STEWARDSHIP FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - STEWARDSHIP FINANCIAL CORP	ex32_1.htm
EX-31.2 - EXHIBIT 31.2 - STEWARDSHIP FINANCIAL CORP	ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - STEWARDSHIP FINANCIAL CORP	ex31_1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________to_________

Commission file number 0-21855

Stewardship Financial Corporation

(Exact name of registrant as specified in its charter)

New Jersey	22-3351447
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

630 Godwin Avenue, Midland Park, NJ	07432
(Address of principal executive offices)	(Zip Code)

(201) 444-7100

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by a checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes oNo x

The number of shares outstanding, net of treasury stock, of the Issuer’s Common Stock, no par value, as of August 8, 2011 was 5,855,047.

Stewardship Financial Corporation

INDEX

	PAGE NUMBER

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

Consolidated Statements of Financial Condition at June 30, 2011 and December 31, 2010 (Unaudited)	1

Consolidated Statements of Income for the Three and Six Months ended June 30, 2011 and 2010 (Unaudited)	2

Consolidated Statement of Changes in Stockholders’ Equity for the Six Months ended June 30, 2011 and 2010 (Unaudited)	3

Consolidated Statements of Comprehensive Income for the Three and Six Months ended June 30, 2011 and 2010 (Unaudited)	4

Consolidated Statements of Cash Flows for the Six Months ended June 30, 2011 and 2010 (Unaudited)	5 - 6

Notes to Consolidated Financial Statements (Unaudited)	7 - 17

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF PERATIONS	18 - 24

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	25

ITEM 4 - CONTROLS AND PROCEDURES	25

PART II - OTHER INFORMATION

ITEM 6 - EXHIBITS	26

SIGNATURES	27

EXHIBIT INDEX	28

Index

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Financial Condition

(Unaudited)

	June 30, 2011		December 31, 2010
Assets

Cash and due from banks	$	24,839,000	$	19,838,000
Other interest-earning assets		1,027,000		145,000
Cash and cash equivalents		25,866,000		19,983,000

Securities available for sale		145,891,000		138,628,000
Securities held to maturity; estimated fair value of $43,698,000 (2011) and $47,316,000 (2010)
		41,426,000		45,394,000
FHLB-NY stock, at cost		2,491,000		2,497,000
Loans, net of allowance for loan losses of $11,230,000 (2011) and $8,490,000 (2010)		457,329,000		443,245,000
Mortgage loans held for sale		-		9,818,000
Premises and equipment, net		6,209,000		6,395,000
Accrued interest receivable		2,803,000		2,806,000
Other real estate owned		275,000		615,000
Bank owned life insurance		9,981,000		9,819,000
Other assets		8,118,000		8,918,000
Total assets	$	700,389,000	$	688,118,000

Liabilities and stockholders' equity

Liabilities
Deposits:
Noninterest-bearing	$	114,518,000	$	99,723,000
Interest-bearing		473,900,000		475,880,000
Total deposits		588,418,000		575,603,000

Federal Home Loan Bank of New York Advances		33,000,000		36,000,000
Subordinated debentures		7,217,000		7,217,000
Securities sold under agreements to repurchase		15,791,000		14,642,000
Accrued interest payable		898,000		977,000
Accrued expenses and other liabilities		1,418,000		1,547,000
Total liabilities		646,742,000		635,986,000

Commitments and contingencies		-		-

Stockholders' equity
Preferred stock, no par value; 2,500,000 shares authorized; 10,000 shares
issued and outstanding at June 30, 2011 and December 31, 2010
Liquidation preference of $10,000,000		9,827,000		9,796,000
Common stock, no par value; 10,000,000 shares authorized;
5,850,558 and 5,847,844 shares issued: 5,850,558 and 5,846,927 shares
outstanding at June 30, 2011 and December 31, 2010, respectively		40,540,000		40,516,000
Treasury stock, 917 shares outstanding at December 31, 2010		-		(13,000	)
Retained earnings		2,161,000		1,959,000
Accumulated other comprehensive income (loss), net		1,119,000		(126,000	)
Total stockholders' equity		53,647,000		52,132,000

Total liabilities and stockholders' equity	$	700,389,000	$	688,118,000

See notes to unaudited consolidated financial statements.

Index

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Income

(Unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2011		2010			2011		2010
Interest income:
Loans	$	6,666,000	$	6,693,000		$	13,106,000	$	13,567,000
Securities held to maturity
Taxable		177,000		376,000			360,000		798,000
Non-taxable		221,000		233,000			444,000		464,000
Securities available for sale
Taxable		878,000		825,000			1,717,000		1,705,000
Non-taxable		52,000		38,000			96,000		87,000
FHLB dividends		30,000		32,000			68,000		69,000
Other interest-earning assets		9,000		4,000			17,000		6,000
Total interest income		8,033,000		8,201,000			15,808,000		16,696,000

Interest expense:
Deposits		1,280,000		1,729,000			2,569,000		3,549,000
Borrowed money		532,000		549,000			1,069,000		1,045,000
Total interest expense		1,812,000		2,278,000			3,638,000		4,594,000

Net interest income before provision for loan losses		6,221,000		5,923,000			12,170,000		12,102,000
Provision for loan losses		1,915,000		4,705,000			3,590,000		6,255,000
Net interest income after provision for loan losses		4,306,000		1,218,000			8,580,000		5,847,000

Noninterest income:
Fees and service charges		538,000		503,000			1,049,000		972,000
Bank owned life insurance		81,000		81,000			161,000		167,000
Gain on sales of mortgage loans		186,000		66,000			590,000		121,000
Gain on calls and sales of securities		21,000		474,000			21,000		802,000
Other		117,000		123,000			206,000		196,000
Total noninterest income		943,000		1,247,000			2,027,000		2,258,000

Noninterest expenses:
Salaries and employee benefits		2,261,000		1,948,000			4,497,000		4,074,000
Occupancy, net		475,000		481,000			1,020,000		970,000
Equipment		238,000		277,000			496,000		586,000
Data processing		338,000		327,000			675,000		652,000
FDIC insurance premium		147,000		237,000			401,000		461,000
Charitable contributions		75,000		(15,000	)		175,000		150,000
Other		1,002,000		916,000			1,956,000		1,702,000
Total noninterest expenses		4,536,000		4,171,000			9,220,000		8,595,000
Income (loss) before income tax expense (benefit)		713,000		(1,706,000	)		1,387,000		(490,000	)
Income tax expense (benefit)		128,000		(641,000	)		319,000		(296,000	)
Net income (loss)		585,000		(1,065,000	)		1,068,000		(194,000	)
Dividends on preferred stock and accretion		138,000		138,000			276,000		275,000
Net income (loss) available to common stockholders	$	447,000	$	(1,203,000	)	$	792,000	$	(469,000	)

Basic earnings (loss) per common share	$	0.08	$	(0.21	)	$	0.14	$	(0.08	)
Diluted earnings (loss) per common share	$	0.08	$	(0.21	)	$	0.14	$	(0.08	)

Weighted average number of common shares outstanding		5,850,506		5,842,366			5,850,116		5,841,176
Weighted average number of diluted common
shares outstanding		5,850,506		5,842,366			5,850,116		5,841,176

See notes to unaudited consolidated financial statements.

Index

Stewardship Financial Corporation and Subsidiary

Consolidated Statement of Changes in Stockholders' Equity

(Unaudited)

	Six Months Ended June 30, 2011
														Accumulated
														Other
														Comprehensive
														Income
	Preferred		Common Stock					Retained			Treasury			(Loss)
	Stock		Shares		Amount			Earnings			Stock			Net			Total

Balance -- December 31, 2010	$	9,796,000		5,846,927	$	40,516,000		$	1,959,000		$	(13,000	)	$	(126,000	)	$	52,132,000
Cash dividends paid on common stock		-		-		-			(585,000	)		-			-			(585,000	)
Payment of discount on dividend
reinvestment plan		-		-		(10,000	)		-			-			-			(10,000	)
Cash dividends accrued on preferred stock		-		-		-			(250,000	)		-			-			(250,000	)
Common stock issued under stock plans		-		3,631		12,000			-			13,000			-			25,000
Stock option compensation expense		-		-		22,000			-			-			-			22,000
Accretion of discount on preferred stock		26,000		-		-			(26,000	)		-						-
Amortization of issuance costs		5,000		-		-			(5,000	)		-						-
Comprehensive income:
Net income		-		-		-			1,068,000			-			-			1,068,000
Change in unrealized holding gains on
securities available for sale arising during
the period (net of taxes of $819,000)		-		-		-			-			-			1,292,000			1,292,000
Reclassification adjustment for gains in
net income (net of taxes of $8,000)		-		-		-			-			-			(13,000	)		(13,000	)
Change in fair value of interest rate
swap (net of taxes of $23,000)		-		-		-			-			-			(34,000	)		(34,000	)
Total comprehensive income																		2,313,000

Balance -- June 30, 2011	$	9,827,000		5,850,558	$	40,540,000		$	2,161,000		$	-		$	1,119,000		$	53,647,000

	Six Months Ended June 30, 2010
														Accumulated
														Other
														Comprehensive
														Income
	Preferred		Common Stock					Retained			Treasury			(Loss)
	Stock		Shares		Amount			Earnings			Stock			Net			Total

Balance -- December 31, 2009	$	9,736,000		5,834,515	$	40,415,000		$	2,922,000		$	-		$	438,000		$	53,511,000
Cash dividends paid on common stock		-		-		-			(1,051,000	)		-			-			(1,051,000	)
Payment of discount on dividend
reinvestment plan		-		-		(19,000	)		-			-			-			(19,000	)
Cash dividends accrued on preferred stock		-		-		-			(250,000	)		-			-			(250,000	)
Common stock issued under stock plans		-		3,037		24,000			-			-			-			24,000
Stock option compensation expense		-		-		26,000			-			-			-			26,000
Stock options exercised		-		9,376		55,000			-			(43,000	)		-			12,000
Accretion of discount on preferred stock		25,000		-		-			(25,000	)		-						-
Amortization of issuance costs		5,000		-		-			(5,000	)		-						-
Comprehensive income:
Net loss		-		-		-			(194,000	)		-			-			(194,000	)
Change in unrealized holding gains on
securities available for sale arising during
the period (net of taxes of $904,000)		-		-		-			-			-			1,405,000			1,405,000
Reclassification adjustment for gains in
net income (net of taxes of $316,000)		-		-		-			-			-			(486,000	)		(486,000	)
Change in fair value of interest rate
swap (net of taxes of $186,000)		-		-		-			-			-			(280,000	)		(280,000	)
Total comprehensive income																		445,000

Balance -- June 30, 2010	$	9,766,000		5,846,928	$	40,501,000		$	1,397,000		$	(43,000	)	$	1,077,000		$	52,698,000

See notes to unaudited consolidated financial statements.

Index

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010

Net income (loss)	$	585,000		$	(1,065,000	)	$	1,068,000		$	(194,000	)

Other comprehensive income (loss):
Change in unrealized holding gains on securities
available for sale arising during the period		2,221,000			1,437,000			2,111,000			2,309,000
Reclassification adjustment for gains in net income		(21,000	)		(474,000	)		(21,000	)		(802,000	)
Net unrealized gains		2,200,000			963,000			2,090,000			1,507,000
Tax effect		(858,000	)		(381,000	)		(811,000	)		(588,000	)
Net unrealized gains, net of tax amount		1,342,000			582,000			1,279,000			919,000

Change in fair value of interest rate swap		(155,000	)		(291,000	)		(57,000	)		(466,000	)
Tax effect		62,000			116,000			23,000			186,000
Change in fair value of interest rate swap,
net of tax amount		(93,000	)		(175,000	)		(34,000	)		(280,000	)

Total other comprehensive income		1,249,000			407,000			1,245,000			639,000

Total comprehensive income (loss)	$	1,834,000		$	(658,000	)	$	2,313,000		$	445,000

The following is a summary of the accumulated other comprehensive income balances, net of tax.

	6/30/2011			12/31/2010

Unrealized gain on securities available for sale	$	1,552,000		$	272,000
Unrealized loss on fair value of interest rate swap		(433,000	)		(398,000	)

Accumulated other comprehensive income, net	$	1,119,000		$	(126,000	)

See notes to unaudited consolidated financial statements.

Index

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended June 30,
	2011			2010
Cash flows from operating activities:
Net income (loss)	$	1,068,000		$	(194,000	)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization of premises and equipment		300,000			416,000
Amortization of premiums and accretion of discounts, net		637,000			370,000
Accretion of deferred loan fees		(20,000	)		(55,000	)
Provision for loan losses		3,590,000			6,255,000
Originations of mortgage loans held for sale		(35,536,000	)		(14,952,000	)
Proceeds from sale of mortgage loans		45,944,000			12,674,000
Gain on sales of mortgage loans		(590,000	)		(121,000	)
Gain on sales and calls of securities		(21,000	)		(802,000	)
Deferred income tax benefit		(1,188,000	)		(791,000	)
Decrease in accrued interest receivable		3,000			315,000
Decrease in accrued interest payable		(79,000	)		(258,000	)
Earnings on bank owned life insurance		(161,000	)		(167,000	)
Stock option expense		22,000			26,000
(Increase) decrease in other assets		1,150,000			(993,000	)
Decrease in other liabilities		(163,000	)		(800,000	)
Net cash provided by operating activities		14,956,000			923,000

Cash flows from investing activities:
Purchase of securities available for sale		(21,306,000	)		(58,544,000	)
Proceeds from maturities and principal repayments on securities available for sale		9,602,000			7,708,000
Proceeds from sales and calls on securities available for sale		6,032,000			39,951,000
Purchase of securities held to maturity		-			(5,566,000	)
Proceeds from maturities and principal repayments on securities held to maturity		2,851,000			2,553,000
Proceeds from calls on securities held to maturity		1,000,000			13,735,000
Sale of FHLB-NY stock		6,000			730,000
Net increase in loans		(17,654,000	)		(2,088,000	)
Additions to premises and equipment		(114,000	)		(194,000	)
Proceeds from sale of other real estate owned		366,000			-
Net cash used in investing activities		(19,217,000	)		(1,715,000	)

Cash flows from financing activities:
Net increase in noninterest-bearing deposits		14,795,000			12,618,000
Net increase (decrease) in interest-bearing deposits		(1,980,000	)		18,635,000
Net increase in securities sold under agreements to repurchase		1,149,000			4,000
Net decrease in short term borrowings		-			(18,600,000	)
Repayment of long term borrowings		(3,000,000	)		-
Cash dividends paid on common stock		(585,000	)		(1,051,000	)
Cash dividends paid on preferred stock		(250,000	)		(250,000	)
Payment of discount on dividend reinvestment plan		(10,000	)		(19,000	)
Exercise of stock options		-			12,000
Issuance of common stock		25,000			24,000
Net cash provided by financing activities		10,144,000			11,373,000

Net increase in cash and cash equivalents		5,883,000			10,581,000
Cash and cash equivalents - beginning		19,983,000			8,871,000
Cash and cash equivalents - ending	$	25,866,000		$	19,452,000

Index

Stewardship Financial Corporation and Subsidiary

Consolidated Statements of Cash Flows (continued)

(Unaudited)

	Six Months Ended June 30,
	2011		2010
Supplemental disclosures of cash flow information:

Cash paid during the period for interest	$	3,717,000	$	4,852,001
Cash paid during the period for income taxes	$	1,215,000	$	1,930,001

See notes to unaudited consolidated financial statements.

Index

Stewardship Financial Corporation and Subsidiary

Notes to Consolidated Financial Statements

June 30, 2011

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Certain information and footnote disclosures normally included in the unaudited consolidated financial statements prepared in accordance with U.S. generally accepting accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Stewardship Financial Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 2010, filed with the SEC on March 30, 2011 (the “2010 Annual Report”).

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, Stewardship Realty LLC, Atlantic Stewardship Insurance Company, LLC and several other subsidiaries formed to hold title to properties acquired through deed in lieu of foreclosure. The Bank’s subsidiaries have an insignificant impact on the daily operations. All intercompany accounts and transactions have been eliminated in the consolidated financial statements. Certain prior period amounts have been reclassified to conform to the current presentation.

The consolidated financial statements of the Corporation have been prepared in conformity with 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 disclosures provided. Actual results could differ significantly from those estimates.

Material estimates

Material estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses and fair value of financial instruments. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize probable incurred losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions in the market area.

Basis of presentation

The interim unaudited consolidated financial statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the SEC and, therefore, do not include information or footnotes necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with GAAP. However, all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of the interim consolidated financial statements, have been included. The results of operations for the six months ended June 30, 2011 are not necessarily indicative of the results which may be expected for the entire year.

Derivatives

Derivative financial instruments are recognized as assets or liabilities at fair value. The Corporation’s 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 issued in 2003 to Stewardship Statutory Trust I (the “Trust”), a statutory business trust (see Note 8 to the Notes to the Audited Consolidated Financial Statements of the Corporation contained in the 2010 Annual Report). The Corporation does not use derivatives for trading purposes.

The Corporation designated the hedge 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 gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged.

Index

The Corporation formally documented the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking the fair value of cash flow hedge to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. 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 fair values or cash flows of the hedged items.

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 in which the hedged transactions will affect earnings.

Recent Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring”. This ASU provides additional guidance for companies when determining whether a loan modification constitutes a troubled debt restructuring. This ASU also provides additional disclosure requirements. The guidance on identifying and disclosing troubled debt restructurings is effective for interim and annual periods beginning on or after June 15, 2011 and applies retroactively to restructurings occurring on or after the beginning of the year. The guidance on measuring the impairment of a receivable restructured in a troubled debt restructuring is effective on a prospective basis. The adoption of this ASU did not have a significant impact on the Corporation’s consolidated financial statements.

In June 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU represents the converged guidance of the FASB and the International Accounting Standards Board (“the Boards”) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards. The amendments of this ASU are to be applied prospectively. The guidance is effective for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted. The Corporation does not expect the adoption of this ASU to have a significant impact on the Corporation’s consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income”. This ASU provides that an entity that reports items of other comprehensive income has the option to present comprehensive income in either one or two consecutive financial statements. The guidance is effective for interim and annual periods beginning after December 15, 2011. Early adoption is allowed. The Corporation does not expect the adoption of this ASU to have a significant impact on the Corporation’s consolidated financial statements.

Index

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:

	June 30, 2011
	Amortized		Gross Unrealized				Fair
	Cost		Gains		Losses		Value

U.S. Treasury	$	15,185,000	$	246,000	$	-	$	15,431,000
U.S. government-sponsored agencies		14,075,000		172,000		35,000		14,212,000
Obligations of state and political
subdivisions		6,159,000		215,000		26,000		6,348,000
Mortgage-backed securities - residential		104,716,000		2,027,000		109,000		106,634,000
Other equity investments		3,211,000		55,000		-		3,266,000
	$	143,346,000	$	2,715,000	$	170,000	$	145,891,000

	December 31, 2010
	Amortized		Gross Unrealized				Fair
	Cost		Gains		Losses		Value

U.S. Treasury	$	9,141,000	$	109,000	$	1,000	$	9,249,000
U.S. government-sponsored agencies		13,600,000		97,000		111,000		13,586,000
Obligations of state and political
subdivisions		4,219,000		79,000		19,000		4,279,000
Mortgage-backed securities - residential		108,078,000		1,169,000		920,000		108,327,000
Other equity investments		3,135,000		52,000		-		3,187,000
	$	138,173,000	$	1,506,000	$	1,051,000	$	138,628,000

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

	June 30, 2011
	Amortized		Gross Unrecognized				Fair
	Cost		Gains		Losses		Value

U.S. government-sponsored agencies	$	2,788,000	$	105,000		-	$	2,893,000
Obligations of state and political
subdivisions		25,724,000		1,360,000		-		27,084,000
Mortgage-backed securities - residential		12,914,000		807,000		-		13,721,000
	$	41,426,000	$	2,272,000	$	-	$	43,698,000

	December 31, 2010
	Amortized		Gross Unrecognized				Fair
	Cost		Gains		Losses		Value

U.S. government-sponsored agencies	$	4,208,000	$	146,000	$	-	$	4,354,000
Obligations of state and political
subdivisions		26,148,000		1,046,000		20,000		27,174,000
Mortgage-backed securities - residential		15,038,000		750,000		-		15,788,000
	$	45,394,000	$	1,942,000	$	20,000	$	47,316,000

The following tables summarize the fair value and unrealized losses of those investment securities which reported an unrealized loss at June 30, 2011 and December 31, 2010, and if the unrealized loss was continuous for the twelve months prior to June 30, 2011 and December 31, 2010.

Index

Available for Sale June 30, 2011	Less than 12 Months					12 Months or Longer				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

U.S. Treasury	$	-		-			-		-	$	-	$	-
U.S. government-
sponsored agencies		2,465,000		(35,000	)		-		-		2,465,000		(35,000	)
Obligations of state and
political subdivisions		1,169,000		(26,000	)		-		-		1,169,000		(26,000	)
Mortgage-backed
securities - residential		13,917,000		(109,000	)		-		-		13,917,000		(109,000	)
Other equity investments		-		-			-		-		-		-
Total temporarily
impaired securities	$	17,551,000	$	(170,000	)	$	-	$	-	$	17,551,000	$	(170,000	)

December 31, 2010	Less than 12 Months					12 Months or Longer				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

U.S. Treasury	$	1,522,000	$	(1,000	)	$	-	$	-	$	1,522,000	$	(1,000	)
U.S. government-
sponsored agencies		3,418,000		(111,000	)		-		-		3,418,000		(111,000	)
Obligations of state and
political subdivisions		1,153,000		(19,000	)		-		-		1,153,000		(19,000	)
Mortgage-backed
securities - residential		39,179,000		(920,000	)		-		-		39,179,000		(920,000	)
Other equity investments		-		-			-		-		-		-
Total temporarily
impaired securities	$	45,272,000	$	(1,051,000	)	$	-	$	-	$	45,272,000	$	(1,051,000	)

Held to Maturity

June 30, 2011

Less than 12 Months

12 Months or Longer

Total

Fair

Value

Unrecognized

Losses

Fair

Value

Unrecognized

Losses

Fair

Value

Unrecognized

Losses

U.S. government-

sponsored agencies

Obligations of state and

political subdivisions

Mortgage-backed

securities - residential

Total temporarily

impaired securities

December 31, 2010	Less than 12 Months					12 Months or Longer				Total
	Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses		Fair Value		Unrecognized Losses

U.S. government-
sponsored agencies	$	-	$	-		$	-	$	-	$	-	$	-
Obligations of state and
political subdivisions		1,403,000		(20,000	)		-		-		1,403,000		(20,000	)
Mortgage-backed
securities - residential		-		-			-		-		-		-
Total temporarily
impaired securities	$	1,403,000	$	(20,000	)	$	-	$	-	$	1,403,000	$	(20,000	)

Index

Other-Than-Temporary-Impairment

At June 30, 2011 there were no securities in a continuous loss position for 12 months or longer. The Corporation’s unrealized losses are primarily due to the changes in interest rates and other market conditions. These securities have not been considered other than temporarily impaired as scheduled principal and interest payments have been made and management anticipates collecting the entire principal balance as scheduled. Because the decline in fair value is attributable to changes in market conditions, and not credit quality, and because the Corporation does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Corporation does not consider these securities to be other-than-temporarily impaired at June 30, 2011.

Note 3. Loans and Allowance for Loan Losses

The following table sets forth the composition of loans:

	June 30, 2011		December 31, 2010

Commercial:
Secured by real estate	$	65,787,000	$	65,200,000
Other		43,249,000		44,327,000
Commercial real estate		249,433,000		219,875,000
Construction:
Commercial		21,075,000		28,652,000
Residential		276,000		875,000
Residential real estate		45,026,000		42,145,000
Consumer:
Secured by real estate		42,474,000		49,360,000
Other		1,288,000		1,280,000
Other		60,000		152,000
Total gross loans		468,668,000		451,866,000

Less: Deferred loan fees, net of costs		109,000		131,000
Allowance for loan losses		11,230,000		8,490,000
		11,339,000		8,621,000

Loans, net	$	457,329,000	$	443,245,000

Index

Activity in the allowance for loan losses is summarized as follows:

	For the three months ended June 30, 2011
	Commercial		Commercial Real Estate		Construction			Residential Real Estate		Consumer			Other Loans		Unallocated			Total

Balance, beginning
of period	$	4,979,000	$	3,305,000	$	752,000		$	288,000	$	532,000		$	3,000	$	14,000		$	9,873,000
Provision charged
to operations		850,000		1,180,000		(168,000	)		131,000		(71,000	)		6,000		(12,000	)		1,916,000
Loans charged off		260,000		288,000		14,000			-		1,000			5,000		-			568,000
Recoveries of loans
charged off		8,000		-		-			-		-			1,000					9,000

Balance, end of
period	$	5,577,000	$	4,197,000	$	570,000		$	419,000	$	460,000		$	5,000	$	2,000		$	11,230,000

	For the six months ended June 30, 2011
	Commercial		Commercial Real Estate		Construction			Residential Real Estate		Consumer		Other Loans		Unallocated			Total

Balance, beginning
of period	$	3,745,000	$	3,112,000	$	930,000		$	184,000	$	510,000	$	2,000	$	7,000		$	8,490,000
Provision charged
to operations		2,201,000		1,477,000		(337,000	)		235,000		10,000		9,000		(5,000	)		3,590,000
Loans charged off		388,000		392,000		23,000			-		60,000		8,000		-			871,000
Recoveries of loans
charged off		19,000		-		-			-		-		2,000					21,000

Balance, end of
period	$	5,577,000	$	4,197,000	$	570,000		$	419,000	$	460,000	$	5,000	$	2,000		$	11,230,000

	For the three months ended June 30, 2010		For the six months ended June 30, 2010

Balance, beginning of period	$	8,174,000	$	6,920,000
Provision charged to operations		4,705,000		6,255,000
Loans charged off		4,145,000		4,514,000
Recoveries of loans charged off		11,000		84,000

Balance, end of period	$	8,745,000	$	8,745,000

Index

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 June 30, 2011 and December 31, 2010.

	June 30, 2011
	Commercial		Commercial Real Estate		Construction		Residential Real Estate		Consumer		Other Loans		Unallocated		Total

Allowance for loan
losses:
Ending allowance
balance attributable
to loans

Individually
evaluated for
impairment	$	2,124,000	$	485,000	$	21,000	$	133,000	$	-	$	-	$	-	$	2,763,000

Collectively
evaluated for
impairment		3,453,000		3,712,000		549,000		286,000		460,000		5,000		2,000		8,467,000
Total ending
allowance
balance	$	5,577,000	$	4,197,000	$	570,000	$	419,000	$	460,000	$	5,000	$	2,000	$	11,230,000

Loans:
Loans
individually
evaluated for
impairment	$	8,384,000	$	14,772,000	$	2,273,000	$	1,106,000	$	826,000	$	-	$	-	$	27,361,000

Loans
collectively
evaluated for
impairment		100,652,000		234,661,000		19,078,000		43,920,000		42,936,000		60,000		-		441,307,000
Total ending
loan balance	$	109,036,000	$	249,433,000	$	21,351,000	$	45,026,000	$	43,762,000	$	60,000	$	-	$	468,668,000

Index

	December 31, 2010
	Commercial		Commercial Real Estate		Construction		Residential Real Estate		Consumer		Other Loans		Unallocated		Total

Allowance for loan
losses:
Ending allowance
balance attributable
to loans

Individually
evaluated for
impairment	$	1,336,000	$	276,000	$	29,000	$	3,000	$	-	$	-	$	-	$	1,644,000

Collectively
evaluated for
impairment		2,409,000		2,836,000		901,000		181,000		510,000		2,000		7,000		6,846,000
Total ending
allowance
balance	$	3,745,000	$	3,112,000	$	930,000	$	184,000	$	510,000	$	2,000	$	7,000	$	8,490,000

Loans:
Loans
individually
evaluated for
impairment	$	7,852,000	$	10,540,000	$	2,303,000	$	1,106,000	$	829,000	$	-	$	-	$	22,630,000

Loans
collectively
evaluated for
impairment		101,675,000		209,335,000		27,224,000		41,039,000		49,811,000		152,000		-		429,236,000
Total ending
loan balance	$	109,527,000	$	219,875,000	$	29,527,000	$	42,145,000	$	50,640,000	$	152,000	$	-	$	451,866,000

The following table presents the recorded investment in nonaccrual loans in the periods indicated:

	June 30, 2011		December 31, 2010

Commercial:
Secured by real estate	$	6,546,000	$	5,924,000
Other		1,728,000		1,798,000
Commercial real estate		11,355,000		10,540,000
Construction:
Commercial		1,997,000		2,020,000
Residential		276,000		283,000
Residential real estate		1,106,000		1,106,000
Consumer:
Secured by real estate		826,000		829,000
Other		-		-
Other		-		-

Total nonperfoming loans	$	23,834,000	$	22,500,000

Index

The following presents loans individually evaluated for impairment by class of loans as of the periods indicated:

	At June 30, 2011
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated

With no related allowance recorded:
Commercial:
Secured by real estate	$	3,715,000	$	2,721,000
Other		484,000		460,000
Commercial real estate		10,309,000		9,255,000
Construction:
Commercial		1,965,000		1,631,000
Residential		277,000		276,000
Residential real estate		-		-
Consumer:
Secured by real estate		1,035,000		826,000
Other		-		-
Other		-		-

With an allowance recorded:
Commercial:
Secured by real estate		3,971,000		3,825,000	$	1,378,000
Other		1,384,000		1,378,000		746,000
Commercial real estate		6,018,000		5,517,000		485,000
Construction:
Commercial		544,000		366,000		21,000
Residential		-		-		-
Residential real estate		1,131,000		1,106,000		133,000
Consumer:
Secured by real estate		-		-		-
Other		-		-		-
Other		-		-		-
Total nonperfoming loans	$	30,833,000	$	27,361,000	$	2,763,000

Index

	Three months ended June 30, 2011				Six months ended June 30, 2011
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:
Commercial:
Secured by real estate	$	2,032,000	$	-	$	1,658,000	$	-
Other		374,000		2,000		455,000		4,000
Commercial real estate		6,908,000		10,000		6,005,000		10,000
Construction:
Commercial		1,566,000		-		1,545,000		-
Residential		278,000		-		279,000		-
Residential real estate		144,000		-		334,000		-
Consumer:
Secured by real estate		828,000		-		828,000		-
Other		-		-		-		-
Other		-		-		-		-

With an allowance recorded:
Commercial:
Secured by real estate		4,311,000		-		4,545,000		-
Other		1,470,000		-		1,416,000		-
Commercial real estate		6,434,000		-		6,403,000		-
Construction:
Commercial		441,000		-		466,000		-
Residential		-		-		-		-
Residential real estate		963,000		-		772,000		-
Consumer:
Secured by real estate		-		-		-		-
Other		-		-		-		-
Other		-		-		-		-
Total nonperfoming loans	$	25,749,000	$	12,000	$	24,706,000	$	14,000

Index

	At and for the year ended December 31, 2010
	Unpaid Principal Balance		Recorded In vestment		Allowance for Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:
Commercial:
Secured by real estate	$	1,037,000	$	911,000
Other		646,000		618,000
Commercial real estate		4,808,000		4,199,000
Construction:
Commercial		1,540,000		1,504,000
Residential		284,000		283,000
Residential real estate		716,000		716,000
Consumer:
Secured by real estate		1,037,000		829,000
Other		-		-
Other		-		-

With an allowance recorded:
Commercial:
Secured by real estate		6,056,000		5,013,000	$	730,000
Other		1,311,000		1,310,000		606,000
Commercial real estate		6,777,000		6,341,000		276,000
Construction:
Commercial		959,000		516,000		29,000
Residential		-		-		-
Residential real estate		415,000		390,000		3,000
Consumer:
Secured by real estate		-		-		-
Other		-		-		-
Other		-		-		-
Total nonperfoming loans	$	25,586,000	$	22,630,000	$	1,644,000	$	23,766,000	$	216,000

Index

The following table presents the aging of the recorded investment in past due loans by class of loans as of June 30, 2011 and December 31, 2010. Nonaccrual loans are included in the disclosure by payment status.

	June 30, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due			Total Past Due		Loans Not Past Due		Total

Commercial:
Secured by real estate	$	510,000	$	275,000	$	6,050,000		$	6,835,000	$	58,952,000	$	65,787,000
Other		65,000		-		1,727,000			1,792,000		41,457,000		43,249,000
Commercial real estate:		622,000		72,000		12,872,000	(1)		13,566,000		235,867,000		249,433,000
Construction:
Commercial		-		1,095,000		902,000			1,997,000		19,078,000		21,075,000
Residential		-		-		276,000			276,000		-		276,000
Residential real estate		-		-		1,106,000			1,106,000		43,920,000		45,026,000
Consumer:
Secured by real estate		478,000		155,000		826,000			1,459,000		41,015,000		42,474,000
Other		-		7,000		-			7,000		1,281,000		1,288,000
Other		-		-		-			-		60,000		60,000
Total	$	1,675,000	$	1,604,000	$	23,759,000		$	27,038,000	$	441,630,000	$	468,668,000

(1) The $12,872,000 includes a single loan with a recorded investment of $2.342 000, representing the only loan in the Corporation’s portfolio that was past due 90 days or more and accruing.

	December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total

Commercial:
Secured by real estate	$	490,000	$	4,014,000	$	2,296,000	$	6,800,000	$	58,400,000	$	65,200,000
Other		-		-		1,798,000		1,798,000		42,529,000		44,327,000
Commercial real estate:		1,789,000		2,324,000		6,650,000		10,763,000		209,112,000		219,875,000
Construction:
Commercial		-		2,731,000		916,000		3,647,000		25,005,000		28,652,000
Residential		-		-		283,000		283,000		592,000		875,000
Residential real estate		-		458,000		1,106,000		1,564,000		40,581,000		42,145,000
Consumer:
Secured by real estate		114,000		449,000		829,000		1,392,000		47,968,000		49,360,000
Other		3,000		-		-		3,000		1,277,000		1,280,000
Other		-		-		-		-		152,000		152,000
Total	$	2,396,000	$	9,976,000	$	13,878,000	$	26,250,000	$	425,616,000	$	451,866,000

Troubled Debt Restructurings

At June 30, 2011 and December 31, 2010, the Corporation had $3,527,000 and $130,000, respectively, of loans whose terms have been modified in troubled debt restructurings. All of these loans are performing in accordance with their new terms. Specific reserves of $24,000 have been allocated for the troubled debt restructurings at June 30, 2011. No reserves were deemed necessary at December 31, 2010. As of June 30, 2011 and December 31, 2010, the Corporation has not committed any additional funds to customers with outstanding loans that are classified as troubled debt restructurings.

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

Index

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. While potentially weak, the borrower is currently marginally acceptable and loss of principal or interest is not presently envisioned.

Substandard – Substandard loans are inadequately protected by the current net worth and paying capacity of the obligor 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 loan with all 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 know 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 effected 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 June 30, 2011 and December 31, 2010, and based on the most recent analysis performed at those times, the risk category of loans by class is as follows:

	June 30, 2011
	Pass		Special Mention		Substandard		Doubtful		Loss		Total

Commercial:
Secured by real estate	$	59,004,000	$	954,000	$	2,631,000	$	3,198,000	$	-	$	65,787,000
Other		41,412,000		573,000		-		1,264,000		-		43,249,000
Commercial real estate:		234,662,000		4,350,000		9,639,000		782,000		-		249,433,000
Construction:
Commercial		19,077,000		1,096,000		902,000		-		-		21,075,000
Residential		-		276,000		-		-		-		276,000
Total	$	354,155,000	$	7,249,000	$	13,172,000	$	5,244,000	$	-	$	379,820,000

	December 31, 2010
	Pass		Special Mention		Substandard		Doubtful		Loss		Total

Commercial:
Secured by real estate	$	59,206,000	$	4,173,000	$	1,801,000	$	-	$	20,000	$	65,200,000
Other		42,399,000		618,000		-		1,267,000		43,000		44,327,000
Commercial real estate:		209,512,000		4,668,000		5,695,000		-		-		219,875,000
Construction:
Commercial		26,631,000		1,614,000		407,000		-		-		28,652,000
Residential		592,000		283,000		-		-		-		875,000
Total	$	338,340,000	$	11,356,000	$	7,903,000	$	1,267,000	$	63,000	$	358,929,000

Index

For residential real estate and consumer loan segments, the Corporation also evaluates credit quality based on payment activity. The following table presents the recorded investment in residential real estate and consumer loans based on payment activity as of June 30, 2011 and December 31, 2010. For purposes of the following table, Nonperforming means loans that are 30 days or more past due:

	June 30, 2011
	Performing		Nonperforming		Total

Residential real estate	$	43,920,000	$	1,106,000	$	45,026,000
Consumer:
Secured by real estate		41,170,000		1,304,000		42,474,000
Other		1,288,000		-		1,288,000
Total	$	86,378,000	$	2,410,000	$	88,788,000

	December 31, 2010
	Performing		Nonperforming		Total

Residential real estate	$	40,581,000	$	1,564,000	$	42,145,000
Consumer:
Secured by real estate		47,968,000		1,392,000		49,360,000
Other		1,277,000		3,000		1,280,000
Total	$	89,826,000	$	2,959,000	$	92,785,000

Note 4. 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 swaps does not represent amounts 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: During the second quarter of 2009, the Corporation entered into a swap with an effective date of March 17, 2010. An interest rate swap with a notional amount of $7 million was designated as a cash flow hedge of the subordinated debentures and was determined to be fully effective during the three and six months ended June 30, 2011. 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 June 30, 2011, the interest rate swap is secured by investment securities with a fair value of $1,035,000.

Summary information about the interest rate swap designated as a cash flow hedge as of June 30, 2011 is as follows:

Notional amount		$7,000,000
Pay rate		7.00%
Receive rate	3 month LIBOR plus 2.95%
Maturity	March 17, 2016
Fair value		$(721,000)

The net expense recorded on the swap transaction totaled $67,000 and $132,000 for the three and six months ended June 30, 2011, respectively, and is reported as a component of interest expense – borrowed money. The net expense recorded on the swap transaction totaled $66,000 and $78,000 for the three and six months ended June 30, 2010, respectively.

The fair value of the interest rate swap of ($721,000) and ($664,000) at June 30, 2011 and December 31, 2010, respectively, was included in accrued expenses and other liabilities on the Consolidated Statements of Financial Condition.

The following table presents the net gains (losses) recorded in accumulated other comprehensive income and the Consolidated Statements of Income relating to the cash flow derivative instruments for the periods indicated.

Index

	For the six months ended June 30, 2011
	Amount of gain (loss) recognized in OCI (Effective Portion)			Amount of gain (loss) reclassified from OCI to interest income		Amount of gain (loss) recognized in other noninterest income (Ineffective Portion)

Interest rate contract	$	(34,000	)	$	-	$	-

	For the six months ended June 30, 2010
	Amount of gain (loss) recognized in OCI (Effective Portion)			Amount of gain (loss) reclassified from OCI to interest income		Amount of gain (loss) recognized in other noninterest income (Ineffective Portion)

Interest rate contract	$	(280,000	)	$	-	$	-

Note 5. 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) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of 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).

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

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

Index

	Fair Value Measurements Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	At June 30, 2011
Assets:
Available for sale securities
U.S. Treasuries	$	15,431,000	$	-		15,431,000	$	-
U.S. government -
sponsered agencies		14,212,000		-		14,212,000		-
Obligations of state and
political subdivisions		6,348,000		-		6,348,000		-
Mortgage-backed
securities - residential		106,634,000		-		106,634,000		-
Other equity investments		3,266,000		-		3,266,000		-
Total available for
sale securities	$	145,891,000	$	-	$	145,891,000	$	-

Liabilities:
Interest rate swap	$	721,000	$	-	$	721,000	$	-

	At December 31, 2010
Assets:
Available for sale securities
U.S. Treasuries	$	9,249,000	$	-	$	9,249,000	$	-
U.S. government -
sponsered agencies		13,586,000		-		13,586,000		-
Obligations of state and
political subdivisions		4,279,000		-		4,279,000		-
Mortgage-backed
securities - residential		108,327,000		-		108,327,000		-
Other equity investments		3,187,000		-		3,187,000		-
Total available for
sale securities	$	138,628,000	$	-	$	138,628,000	$	-

Liabilities:
Interest rate swap	$	664,000	$	-	$	664,000	$	-

Index

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	At June 30, 2011
Assets:
Impaired loans
Commercial:
Secured by real estate	$	419,000	$	-	$	-	$	419,000
Other		-		-		-		-
Commercial real estate		1,235,000		-		-		1,235,000
Construction:
Commercial		345,000		-		-		345,000
Residential real estate		973,000		-		-		973,000
	$	2,972,000	$	-	$	-	$	2,972,000

	At December 31, 2010
Assets:
Impaired loans
Commercial:
Secured by real estate	$	1,725,000	$	-	$	-	$	5,326,000
Other		-		-		-		704,000
Commercial real estate		2,426,000		-		-		6,065,000
Construction:
Commercial		487,000		-		-		487,000
Residential real estate		387,000		-		-		387,000
	$	5,025,000	$	-	$	-	$	12,969,000

Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a recorded investment of $3,272,000 at June 30, 2011, with a valuation allowance of $300,000, resulting in an additional provision for loan losses of $712,000 for the six months ended June 30, 2011.

Collateral dependent impaired loans had a recorded investment of $5,152,000 with a valuation allowance of $127,000, resulting in an additional provision for loan losses of $413,000 for year ended December 31, 2010.

Fair value estimates, methods and assumptions are set forth below for the Corporation’s financial instruments.

Index

	June 30, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	25,866,000	$	25,866,000	$	19,983,000	$	19,983,000
Securities available for sale		145,891,000		145,891,000		138,628,000		138,628,000
Securities held to maturity		41,426,000		43,698,000		45,394,000		47,316,000
FHLB-NY stock		2,491,000		N/A		2,497,000		N/A
Net loans		457,329,000		458,195,000		443,245,000		445,671,000
Accrued interest receivable		2,803,000		2,803,000		2,806,000		2,806,000

Financial liabilities:
Deposits		588,418,000		591,129,000		575,603,000		577,485,000
FHLB-NY Advances		33,000,000		34,369,000		36,000,000		33,892,000
Securities sold under agreements
to repurchase		15,791,000		15,791,000		14,642,000		14,642,000
Subordinated debenture		7,217,000		7,218,000		7,217,000		6,803,000
Accrued interest payable		898,000		898,000		977,000		977,000
Interest rate swap		721,000		721,000		664,000		664,000

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and cash equivalents – The carrying amount approximates fair value.

Securities available for sale and held to maturity – The methods for determining fair values were described previously.

FHLB-NY stock – It is not practicable to determine the fair value of stock of the Federal Home Loan Bank of New York (“FHLB-NY”) due to restrictions placed on the transferability of the stock.

Net loans – 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. The fair value of loans is estimated by discounting cash flows using estimated marked discount rates which reflect the credit and interest rate risk inherent in the loans.

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. The fair value of the certificates of deposit is based on the discounted value of cash flows. The discount rate is estimated using marked discount rates which reflect interest rate risk inherent in the certificates of deposit.

FHLB-NY advances – With respect to the FHLB-NY borrowings, the carrying amount of the borrowings which mature in one day approximates fair value. For borrowings with a longer maturity, 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 inherent in the term borrowings.

Securities sold under agreements to repurchase – The carrying value approximates fair value due to the relatively short time before maturity.

Subordinated debenture – The fair value of the subordinated debenture is based on the discounted value of cash flows. The discount rate is estimated using market rates which reflect the interest rate risk inherent in the debenture.

Accrued interest payable – The carrying amount approximates fair value.

Interest rate swap – The methods for determining fair values were described previously.

Commitments to extend credit – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties, and at June 30, 2011 and December 31, 2010 the fair value of such commitments were not material.

Limitations

The preceding fair value estimates were made at June 30, 2011 and December 31, 2010 based on pertinent market data and relevant information on 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

Index

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 June 30, 2011 and December 31, 2010, 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 6. Earnings Per Share

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

The following reconciles the income available to common shareholders (numerator) and the weighted average common stock outstanding (denominator) for both basic and diluted earnings per share.

	Three Months Ended June 30,					Six Months Ended June 30,
	2011		2010			2011		2010
	(in thousands, except per share data)

Net income (loss)	$	585	$	(1,065	)	$	1,068	$	(194	)
Dividends on preferred stock and accretion		138		138			276		275
Net income (loss) available to common stockholders	$	447	$	(1,203	)	$	792	$	(469	)

Weighted average shares		5,851		5,842			5,850		5,841
Effect of dilutive stock options		N/A		N/A			N/A		N/A
Total weighted average dilutive shares		5,851		5,842			5,850		5,841

Basic earnings (loss) per common share	$	0.08	$	(0.21	)	$	0.14	$	(0.08	)

Diluted earnings (loss) per common share	$	0.08	$	(0.21	)	$	0.14	$	(0.08	)

For periods in which a loss is reported, the impact of dilutive stock options and common stock warrants is not considered as the result would be antidilutive. For the three and six months ended June 30, 2011, stock options to purchase 64,728 average shares of common stock were not considered in computing diluted earnings per share of common stock because they were antidilutive. Stock options to purchase average shares of common stock of 71,613 and 71,922 were not considered in computing diluted earnings per share for the three and six months ended June 30, 2010, respectively, because they were antidilutive. The U.S. Treasury’s warrant to purchase 133,475 average shares of common stock in both the three and six month periods ended June 30, 2011 was not considered in computing diluted earnings per common share because it was antidilutive.

Index

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

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

Critical Accounting Policies and Estimates

“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures found elsewhere in this Quarterly Report on Form 10-Q, are based upon the Corporation’s consolidated financial statements, which have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Corporation’s Audited Consolidated Financial Statements for the year ended December 31, 2010 included in the 2010 Annual Report contains a summary of the Corporation’s significant accounting policies. Management believes the Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.

The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey. Accordingly, the collectability of a substantial portion of the carrying value of the Corporation’s loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the northern New Jersey area experience adverse economic changes. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.

Financial Condition

Total assets increased $12.3 million, or 1.8%, to $700.4 million at June 30, 2011 from $688.1 million at December 31, 2010. Cash and cash equivalents increased $5.9 million to $25.9 million at June 30, 2011 from $20.0 million at December 31, 2010, reflecting planned additional liquidity. Securities available for sale increased $7.3 million to $145.9 million while securities held to maturity decreased $4.0 million to $41.4 million. Net loans increased $14.1 million from $443.2 million at December 31, 2010 to $457.3 million at June 30, 2011. Increases due to new loans originated were partially offset by a $2.7 million net increase in the allowance for loan losses and regular principal payments and payoffs during the six months ended June 30, 2011. There were no loans held for sale at June 30, 2011 compared to $9.8 million at December 31, 2011. Rising mortgage interest rates during the early part of 2011 had contributed to a slowdown in loan application volume and by June 30, 2011, all mortgage loan applications which had funded were and sold. With a more recent decline in mortgage interest rate, there has again been a current increase in loan application volume.

Deposits totaled $588.4 million at June 30, 2011, an increase of $12.8 million, or 2.2%, from $575.6 million at December 31, 2010. The growth in deposits consisted of a $14.8 million increase in noninterest-bearing accounts partially offset by a $2.0 million decrease in interest-bearing accounts.

Index

FHLB – NY advances were $33.0 million at June 30, 2011 compared to $36.0 million at December 31, 2010. The decrease in these borrowings was the result of an increase in deposits which was used to pay down maturing advances.

Results of Operations

General

The Corporation reported net income of $585,000, or $0.08 diluted earnings per common share for the three months ended June 30, 2011, compared to a net loss of $1.1 million, or a $0.21 loss per diluted common share for the three months ended June 30, 2010. For the six months ended June 30, 2011, the Corporation reported net income of $1.1 million, or $0.14 diluted earnings per common share. These results compare to a net loss was $194,000, or $0.08 per diluted common share for the six months ended June 30, 2010.

Net Interest Income

Net interest income for the three and six months ended June 30, 2011 was $6.2 million and $12.2 million, respectively, compared to $5.9 million and $12.1 million recorded in the prior year periods. The increases in the current year periods are primarily due to a decline in the cost of interest bearing liabilities. The net interest rate spread and net yield on interest earning assets for the three months ended June 30, 2011 were 3.62% and 3.89%, respectively, compared to 3.48% and 3.84% for the three months ended June 30, 2010. For the six months ended June 30, 2011, the net interest rate spread and net yield on interest earning assets were 3.61% and 3.86%, respectively, compared to 3.61% and 3.96% for the six months ended June 30, 2010. The net yield on interest earning assets during the current year periods reflects a decline in loan interest rates and yields on securities offset by a decline in the interest rates on deposits and borrowings.

The following table reflects the components of the Corporation’s net interest income for the three and six months ended June 30, 2011 and 2010 including: (1) average assets, liabilities and stockholders’ equity based on average daily balances, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, and (4) net yield on interest-earning assets. Nontaxable income from investment securities and loans is presented on a tax-equivalent basis assuming a statutory tax rate of 34% for the periods presented. This was accomplished by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes.

Index

Analysis of Net Interest Income (Unaudited)

For the Three Months Ended June 30

	2011									2010
	Average Balance			Interest Income/ Expense			Average Rates Earned/ Paid			Average Balance			Interest Income/ Expense			Average Rates Earned/ Paid
	(Dollars in thousands)

Assets

Interest-earning assets:
Loans (1) (2)	$	463,938		$	6,677			5.77	%	$	461,879		$	6,703			5.82	%
Taxable investment securities (1)		159,968			1,085			2.72			138,948			1,234			3.56
Tax-exempt investment securities (1) (2)		31,878			405			5.10			31,376			397			5.08
Other interest-earning assets		1,045			9			3.45			1,233			4			1.30
Total interest-earning assets		656,829			8,176			4.99			633,436			8,338			5.28

Non-interest-earning assets:
Allowance for loan losses		(10,274	)								(7,543	)
Other assets		50,898									42,156
Total assets	$	697,453								$	668,049


Liabilities and Stockholders' Equity

Interest-bearing liabilities:
Interest-bearing demand deposits	$	248,327		$	484			0.78	%	$	236,358		$	825			1.40	%
Savings deposits		52,262			34			0.26			48,404			51			0.42
Time deposits		173,542			762			1.76			165,097			853			2.07
Repurchase agreements		16,428			184			4.49			15,400			184			4.79
FHLB-NY borrowing		33,001			222			2.70			36,263			239			2.64
Subordinated debenture		7,217			126			7.00			7,217			126			7.00
Total interest-bearing liabilities		530,777			1,812			1.37			508,739			2,278			1.80
Non-interest-bearing liabilities:
Demand deposits		110,758									99,926
Other liabilities		2,502									4,968
Stockholders' equity		53,416									54,416
Total liabilities and stockholders' equity	$	697,453								$	668,049

Net interest income (taxable equivalent basis)					6,364									6,060
Tax Equivalent adjustment					(143	)								(137	)
Net interest income				$	6,221								$	5,923

Net interest spread (taxable equivalent basis)								3.62	%								3.48	%

Net yield on interest-earning
assets (taxable equivalent basis) (3)								3.89	%								3.84	%

(1)

For purpose of these calculations, nonaccruing loans are included in the average balance. Loans and total interest-earning assets are net of unearned income. Securities are included at amortized cost.

(2)

The tax equivalent adjustments are based on a marginal tax rate of 34%.

(3)

Net interest income (taxable equivalent basis) divided by average interest-earning assets.

Index

Analysis of Net Interest Income (Unaudited)

For the Six Months Ended June 30,

	2011									2010
	Average Balance			Interest Income/ Expense			Average Rates Earned/ Paid			Average Balance			Interest Income/ Expense			Average Rates Earned/ Paid
	(Dollars in thousands)

Assets

Interest-earning assets:
Loans (1) (2)	$	460,133		$	13,128			5.75	%	$	461,950		$	13,589			5.93	%
Taxable investment securities (1)		157,651			2,145			2.74			136,149			2,573			3.81
Tax-exempt investment securities (1) (2)		31,456			801			5.14			31,839			811			5.14
Other interest-earning assets		730			17			4.70			679			6			1.78
Total interest-earning assets		649,970			16,091			4.99			630,617			16,979			5.43

Non-interest-earning assets:
Allowance for loan losses		(9,529	)								(7,427	)
Other assets		51,374									39,845
Total assets	$	691,815								$	663,035


Liabilities and Stockholders' Equity

Interest-bearing liabilities:
Interest-bearing demand deposits	$	248,843		$	959			0.78	%	$	229,562		$	1,595			1.40	%
Savings deposits		50,326			65			0.26			47,855			100			0.42
Time deposits		174,416			1,545			1.79			168,198			1,854			2.22
Repurchase agreements		15,540			365			4.74			15,399			365			4.78
FHLB-NY borrowing		34,128			454			2.68			41,013			486			2.39
Subordinated debenture		7,217			250			6.99			7,217			194			5.42
Total interest-bearing liabilities		530,470			3,638			1.38			509,244			4,594			1.82
Non-interest-bearing liabilities:
Demand deposits		105,566									94,987
Other liabilities		2,813									4,434
Stockholders' equity		52,966									54,370
Total liabilities and stockholders' equity	$	691,815								$	663,035

Net interest income (taxable equivalent basis)					12,453									12,385
Tax Equivalent adjustment					(283	)								(283	)
Net interest income				$	12,170								$	12,102

Net interest spread (taxable equivalent basis)								3.61	%								3.61	%

Net yield on interest-earning
assets (taxable equivalent basis) (3)								3.86	%								3.96	%

(1)

(2)

The tax equivalent adjustments are based on a marginal tax rate of 34%.

(3)

Net interest income (taxable equivalent basis) divided by average interest-earning assets.

Index

For the three months ended June 30, 2011, total interest income, on a tax equivalent basis, decreased $162,000 to $8.176 million, or 1.9%, when compared to the same prior year period. The decrease was due to a decrease in yields on interest-earning assets partially offset by an increase in the average balance of interest-earning assets. Total interest income on a tax equivalent basis decreased $888,000 to $16.091 million for the six months ended June 30, 2011, or 5.2%, compared to the same period for 2010. Consistent with the three month period, the decrease in the current six month period is due to a decrease in the overall yield on interest-earning assets, partially offset by an increase in the average interest-earning assets. The average rate earned on interest-earning assets was 4.99% for both the three and six months ended June 30, 2011 compared to an average rate of 5.28% and 5.43% for the three and six months ended June 30, 2010, respectively. The decline in the asset yield reflects the effect of a prolonged low interest rate environment as well as the impact of nonaccrual loans. Average interest-earning assets increased $23.4 million and $19.4 million for the three and six months ended June 30, 2011, respectively, when compared to the same prior year periods.

Interest paid on deposits and borrowed money decreased $466,000, or 20.5%, to $1.812 million and $956,000, or 20.8%, to $3.638 million for the three and six months ended June 30, 2011 compared to the same periods for 2010. The declines are due to general decreases in rates paid on deposits and borrowings, partially offset by increases in average interest-bearing liabilities. The average balance of total interest-bearing deposits and borrowings increased $22.0 million and $21.2 million for the three and six months ended June 30, 2011, respectively, from the comparable 2010 periods. For the three months ended June 30, 2011, the total cost for interest-bearing liabilities declined to 1.37% representing a 43 basis point decline when compared to the same prior year period. Yields on deposits and borrowed money decreased 44 basis points from 1.82% for the six month period ended June 30, 2010 to 1.38% for the comparable period in 2011.

Provision for Loan Losses

The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable incurred losses associated with its loan portfolio. On an ongoing basis, management analyzes the adequacy of this allowance by considering the nature and volume of the Corporation’s loan activity, financial condition of the borrower, fair market value of the underlying collateral, and changes in general market conditions. Additions to the allowance for loan losses are charged to operations in the appropriate period. Actual loan losses, net of recoveries, serve to reduce the allowance. The appropriate level of the allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates.

The loan loss provision totaled $1.915 million and $3.590 million for the three and six months ended June 30, 2011, respectively, compared to $4.705 million and $6.255 million for the three and six months ended June 30, 2010, respectively. Nonaccrual loans of $23.8 million at June 30, 2011 reflected a slight increase from $22.5 million of nonaccrual loans at December 31, 2010, but are comparable to $24.0 million at March 31, 2011. The allowance for loan losses related to the impaired loans increased from $413,000 at December 31, 2010 to $712,000 at June 30, 2011. During the first six months of 2011, the Corporation charged off loans totaling $871,000 and recovered $21,000 in previously charged off loans compared to $4.5 million and $84,000, respectively, during the same period in 2010. Approximately $2.1 million of the charge offs in 2010 were related to a loan to one borrower.

The current period loan loss provision primarily is indicative of continuing economic conditions that have 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 a summary of the allowance for loan losses and nonperforming assets.

Noninterest Income

Noninterest income was $943,000 and $2.0 million for the three and six months ended June 30, 2011, respectively, compared to $1.2 million and $2.3 million for the comparable prior year periods, respectively. An increase in the fees and service charges in the current year periods is primarily due to growth in the deposit base. Gains on sales of mortgage loans totaled $186,000 and $590,000 for the three and six months ended June 30, 2011, respectively, an increase from $66,000 and $121,000 for the three and six months ended June 30, 2010, respectively, due to an increase in mortgage activity resulting from lower mortgage loan interest rates in the 2011 periods and the Corporation’s promotion of a no-cost closing program. Prior year noninterest income included gains on calls and sales of securities of $474,000 and $802,000 for the three and six months ended June 30, 2010, respectively while only $21,000 of gains on calls and sales of securities were realized in the comparable current year periods.

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Noninterest Expense

Noninterest expenses for the three and six months ended June 30, 2011 were $4.5 million and $9.2 million, respectively. For the comparable prior year periods, noninterest expenses were $4.2 million and $8.6 million, respectively. A higher level of expense associated with charitable contributions reflects the increased level of net income for the current year periods. In addition, the increase in noninterest expenses in the current year periods reflects the costs, such as legal and other collection-related expenses, incurred in connection with management of nonperforming assets. Partially offsetting these expense increases is a decrease in the FDIC insurance premiums reflecting a recent change in the quarterly assessment base.

Income Tax Expense

Income tax expense totaled $128,000 and $319,000 for the three and six months ended June 30, 2011, respectively. In the prior year, for the three and six months ended June 30, 2010, the Corporation recorded an income tax benefit of $641,000 and $296,000, respectively. The effective tax rate for the three and six months ended June 30, 2011 of 18.0% and 23.0%, respectively, reflects a decrease in our overall projected effective tax rate as a result of our tax exempt income representing a larger percentage of pretax income due to lower projected earnings. The tax benefit for the three and six months ended June 30, 2010 reflects the utilization of a capital loss carryforward to offset the taxability of a portion of the gain on calls and sales of securities. In addition, the tax benefit in these prior year periods also reflects a decrease in the overall projected effective tax rate as a result of our tax exempt income representing a larger percentage of pretax income due to lower projected earnings.

Asset Quality

The Corporation’s principal earning asset is its loan portfolio. Inherent in the lending function is the risk of deterioration in the borrowers’ ability to repay loans under existing loan agreements. Because of this risk, reserves are maintained to absorb probable incurred loan losses. In determining the adequacy of the allowance for loan losses, management of the Corporation considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with general economic and real estate market conditions. Although management attempts to establish a reserve sufficient to offset probable incurred losses in the portfolio, changes in economic conditions, regulatory policies and borrowers’ performance could require future changes to the allowance.

Risk elements include nonaccrual loans, past due and restructured loans, potential problem loans, loan concentrations and other real estate owned. The following table shows the composition of nonperforming assets at the end of the last four quarters:

	June 30, 2011			March 31, 2011			December 31, 2010			September 30, 2010

Nonaccrual loans (1)	$	23,834		$	24,010		$	22,500		$	24,334
Loans past due 90 days or more and accruing (2)		2,342			-			-			10
Restructured loans		3,527			120			130			140
Total nonperforming loans		29,703			24,130			22,630			24,484

Other real estate owned		275			313			615			356
Total nonperforming assets	$	29,978		$	24,443		$	23,245		$	24,840

Allowance for loan losses	$	11,230		$	9,874		$	8,490		$	9,327

Nonperforming loans to total gross loans		6.34	%		5.25	%		5.01	%		5.43	%
Nonperforming assets to total assets		4.28	%		3.49	%		3.38	%		3.65	%
Allowance for loan losses to total gross loans		2.40	%		2.15	%		1.88	%		2.07	%
Allowance for loan losses to
nonperforming loans		37.81	%		40.92	%		37.52	%		38.09	%

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

(2) Represents loans as to which payment of principal or interest is contractually past due 90 days or more but which are currently accruing income at the contractually stated rates. A determination is made to continue accruing income on those loans which are sufficiently collateralized and on which management believes all interest and principal owed will be collected.

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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 has been diligent and proactive in identifying and dealing with problem credits and is focused on resolving the nonperforming loans and mitigating future losses in the portfolio. All delinquent loans continue to be reviewed by management on a biweekly basis.

The nonaccrual loans are comprised of 61 loans, primarily commercial real estate loans, commercial loans and construction loans. While the Corporation maintains strong underwriting requirements, the number and amount of nonaccrual loans is reflective 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 cautious review, management has continued to keep these loans on nonaccrual.

Since December 31, 2010, nonaccrual loans have increased $1.3 million to $23.8 million at the end of the most recent quarter but have decreased slightly from $24.0 million at March 31, 2011. The ratio of allowance for loan losses to nonperforming loans increased slightly to 37.81% at June 30, 2011 from 37.52% at December 31, 2010, but reflects a decrease from 40.92% at March 31, 2011. The ratio of allowance for loan losses to nonperforming loans is reflective of detailed analysis and the probable incurred losses we have identified with these nonperforming loans. In calculating this metric, the effect of an increase in the allowance for loan losses has been offset by an increase in loans past due 90 days or more and accruing and restructured loans.

At June 30, 2011, the $2.3 million of loans past due 90 days or more and accruing represents a single loan for which a contract for sale of the underlying collateral is pending, with such sale expected to occur in the very near future, with the Corporation receiving a full payoff, including all accrued interest and principal outstanding.

Included in restructured loans as of June 30, 2011 is a loan for $2.3 million for which the estate of our borrower was provided with a forbearance to allow time to market for sale the underlying commercial real estate collateral. A contract for the sale of the property is currently pending, whereby upon closing of the sale transaction, the Corporation will collect all outstanding principal and accrued interest owed under the loan. The June 30, 2011 balance in restructured loans also includes two loans to a related borrower for $1.1 million. While these loans are current under their restructured terms, because of the below market rate of interest, these loans will continue to be reflected as restructured loans in accordance with accounting practices.

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 incurred losses. The majority of our nonperforming loans are secured by real estate collateral. While our nonperforming loans have remained elevated from historic levels since March 31, 2010, the underlying collateral coverage for a considerable portion of the nonperforming loans supports the significant collection of our principal, and therefore, we do not estimate a proportionate upward trending in losses.

At June 30, 2011 the level of loans past due 30-89 days was $3.3 million, an improvement from $13.0 million at March 31, 2011 and $12.4 million at December 31, 2010. The Corporation will continue to monitor delinquencies for early identification of new problem loans. As such, the entire commercial construction portfolio is being actively monitored.

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. 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 to 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.

In establishing the allowance for loan losses, the Corporation utilizes a two tier approach by: (1) identifying problem loans and allocating specific loss allowances on such loans and (2) establishing a general valuation allowance on the remainder of its loan portfolio. The Corporation maintains a loan review system that allows for a periodic review of its loan portfolio and the early identification of potential problem loans. Such a system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers.

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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.

Primarily as a result of the continuing higher level of nonperforming loans, the Corporation continues to record an elevated provision for loan losses. For the three and six months ended June 30, 2011, the provision for loan losses was $1.915 million and $3.590 million, respectively. The prior year provision for loan losses was $4.705 million and $6.255 million for the three and six months ended June 30 2010, respectively. The total allowance for loan losses increased to 2.40% of total loans from a comparable ratio of 2.15% at March 31, 2011 and 1.88% at December 31, 2010.

When it is probable 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. After net chargeoffs of $559,000 and $850,000 for the three and six months ended June 30, 2011, respectively, the allowance for loan losses totaled $11.2 million as of June 30, 2011 compared to $9.9 million and $8.5 million as of March 31, 2011 and December 31, 2010, respectively. In general, the chargeoffs reflect partial writedowns on nonaccrual loans due to the initial evaluation of market values of the underlying real estate collateral in accordance with Accounting Standards Codification 310-40. While we have taken the conservative position of partial and full chargeoffs on loans, we continue to aggressively pursue collection, including legal action.

As of June 30, 2011, there were $28.5 million of other loans not included in the above table, compared to $22.2 million and $23.9 million at March 31, 2011 and December 31, 2010, respectively, where credit conditions of borrowers caused management to have concerns about the possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in disclosure of such loans as nonperforming at a future date. These loans have been considered by management in conjunction with the analysis of the adequacy of the allowance for loan losses.

The Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey.

Capital Adequacy

The Corporation is subject to capital adequacy guidelines promulgated by the Board of Governors of the Federal Reserve System (“FRB”). The Bank is subject to similar capital adequacy requirements imposed by the Federal Deposit Insurance Corporation. The FRB has issued regulations to define the adequacy of capital based upon the sensitivity of assets and off-balance sheet exposures to risk factors. Four categories of risk weights (0%, 20%, 50%, and 100%) were established to be applied to different types of balance sheet assets and off-balance sheet exposures. The aggregate of the risk-weighted items (risk-based assets) is the denominator of the ratio; the numerator of the ratio is risk-based capital. Under the regulations, risk-based capital has been classified into two categories. Tier 1 capital includes common and qualifying perpetual preferred shareholders’ equity less goodwill. Tier 2 capital includes mandatory convertible debt, allowance for loan losses, subject to certain limitations, and certain subordinated and term debt securities. Total qualifying capital consists of Tier 1 capital and Tier 2 capital; however; the amount of Tier 2 capital may not exceed the amount of Tier 1 capital. At June 30, 2011, the minimum risk-based capital requirements to be considered adequately capitalized were 4% for Tier 1 capital and 8% for total capital.

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Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non risk-adjusted) for the preceding quarter. At June 30, 2011 the minimum leverage ratio requirement to be considered well capitalized was 4%. The following table summarizes the capital ratios for the Corporation and the Bank at June 30, 2011.

	Actual			Required for Capital Adequacy Purposes			To Be Well Capitalized Under Prompt Corrective Action Regulations
Leverage ratio
Corporation		8.53	%		4.00	%		N/A
Bank		8.11	%		4.00	%		5.00	%

Risk-based capital
Tier I
Corporation		12.01	%		4.00	%		N/A
Bank		11.38	%		4.00	%		6.00	%
Total
Corporation		13.27	%		8.00	%		N/A
Bank		12.65	%		8.00	%		10.00	%

Liquidity and Capital Resources

The Corporation’s primary sources of funds are deposits, amortization and prepayments of loans and mortgage-backed securities, maturities of investment securities and funds provided from operations. While scheduled loan and mortgage-backed securities amortization and maturities of investment securities are a relatively predictable source of funds, deposit flow and prepayments on loans and mortgage-backed securities are greatly influenced by market interest rates, economic conditions and competition. The Corporation’s liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities.

The primary source of cash from operating activities is net income. Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in interest-earning cash accounts or in short-term investments, such as federal funds sold.

Cash and cash equivalents increased $5.9 million during the first six months of 2011. Net operating and financing activities provided $15.0 million and $10.1 million, respectively, while investing activities used $19.2 million.

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. In addition, the Corporation has available overnight variable repricing lines of credit with other correspondent banks totaling $16.0 million on an unsecured basis.

With respect to the payment of dividends on common stock, the Corporation has historically paid a quarterly cash dividend, however management recognizes that the payment of future dividends could be impacted by losses or reduced earnings and the Corporation cannot assure the payment of future dividends.

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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable to smaller reporting companies.

ITEM 4. Controls and Procedures

Evaluation of internal controls and procedures

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have concluded that our internal 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.

Changes in Internal Controls over Financial Reporting

Pursuant to Rule 13a-15(d) under the Exchange Act, our management, with the participation of our principal executive officer and principal financial officer, has evaluated our internal controls over financial reporting and based upon such evaluation concluded that there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II -- Other Information

Item 6. Exhibits

See Exhibit Index following this report.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Stewardship Financial Corporation


Date: August 15, 2011	By:	/s/ Paul Van Ostenbridge
		Paul Van Ostenbridge
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: August 15, 2011	By:	/s/ Claire M. Chadwick
		Claire M. Chadwick
		Senior Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit Number		Description of Exhibits

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

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