year ended December 31, 2013. The negative provision reflects the improved credit quality of the portfolio and the significant reduction in nonperforming loans and chargeoffs in 2014. The allowance for loan loss was $9.6 million, or 2.01% of total loans as of December 31, 2014 compared to $9.9 million, or 2.28% of total loans a year earlier.
The loan loss provision takes into account any growth or contraction in the loan portfolio and any changes in nonperforming loans as well as the impact of charge-offs. In determining the level of the allowance for loan loss, the Corporation also considered the types of loans as well as the overall seasoning of new loans to determine the risk that was inherent in the portfolio.
Nonperforming loans decreased from $10.2 million, or 2.34% of total loans, at December 31, 2013 to $3.6 million, or 0.76% of total loans, at December 31, 2014. During the year ended December 31, 2014, the Corporation charged-off $1.4 million of loan balances and recovered $1.1 million in previously charged-off loans compared to $5.0 million and $520,000, respectively, in the prior year. The allowance for loan losses related to the impaired loans increased from $372,000 at December 31, 2013 to $920,000 at December 31, 2014.
In addition to these factors, the Corporation evaluated the economic conditions and overall real estate climate in the primary business markets in which it operates when considering the overall risk of the lending portfolio. While 2013 reflected improvement, the asset quality issues caused by the national economic downturn that began in 2008, and the reduced level of current year charge-offs and provision for loan losses are reflective of economic conditions that contributed to an increase in loan delinquencies and the softness in the real estate market. The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio and general market conditions.
See “Asset Quality” section below for further information concerning the allowance for loan losses and nonperforming assets.
Noninterest Income
Noninterest income consists of all income other than interest income and is principally derived from service charges on deposits, income derived from bank-owned life insurance, gains from calls and sales of securities, gains and losses on sales of loans and income derived from debit cards and ATM usage. In addition, gains on sales of other real estate owned (“OREO”) are reflected as noninterest income.
Noninterest income was $3.0 million for the year ended December 31, 2014 as compared to $4.0 million for the prior year. Noninterest income for the year ended December 31, 2014 included $165,000 of gains on calls and sales of securities as compared to $153,000 for the year ended December 31, 2013. The year ended December 31, 2014 includes a $241,000 loss from the sale of nonperforming loans as well as reduced gains on sales of mortgage loans. Gains on sales of mortgage loans totaled $72,000 for 2014, a decrease from $649,000 for the year ended December 31, 2013 reflective of a rise in mortgage rates which reduced application volume. For the year ended December 31, 2014, gains on sales of OREO were $63,000 compared to $326,000 for prior year OREO activity. Noninterest income of $537,000 was recorded in 2013 as a result of a death benefit insurance payment received in 2013.
Noninterest Expense
Noninterest expense for the years ended December 31, 2014 and 2013 were $20.2 million and $19.8 million, respectively. An increase in data processing expense is reflective of costs associated with the outsourcing and migration of the Corporation’s information technology environment/network, including disaster recovery/business continuity planning, to a third party hosted environment. An increase in advertising expense includes costs associated with television and radio marketing.
Income Taxes
Income tax expense totaled $1.4 million and $640,000 for the years ended December 31, 2014 and 2013, respectively, representing effective tax rates of 31.5% and 20.6%. The tax expense for 2013 reflects a decrease in our overall projected effective tax rate as a result of our tax exempt income, including the gain on life insurance proceeds, which represented a larger percentage of pretax income.
Financial Condition
Total assets at December 31, 2014 were $693.6 million, an increase of $20.0 million, or 3.0%, over the $673.5 million at December 31, 2013. Cash and cash equivalents decreased $7.3 million to $10.1 million at December 31, 2014 from $17.4 million at December 31, 2013. During 2014, the Corporation reclassified $24.0 million of securities available-for-sale to securities held to maturity as the Corporation has the intent and ability to hold these securities until maturity. The securities were transferred to the held to maturity portfolio to protect the Corporation’s tangible common equity against rising interest rates and to appropriately align the mix of securities within held to maturity and available-for-sale. After the reclassification, the balance in securities available-for-sale reflected a $19.5 million decrease while securities held to maturity increased $29.1 million since December 31, 2013. Net loans increased $43.4 million from $424.3 million at December 31, 2013 to $467.7 million at December 31, 2014. Increases due to new loans originated
and purchased were partially offset by regular principal payments and payoffs in 2014. In addition, $2.4 million of loans were transferred to OREO. There were no loans held for sale at December 31, 2014. At December 31, 2013 loans held for sale totaled $2.8 million and represented the fair value of a small group of nonperforming loans that, at December 31, 2013, the Corporation had categorized as held for sale at the lower of cost or fair value of the underlying collateral, less cost to sell. This loan group was sold during the first quarter of 2014 and resulted in a net loss to the Corporation of $241,000, reflecting further declines in fair value. OREO reflected a net increase of $857,000 reflecting the foreclosure on additional properties partially offset by sales of properties.
Loan Portfolio
The Corporation’s loan portfolio at December 31, 2014, net of allowance for loan losses, totaled $467.7 million, an increase of $43.4 million, or a 10.2% increase over the $424.3 million at December 31, 2013. Residential real estate mortgages increased $296,000. Although the Corporation continued its policy of selling the majority of its residential real estate loans in the secondary market, certain residential real estate loans were placed into the portfolio to partially compensate for payoffs and normal amortization. Of the loans sold, all have been sold with servicing of the loan transferring to the purchaser. Commercial real estate mortgage loans consisting of $295.3 million, or 61.9% of the total portfolio, represent the largest portion of the loan portfolio. These loans reflected an increase of $38.8 million from $256.5 million, or 59.1% of the total loan portfolio at December 31, 2013. Commercial loans increased $2.0 million to $75.9 million, representing 15.9% of the total loan portfolio. Consumer installment loans and home equity loans increased $2.3 million, partially attributable to borrowers protecting a low interest rate on their first lien and taking advantage of low interest rates by using the equity in the home to borrow against.
The Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey. The Corporation has not made loans to borrowers outside the United States.
At December 31, 2014, aside from the real estate concentration described above, 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 each of the last five years:
(1) Includes construction loans
(2) Includes automobile, home improvement, second mortgages, and unsecured loans.
The following table sets forth certain categories of gross loans as of December 31, 2014 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.
The following table sets forth the dollar amount of all gross loans due one year or more after December 31, 2014, which have predetermined interest rates or floating or adjustable interest rates:
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. The Corporation manages this risk by maintaining reserves to absorb probable incurred loan losses. In determining the adequacy of the allowance for loan losses, management considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with general economic and real estate market conditions. Although management endeavors to establish a reserve sufficient to offset probable incurred losses in the portfolio, changes in economic conditions, regulatory policies and borrower’s performance could require future changes to the allowance.
In establishing the allowance for loan losses, the Corporation utilizes a two-tiered approach by (1) identifying problem loans and allocating specific loss allowances to such loans and (2) establishing a general loan loss allowance on the remainder of its loan portfolio. The Corporation maintains a loan review system that allows for a periodic review of its loan portfolio and the early identification of potential problem loans. Such a system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers.
Allocations of specific loan loss allowances are established for identified loans based on a review of various information including appraisals of underlying collateral. Appraisals are performed by independent licensed appraisers to determine the value of impaired, collateral-dependent loans. Appraisals are periodically updated to ascertain any further decline in value. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loss experience, composition of the loan portfolio, current economic conditions and management’s judgment.
During the fourth quarter of 2014, management made certain changes and enhancements to its process over measuring the general portion of the allowance for loan losses. In connection with its periodic risk assessment and monitoring process, the Corporation re-evaluated a number of assumptions supporting the methodology, including the look-back period used to evaluate the historical loss factors for its portfolios, as well as performing a study of its loss emergence period ("LEP") data. As a result of this review, management updated a number of assumptions, including lengthening the look back period for all loan portfolios as well as the LEP for certain portfolios. Given these changes to the quantitative methodology, management reassessed its qualitative and environmental factors to align with the revised model assumptions. These changes had no material impact on the overall allowance.
The Corporation’s accounting policies are set forth in Note 1 to the Corporation’s Audited Consolidated Financial Statements. The application of some of these policies requires 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 Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey. Future adjustments to the allowance may be necessary due to economic, operating, regulatory, and other conditions beyond the Corporation’s control. In management’s opinion, the allowance for loan losses totaling $9.6 million is adequate to cover probable incurred losses inherent in the portfolio at December 31, 2014.
Nonperforming Assets
Risk elements include nonaccrual loans, past due and restructured loans, potential problem loans, loan concentrations and other real estate owned (i.e., property acquired through foreclosure or deed in lieu of foreclosure). The Corporation’s loans are generally placed on a nonaccrual status when they become past due in excess of 90 days as to payment of principal and interest or earlier if collection of principal or interest is considered doubtful. Interest previously accrued on these loans and not yet paid is charged against income during the current period. Interest earned thereafter may only be 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 in the process of collection, adequately 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 make concessions to the terms of the loan or reduce the contractual interest rates to below market rates in order for the borrower to continue to make payments.
The following table sets forth certain information regarding the Corporation’s nonperforming assets as of December 31 of each of the preceding five years:
(1)Restructured loans classified in the nonaccrual category totaled $824,000, $1.4 million, $1.3 million, $9.1 million, and $4.0 million for the years ended December 31, 2014, 2013, 2012, 2011 and 2010, respectively.
(2)There were no restructured loans classified in the past due 90 days or more and accruing for any years presented.
(3)Gross loans includes $2.8 million of loans held for sale at December 31, 2013.
A loan is generally placed on nonaccrual when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The identification of nonaccrual loans reflects careful monitoring of the loan portfolio. The Corporation is focused on resolving nonperforming loans and mitigating future losses in the portfolio. All delinquent loans continue to be reviewed by management.
At December 31, 2014, the nonaccrual loans were comprised of 25 loans, primarily commercial real estate loans and commercial loans. While the Corporation maintains strong underwriting requirements, the number and amount of nonaccrual loans is a reflection of the prolonged weakened economic conditions and the corresponding effects it has had on our commercial borrowers and the current real estate environment. Certain loans, including restructured loans, are current, but in accordance with applicable guidance and other weakness concerns, management has continued to keep these loans on nonaccrual status.
As of December 31, 2014, nonaccrual loans have decreased over 64% since December 31, 2013 to $3.6 million. The decrease reflects sales, payments received, payoffs, charge-offs and loans returned to an accrual status, partially offset by a small number of new nonaccrual loans. The ratio of allowance for loan losses to nonperforming loans increased to 264.66% at December 31, 2014 from 97.03% at December 31, 2013. The ratio of allowance for loan losses to nonperforming loans is reflective of a detailed analysis and the probable losses to be incurred that the Corporation has identified with these nonperforming loans. The increase in this metric reflects the effect of the decrease in nonaccrual loans partially offset by a decrease in the allowance for loan losses.
Evaluation of all nonperforming loans includes the updating of appraisals and specific evaluation of such loans to determine estimated cash flows from business and/or collateral. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable losses to be incurred. The majority of our nonperforming loans are secured by real estate collateral. While we have continued to record appropriate charge-offs, the existing underlying collateral coverage for a considerable portion of the nonperforming loans currently supports the collection of our remaining principal.
For loans not included in nonperforming loans, at December 31, 2014, the level of loans past due 30-89 days was $1.1 million, a decrease of $800,000 from $1.9 million at December 31, 2013. We will continue to monitor delinquencies for early identification of new problem loans.
The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable losses to be incurred associated with its loan portfolio. The Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity and requires management to make difficult and subjective judgments.
The adequacy of the allowance for loan losses is based upon management’s evaluation of the known and inherent risks in the portfolio, consideration of the size and composition of the loan portfolio, actual loan loss experience, the level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions.
The allowance for loan losses contains an unallocated reserve amount to cover inherent losses which may not otherwise have been measured. Due to the complexity in determining the estimated amount of allowance for loan losses, these unallocated reserves reflect management's attempt to ensure that the overall allowance reflects an appropriate level of reserves. During the year ended December 31, 2014, the Corporation increased its unallocated allowance for loan losses by $398,000. The increase is partially attributed to the increase in the overall loan portfolio. Management believes that the unallocated reserves at December 31, 2014 are appropriate and are expected to be impacted as the Corporation demonstrates a sustained level of performance in the loan portfolio.
For the year ended December 31, 2014, a negative provision for loan loss was recorded in the amount of $50,000. For the year ended December 31, 2013, the provision for loan losses was $3.8 million. The recording of a negative provision for the current year is reflective of both the recording of recoveries of past chargeoffs and a reduction in the level of nonaccrual loans. The total allowance for loan losses of $9.6 million represented 2.01% of total loans at December 31, 2014 compared to $9.9 million or a ratio of 2.28% at December 31, 2013.
At December 31, 2014 and 2013, the Corporation had $12.9 million and $16.6 million, respectively, of loans whose terms have been modified in troubled debt restructurings. Of these loans, $12.0 million and $15.2 million were performing in accordance with their new terms at December 31, 2014 and 2013, respectively, and not included in the table above. The remaining troubled debt restructures are reported as nonaccrual loans. Specific reserves of $868,000 and $281,000 have been allocated for the troubled debt restructurings at December 31, 2014 and 2013, respectively. As of December 31, 2013, the Corporation had committed $257,000 of additional funds to a single customer with an outstanding construction loan that is classified as a troubled debt restructuring. There were no committed funds at December 31, 2014.
The balance in performing restructured loans also includes loans that are current under their restructured terms, but because of the below market rate of interest and other forbearance agreements, continue to be reflected as restructured loans and impaired loans in accordance with accounting practices. These loans included two loan relationships at December 31, 2014 totaling $5.3 million and three loan relationships at December 31, 2013 totaling $7.5 million.
For the year ended December 31, 2014, gross interest income which would have been recorded had the restructured and non-accruing loans been current in accordance with their original terms amounted to $1.1 million, of which $747,000 was included in interest income for the year ended December 31, 2014.
When management expects that some portion or all of a loan balance will not be collected, that amount is charged-off as a loss against the allowance for loan losses. For the year ended December 31, 2014, net charge-offs were $263,000 compared to $4.5 million for the year ended December 31, 2013. These net charge-offs reflect partial writedowns or full charge-offs on nonaccrual loans due to the initial and ongoing evaluations of market values of the underlying real estate collateral in accordance with Accounting Standards Codification (“ASC”) 310-40. While regular monthly payments continue to be made on many of the nonaccrual loans, certain charge-offs result, nevertheless, from the borrowers’ inability to provide adequate documentation evidencing their ability to continue to service their debt. Management believes the charge-off of these reserves provides a clearer indication of the value of nonaccrual loans. Regardless of our actions of recording partial and full charge-offs on loans, we continue to aggressively pursue collection, including legal action.
As of December 31, 2014, there were $11.3 million of other loans not included in the preceding table, compared to $10.5 million at December 31, 2013, where credit conditions of borrowers, including real estate tax delinquencies, caused management to have concerns about the possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in disclosure of such loans as nonperforming loans at a future date. These loans have been considered by management in conjunction with the analysis of the adequacy of the allowance for loan losses.
The following table sets forth, for each of the preceding five years, the historical relationships among the amount of loans outstanding, the allowance for loan losses, the provision for loan losses, the amount of loans charged-off and the amount of loan recoveries:
The following table sets forth the allocation of the allowance for loan losses, for each of the preceding five years, as indicated by loan categories:
(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 currently comprised of U.S. government and agency obligations, state and political subdivision obligations, mortgage-backed securities, asset-backed securities, corporate debt securities and other equity investments, and has been classified as held to maturity or available-for-sale. Investments in debt securities that the
Corporation has the intention 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 gains or losses reported in a separate component of shareholders’ 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 decreased to $124.9 million at December 31, 2014, from $168.4 million at December 31, 2013, a decrease of $43.5 million, or 25.8%. Securities held to maturity increased $29.1 million, or 112.2%, to $55.1 million at December 31, 2014 from $26.0 million at December 31, 2013.
The changes in available-for-sale and held to maturity securities for the year ending December 31, 2014 is primarily attributed to a $24.0 million transfer of previously-designated available-for-sale securities to a held to maturity designation at fair value. In accordance with Accounting Standards Codification 320, Investment - Debt and Equity Securities, the Corporation is required at each balance sheet due date to reassess the classification of each security held. The reclassification which occurred during the three months ended June 30, 2014 is permitted as the Corporation has appropriately determined the ability and intent to now hold these securities as an investment, until maturity or call. The securities were transferred at fair value to the held to maturity portfolio to protect our tangible common equity against rising interest rates and to appropriately align the mix of securities within held to maturity and available-for-sale. The securities transferred had a net loss of $742,000 that is reflected in accumulated other comprehensive loss on the consolidated statement of financial condition, net of subsequent amortization, which is being recognized over the life of the securities.
The change in securities available-for-sale for the year ending December 31, 2013 includes the sale of $12.0 million of obligations of state and political subdivisions transacted to lower the impact of tax-free income on the portfolio and help fund the purchase of loan participations. Partially offsetting the sale, purchases of available-for-sale securities reflects the Corporation’s focus on liquidity in the current economic environment.
The following table sets forth the classification of the Corporation’s investment securities by major category at the end of the last three years:
(a)Collateralized by student loans
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 debt securities available-for-sale as of December 31, 2014. 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.
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 debt securities held to maturity as of December 31, 2014. 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.
Deposits
The Corporation had deposits at December 31, 2014 totaling $556.5 million, a decrease of $21.1 million, or 3.7%, over the comparable period of 2013, when deposits totaled $577.6 million. The Corporation relied on its branch network and current competitive products and services to maintain deposits during 2014. In addition, there were $10.5 million of brokered certificates of deposit at December 31, 2014. There were no brokered certificates of deposit at December 31, 2013.
The following table sets forth the classification of the Corporation’s deposits by major category as of December 31 of each of the three preceding years:
As of December 31, 2014, 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):
Borrowings
Although deposits with the Bank are the Corporation’s primary source of funds, the Corporation’s policy has been to utilize borrowings to the extent that they are a less costly source of funds, when the Corporation desires additional capacity to fund loan demand, or to extend the life of its liabilities as a means of managing exposure to interest rate risk. The Corporation’s borrowings are a combination of advances from the Federal Home Loan Bank of New York (“FHLB-NY”), including overnight repricing lines of credit, and, to a lesser extent, securities sold under agreements to repurchase.
Interest Rate Sensitivity
Interest rate movements 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 interest-earning assets and interest-bearing 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 or mismatch between the amount of assets and liabilities that mature or reprice in a given period is defined as the interest rate sensitivity gap. A “negative” gap results when the amount of interest-bearing liabilities maturing or repricing within a specified time period exceeds the amount of interest-earning assets maturing or repricing within the same period of time. Conversely, a “positive” gap results when the amount of interest-earning assets maturing or repricing exceed the amount of interest-bearing liabilities maturing or repricing in the same given time frame. 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 table sets forth estimated maturity/repricing structure of the Corporation’s interest-earning assets and interest-bearing liabilities as of December 31, 2014. 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.
(1) Includes securities held to maturity, securities available-for sale and FHLB-NY Stock.
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. Assumptions have been built into the model for prepayments for assets and decay rates for nonmaturity deposits such as savings and interest bearing demand. The model assumes an immediate rate shock to interest rates without management’s ability to proactively change the mix of assets or liabilities. Based on the reports generated for December 31, 2014, an immediate interest rate increase of 200 basis points would have resulted in a decrease in net interest income of 3.5%, or $809,000, and an immediate interest rate decrease of 200 basis points would have resulted in a decrease in net interest income of 6.1% or $1.4 million. Management cannot provide any assurance about the actual effect of changes in interest rates on the Corporation’s net interest income.
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 loans and mortgage-backed securities are greatly influenced by market interest rates, economic conditions, and competition.
The Corporation’s liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities. These activities are summarized below:
Cash was generated by operating activities in each of the above periods. The primary source of cash from operating activities during each period was operating 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 Corporation’s Audited Consolidated Financial Statements.
The Corporation has various contractual obligations that may require future cash payments. The following table summarizes the Corporation’s contractual obligations at December 31, 2014 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
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. We anticipate that the Corporation will have sufficient funds available to meet its current contractual commitments. Should we need temporary funding, the Corporation has the ability to borrow overnight with the FHLB-NY. The overall borrowing capacity is contingent on available collateral to secure borrowings and the ability to purchase additional activity-based capital stock of the FHLB-NY. The Corporation may also borrow from the Discount Window of the Federal Reserve Bank of New York based on the market value of collateral pledged. At December 31, 2014 and 2013, the borrowing capacity at the Discount Window was $5.0 million and $5.7 million, respectively. In addition, the Corporation had
available overnight variable repricing lines of credit with other correspondent banks totaling $35 million on an unsecured basis. There were no borrowings under these lines of credit at December 31, 2014 and 2013.
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.
Of the $1.1 million commitments under standby and commercial letters of credit, approximately $1.1 million expire 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.
At December 31, 2014, the Corporation had residential mortgage commitments to extend credit aggregating approximately $2.7 million at fixed rates averaging 3.78% and none at variable rates. Approximately $205,000 of these loan commitments will be sold to investors upon closing. Commercial, construction, and home equity loan commitments of approximately $15.8 million were extended with variable rates averaging 4.46% and approximately $1.9 million extended at fixed rates averaging 3.16%. Generally, commitments were due to expire within approximately 60 days.
The unused lines of credit consist of $16.7 million relating to a home equity line of credit program and an unsecured line of credit program (cash reserve), $4.4 million relating to an unsecured overdraft protection program, and $37.5 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.
Capital
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Regulations of the Board of Governors of the FRB require bank holding companies to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 2014, 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.
The following table summarizes the capital ratios for the Corporation and the Bank at December 31, 2014.
* The minimum leverage ratio set by the FRB and the FDIC 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.
On September 1, 2011 (the “Series B Preferred Issue Date”), as part of the Treasury’s Small Business Lending Fund (“SBLF”) program, pursuant to a Securities Purchase Agreement between the Corporation and the Secretary of the Treasury, in exchange for issuing to the Treasury 15,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Shares”), having a liquidation preference of $1,000 per share, the Corporation received $15.0 million. The SBLF is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage small business lending by providing capital to qualified community banks with assets of less than $10 billion.
The terms of the Series B Preferred Shares impose restrictions on the Corporation’s ability to declare or pay dividends or purchase, redeem or otherwise acquire for consideration, shares of our Common Stock and any class or series of stock of the Corporation the terms of which do not expressly provide that such class or series will rank senior or junior to the Series B Preferred Shares as to dividend rights and/or rights on liquidation, dissolution or winding up of the Corporation. Specifically, the terms provide for the payment of a non-cumulative quarterly dividend, payable in arrears, which the Corporation accrues as earned over the period that the Series B Preferred Shares are outstanding. The dividend rate was subject to fluctuation on a quarterly basis during the first ten quarters during which the Series B Preferred Shares were outstanding or until December 31, 2013, based upon changes in the level of Qualified Small Business Lending (“QSBL” as defined in the Securities Purchase Agreement)from 1% to 5% per annum and since then, for the eleventh dividend period through that portion of the nineteenth dividend period prior to the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., through February 29, 2016), the dividend rate became fixed at 4.56%. In general, the dividend rate decreased as the level of the Bank’s QSBL increased. With respect to that portion of the nineteenth dividend period that begins on the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., beginning on March 1, 2016) and all dividend periods thereafter, the dividend rate will be increased and fixed at 9%. Such dividends are not cumulative but the Corporation may only declare and pay dividends on its Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Tier 1 capital on the date of entering into the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of the issuance and ending on the tenth anniversary of the issuance, by 10% for each 1% increase in QSBL over the baseline level.
In addition, the Series B Preferred Shares are non-voting except in limited circumstances and, in the event that the Corporation has not timely declared and paid dividends on the Series B Preferred Shares for six dividend periods or more, whether or not consecutive, and shares of Series B Preferred Shares with an aggregate liquidation preference of at least $25 million are still outstanding, the Treasury may designate two additional directors to be elected to the
Corporation’s Board of Directors. Subject to the approval of the Bank’s federal banking regulator, the FRB, the Corporation may redeem the Series B Preferred Shares at any time at the Corporation’s option, at a redemption price equal to the liquidation preference per share plus the per share amount of any unpaid dividends for the then-current period through the date of the redemption. The Series B Preferred Shares are currently includable, and are expected to be includable in the future, in Tier 1 capital for regulatory capital.
The proceeds from the issuance of the Series B Preferred Shares were used to repurchase shares of the Corporation’s Series A Preferred Shares previously issued in connection with the Corporation’s participation in the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) for an aggregate purchase price of $10,022,222, in cash, including accrued but unpaid dividends through the date of repurchase. Subsequently, on October 15, 2011, the Corporation completed the repurchase of the warrant held by the Treasury in connection with the TARP participation for an aggregate purchase price of $107,398 in cash.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable to smaller reporting companies.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Stewardship Financial Corporation and Subsidiary:
We have audited the accompanying consolidated statements of financial condition of Stewardship Financial Corporation and Subsidiary (the Corporation) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income (loss), changes in shareholders’ equity, and cash flows for the years then ended. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2014 and 2013, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Short Hills, New Jersey
March 27, 2015
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Financial Condition
See accompanying notes to consolidated financial statements.
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Income
See accompanying notes to consolidated financial statements.
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Comprehensive Income (Loss)
See accompanying notes to consolidated financial statements.
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
See accompanying notes to consolidated financial statements.
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows
Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows, continued
See accompanying notes to consolidated financial statements.
Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
Note 1. SIGNIFICANT ACCOUNTING POLICIES
Nature of operations and principles of consolidation
The consolidated financial statements include the accounts of Stewardship Financial Corporation and its wholly owned subsidiary, Atlantic Stewardship Bank (“the Bank”), together referred to as “the Corporation”. The Bank includes its wholly-owned subsidiaries, Stewardship Investment Corporation (whose primary business is to own and manage an investment portfolio), Stewardship Realty LLC (whose primary business is to own and manage property at 612 Godwin Avenue, Midland Park, New Jersey), Atlantic Stewardship Insurance Company, LLC (whose primary business is insurance) and several other subsidiaries formed to hold title to properties acquired through foreclosure or deed in lieu of foreclosure. The Bank’s subsidiaries have an insignificant impact on the daily operations. All intercompany accounts and transactions are eliminated in the consolidated financial statements.
The Corporation provides financial services through the Bank’s offices in Bergen, Passaic, and Morris Counties, New Jersey. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial, residential mortgage and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow generated from the operations of businesses. There are no significant concentrations of loans to any one industry or customer. The Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey and, therefore, collectability 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.
Basis of consolidated financial statements presentation
The consolidated financial statements of the Corporation have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”). In preparing the financial statements, management is required to make estimates and assumptions, based on available information, that affect the amounts reported in the financial statements and the disclosures provided. The estimate of the allowance for loan losses, the valuation of deferred tax assets, and fair value and impairment of securities are particularly critical because they involve a higher degree of complexity and subjectivity and require estimates and assumptions about highly uncertain matters. Actual results may differ from those estimates and assumptions. The current economic environment has increased the degree of uncertainty inherent in these material estimates.
Cash flows
Cash and cash equivalents include cash and deposits with other financial institutions under 90 days and interest-bearing deposits in other banks with original maturities under 90 days. Net cash flows are reported for customer loan and deposit transactions, and short term borrowings and securities sold under agreement to repurchase.
Securities available-for-sale and held to maturity
The Corporation classifies its securities as held to maturity or 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 amortized cost. 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 shareholders’ equity, net of the related tax effects.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Federal Home Loan Bank (“FHLB”) Stock
The Bank is a member of the FHLB system. Members are required to own a certain amount of FHLB stock based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on the ultimate recovery of par value. Cash dividends are reported as income.
Loans held for sale
Loans held for sale generally represent mortgage loans originated and intended for sale in the secondary market, which are carried at the lower of cost or fair value 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. All loans are sold with loan servicing rights released to the buyer. There were no loans held for sale at December 31, 2014.
Loans held for sale at December 31, 2013 represent a group of nonperforming loans to a single borrower that were being marketed for sale. The estimated fair value was based on the fair value of the notes.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal amount outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. The recorded investment in loans represents the outstanding principal balance after charge-offs and does not include accrued interest receivable as the inclusion is not significant to the reported amounts.
Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or are charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to an accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for loan losses
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the collectability of the full loan balance is in doubt. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for
specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.
A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans for which the terms have been modified and for which the borrower is experiencing financial difficulties are considered troubled debt restructuring and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the note, or the fair value of the collateral if the loan is collateral-dependent. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment and, accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component of the allowance is based on historical loss experience, including an appropriate loss emergence period, adjusted for qualitative factors. The historical loss experience is determined for each portfolio segment and class, and is based on the actual loss history experienced by the Corporation over the most recent 5 years. For each portfolio segment the Bank prepares an analysis which examines the historical loss experience as well as the loss emergence period. The analysis is updated quarterly for the purpose of determining the assigned allocation factors which are essential components of the allowance for loan losses calculation. This actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment or class. These qualitative factors include consideration of the following: levels of and trends in charge-offs; levels of and trends in delinquencies and impaired loans; levels and trends in loan size; levels of real estate concentrations; national and local economic trends and conditions; the depth and experience of lending management and staff; and other changes in lending policies, procedures, and practices.
For purposes of determining the allowance for loan losses, loans in the portfolio are segregated by type into the following segments: commercial, commercial real estate, construction, residential real estate, consumer and other. The Corporation also sub-divides these segments into classes based on the associated risks within those segments. Commercial loans are divided into the following two classes: secured by real estate and other. Construction loans are divided into the following two classes: commercial and residential. Consumer loans are divided into two classes: secured by real estate and other. The models and assumptions used to determine the allowance require management’s judgment. Assumptions, data and computations are appropriately reviewed and properly documented.
The risk characteristics of each of the identified portfolio segments are as follows:
Commercial - Commercial loans are generally of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Furthermore, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.
Commercial Real Estate - Commercial real estate loans are secured by multi-family and nonresidential real estate and generally have larger balances and generally are considered to involve a greater degree of risk than residential real estate loans. Commercial real estate loans depend on the global cash flow analysis of the borrower and the net operating income of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property. Of primary concern in commercial real estate lending is the borrower’s creditworthiness and the cash flow from the property. Payments on loans secured by income producing properties often depend on successful
operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. Commercial real estate is also subject to adverse market conditions that cause a decrease in market value or lease rates, obsolescence in location or function and market conditions associated with over supply of units in a specific region.
Construction - Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, additional funds may be required to be advanced in excess of the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, the value of the building may be insufficient to assure full repayment if liquidation is required. If foreclosure is required on a building before or at completion due to a default, there can be no assurance that all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs will be recovered.
Residential Real Estate - Residential real estate loans are generally made on the basis of the borrower’s ability to make repayment from his or her employment income or other income, and which are secured by real property whose value tends to be more easily ascertainable. Repayment of residential real estate loans is subject to adverse employment conditions in the local economy leading to increased default rate and decreased market values from oversupply in a geographic area. In general, residential real estate loans depend on the borrower’s continuing financial stability and, therefore, are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Consumer loans - Consumer loans secured by real estate may entail greater risk than residential mortgage loans due to a lower lien position. In addition, other consumer loans, particularly loans secured by assets that depreciate rapidly, such as motor vehicles, are subject to greater risk. In all cases, collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability and, therefore, are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Generally, when it is probable that some portion or all of a loan balance will not be collected, regardless of portfolio segment, that amount is charged-off as a loss against the allowance for loan losses. On loans secured by real estate, the charge-offs reflect partial writedowns due to the initial valuation of market values of the underlying real estate collateral in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-40. Consumer loans are generally charged-off in full when they reach 90 - 120 days past due.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Corporation, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
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.
Long-Term Assets
Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recovered from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Other Real Estate Owned
Other real estate owned (OREO) consists of property acquired through foreclosure or deed in lieu of foreclosure and property that is in-substance foreclosed. OREO is initially recorded at 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.
Bank owned life insurance
The Corporation has purchased life insurance policies on certain key officers. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Dividend Reinvestment Plan
The Corporation offers shareholders the opportunity to participate in a dividend reinvestment plan. Plan participants may reinvest cash dividends to purchase new shares of stock at 95% of the market value, based on the most recent trades. Cash dividends due to the plan participants are utilized to acquire shares from either, or a combination of, the issuance of authorized shares or purchases of shares in the open market through an approved broker. The Corporation reimburses the broker for the 5% discount when the purchase of the Corporation’s stock is completed. The plan is considered to be non-compensatory.
Stock-based compensation
Stock-based compensation cost is based on the fair value of the awards at the date of grant. The fair value of restricted stock awards is based upon the average of the high and low sale price reported for the Corporation’s common stock on the date of grant. Compensation cost is recognized for restricted stock over the required service period, generally defined as the vesting period.
Income taxes
The Corporation records income taxes in accordance with ASC 740, Income Taxes, as amended, using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense.
Comprehensive income (loss)
Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income includes unrealized gains and losses on securities available-for-sale, accretion of losses related to securities transferred from available-for-sale to held to maturity, and unrealized gains or losses on cash flow hedges, net of tax, which are also recognized as separate components of equity.
Earnings per common share
Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Common stock equivalents are not included in the calculation.
Diluted earnings per share is computed similar to that of 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.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Loss contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.
Dividend restriction
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Corporation or by the Corporation to its shareholders. The Corporation's ability to pay cash dividends is based, among other things, on its ability to receive cash from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's profits, combined with the retained net profits of the preceding two years. At December 31, 2014 the Bank could have paid dividends totaling approximately $3.94 million. At December 31, 2014, this restriction did not result in any effective limitation in the manner in which the Corporation is currently operating. See Note 10 to the consolidated financial statements with respect to restrictions on the Corporation’s ability to declare and pay dividends resulting from the terms of the Corporation’s Series B Preferred Shares.
Derivatives
Derivative financial instruments are recognized as assets or liabilities at fair value. The Corporation’s only free standing derivative consists of an interest rate swap agreement, which is used as part of its asset liability management strategy to help manage interest rate risk related to its subordinated debentures. The Corporation does not use derivatives for trading purposes.
The Corporation designated the interest rate swap as a cash flow hedge, which is a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability. For a cash flow hedge, the change in the fair value on the derivative is reported in other comprehensive income (loss) and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Net cash settlements on this interest rate swap that qualify for hedge accounting are recorded in interest expense. Changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings.
The Corporation formally documented the risk-management objective and the strategy for undertaking the hedge transaction at the inception of the hedging relationship. This documentation includes linking the fair value of the cash flow hedge to the subordinated debt on the balance sheet. The Corporation formally assessed, both at the hedge’s inception and on an ongoing basis, whether the derivative instrument used is highly effective in offsetting changes in cash flows of the subordinated debt.
When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that would be accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
Fair value of financial instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Adoption of New Accounting Standards
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, "Income Taxes, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists". This ASU requires that an unrecognized tax benefit, or a portion thereof, should be presented in the consolidated financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The standard is effective for reporting periods, including interim periods, beginning after December 15, 2013. The adoption of the standard did not have a material effect on the Corporation’s consolidated financial statements.
In January 2014, the FASB issued ASU 2014-04, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” This ASU applies to all creditors who obtain physical possession of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable. The amendments in this ASU clarify when an in substance repossession or foreclosure occurs and requires disclosure of both (1) the amount of foreclosed residential real estate property held by a creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in ASU 2014-04 are effective for fiscal years, including interim periods, beginning after December 15, 2014. The adoption of the amendments in this ASU are not expected to have a material impact on the Corporation’s consolidated financial statements.
Note 2. SECURITIES - AVAILABLE-FOR-SALE AND HELD TO MATURITY
The fair value of the available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
(a) Collateralized by student loans
Cash proceeds realized from sales and calls of securities available-for-sale for the years ended December 31, 2014 and 2013 were $11,155,000 and $18,823,000, respectively. There were gross gains totaling $165,000 and no gross losses realized on sales or calls during the year ended December 31, 2014. There were gross gains totaling $233,000 and gross losses totaling $80,000 realized on sales or calls during the year ended December 31, 2013.
The fair value of available-for-sale securities pledged to secure public deposits for the year ending December 31, 2014 and 2013 was $670,000 and $944,000, respectively. See also Note 7 to the consolidated financial statements regarding securities pledged as collateral for Federal Home Loan Bank of New York advances and securities sold under agreements to repurchase.
The following is a summary of the held to maturity securities and related unrealized gains and losses:
There were no cash proceeds realized from calls of securities held to maturity for the year ended December 31, 2014. Cash proceeds realized from calls of securities held to maturity for the year ended December 31, 2013 were $1,170,000. There were no gross gains and no gross losses realized from calls for the years ended December 31, 2014 and 2013.
The fair value of held to maturity securities pledged to secure public deposits for the year ending December 31, 2014 was $751,000. There were no held to maturity securities pledged to secure public deposits for the year ending December 31, 2013. See also Note 7 to the consolidated financial statements regarding securities pledged as collateral for Federal Home Loan Bank of New York advances and securities sold under agreements to repurchase.
Issuers may have the right to call or prepay obligations with or without call or prepayment penalties. This might cause actual maturities to differ from the contractual maturities.
Mortgage-backed securities are a type of asset-backed security secured by a mortgage or collection of mortgages, purchased by government agencies such as the Government National Mortgage Association and government sponsored agencies such as the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation, which then issue securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool. At year end 2014 and 2013, there were no holdings of securities of any one issuer other than the U.S. government and its agencies in an amount greater than 10% of shareholders' equity.
The changes in available-for-sale and held to maturity securities for the year ending December 31, 2014 is primarily attributed to a $24.0 million transfer of previously-designated available-for-sale securities to a held to maturity designation at fair value. In accordance with ASC 320, Investment - Debt and Equity Securities, the Corporation is required at each balance sheet due date to reassess the classification of each security held. The reclassification, which occurred during the three months ended June 30, 2014, is permitted as the Corporation has appropriately determined the ability and intent to now hold these securities as an investment, until maturity or call. The securities were transferred to the held to maturity portfolio to protect our tangible common equity against rising interest rates and to appropriately align the mix of securities within held to maturity and available-for-sale. The securities transferred had a net loss of $742,000 that is reflected in accumulated other comprehensive loss on the consolidated statement of financial condition, net of subsequent amortization, which is being recognized over the life of the securities.
The following table presents the amortized cost and fair value of the debt securities portfolio by contractual maturity. As issuers may have the right to call or prepay obligations with or without call or prepayment premiums, the actual maturities may differ from contractual maturities. Securities not due at a single maturity date, such as mortgage-backed securities and asset-backed securities, are shown separately.
The following tables summarize the fair value and unrealized losses of those investment securities which reported an unrealized loss at December 31, 2014 and 2013, and if the unrealized loss position was continuous for the twelve months prior to December 31, 2014 and 2013.
Other-Than-Temporary-Impairment
At December 31, 2014, there were twenty-four U.S. government-sponsored agency securities, two obligation of state and political subdivisions securities, twenty-eight mortgage-backed securities, two corporate debt securities, and one other equity investments security in a continuous loss position for 12 months or longer. Management has assessed
the securities that were in an unrealized loss position at December 31, 2014 and 2013 and determined that any decline in fair value below amortized cost primarily relate to changes in interest rates and market spreads and was temporary.
In making this determination management considered the following factors: the period of time the securities were in an unrealized loss position; the percentage decline in comparison to the securities’ amortized cost; any adverse conditions specifically related to the security, an industry or a geographic area; the rating or changes to the rating by a credit rating agency; the financial condition of the issuer and guarantor and any recoveries or additional declines in fair value subsequent to the balance sheet date.
Management does not intend to sell securities in an unrealized loss position and it is not more likely than not that the Corporation will be required to sell these securities before the recovery of their amortized cost bases, which may be at maturity.
Note 3. LOANS AND ALLOWANCE FOR LOAN LOSSES
At December 31, 2014 and 2013, respectively, the loan portfolio consisted of the following:
During the year ended December 31, 2014, the Corporation purchased the guaranteed portion of several Small Business Administration (SBA) loans. Due to the guarantee of the principal amount of these SBA loans, no allowance for loan losses is established for these SBA loans.
At December 31, 2014 and 2013, loan participations sold by the Corporation to other lending institutions totaled approximately $12,948,000 and $12,725,000, respectively. These amounts are not included in the totals presented above.
The Corporation has entered into lending transactions with directors, executive officers and principal shareholders of the Corporation and their affiliates. At December 31, 2014 and 2013, these loans aggregated approximately $2,533,000 and $2,515,000, respectively. During the year ended December 31, 2014, new loans totaling $854,000 were granted and repayments totaled approximately $836,000. The loans, at December 31, 2014, were current as to principal and interest payments.
Activity in the allowance for loan losses is summarized as follows:
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2014 and 2013:
The following table presents the recorded investment in nonaccrual loans at the dates indicated:
At December 31, 2013, there was one relationship, which included four nonaccrual commercial real estate loans totaling $2.8 million, which was classified as held for sale and included in the table above. The $2.8 million was sold and there were no nonaccrual loans classified as held for sale at December 31, 2014.
At December 31, 2014 and 2013 there were no loans that were past due 90 days and still accruing.
The following table presents loans individually evaluated for impairment by class of loans at and for the periods indicated:
During the year ended December 31, 2014, no interest income was recognized on a cash basis.
During the year ended December 31, 2013, no interest income was recognized on a cash basis.
The following table presents the aging of the recorded investment in past due loans by class of loans as of December 31, 2014 and 2013. Nonaccrual loans are included in the disclosure by payment status:
Troubled Debt Restructurings
At December 31, 2014 and 2013, the Corporation had $12.9 million and $16.6 million, respectively, of loans whose terms have been modified in troubled debt restructurings. Of these loans, $12.0 million and $15.2 million were performing in accordance with their new terms at December 31, 2014 and 2013, respectively. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $868,000 and $281,000 have been allocated for the troubled debt restructurings at December 31, 2014 and 2013, respectively. As of December 31, 2013, the Corporation had committed $257,000 of additional funds to a single customer with an outstanding construction loan that is classified as a troubled debt restructuring. There were no committed amounts at December 31, 2014
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Corporation’s internal underwriting policy.
The following table presents loans by class that were modified as troubled debt restructurings that occurred during the year ended December 31, 2014 and 2013:
During the year ended December, 2014, three loans were modified as troubled debt restructurings. The modification of the terms of the two commercial - secured by real estate loans represented a term out of the remaining balances on these matured loans as well as an interest rate reduction. The modification of the terms of the commercial real estate loan involved an extension of the loan with an additional borrower added.
During the year ended December 31, 2013, four loans were modified as trouble debt restructurings. The terms of a $17,000 loan represented a term out of a remaining balance on a matured loan. The modification of the terms of a $2.0 million loan represented a period of principal forbearance as well as some principal forgiveness, which is partially contingent on three years of satisfactory performance under the forbearance agreement. The modification of the terms of two loans to one borrower totaling $4.3 million represented a period of principal forbearance.
For the years ended December 31, 2014 and December 31, 2013, the troubled debt restructurings described above resulted in a net increase in the allowance for loan losses of $587,000 and $63,000, respectively. There were no charge-offs in 2014 related to these troubled debt restructurings. In 2013 there were $616,000 of charge-offs related to these troubled debt restructurings.
A loan is considered to be in payment default once it is contractually 90 days past due under the modified terms. There are no troubled debt restructurings for which there was a payment default within twelve months following the modification.
Credit Quality Indicators
The Corporation categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial, commercial real estate and commercial construction loans. This analysis is performed at the time the loan is originated and annually thereafter. The Corporation uses the following definitions for risk ratings.
Special Mention - A Special Mention asset has potential weaknesses that deserve management’s close attention, which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or the Bank’s credit position at some future date. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.
Substandard - Substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or by the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful - A Doubtful loan has all of the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable or improbable. The likelihood of loss is extremely high, but because of certain important and reasonably specific factors, an estimated loss is deferred until a more exact status can be determined.
Loss - A loan classified Loss is considered uncollectible and of such little value that its continuance as an asset is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off a basically worthless asset even though partial recovery may be affected in the future.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of December 31, 2014 and 2013, and based on the most recent analysis performed at those times, the risk category of loans by class is as follows:
The Corporation considers the historical and projected performance of the loan portfolio and its impact on the allowance for loan losses. For residential real estate and consumer loan segments, the Corporation evaluates credit quality primarily based on payment activity and historical loss data. The following table presents the recorded investment in residential real estate and consumer loans based on payment activity as of December 31, 2014 and 2013.
Note 4. PREMISES AND EQUIPMENT, NET
The balance of premises and equipment consists of the following at December 31, 2014 and 2013:
Amounts charged to net occupancy expense for depreciation and amortization of banking premises and equipment amounted to $420,000 and $428,000 in 2014 and 2013, respectively.
Note 5. OTHER REAL ESTATE OWNED
The balance of other real estate owned consists of the following at December 31, 2014 and 2013:
Activity in the allowance for losses on other real estate owned was as follows:
Net gain on sale of other real estate owned totaled $63,000 and $326,000 for the year ended December 31, 2014 and 2013, respectively.
Expenses related to other real estate owned include:
Note 6. DEPOSITS
Certificates of deposit with balances of $100,000 or more at December 31, 2014 and 2013, totaled $75,859,000 and $83,609,000, respectively.
The scheduled maturities of certificates of deposit were as follows:
Note 7. BORROWINGS
Federal Home Loan Bank of New York Advances
The following table presents Federal Home Loan Bank of New York ("FHLB-NY") advances by maturity date:
During 2014 and 2013, the maximum amount of FHLB-NY advances outstanding at any month end was $66.7 million and $40.1 million, respectively. The average amount of advances outstanding during the year ended December 31, 2014 and 2013 was $32.5 million and $26.7 million, respectively.
At December 31, 2014, FHLB advances totaling $10.0 million had a quarterly call feature which has reached its first call date.
Advances from the FHLB-NY are all fixed rate borrowings and are secured by a blanket assignment of the Corporation's unpledged, qualifying mortgage loans and by mortgage-backed securities or investment securities. The loans remain under the control of the Corporation. Securities are maintained in safekeeping with the FHLB-NY. As of December 31, 2014 and 2013, the advances were collateralized by $63.2 million, of first mortgage loans under the blanket lien arrangement. Additionally, the advances were collateralized by $21.5 million and $5.1 million of investment securities as of December 31, 2014 and 2013, respectively. Based on the collateral the Corporation was eligible to borrow up to a total of $84.7 million at December 31, 2014 and $68.3 million at December 31, 2013.
The Corporation has the ability to borrow overnight with the FHLB-NY. As of December 31, 2014 overnight borrowings with the FHLB-NY were $6.7 million. At December 31, 2013 there were no overnight borrowings with FHLB-NY. The overall borrowing capacity is contingent on available collateral to secure borrowings and the ability to purchase additional activity-based capital stock of the FHLB-NY.
The Corporation may also borrow from the Discount Window of the Federal Reserve Bank of New York based on the market value of collateral pledged. At December 31, 2014 and 2013, the Corporation’s borrowing capacity at the Discount Window was $5.1 million and $5.7 million, respectively. In addition, at December 31, 2014 and 2013 the Corporation had available overnight variable repricing lines of credit with other correspondent banks totaling $35 million and $21 million, respectively, on an unsecured basis. There were no borrowings under these lines of credit at December 31, 2014 and 2013.
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase represent financing arrangements.
As of December 31, 2013 the balance of securities sold under agreements to repurchase included a wholesale repurchase agreement with a broker that was repaid in full at maturity in 2014. After a fixed rate period, the borrowing converted to a floating rate at 9.00% minus 3-month London Interbank Offered Rate (LIBOR) measured on a quarterly basis with a 5.15% cap and a 0.0% floor. This repurchase agreement was collateralized by agency securities maintained in safekeeping with the broker.
The remaining balance at December 31, 2013 was securities sold to Bank customers at a fixed rate with maturities varying from 6 months to one year. These securities were maintained in a separate safekeeping account within the Corporation's control.
At December 31, 2013, securities sold under agreements to repurchase were collateralized by U.S. Treasury and U.S. government-sponsored agency securities having a carrying value of approximately $8,282,000.
At December 31, 2014, there were no securities sold under agreements to repurchase.
Information concerning securities sold under agreements to repurchase is summarized as follows:
Note 8. SUBORDINATED DEBENTURES
In 2003, the Corporation formed Stewardship Statutory Trust I (the “Trust”), a statutory business trust, which on September 17, 2003 issued $7.0 million Fixed/Floating Rate Capital Securities (“Capital Securities”). The Trust used the proceeds to purchase from the Corporation, $7,217,000 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. The Corporation’s obligation with respect to the Capital Securities, and the Debentures, when taken together, provide a full and unconditional guarantee on a subordinated basis by the Corporation of the Trust’s obligations to pay amounts when due on the Capital Securities. The Corporation is not considered the primary beneficiary of this Trust (variable interest entity); therefore the trust is not consolidated in the Corporation’s consolidated financial statements, but rather the Debentures are shown as a liability.
Prior to September 17, 2008, the Capital Securities and the Debentures both had a fixed interest rate of 6.75%. Beginning September 17, 2008, the rate floats quarterly at a rate of three month LIBOR plus 2.95%. At both December 31, 2014 and 2013, the rate on both the Capital Securities and the Debentures was 3.19%. The Corporation has the right to defer payments of interest on the Debentures by extending the interest payment period for up to 20 consecutive quarterly periods.
The Debentures may be included in Tier 1 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.
Note 9. REGULATORY CAPITAL REQUIREMENTS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Regulations of the Board of Governors of the Federal Reserve System require bank holding companies to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 2014, 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.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
At the years ended 2014 and 2013, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events that have occurred since that notification that management believes would change the Bank's category.
Management believes that, as of December 31, 2014, 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 and the Bank's actual capital amounts and ratios as of December 31, 2014 and 2013 compared to the minimum capital adequacy requirements and the requirements for classification as a well capitalized institution under the prompt corrective action regulations:
As presented above, at December 31, 2014, the Bank’s regulatory capital ratios exceeded the established minimum capital requirements.
Note 10. PREFERRED STOCK
In connection with the Corporation’s participation in the U.S. Department of the Treasury’s Small Business Lending Fund program (“SBLF”), a $30 billion fund established under the Small Business Jobs Act of 2010 that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion, on September 1, 2011 (the “Series B Preferred Issue Date”), pursuant to a Securities Purchase Agreement between the Corporation and the Secretary of the Treasury, the Corporation issued 15,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Shares”) to the Treasury for an aggregate purchase price of $15 million, in cash.
The terms of the Series B Preferred Shares impose restrictions on the Corporation’s ability to declare or pay dividends or purchase, redeem or otherwise acquire for consideration, shares of our Common Stock and any class or series of stock of the Corporation the terms of which do not expressly provide that such class or series will rank senior or junior to the Series B Preferred Shares as to dividend rights and/or rights on liquidation, dissolution or winding up of the Corporation. Specifically, the terms provide for the payment of a non-cumulative quarterly dividend, payable in arrears, which the Corporation accrues as earned over the period that the Series B Preferred Shares are outstanding. The dividend rate was subject to fluctuation on a quarterly basis during the first ten quarters during which the Series B Preferred Shares were outstanding, based upon changes in the level of Qualified Small Business Lending (“QSBL” as defined in the Securities Purchase Agreement) from 1% to 5% per annum and, since then, for the eleventh dividend period through that portion of the nineteenth dividend period prior to the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., through February 29, 2016) the dividend rate became fixed at 4.56%. In general, the dividend rate decreased as the level of the Bank’s QSBL increased. With respect to that portion of the nineteenth dividend period that begins on the four and one-half year anniversary of the Series B Preferred Issue Date (i.e., beginning on March 1, 2016) and all dividend periods thereafter, the dividend rate will be increased and fixed at 9%. Such dividends are not cumulative but the Corporation may only declare and pay dividends on its Common Stock (or any other equity securities junior to the Series B Preferred Shares) if it has declared and paid dividends on the Series B Preferred Shares for the current dividend period and if, after payment of such dividend, the dollar amount of the Corporation’s Tier 1 capital would be at least 90% of the Tier 1 capital on the date of entering into the SBLF program, excluding any subsequent net charge-offs and any redemption of the Series B Preferred Shares (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of the issuance and ending on the tenth anniversary of the issuance, by 10% for each 1% increase in QSBL over the baseline level.
In addition, the Series B Preferred Shares are non-voting except in limited circumstances and, in the event that the Corporation has not timely declared and paid dividends on the Series B Preferred Shares for six dividend periods or more, whether or not consecutive, and shares of Series B Preferred Shares with an aggregate liquidation preference of at least $25 million are still outstanding, the Treasury may designate two additional directors to be elected to the Corporation’s Board of Directors. Subject to the approval of the Bank’s federal banking regulator, the FRB, the Corporation may redeem the Series B Preferred Shares at any time at the Corporation’s option, at a redemption price equal to the liquidation preference per share plus the per share amount of any unpaid dividends for the then-current period through the date of the redemption. The Series B Preferred Shares are currently includable, and are expected to be includable in the future, in Tier 1 capital for regulatory capital.
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 expense for the year ended December 31, 2014 and 2013 was $170,000 and $100,000, respectively.
The Corporation also has a 401(k) plan which covers all eligible employees. Participants may elect to contribute up to 100% 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, 2014 and 2013 amounted to approximately $141,000 and $155,000, respectively.
The Corporation offers an Employee Stock Purchase Plan which allows all eligible employees to authorize a specific payroll deduction from his or her base compensation for the purchase of the Corporation’s Common Stock. Total stock
purchases amounted to 6,560 and 8,439 shares during 2014 and 2013, respectively. At December 31, 2014, the Corporation had 171,074 shares reserved for issuance under this plan.
Note 12. STOCK-BASED COMPENSATION
At December 31, 2014, the Corporation had various types of the following stock award programs.
Director Stock 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. Shares are purchased for directors in the open market and resulted in purchases of 5,060 and 7,162 shares for 2014 and 2013, respectively. At December 31, 2014, the Corporation had 528,094 shares authorized but unissued for this plan.
Stock Incentive Plan
The 2010 Stock Incentive Plan covers both employees and directors. The purpose of the plan is to promote the long-term growth and profitability of the Corporation by (i) providing key people with incentives to improve shareholder value and to contribute to the growth and financial success of the Corporation, and (ii) enabling the Corporation to attract, retain and reward the best available persons. There were 49,661 restricted shares granted during the year ended December 31, 2014. No awards were granted during the year ended December 31, 2013. The value of restricted shares is based upon an average of the high and low closing price of the common stock on the date of grant. The shares generally vest over a three year service period with compensation expense recognized on a straight-line basis. Stock based compensation expense related to stock grants was $69,000 for the year ended December 31, 2014. At December 31, 2014 the Corporation had 142,694 shares authorized but unissued for this plan.
Note 13. EARNINGS PER COMMON 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:
There were no stock options to purchase shares of common stock for the year ended December 31, 2014. For the year ended December 31, 2013, stock options to purchase 3,627 of average shares of common stock were not considered in computing diluted earnings per share of common stock because they were antidilutive.
Note 14. INCOME TAXES
The components of income tax benefit are summarized as follows:
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:
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:
At December 31, 2014, the Corporation has provided a full valuation allowance relating to both federal and state tax benefit of all contribution carryforwards and for the parent company only state tax benefit of net operating loss carryforwards. Management has determined that it is more likely than not that it will not be able to realize the deferred tax benefits described above.
The Corporation has approximately $359,000 of taxes paid in the carryback period that could be utilized against the deferred tax asset. The remaining $5.6 million of net deferred tax assets more likely than not will be utilized through future earnings.
The Corporation has alternate minimum tax (AMT) credit carryforwards of approximately $425,000 to reduce regular Federal income taxes in future years to the extent that the regular federal income tax exceeds AMT. The AMT credit carryforwards have no expiration date.
There were no unrecognized tax benefits during the years or at the years ended December 31, 2014 and 2013 and management does not expect a significant change in unrecognized benefits in the next twelve months. There were no tax interest and penalties recorded in the income statement for the years ended December 31, 2014 and 2013. There were no tax interest and penalties accrued for the years ended December 31, 2014 and 2013.
The Corporation and its subsidiaries are subject to U.S. federal income tax as well as income tax of the State of New Jersey.
The Corporation is no longer subject to examination by taxing authorities for years before 2010.
Note 15. COMMITMENTS AND CONTINGENCIES
Loan Commitments
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, 2014, the Corporation had residential mortgage commitments to extend credit aggregating approximately $2.7 million at fixed rates averaging 3.78% and none at variable rates. Approximately $205,000 of these loan commitments will be sold to investors upon closing. Commercial, construction, and home equity loan commitments of approximately $15.8 million were extended with variable rates averaging 4.46% and approximately $1.9 million extended at fixed rates averaging 3.16% Generally, commitments were due to expire within approximately 60 days.
Additionally, at December 31, 2014, the Corporation was committed for approximately $58.6 million of unused lines of credit, consisting of $16.7 million relating to a home equity line of credit program and an unsecured line of credit program (cash reserve), $4.4 million relating to an unsecured overdraft protection program, and $37.5 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 letters of credit were approximately $1.1 million at December 31, 2014, all of which 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 borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby 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.
Lease Commitments
At December 31, 2014, the minimum rental commitments on the noncancellable leases with an initial term of one year and expiring thereafter are as follows:
Rental expense under long-term operating leases for branch offices amounted to approximately $1,106,000 and $1,210,000 during the years ended December 31, 2014 and 2013, respectively. Rental income was approximately $46,000 for the years ended December 31, 2014 and 2013.
Contingencies
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. INTEREST RATE SWAP
The Corporation utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swap does not represent an amount exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.
Interest Rate Swap Designated as Cash Flow Hedge: The Corporation entered into an interest rate swap with a notional amount of $7 million. It was designated as a cash flow hedge of the Debentures (See Note 8 of the consolidated financial statements) and was determined to be fully effective during the years ended December 31, 2014 and 2013. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swap is recorded in other assets (liabilities) with changes in fair value recorded in other comprehensive income (loss). The amount included in accumulated other comprehensive income (loss) would be reclassified to current earnings should the hedge no longer be considered effective. The Corporation expects the hedge to remain fully effective during the remaining term of the swap. As of December 31, 2014, the Corporation has secured the interest rate swap by pledging investment securities with a fair value of $989,000.
Summary information as of December 31, 2014 about the interest rate swap designated as a cash flow hedge is as follows:
The net expense recorded on the swap transaction totaled $271,000 and $268,000 for the years ended December 31, 2014 and 2013, respectively, and is reported as a component of interest expense - borrowed money.
The fair value of the interest rate swap of ($314,000) and ($559,000) at December 31, 2014 and 2013, respectively, was included in accrued expenses and other liabilities on the Consolidated Statements of Financial Condition.
The following table presents the after tax net gains recorded in accumulated other comprehensive income and the Consolidated Statements of Income relating to the cash flow derivative instruments for the periods indicated.
Note 17. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values of investment securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). As the Corporation is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Corporation compares the prices received from the pricing service to a secondary pricing source. The Corporation’s internal price verification procedures have not historically resulted in adjustment in the prices obtained from the pricing service.
The interest rate swaps are reported at fair values obtained from brokers who utilize internal models with observable market data inputs to estimate the values of these instruments (Level 2 inputs).
The Corporation measures impairment of collateralized loans and other real estate owned (“OREO”) based on the estimated fair value of the collateral less estimated costs to sell the collateral, incorporating assumptions that experienced parties might use in estimating the value of such collateral (Level 3 inputs). At the time a loan or OREO is considered impaired, it is valued at the lower of cost or fair value. Generally, impaired loans carried at fair value have been partially charged-off or receive specific allocations of the allowance for loan losses. OREO is initially recorded at fair value less estimated selling costs. For collateral dependent loans and OREO, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, the net book value recorded for the collateral on the borrower’s financial
statements, or aging reports. Collateral is then adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the borrower and borrower’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Appraisals are generally obtained to support the fair value of collateral. Appraisals for both collateral-dependent impaired loans and OREO are performed by licensed appraisers whose qualifications and licenses have been reviewed and verified by the Corporation. The Corporation utilizes a third party to order appraisals and, once received, reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.
Real estate appraisals typically incorporate measures such as recent sales prices for comparable properties. In addition, appraisers may make adjustments to the sales price of the comparable properties as deemed appropriate based on the age, condition or general characteristics of the subject property. Management generally applies a 12% discount to real estate appraised values to cover disposition / selling costs and to reflect the potential price reductions in the market necessary to complete an expedient transaction and to factor in the impact of the perception that a transaction being completed by a bank may result in further price reduction pressure.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
There were no transfers of assets between Level 1 and Level 2 during 2014 and 2013. There were no changes to the valuation techniques for fair value measurements as of December 31, 2014 and 2013.
Assets and Liabilities Measured on a Non-Recurring Basis
Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment of $1,690,000, with a valuation allowance of $88,000, resulting in an increase of the allocation for loan losses of $155,000 for the year ended December 31, 2014.
Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment of $17,180,000, with a valuation allowance of $268,000, resulting in an increase of the provision for loan losses of $3,975,000 for the year ended December 31, 2013.
OREO had a recorded investment value of $1,375,000 with a $67,000 valuation allowance at December 31, 2014. At December 31, 2013, OREO had a recorded investment of $480,000 with a $29,000 valuation allowance. Additional valuation allowances of $235,000 and $29,000 were recorded for the years ended December 31, 2014 and 2013, respectively.
For the Level 3 assets measured at fair value on a non-recurring basis, the significant unobservable inputs used in the fair value measurements were as follows:
Fair value estimates for the Corporation’s financial instruments are summarized below:
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 and is classified as Level 1.
Securities available-for-sale and held to maturity - The methods for determining fair values were described previously.
Loans held for sale - The amount at December 31, 2013 represents the estimated fair value of a group of nonperforming loans to a single borrower that are being marketed for sale. The estimated fair value is based on the fair value of the note resulting in a Level 3 classification.
Loans, net - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as residential and commercial mortgages, commercial and other installment loans. The fair value of loans is estimated by discounting cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans resulting in a Level 3 classification. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.
FHLB-NY stock - It is not practicable to determine the fair value of FHLB-NY stock due to restrictions placed on the transferability of the stock.
Accrued interest receivable - The carrying amount approximates fair value.
Deposits - The fair value of deposits, with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of certificates of deposit is based on the discounted value of cash flows resulting in a Level 2 classification. The discount rate is estimated using market discount rates which reflect interest rate risk inherent in the certificates of deposit. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable deposits.
FHLB-NY advances - With respect to FHLB-NY borrowings, the fair value is based on the discounted value of cash flows. The discount rate is estimated using market discount rates which reflect the interest rate risk and credit risk inherent in the term borrowings resulting in a Level 2 classification.
Securities sold under agreements to repurchase - The carrying value approximates fair value due to the relatively short time before maturity resulting in a Level 2 classification.
Subordinated debentures - The fair value of the Debentures is based on the discounted value of the cash flows. The discount rate is estimated using market rates which reflect the interest rate and credit risk inherent in the Debentures resulting in a Level 3 classification.
Accrued interest payable - The carrying amount approximates fair value.
Interest rate swap - The fair value of derivatives, which is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition, are based on valuation models using observable market data as of the measurement date (Level 2).
Commitments to extend credit - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. At December 31, 2014 and 2013 the fair value of such commitments were not material.
Limitations
The preceding fair value estimates were made at December 31, 2014 and 2013 based on pertinent market data and relevant information concerning the financial instruments. These estimates do not include any premiums or discounts that could result from an offer to sell at one time the Corporation's entire holdings of a particular financial instrument or category thereof. Since no market exists for a substantial portion of the Corporation's financial instruments, fair value estimates were necessarily based on judgments with respect to future expected loss experience, current economic conditions, risk assessments of various financial instruments, and other factors. Given the subjective nature of these estimates, the uncertainties surrounding them and the matters of significant judgment that must be applied, these fair value estimates cannot be calculated with precision. Modifications in such assumptions could meaningfully alter these estimates.
Since these fair value approximations were made solely for on- and off-balance sheet financial instruments at December 31, 2014 and 2013, no attempt was made to estimate the value of anticipated future business.
Furthermore, certain tax implications related to the realization of unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into the estimates.
Note 18. PARENT COMPANY ONLY
The Corporation was formed in January 1995 as a bank holding company to operate its wholly-owned 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. Condensed financial statements are presented below:
Condensed Statements of Financial Condition
Condensed Statements of Income
Condensed Statements of Cash Flows
Note 19. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), both gross and net of tax, are presented for the periods below:
The following table presents the after-tax changes in the balances of each component of accumulated other comprehensive income for the years ended December 31, 2014 and 2013.
The following table presents amounts reclassified from each component of accumulated other comprehensive income on a gross and net of tax basis for the years ended December 31, 2014 and 2013.
Note 20. QUARTERLY FINANCIAL DATA (Unaudited)
The following table contains quarterly financial data for the years ended December 31, 2014 and 2013 (dollars in thousands).
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A
Item 9A . Controls and Procedures
(a)Evaluation of internal controls and procedures
Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal financial officer have concluded that our internal disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
(b)Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and can only provide reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
We assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (1992). Based on our assessment using those criteria, our management (including our principal executive officer and principal accounting officer) concluded that our internal control over financial reporting was effective as of December 31, 2014.
This Annual Report on Form 10-K does not include an attestation report of the Corporation’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Corporation’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report in this Annual Report on Form 10-K.
(c)Changes in Internal Controls over Financial Reporting
There were no significant changes in our internal control over financial reporting or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information concerning directors and executive officers contained under the captions “Election of Directors”: “Senior Executive Officers” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934,” in the Proxy Statement for the Corporation’s 2015 Annual Meeting of Shareholders is incorporated herein by reference.
Code of Ethics
The Corporation has adopted a Code of Ethical Conduct for Senior Financial Managers that applies to its principal executive officer, principal financial officer, principal accounting officer, controller and any other person performing similar functions. The Corporation’s Code of Ethical Conduct for Senior Financial Managers is posted on our website, www.asbnow.com. The Corporation intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of its Code of Ethical Conduct for Senior Financial Managers by filing an 8-K and by posting such information on its website.
Audit Committee and Audit Committee Financial Expert
The members of our Audit Committee as of December 31, 2014 were Howard Yeaton (Chairman), Wayne Aoki, John L. Steen and Michael Westra. The Audit Committee determined that Howard Yeaton, Wayne Aoki and Michael Westra were “audit committee financial experts” as defined in Item 407(d)(5) of Regulation S-K as promulgated by the Securities and Exchange Commission. All members of our Audit Committee are “independent” as defined under Nasdaq listing rule 5605(a)(2).
Item 11.
Item 11. Executive Compensation
Information concerning executive compensation under the caption “Executive Compensation” and director compensation under the heading “Director Compensation” in the Proxy Statement for the Corporation’s 2015 Annual Meeting of Shareholders is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table provides information with respect to the equity securities that are authorized for issuance under our compensation plans as of December 31, 2014:
Equity Compensation Plan Information
The only equity compensation plan not approved by security holders is the Director Stock Plan. The Director Stock Plan permits members of the Board of Directors to receive any monthly Board of Directors’ fees in shares of the Corporation’s Common Stock, rather than in cash. The Corporation purchased 5,060 shares of the Corporation’s Common Stock in the open market during 2014 for the benefit of the Director Stock Plan.
Information concerning security ownership of certain beneficial owners and management under the caption “Stock Ownership of Management and Principal Shareholders” in the Proxy Statement for the Corporation’s 2015 Annual Meeting of Shareholders is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information concerning certain relationships and related transactions under the captions “Election of Directors” and “Certain Relationships and Related Transactions,” in the Proxy Statement for the Corporation’s 2015 Annual Meeting of Shareholders is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
Information concerning principal accountant fees and services under the caption “Fees Billed by our Independent Registered Public Accounting Firm During Fiscal 2014 and Fiscal 2013,” in the Proxy Statement for the Corporation’s 2015 Annual Meeting of Shareholders is incorporated herein by reference.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements
The Consolidated Financial Statements of Stewardship Financial Corporation and Subsidiary included in Item 8:
Report of Independent Registered Public Accounting Firm for Fiscal Year 2014
Consolidated Statements of Financial Condition as of December 31, 2014 and 2013
Consolidated Statements of Income for the years ended December 31, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2014 and 2013
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2014 and 2013
Consolidated Statements of Cash Flows for the years ended December 31, 2014 and 2013
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
None.
(3) Exhibits
Exhibit
Number Description of Exhibits
3(i) Restated Certificate of Incorporation of Stewardship Financial Corporation (1)
3(i).2 Certificate of Amendment to the Certificate of Incorporation of Stewardship Financial Corporation (2)
3(ii) Amended and Restated By-Laws of Stewardship Financial Corporation (3)
4.1 Form of Certificate for Senior Non-Cumulative Perpetual Preferred Stock, Series B (4)
10.1 1995 Employee Stock Purchase Plan (5)
10.2 Stewardship Financial Corporation Dividend Reinvestment Plan (6)
10.3 Stewardship Financial Corporation Director Stock Plan (7)
10.4 Amended and Restated Director Stock Plan (8)
10.5 Dividend Reinvestment Plan (9)
10.6 Dividend Reinvestment Plan (10)
10.7 Dividend Reinvestment Plan, as amended and restated effective May 18, 2010 (11)
10.8 2010 Stock Incentive Plan (12)
10.9 Small Business Lending Fund - Securities Purchase Agreement effective September 1, 2011 between the Corporation and the Secretary of the Treasury, and Repurchase Letter dated September 1, 2011 between the Corporation and the U.S. Department of the Treasury (13)
10.10 Change in Control Severance Agreement dated November 12, 2013 between the Corporation and Paul Van Ostenbridge (14)
10.11 Change in Control Severance Agreement dated November 12, 2013 between the Corporation and Claire M. Chadwick (15)
10.12 Change in Control Severance Agreement dated November 12, 2013 between the Corporation and Mark J. Maurer (16)
10.13 Change in Control Severance Agreement dated March 26, 2015 between the Corporation and Peter Ameen
Annual Report to Shareholders for the year ended December 31, 2014
Subsidiaries of the Registrant
23. Consent of KPMG LLP
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The following materials from Stewardship Financial Corporation’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income, (iii) Consolidated Statement of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Comprehensive Income, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements (17)
-----------------------------------------------------------------
(1)Incorporated by reference from Exhibit 3(i).1 to the Corporation’s Quarterly Report on Form 10-Q, filed May 15, 2009.
(2)Incorporated by reference from Exhibit 3.1 to the Corporation’s Current Report on Form 8-K, filed September 7, 2011.
(3)Incorporated by reference from Exhibit 3.1(i) to the Corporation’s Annual Report on Form 10-K, filed March 28, 2013.
(4)Incorporated by reference from Exhibit 4.1 to the Corporation’s Current Report on Form 8-K, filed September 7, 2011.
(5)Incorporated by reference from Exhibit 4(c) to the Corporation’s Registration Statement on Form S-8, Registration No. 333-20793, filed January 31, 1997.
(6)Incorporated by reference from Exhibit 4(a) to the Corporation’s Registration Statement on Form S-3, Registration No. 333-20699, filed January 30, 1997.
(7)Incorporated by reference from Exhibit 4(a) to the Corporation’s Registration Statement on Form S-8, Registration No. 333-31245, filed July 14, 1997.
(8)Incorporated by reference from Exhibit 10(viii) to the Corporation’s Annual Report on Form 10-KSB, filed March 31, 1999.
(9)Incorporated by reference from Exhibit 4(a) to the Corporation’s Registration Statement on Form S-3, Registration No. 333-54738, filed January 31, 2001.
(10)Incorporated by reference from Exhibit 4(a) to the Corporation’s Registration Statement on Form S-3, Registration No. 333-133632, filed April 28, 2006.
(11)Incorporated by reference from Exhibit 4.2 to the Corporation’s Registration Statement on Form S-3, Registration No. 333-167374, filed June 8, 2010.
(12)Incorporated by reference from Exhibit 10.1 to the Corporation’s Current Report on Form 8-K, filed May 19, 2010.
(13)Incorporated by reference from Exhibits 10.1 and 10.2 to the Corporation’s Current Report on Form 8-K, filed September 7, 2011.
(14)Incorporated by reference from Exhibit 10.1 to the Corporation’s Quarterly Report on Form 10-Q, filed November 13, 2013.
(15)Incorporated by reference from Exhibit 10.2 to the Corporation’s Quarterly Report on Form 10-Q, filed November 13, 2013.
(16)Incorporated by reference from Exhibit 10.3 to the Corporation’s Quarterly Report on Form 10-Q, filed November 13, 2013.
(17) This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Corporation specifically incorporates it by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
STEWARDSHIP FINANCIAL CORPORATION
By: /s/ Paul Van Ostenbridge
Paul Van Ostenbridge
Chief Executive Officer and Director
Dated: March 27, 2015
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title Date
/s/ Paul Van Ostenbridge
Chief Executive Officer March 27, 2015
Paul Van Ostenbridge
and Director
(Principal Executive Officer)
/s/ Claire M. Chadwick
Chief Financial Officer March 27, 2015
Claire M. Chadwick
(Principal Financial Officer and
Principal Accounting Officer)
/s/ Wayne Aoki
Director March 27, 2015
Wayne Aoki
/s/ Richard W. Culp
Director March 27, 2015
Richard W. Culp
/s/ William Hanse
Chairman of the Board March 27, 2015
William Hanse
/s/ Margo Lane
Director March 27, 2015
Margo Lane
/s/ John C. Scoccola
Director March 27, 2015
John C. Scoccola
/s/ John L. Steen
Director March 27, 2015
John L. Steen
/s/ Robert Turner
Secretary and Director March 27, 2015
Robert Turner
/s/ William J. Vander Eems
Director March 27, 2015
William J. Vander Eems
/s/ Michael Westra
Vice Chairman of the Board March 27, 2015
Michael Westra
/s/ Howard Yeaton
Director March 27, 2015
Howard Yeaton
EXHIBIT INDEX
Exhibit
Number
Description of Exhibits
10.13
Change in Control Severance Agreement dated March 26, 2015 between the Corporation and Peter Ameen
Annual Report to Shareholders for the year ended December 31, 2014
Subsidiaries of the Registrant
Consent of KPMG LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The following materials from Stewardship Financial Corporation’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income, (iii) Consolidated Statement of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Comprehensive Income, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements (1)
(1)This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Corporation specifically incorporates it by reference.