Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - STEWARDSHIP FINANCIAL CORPssfn_2016930xex32-1.htm
EX-31.2 - EXHIBIT 31.2 - STEWARDSHIP FINANCIAL CORPssfn_2016930xex31-2.htm
EX-31.1 - EXHIBIT 31.1 - STEWARDSHIP FINANCIAL CORPssfn_2016930xex31-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016
o
TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________
 
Commission file number 1-33377
Stewardship Financial Corporation
(Exact name of registrant as specified in its charter)
 
 
New Jersey
22-3351447
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
630 Godwin Avenue, Midland Park, NJ
07432
(Address of principal executive offices)
(Zip Code)
 
 
(201) 444-7100
(Registrant's telephone number, including area code)
 
 
 
(Former name, former address and former fiscal year, if changed since last report)

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

The number of shares outstanding, net of treasury stock, of the Registrant’s Common Stock, no par value, as of November 8, 2016 was 6,118,248.




Stewardship Financial Corporation 
INDEX
 
 
PAGE
 
NUMBER
 
 
 
 
 
 
1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Financial Condition

 
September 30,
2016
 
December 31, 2015
 
(Unaudited)
 
 
Assets
 

 
 

Cash and due from banks
$
20,700,000

 
$
10,731,000

Other interest-earning assets
325,000

 
179,000

Cash and cash equivalents
21,025,000

 
10,910,000

 
 
 
 
Securities available-for-sale
103,546,000

 
93,354,000

Securities held to maturity; estimated fair value of $54,987,000 (2016)
 

 
 

and $61,281,000 (2015)
54,179,000

 
60,738,000

Federal Home Loan Bank of New York stock, at cost
2,425,000

 
2,608,000

Loans held for sale
300,000

 
1,522,000

Loans, net of allowance for loan losses of $8,150,000 (at September 30, 2016)
 

 
 

     and $8,823,000 (at December 31, 2015)
543,846,000

 
517,556,000

Premises and equipment, net
6,643,000

 
6,799,000

Accrued interest receivable
1,998,000

 
1,967,000

Other real estate owned, net
834,000

 
880,000

Bank owned life insurance
16,439,000

 
14,111,000

Other assets
6,692,000

 
7,443,000

Total assets
$
757,927,000

 
$
717,888,000

 
 
 
 
Liabilities and Shareholders' equity
 

 
 

 
 
 
 
Liabilities
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
172,072,000

 
$
147,828,000

Interest-bearing
474,012,000

 
456,925,000

Total deposits
646,084,000

 
604,753,000

 
 
 
 
Federal Home Loan Bank of New York advances
35,000,000

 
40,000,000

Subordinated Debentures and Subordinated Notes
23,235,000

 
23,186,000

Accrued interest payable
473,000

 
791,000

Accrued expenses and other liabilities
1,567,000

 
1,585,000

Total liabilities
706,359,000

 
670,315,000

 
 
 
 
Shareholders' equity
 

 
 

Common stock, no par value; 10,000,000 shares authorized;
 

 
 

6,118,248 and 6,085,528 shares issued and outstanding
 

 
 

at September 30, 2016, and December 31, 2015, respectively
41,604,000

 
41,410,000

Retained earnings
9,871,000

 
7,008,000

Accumulated other comprehensive income (loss), net
93,000

 
(845,000
)
Total Shareholders' equity
51,568,000

 
47,573,000

Total liabilities and Shareholders' equity
$
757,927,000

 
$
717,888,000


See accompanying notes to consolidated financial statements.      




1


Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Income (Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Interest income:
 

 
 

 
 
 
 
Loans
$
5,833,000

 
$
5,689,000

 
$
17,601,000

 
$
16,758,000

Securities held to maturity:
 

 
 

 


 


Taxable
272,000

 
243,000

 
840,000

 
683,000

Nontaxable
77,000

 
114,000

 
280,000

 
363,000

Securities available-for-sale:
 

 
 

 


 


Taxable
408,000

 
320,000

 
1,194,000

 
1,024,000

Nontaxable
9,000

 
6,000

 
21,000

 
18,000

FHLB dividends
30,000

 
30,000

 
93,000

 
93,000

Other interest-earning assets
28,000

 
10,000

 
56,000

 
27,000

Total interest income
6,657,000

 
6,412,000

 
20,085,000

 
18,966,000

Interest expense:
 

 
 

 
 
 
 
Deposits
586,000

 
545,000

 
1,704,000

 
1,503,000

FHLB-NY Borrowings
164,000

 
213,000

 
568,000

 
640,000

Subordinated Debentures and Subordinated Notes
363,000

 
235,000

 
1,138,000

 
485,000

Total interest expense
1,113,000

 
993,000

 
3,410,000

 
2,628,000

Net interest income before provision for loan losses
5,544,000

 
5,419,000

 
16,675,000

 
16,338,000

Provision for loan losses
(250,000
)
 
(400,000
)
 
(1,050,000
)
 
(1,100,000
)
Net interest income after provision for loan losses
5,794,000

 
5,819,000

 
17,725,000

 
17,438,000

Noninterest income:
 

 
 

 
 
 
 
Fees and service charges
536,000

 
541,000

 
1,595,000

 
1,577,000

Bank owned life insurance
120,000

 
103,000

 
328,000

 
300,000

Gain on calls and sales of securities, net
6,000

 

 
62,000

 
152,000

Gain on sales of mortgage loans
33,000

 
52,000

 
70,000

 
117,000

Gain on sale of other real estate owned

 

 
6,000

 
53,000

Miscellaneous
128,000

 
142,000

 
413,000

 
439,000

Total noninterest income
823,000

 
838,000

 
2,474,000

 
2,638,000

Noninterest expenses:
 

 
 

 
 
 
 
Salaries and employee benefits
2,788,000

 
2,785,000

 
8,245,000

 
8,181,000

Occupancy, net
400,000

 
427,000

 
1,202,000

 
1,317,000

Equipment
155,000

 
175,000

 
453,000

 
496,000

Data processing
485,000

 
468,000

 
1,434,000

 
1,380,000

Advertising
165,000

 
195,000

 
473,000

 
665,000

FDIC insurance premium
100,000

 
87,000

 
296,000

 
317,000

Charitable contributions
80,000

 
90,000

 
240,000

 
230,000

Stationery and supplies
42,000

 
59,000

 
122,000

 
119,000

Legal
58,000

 
65,000

 
148,000

 
258,000

Bank-card related services
150,000

 
144,000

 
431,000

 
398,000

Other real estate owned
27,000

 
118,000

 
129,000

 
279,000

Miscellaneous
549,000

 
512,000

 
1,727,000

 
1,639,000

Total noninterest expenses
4,999,000

 
5,125,000

 
14,900,000

 
15,279,000

Income before income tax expense
1,618,000

 
1,532,000

 
5,299,000

 
4,797,000

Income tax expense
583,000

 
532,000

 
1,911,000

 
1,658,000

Net income
1,035,000

 
1,000,000

 
3,388,000

 
3,139,000

Dividends on preferred stock

 
114,000

 

 
456,000

Net income available to common shareholders
$
1,035,000

 
$
886,000

 
$
3,388,000

 
$
2,683,000

Basic and diluted earnings per common share
$
0.17

 
$
0.15

 
$
0.55

 
$
0.44

Weighted average number of basic and diluted common shares outstanding
6,115,987

 
6,091,627

 
6,106,723

 
6,074,763


See accompanying notes to consolidated financial statements. 

2


Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
1,035,000

 
$
1,000,000

 
$
3,388,000

 
$
3,139,000

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in unrealized holding gains (losses) on securities available-for-sale
(86,000
)
 
265,000

 
830,000

 
403,000

Reclassification adjustment for gains in net income
(3,000
)
 

 
(38,000
)
 
(91,000
)
Accretion of loss on securities reclassified to held to maturity
39,000

 
29,000

 
109,000

 
150,000

Change in fair value of interest rate swap

 
39,000

 
37,000

 
110,000

Total other comprehensive income (loss)
(50,000
)
 
333,000

 
938,000

 
572,000

Total comprehensive income
$
985,000

 
$
1,333,000

 
$
4,326,000

 
$
3,711,000

 
See accompanying notes to consolidated financial statements.


3


Stewardship Financial Corporation and Subsidiary
Consolidated Statement of Changes in Shareholders' Equity
(Unaudited)
 
Nine Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
Accumulated
Other
Comprehensive
 
 
 
Preferred
 
Common Stock
 
Retained
 
Income
 
 
 
Stock
 
Shares
 
Amount
 
Earnings
 
(Loss), Net
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Balance -- December 31, 2015
$

 
6,085,528

 
$
41,410,000

 
$
7,008,000

 
$
(845,000
)
 
$
47,573,000

Cash dividends declared on common stock

 

 

 
(488,000
)
 

 
(488,000
)
Payment of discount on dividend reinvestment plan

 

 
(3,000
)
 

 

 
(3,000
)
Common stock issued under dividend reinvestment plan

 
10,089

 
59,000

 

 

 
59,000

Common stock issued under stock plans

 
3,590

 
21,000

 

 

 
21,000

Issuance of restricted stock

 
34,332

 
198,000

 
(198,000
)
 

 

Amortization of restricted stock, net

 
(15,291
)
 
(86,000
)
 
161,000

 

 
75,000

Tax benefit from restricted stock vesting

 

 
5,000

 

 

 
5,000

Net income

 

 

 
3,388,000

 

 
3,388,000

Other comprehensive income

 

 

 

 
938,000

 
938,000

Balance -- September 30, 2016
$

 
6,118,248

 
$
41,604,000

 
$
9,871,000

 
$
93,000

 
$
51,568,000


 
Nine Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
Accumulated
Other
Comprehensive
 
 
 
Preferred
 
Common Stock
 
Retained
 
Income
 
 
 
Stock
 
Shares
 
Amount
 
Earnings
 
(Loss), Net
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Balance -- December 31, 2014
$
14,984,000

 
6,034,933

 
$
41,125,000

 
$
3,817,000

 
$
(957,000
)
 
$
58,969,000

Cash dividends declared on common stock

 

 

 
(364,000
)
 

 
(364,000
)
Payment of discount on dividend reinvestment plan

 

 
(2,000
)
 

 

 
(2,000
)
Cash dividends declared on preferred stock

 

 

 
(456,000
)
 

 
(456,000
)
Common stock issued under dividend reinvestment plan

 
8,204

 
44,000

 

 

 
44,000

Common stock issued under stock plans

 
6,233

 
33,000

 

 

 
33,000

Issuance of restricted stock

 
50,974

 
279,000

 
(279,000
)
 

 

Amortization of restricted stock, net

 
(7,062
)
 
(38,000
)
 
118,000

 

 
80,000

Tax benefit from restricted stock vesting

 

 
3,000

 

 

 
3,000

Amortization of issuance costs
16,000

 

 

 
(16,000
)
 

 

Repurchase of SBLF preferred stock
(15,000,000
)
 

 

 

 

 
(15,000,000
)
Net income

 

 

 
3,139,000

 

 
3,139,000

Other comprehensive income

 

 

 

 
572,000

 
572,000

Balance -- September 30, 2015
$

 
6,093,282

 
$
41,444,000

 
$
5,959,000

 
$
(385,000
)
 
$
47,018,000


See accompanying notes to consolidated financial statements.

4


Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash flows from operating activities:
 

 
 

Net income
$
3,388,000

 
$
3,139,000

Adjustments to reconcile net income to
 

 
 

net cash provided by operating activities:
 

 
 

Depreciation and amortization of premises and equipment
282,000

 
290,000

Amortization of premiums and accretion of discounts, net
470,000

 
514,000

Amortization of restricted stock
75,000

 
80,000

Amortization of subordinated debenture issuance costs
49,000

 
6,000

Accretion of deferred loan fees
75,000

 
66,000

Provision for loan losses
(1,050,000
)
 
(1,100,000
)
Originations of mortgage loans held for sale
(5,115,000
)
 
(9,037,000
)
Proceeds from sale of mortgage loans
6,407,000

 
7,584,000

Gain on sales of mortgage loans
(70,000
)
 
(117,000
)
Gain on calls and sales of securities
(62,000
)
 
(152,000
)
Gain on sale of other real estate owned
(6,000
)
 
(53,000
)
Deferred income tax expense
208,000

 
331,000

(Increase) decrease in accrued interest receivable
(31,000
)
 
133,000

Increase (decrease) in accrued interest payable
(318,000
)
 
179,000

Earnings on bank owned life insurance
(328,000
)
 
(300,000
)
(Increase) decrease in other assets
(1,000
)
 
718,000

Increase (decrease) in other liabilities
19,000

 
(2,172,000
)
Net cash provided by operating activities
3,992,000

 
109,000

Cash flows from investing activities:
 

 
 

Purchase of securities available-for-sale
(39,683,000
)
 
(85,000
)
Proceeds from maturities and principal repayments on securities available-for-sale
10,617,000

 
9,451,000

Proceeds from sales and calls on securities available-for-sale
19,852,000

 
28,845,000

Purchase of securities held to maturity
(32,403,000
)
 
(18,462,000
)
Proceeds from maturities and principal repayments on securities held to maturity
7,321,000

 
7,397,000

Proceeds from calls on securities held to maturity
31,720,000

 
6,000,000

Sale of FHLB-NY stock
183,000

 
742,000

Net increase in loans
(25,467,000
)
 
(41,014,000
)
Proceeds from sale of other real estate owned
184,000

 
1,149,000

Purchase of bank owned life insurance
(2,000,000
)
 

Additions to premises and equipment
(126,000
)
 
(596,000
)
Net cash used in investing activities
(29,802,000
)
 
(6,573,000
)
Cash flows from financing activities:
 

 
 

Net increase in noninterest-bearing deposits
24,244,000

 
14,357,000

Net increase in interest-bearing deposits
17,087,000

 
15,035,000

Decrease in long term borrowings
(5,000,000
)
 

Repurchase of SBLF preferred stock

 
(15,000,000
)
Proceeds from issuance of subordinated notes

 
15,953,000

Net decrease in short term borrowings

 
(17,200,000
)
Cash dividends paid on common stock
(488,000
)
 
(364,000
)
Cash dividends paid on preferred stock

 
(456,000
)
Payment of discount on dividend reinvestment plan
(3,000
)
 
(2,000
)
Issuance of common stock for cash
80,000

 
77,000

Tax benefit from restricted stock vesting
5,000

 
3,000

Net cash provided by financing activities
35,925,000

 
12,403,000

Net increase in cash and cash equivalents
10,115,000

 
5,939,000

Cash and cash equivalents - beginning
10,910,000

 
10,086,000

Cash and cash equivalents - ending
$
21,025,000

 
$
16,025,000


5



Stewardship Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows (continued)
(Unaudited)
 
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Supplemental disclosures of cash flow information:
 

 
 

Cash paid during the period for interest
$
3,728,000

 
$
2,449,000

Cash paid during the period for income taxes
$
1,486,000

 
$
1,736,000

Transfers from loans to other real estate owned
$
152,000

 
$
477,000

 
See accompanying notes to consolidated financial statements.  


6


Stewardship Financial Corporation and Subsidiary
Notes to Consolidated Financial Statements
September 30, 2016
(Unaudited)
 
Note 1. Summary of Significant Accounting Policies
 
Certain information and note disclosures normally included in the unaudited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These unaudited consolidated financial statements should be read in conjunction with the audited 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, 2015, filed with the SEC on March 24, 2016 (the “2015 Annual Report”).
 
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 three and nine months ended September 30, 2016 are not necessarily indicative of the results which may be expected for the entire year.
 
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 foreclosure or deed in lieu of foreclosure. The Bank’s subsidiaries have an insignificant impact on the Bank’s daily operations. All intercompany accounts and transactions have been eliminated in the consolidated financial statements.
 
The consolidated financial statements of the Corporation have been prepared in conformity with GAAP. In preparing the consolidated financial statements, management is required to make estimates and assumptions, based on available information, that affect the amounts reported in the consolidated 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 deferred income taxes. Management believes the Corporation’s policies with respect to the methodology for the determination of the allowance for loan losses and the evaluation of deferred income taxes involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors.
 
Adoption of New Accounting Standards
 
In April 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2015-03, “Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs.” This ASU is part of the FASB’s initiative to reduce complexity in accounting standards. To simplify presentation of debt issuance costs, the amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in ASU 2015-03 are effective for fiscal years, including interim periods, beginning after December 15, 2015. The adoption of the amendments in this standard did not have a material impact on the Corporation’s consolidated financial statements.


7


In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Liabilities." This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This amendment supersedes the guidance to classify equity securities with readily determinable fair values into different categories, requires equity securities to be measured at fair value with changes in the fair value recognized through net income, and simplifies the impairment assessment of equity investments without readily determinable fair values. The amendment requires public business entities that are required to disclose the fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price notion. The amendment requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option. The amendment requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. The amendment reduces diversity in current practice by clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity’s other deferred tax assets. This amendment is effective for fiscal years, including interim periods, beginning after December 15, 2017. Entities should apply the amendment by means of a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, with the exception of the amendment related to equity securities without readily determinable fair values, which should be applied prospectively to equity investments that exist as of the date of adoption. The Corporation is currently evaluating the impact that the adoption of the guidance will have on the Corporation's consolidated financial statements.
 
In February 2016, the FASB issued ASU 2016-02, “Leases (Subtopic 842).” This ASU requires all lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Lessor accounting remains largely unchanged under the new guidance. The amendments in ASU 2016-02 are effective for fiscal years, including interim periods, beginning after December 15, 2018. Early adoption of ASU 2016-02 is permitted. The Corporation is currently assessing the impact that the adoption of the guidance will have on the Corporation's consolidated financial statements.
 
In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”. The objective of this ASU is to simplify accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under ASU 2016-09, all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current accounting) or account for forfeitures when they occur. Within the Cash Flow Statement, excess tax benefits should be classified along with other income tax cash flows as an operating activity, and cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity. The amendments in ASU 2016-09 are effective for fiscal years, including interim periods, beginning after December 15, 2016. Early adoption of ASU 2016-09 is permitted. The Corporation is currently assessing the impact that the adoption of the guidance will have on the Corporation's consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments by a reporting entity at each reporting date. The amendments in this ASU require financial assets measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses would represent a valuation account that would be deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement would reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses would be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity will be required to use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The amendments in ASU

8


2016-13 are effective for fiscal years, including interim periods, beginning after December 15, 2019. Early adoption of ASU 2016-09 is permitted for fiscal years beginning after December 15, 2018. The Corporation is currently evaluating the potential impact that the adoption of the guidance will have on the Corporation's consolidated financial statements.


Note 2. Securities – Available-for-Sale and Held to Maturity
 
The fair value of the available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
 
 
September 30, 2016
 
Amortized
 
Gross Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
 
 
 
 
 
 
 
U.S. government-sponsored agencies
$
20,252,000

 
$
127,000

 
$
11,000

 
$
20,368,000

Obligations of state and political subdivisions
2,317,000

 
24,000

 
13,000

 
2,328,000

Mortgage-backed securities
55,006,000

 
570,000

 
66,000

 
55,510,000

Asset-backed securities (a)
8,870,000

 

 
140,000

 
8,730,000

Corporate debt
12,952,000

 
50,000

 
144,000

 
12,858,000

 
 
 
 
 
 
 
 
Total debt securities
99,397,000

 
771,000

 
374,000

 
99,794,000

Other equity investments
3,858,000

 

 
106,000

 
3,752,000

 
 
 
 
 
 
 
 
 
$
103,255,000

 
$
771,000

 
$
480,000

 
$
103,546,000

 
 
December 31, 2015
 
Amortized
 
Gross Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
 
 
 
 
 
 
 
U.S. government-sponsored agencies
$
31,266,000

 
$
81,000

 
$
393,000

 
$
30,954,000

Obligations of state and political subdivisions
1,409,000

 
2,000

 
1,000

 
1,410,000

Mortgage-backed securities
45,520,000

 
213,000

 
496,000

 
45,237,000

Asset-backed securities (a)
9,877,000

 

 
176,000

 
9,701,000

Corporate debt
2,500,000

 

 
81,000

 
2,419,000

 
 
 
 
 
 
 
 
Total debt securities
90,572,000

 
296,000

 
1,147,000

 
89,721,000

Other equity investments
3,778,000

 

 
145,000

 
3,633,000

 
 
 
 
 
 
 
 
 
$
94,350,000

 
$
296,000

 
$
1,292,000

 
$
93,354,000

 
(a) Collateralized by student loans
 
Cash proceeds realized from sales and calls of securities available-for-sale for the three and nine months ended September 30, 2016 were $8,803,000 and $19,852,000, respectively. Cash proceeds realized from sales and calls of securities available-for-sale for the three and nine months ended September 30, 2015 were $1,000,000 and $28,845,000, respectively. There were gross gains totaling $3,000 and no gross losses realized on calls during the three months ended September 30, 2016. There were gross gains totaling $10,000 and no gross losses realized on calls during the nine months ended September 30, 2016. While there were no gross gains and no gross losses realized on sales or calls during the three months ended September 30, 2015, gross gains and gross losses realized on sales and calls during the nine months ended September 30, 2015 totaled $213,000 and $61,000, respectively.

9



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

 
September 30, 2016
 
Amortized
 
Gross Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
 
 
 
 
 
 
 
U.S. Treasury
$
999,000

 
$
14,000

 
$

 
$
1,013,000

U.S. government-sponsored agencies
17,172,000

 
63,000

 
65,000

 
17,170,000

Obligations of state and political subdivisions
7,542,000

 
120,000

 
5,000

 
7,657,000

Mortgage-backed securities
28,466,000

 
681,000

 

 
29,147,000

 
 
 
 
 
 
 
 
 
$
54,179,000

 
$
878,000

 
$
70,000

 
$
54,987,000

 
 
December 31, 2015
 
Amortized
 
Gross Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
 
 
 
 
 
 
 
U.S. Treasury
$
999,000

 
$

 
$
11,000

 
$
988,000

U.S. government-sponsored agencies
15,109,000

 
132,000

 
24,000

 
15,217,000

Obligations of state and political subdivisions
11,219,000

 
268,000

 

 
11,487,000

Mortgage-backed securities
33,411,000

 
295,000

 
117,000

 
33,589,000

 
 
 
 
 
 
 
 
 
$
60,738,000

 
$
695,000

 
$
152,000

 
$
61,281,000

 
Cash proceeds realized from calls of securities held to maturity for the three and nine months ended September 30, 2016 were $15,150,000 and $31,720,000, respectively. Cash proceeds realized from calls of securities held to maturity for the three and nine months ended September 30, 2015 were $900,000 and $6,000,000, respectively. There were gross gains totaling $3,000 and no gross losses realized on calls during the three months ended September 30, 2016. There were gross gains totaling $52,000 and no gross losses realized on calls during the nine months ended September 30, 2016. There were no gross gains and no gross losses realized on calls during the three and nine months ended September 30, 2015.
 
Mortgage-backed securities are a type of asset-backed security secured by a mortgage or collection of mortgages, purchased by government agencies such as the Government National Mortgage Association and government sponsored agencies such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, which then issue securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool.
 
Issuers may have the right to call or prepay obligations with or without call or prepayment penalties. This might cause actual maturities to differ from the contractual maturities.

10



The following table presents the amortized cost and fair value of the debt securities portfolio by contractual maturity. As issuers may have the right to call or prepay obligations with or without call or prepayment premiums, the actual maturities may differ from contractual maturities. Securities not due at a single maturity date, such as mortgage-backed securities and asset-backed securities, are shown separately.
 
 
September 30, 2016
 
Amortized
Cost
 
Fair
Value
 
 
 
 
Available-for-sale
 

 
 

Within one year
$
500,000

 
$
501,000

After one year, but within five years
7,041,000

 
7,080,000

After five years, but within ten years
22,025,000

 
22,028,000

After ten years
5,955,000

 
5,945,000

Mortgage-backed securities
55,006,000

 
55,510,000

Asset-backed securities
8,870,000

 
8,730,000

 
 
 
 
Total
$
99,397,000

 
$
99,794,000

 
 
 
 
Held to maturity
 

 
 

Within one year
$
1,733,000

 
$
1,754,000

After one year, but within five years
7,201,000

 
7,353,000

After five years, but within ten years
15,271,000

 
15,235,000

After ten years
1,508,000

 
1,498,000

Mortgage-backed securities
28,466,000

 
29,147,000

 
 
 
 
Total
$
54,179,000

 
$
54,987,000

 
The following tables summarize the fair value and unrealized losses of those investment securities which reported an unrealized loss at September 30, 2016 and December 31, 2015, and if the unrealized loss position was continuous for the twelve months prior to September 30, 2016 and December 31, 2015.
Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government- sponsored agencies
$
6,160,000

 
$
(2,000
)
 
$
3,785,000

 
$
(9,000
)
 
$
9,945,000

 
$
(11,000
)
Obligations of state and political subdivisions
901,000

 
(13,000
)
 

 

 
901,000

 
(13,000
)
Mortgage-backed securities
9,152,000

 
(36,000
)
 
3,615,000

 
(30,000
)
 
12,767,000

 
(66,000
)
Asset-backed securities

 

 
8,729,000

 
(140,000
)
 
8,729,000

 
(140,000
)
Corporate debt
6,850,000

 
(103,000
)
 
959,000

 
(41,000
)
 
7,809,000

 
(144,000
)
Other equity investments

 

 
3,692,000

 
(106,000
)
 
3,692,000

 
(106,000
)
 
 

 
 

 
 

 
 

 
 

 
 

Total temporarily impaired securities
$
23,063,000

 
$
(154,000
)
 
$
20,780,000

 
$
(326,000
)
 
$
43,843,000

 
$
(480,000
)


11


December 31, 2015
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government- sponsored agencies
$
18,396,000

 
$
(183,000
)
 
$
7,296,000

 
$
(210,000
)
 
$
25,692,000

 
$
(393,000
)
Obligations of state and political subdivisions
984,000

 
(1,000
)
 

 

 
984,000

 
(1,000
)
Mortgage-backed securities
8,599,000

 
(69,000
)
 
16,278,000

 
(427,000
)
 
24,877,000

 
(496,000
)
Asset-backed securities
6,791,000

 
(56,000
)
 
2,910,000

 
(120,000
)
 
9,701,000

 
(176,000
)
Corporate debt

 

 
1,419,000

 
(81,000
)
 
1,419,000

 
(81,000
)
Other equity investments

 

 
3,573,000

 
(145,000
)
 
3,573,000

 
(145,000
)
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
$
34,770,000

 
$
(309,000
)
 
$
31,476,000

 
$
(983,000
)
 
$
66,246,000

 
$
(1,292,000
)
 
Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government- sponsored agencies
$
8,831,000

 
$
(65,000
)
 
$

 
$

 
$
8,831,000

 
$
(65,000
)
Obligations of state and political subdivisions
738,000

 
(5,000
)
 

 

 
738,000

 
(5,000
)
 
 

 
 

 
 

 
 

 
 

 
 

Total temporarily impaired securities
$
9,569,000

 
$
(70,000
)
 
$

 
$

 
$
9,569,000

 
$
(70,000
)
 
December 31, 2015
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
988,000

 
$
(11,000
)
 
$

 
$

 
$
988,000

 
$
(11,000
)
U.S. government- sponsored agencies
4,955,000

 
(24,000
)
 

 

 
4,955,000

 
(24,000
)
Mortgage-backed securities
15,183,000

 
(90,000
)
 
1,066,000

 
(27,000
)
 
16,249,000

 
(117,000
)
 
 

 
 

 
 

 
 

 
 

 
 

Total temporarily impaired securities
$
21,126,000

 
$
(125,000
)
 
$
1,066,000

 
$
(27,000
)
 
$
22,192,000

 
$
(152,000
)
 
Other-Than-Temporary-Impairment
 
At September 30, 2016, there were available-for-sale investments comprising two U.S. government-sponsored agency securities, five mortgage-backed securities, three asset-backed securities, one corporate debt security, and one other equity investments security in a continuous loss position for twelve months or longer. Management has assessed the securities that were in an unrealized loss position at September 30, 2016 and December 31, 2015 and has determined that any decline in fair value below amortized cost primarily relates to changes in interest rates and market spreads and was temporary.


12


In making this determination management considered the following factors in estimating the cash flows expected to be collected from the security: the period of time the securities were in an unrealized loss position; the percentage decline in comparison to the securities’ amortized cost; any adverse conditions specifically related to the security, an industry or a geographic area; the rating or changes to the rating by a credit rating agency; the financial condition of the issuer and guarantor and any recoveries or additional declines in fair value subsequent to the balance sheet date. The Corporation expects to collect all amounts contractually due and none of the debt securities can be prepaid at less than the par values.
 
The Corporation does not intend to sell these securities in an unrealized loss position and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost bases, which may be at maturity.
 
Note 3. Loans and Allowance for Loan Losses
 
At September 30, 2016 and December 31, 2015, respectively, the loan portfolio consisted of the following:

 
September 30,
2016
 
December 31,
2015
Commercial:
 

 
 

Secured by real estate
$
34,252,000

 
$
37,993,000

Other
37,738,000

 
26,867,000

Commercial real estate
347,556,000

 
334,489,000

Commercial construction
10,576,000

 
4,609,000

Residential real estate
81,700,000

 
82,955,000

Consumer:
 

 
 

Secured by real estate
29,368,000

 
29,224,000

Other
212,000

 
580,000

Government Guaranteed Loans - guaranteed portion
10,637,000

 
9,626,000

Other
67,000

 
134,000

 
 
 
 
Total gross loans
552,106,000

 
526,477,000

 
 
 
 
Less: Deferred loan costs, net
110,000

 
98,000

          Allowance for loan losses
8,150,000

 
8,823,000

 
8,260,000

 
8,921,000

 
 
 
 
Loans, net
$
543,846,000

 
$
517,556,000

 
The Corporation has purchased the guaranteed portion of several government guaranteed loans. Due to the guarantee of the principal amount of these loans, no allowance for loan losses is established for these government guaranteed loans.
 


13



Activity in the allowance for loan losses is summarized as follows:
 
 
For the three months ended September 30, 2016
 
Balance,
beginning
of period
 
Provision
charged
to operations
 
Loans
charged off
 
Recoveries
of loans
charged off
 
Balance,
end
of period
 
 
 
 
 
 
 
 
 
 
Commercial
$
3,673,000

 
$
(460,000
)
 
$
(68,000
)
 
$
23,000

 
$
3,168,000

Commercial real estate
4,224,000

 
216,000

 
(18,000
)
 
78,000

 
4,500,000

Commercial construction
184,000

 
67,000

 

 

 
251,000

Residential real estate
106,000

 
(32,000
)
 

 

 
74,000

Consumer
132,000

 
(32,000
)
 
(3,000
)
 

 
97,000

Other loans

 

 
(1,000
)
 
1,000

 

Unallocated
69,000

 
(9,000
)
 

 

 
60,000

 
 
 
 
 
 
 
 
 
 
Total
$
8,388,000

 
$
(250,000
)
 
$
(90,000
)
 
$
102,000

 
$
8,150,000

 
 
For the nine months ended September 30, 2016
 
Balance,
beginning
of period
 
Provision
charged
to operations
 
Loans
charged off
 
Recoveries
of loans
charged off
 
Balance,
end
of period
 
 
 
 
 
 
 
 
 
 
Commercial
$
3,698,000

 
$
(862,000
)
 
$
(71,000
)
 
$
403,000

 
$
3,168,000

Commercial real estate
4,660,000

 
(215,000
)
 
(82,000
)
 
137,000

 
4,500,000

Commercial construction
114,000

 
137,000

 

 

 
251,000

Residential real estate
109,000

 
(35,000
)
 

 

 
74,000

Consumer
118,000

 
(13,000
)
 
(10,000
)
 
2,000

 
97,000

Other loans
3,000

 
(1,000
)
 
(3,000
)
 
1,000

 

Unallocated
121,000

 
(61,000
)
 

 

 
60,000

 
 
 
 
 
 
 
 
 
 
Total
$
8,823,000

 
$
(1,050,000
)
 
$
(166,000
)
 
$
543,000

 
$
8,150,000

 
 
For the three months ended September 30, 2015
 
Balance,
beginning
of period
 
Provision
charged
to operations
 
Loans
charged off
 
Recoveries
of loans
charged off
 
Balance,
end
of period
 
 
 
 
 
 
 
 
 
 
Commercial
$
3,317,000

 
$
(360,000
)
 
$
(323,000
)
 
$
194,000

 
$
2,828,000

Commercial real estate
5,289,000

 
148,000

 

 
23,000

 
5,460,000

Commercial construction
14,000

 
(15,000
)
 

 
12,000

 
11,000

Residential real estate
140,000

 
(2,000
)
 

 

 
138,000

Consumer
139,000

 
12,000

 

 
1,000

 
152,000

Other loans
3,000

 
1,000

 
(1,000
)
 

 
3,000

Unallocated
397,000

 
(184,000
)
 

 

 
213,000

 
 
 
 
 
 
 
 
 
 
Total
$
9,299,000

 
$
(400,000
)
 
$
(324,000
)
 
$
230,000

 
$
8,805,000


14


 
For the nine months ended September 30, 2015
 
Balance,
beginning
of period
 
Provision
charged
to operations
 
Loans
charged off
 
Recoveries
of loans
charged off
 
Balance,
end
of period
 
 
 
 
 
 
 
 
 
 
Commercial
$
3,704,000

 
$
(701,000
)
 
$
(595,000
)
 
$
420,000

 
$
2,828,000

Commercial real estate
5,017,000

 
319,000

 

 
124,000

 
5,460,000

Commercial construction
150,000

 
(492,000
)
 

 
353,000

 
11,000

Residential real estate
142,000

 
(4,000
)
 

 

 
138,000

Consumer
189,000

 
(40,000
)
 

 
3,000

 
152,000

Other loans
2,000

 
3,000

 
(2,000
)
 

 
3,000

Unallocated
398,000

 
(185,000
)
 

 

 
213,000

 
 
 
 
 
 
 
 
 
 
Total
$
9,602,000

 
$
(1,100,000
)
 
$
(597,000
)
 
$
900,000

 
$
8,805,000



 


 
 

 
 

 

 

 

 
 
 

 




15


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 September 30, 2016 and December 31, 2015.


 
September 30, 2016
 
Commercial
 
Commercial
Real Estate
 
Commercial
Construction
 
Residential
Real Estate
 
Consumer
 
Government
Guaranteed
 
Other
Loans
 
Unallocated
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending allowance balance attributable to loans
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
10,000

 
$
607,000

 
$

 
$

 
$

 
$

 
$

 
$

 
$
617,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
3,158,000

 
3,893,000

 
251,000

 
74,000

 
97,000

 

 

 
60,000

 
7,533,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total ending allowance balance
$
3,168,000

 
$
4,500,000

 
$
251,000

 
$
74,000

 
$
97,000

 
$

 
$

 
$
60,000

 
$
8,150,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$
2,169,000

 
$
6,081,000

 
$

 
$

 
$
80,000

 
$

 
$

 
$

 
$
8,330,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans collectively evaluated for impairment
69,821,000

 
341,475,000

 
10,576,000

 
81,700,000

 
29,500,000

 
10,637,000

 
67,000

 

 
543,776,000

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Total ending loan balance
$
71,990,000

 
$
347,556,000

 
$
10,576,000

 
$
81,700,000

 
$
29,580,000

 
$
10,637,000

 
$
67,000

 
$

 
$
552,106,000



16


 
December 31, 2015
 
Commercial
 
Commercial
Real Estate
 
Commercial
Construction
 
Residential
Real Estate
 
Consumer
 
Government
Guaranteed
 
Other
Loans
 
Unallocated
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending allowance balance attributable to loans
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
81,000

 
$
638,000

 
$

 
$

 
$

 
$

 
$

 
$

 
$
719,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
3,617,000

 
4,022,000

 
114,000

 
109,000

 
118,000

 

 
3,000

 
121,000

 
8,104,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total ending allowance balance
$
3,698,000

 
$
4,660,000

 
$
114,000

 
$
109,000

 
$
118,000

 
$

 
$
3,000

 
$
121,000

 
$
8,823,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$
3,348,000

 
$
8,113,000

 
$

 
$

 
$
84,000

 
$

 
$

 
$

 
$
11,545,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans collectively evaluated for impairment
61,512,000

 
326,376,000

 
4,609,000

 
82,955,000

 
29,720,000

 
9,626,000

 
134,000

 

 
514,932,000

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Total ending loan balance
$
64,860,000

 
$
334,489,000

 
$
4,609,000

 
$
82,955,000

 
$
29,804,000

 
$
9,626,000

 
$
134,000

 
$

 
$
526,477,000




The following table presents the recorded investment in nonaccrual loans at the dates indicated:
 
September 30, 2016
 
December 31, 2015
Commercial:
 

 
 

Secured by real estate
$
598,000

 
$
1,300,000

Other

 
14,000

Commercial real estate
252,000

 
484,000

Consumer:
 

 
 

Secured by real estate
79,000

 
84,000

 
 
 
 
Total nonaccrual loans
$
929,000

 
$
1,882,000


At September 30, 2016 and December 31, 2015, there were no loans that were past due 90 days and still accruing.

17



The following table presents loans individually evaluated for impairment by class of loan at and for the periods indicated:

 
At and for the nine months ended September 30, 2016
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance for
Loan Losses
Allocated
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

 
 

Secured by real estate
$
2,061,000

 
$
1,805,000

 
 

 
$
2,184,000

 
$
68,000

Other

 

 
 

 
34,000

 

Commercial real estate
3,151,000

 
2,891,000

 
 

 
3,121,000

 
149,000

Consumer:
 

 
 

 
 

 
 

 
 

Secured by real estate
82,000

 
80,000

 
 

 
82,000

 

 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

 
 

Secured by real estate
121,000

 
121,000

 
$

 
203,000

 
7,000

Other
243,000

 
243,000

 
10,000

 
253,000

 
14,000

Commercial real estate
3,190,000

 
3,190,000

 
607,000

 
4,342,000

 
98,000

 
 
 
 
 
 
 
 
 
 
 
$
8,848,000

 
$
8,330,000

 
$
617,000

 
$
10,219,000

 
$
336,000


During the three and nine months ended September 30, 2016, no interest income was recognized on a cash basis.
 
At and for the year ended December 31, 2015
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance for
Loan Losses
Allocated
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

 
 

Secured by real estate
$
3,244,000

 
$
2,729,000

 
 

 
$
3,683,000

 
$
156,000

Other
137,000

 
137,000

 
 

 
61,000

 
2,000

Commercial real estate
3,245,000

 
2,885,000

 
 

 
2,890,000

 
121,000

Commercial construction

 

 
 

 
215,000

 

Residential real estate

 

 
 

 
74,000

 

Consumer:
 

 
 

 
 

 
 

 
 

Secured by real estate
84,000

 
84,000

 
 

 
226,000

 

 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

 
 

Secured by real estate
390,000

 
308,000

 
$
80,000

 
405,000

 
14,000

Other
174,000

 
174,000

 
1,000

 
463,000

 
31,000

Commercial real estate
5,228,000

 
5,228,000

 
638,000

 
5,534,000

 
211,000

 
 
 
 
 
 
 
 
 
 
 
$
12,502,000

 
$
11,545,000

 
$
719,000

 
$
13,551,000

 
$
535,000



18


During the year ended December 31, 2015, no interest income was recognized on a cash basis.

The following table presents the aging of the recorded investment in past due loans by class of loans as of September 30, 2016 and December 31, 2015. Nonaccrual loans are included in the disclosure by payment status.

 
September 30, 2016
 
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
$

 
$

 
$
598,000

 
$
598,000

 
$
33,654,000

 
$
34,252,000

Other

 

 

 

 
37,738,000

 
37,738,000

Commercial real estate
158,000

 

 
252,000

 
410,000

 
347,146,000

 
347,556,000

Commercial construction

 

 

 

 
10,576,000

 
10,576,000

Residential real estate
315,000

 

 

 
315,000

 
81,385,000

 
81,700,000

Consumer:
 
 
 
 
 
 
 
 
 
 
 

Secured by real estate
69,000

 

 
40,000

 
109,000

 
29,259,000

 
29,368,000

Other

 

 

 

 
212,000

 
212,000

Government Guaranteed

 

 

 

 
10,637,000

 
10,637,000

Other

 

 

 

 
67,000

 
67,000

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
542,000

 
$

 
$
890,000

 
$
1,432,000

 
$
550,674,000

 
$
552,106,000


 
December 31, 2015
 
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
$

 
$

 
$
1,011,000

 
$
1,011,000

 
$
36,982,000

 
$
37,993,000

Other

 

 

 

 
26,867,000

 
26,867,000

Commercial real estate
271,000

 

 

 
271,000

 
334,218,000

 
334,489,000

Commercial construction

 

 

 

 
4,609,000

 
4,609,000

Residential real estate

 

 

 

 
82,955,000

 
82,955,000

Consumer:
 

 
 

 
 

 
 

 
 

 
 

Secured by real estate
112,000

 

 
41,000

 
153,000

 
29,071,000

 
29,224,000

Other

 

 

 

 
580,000

 
580,000

Government Guaranteed

 

 

 

 
9,626,000

 
9,626,000

Other

 

 

 

 
134,000

 
134,000

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
383,000

 
$

 
$
1,052,000

 
$
1,435,000

 
$
525,042,000

 
$
526,477,000


Troubled Debt Restructurings
 
In order to determine whether a borrower is experiencing financial difficulty necessitating a restructuring, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Corporation’s internal underwriting policy. A loan is considered to be in payment default once it is contractually 90 days past due under the modified terms.
 
At September 30, 2016 and December 31, 2015, the Corporation had $7.7 million and $10.2 million, respectively, of loans whose terms have been modified in troubled debt restructurings. Of these loans, $7.4 million and $9.7 million were performing in accordance with their new terms at September 30, 2016 and December 31, 2015, respectively. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $617,000 and $708,000 have been allocated for the troubled debt restructurings at September 30, 2016 and December 31, 2015, respectively. As of September 30, 2016 and December 31, 2015, the Corporation has committed $178,000 and

19


$138,000, respectively, of additional funds to a single customer with an outstanding line of credit that is classified as a troubled debt restructuring.
 
There are no troubled debt restructurings for which there was a payment default within twelve months following the modification.

There were no new loans classified as a troubled debt restructuring during the three and nine months ended September 30, 2016 or September 30, 2015.
 
Credit Quality Indicators
 
The Corporation categorizes certain loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial, commercial real estate and commercial construction loans. This analysis is performed at the time the loan is originated and annually thereafter. The Corporation uses the following definitions for risk ratings.
 
Special Mention – A Special Mention asset has potential weaknesses that deserve management’s close attention, which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or the Bank’s credit position at some future date. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.
 
Substandard – Substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or by the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
 
Doubtful – A Doubtful loan has all of the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable or improbable. The likelihood of loss is extremely high, but because of certain important and reasonably specific factors, an estimated loss is deferred until a more exact status can be determined.
 
Loss – A loan classified Loss is considered uncollectible and of such little value that its continuance as an asset is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off a basically worthless asset even though partial recovery may be 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 September 30, 2016 and December 31, 2015, and based on the most recent analysis performed at those times, the risk category of loans by class is as follows:

 
September 30, 2016
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
Commercial:
 

 
 

 
 

 
 

 
 

 
 

Secured by real estate
$
32,340,000

 
$
841,000

 
$
1,071,000

 
$

 
$

 
$
34,252,000

Other
36,705,000

 
437,000

 
596,000

 

 

 
37,738,000

Commercial real estate
337,918,000

 
7,946,000

 
1,692,000

 

 

 
347,556,000

Commercial construction
10,576,000

 

 

 

 

 
10,576,000

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
417,539,000

 
$
9,224,000

 
$
3,359,000

 
$

 
$

 
$
430,122,000



20


 
December 31, 2015
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
Commercial:
 

 
 

 
 

 
 

 
 

 
 

Secured by real estate
$
35,263,000

 
$
1,431,000

 
$
1,299,000

 
$

 
$

 
$
37,993,000

Other
25,725,000

 
745,000

 
397,000

 

 

 
26,867,000

Commercial real estate
326,737,000

 
4,034,000

 
3,718,000

 

 

 
334,489,000

Commercial construction
4,609,000

 

 

 

 

 
4,609,000

 
 
 
 
 
 
 
 
 
 
 
 
Total
$
392,334,000

 
$
6,210,000

 
$
5,414,000

 
$

 
$

 
$
403,958,000


The Corporation considers the performance of the loan portfolio and its impact on the allowance for loans losses. 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 September 30, 2016 and December 31, 2015. The past due and nonaccrual amounts include loans that have 1-29 days delinquent.

 
September 30, 2016
 
Current
 
Past Due and
Nonaccrual
 
Total
 
 
 
 
 
 
Residential real estate
$
81,051,000

 
$
649,000

 
$
81,700,000

Consumer:
 

 
 

 
 

Secured by real estate
28,067,000

 
1,301,000

 
29,368,000

Other
210,000

 
2,000

 
212,000

 
 
 
 
 
 
Total
$
109,328,000

 
$
1,952,000

 
$
111,280,000


 
December 31, 2015
 
Current
 
Past Due and
Nonaccrual
 
Total
 
 
 
 
 
 
Residential real estate
$
82,415,000

 
$
540,000

 
$
82,955,000

Consumer:
 

 
 

 
 

Secured by real estate
27,730,000

 
1,494,000

 
29,224,000

Other
578,000

 
2,000

 
580,000

 
 
 
 
 
 
Total
$
110,723,000

 
$
2,036,000

 
$
112,759,000


Note 4. 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.
 

21


The fair values of investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values of investment securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). As the Corporation is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Corporation compares the prices received from the pricing service to a secondary pricing source. The Corporation’s internal price verification procedures have not historically resulted in adjustment in the prices obtained from the pricing service.
 
The interest rate swaps are reported at fair values obtained from brokers who utilize internal models with observable market data inputs to estimate the values of these instruments (Level 2 inputs).
 
The Corporation measures impairment of collateralized loans and other real estate owned (“OREO”) based on the estimated fair value of the collateral less estimated costs to sell the collateral, incorporating assumptions that experienced parties might use in estimating the value of such collateral (Level 3 inputs). At the time a loan or OREO is considered impaired, it is valued at the lower of cost or fair value. Generally, impaired loans carried at fair value have been partially charged-off or receive specific allocations of the allowance for loan losses. OREO is initially recorded at fair value less estimated selling costs. For collateral dependent loans and OREO, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, the net book value recorded for the collateral on the borrower’s financial statements, or aging reports. Collateral is then adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the borrower and borrower’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
 
Appraisals are generally obtained to support the fair value of collateral. Appraisals for both collateral-dependent impaired loans and OREO are performed by licensed appraisers whose qualifications and licenses have been reviewed and verified by the Corporation. The Corporation utilizes a third party to order appraisals and, once received, reviews the assumptions and approaches utilized in the appraisal as well as the resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.
 
Real estate appraisals typically incorporate measures such as recent sales prices for comparable properties. In addition, appraisers may make adjustments to the sales price of the comparable properties as deemed appropriate based on the age, condition or general characteristics of the subject property. Management generally applies a 12% discount to real estate appraised values to cover disposition / selling costs and to reflect the potential price reductions in the market necessary to complete an expedient transaction and to factor in the impact of the perception that a transaction being completed by a bank may result in further price reduction pressure.


22


Assets and Liabilities Measured on a Recurring Basis
 
Assets and liabilities measured at fair value on a 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 September 30, 2016
Assets:
 

 
 

 
 

 
 

Available-for-sale securities
 

 
 

 
 

 
 

U.S. government - sponsored agencies
$
20,368,000

 
$

 
$
20,368,000

 
$

Obligations of state and political subdivisions
2,328,000

 

 
2,328,000

 

Mortgage-backed securities - residential
55,510,000

 

 
55,510,000

 

Asset-backed securities
8,730,000

 

 
8,730,000

 

Corporate debt
12,858,000

 

 
12,858,000

 

Other equity investments
3,752,000

 
3,692,000

 
60,000

 

 
 
 
 
 
 
 
 
Total available-for-sale securities
$
103,546,000

 
$
3,692,000

 
$
99,854,000

 
$

 
 
 
 
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 December 31, 2015
Assets:
 

 
 

 
 

 
 

Available-for-sale securities
 

 
 

 
 

 
 

U.S. government - sponsored agencies
$
30,954,000

 
$

 
$
30,954,000

 
$

Obligations of state and political subdivisions
1,410,000

 

 
1,410,000

 

Mortgage-backed securities - residential
45,237,000

 

 
45,237,000

 

Asset-backed securities
9,701,000

 

 
9,701,000

 

Corporate debt
2,419,000

 

 
2,419,000

 

Other equity investments
3,633,000

 
3,573,000

 
60,000

 

 
 
 
 
 
 
 
 
Total available-for-sale securities
$
93,354,000

 
$
3,573,000

 
$
89,781,000

 
$

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Interest rate swap
$
62,000

 
$

 
$
62,000

 
$

 
There were no transfers of assets between Level 1 and Level 2 during the nine months ended September 30, 2016 or during the year ended December 31, 2015. There were no changes to the valuation techniques for fair value measurements as of September 30, 2016 and December 31, 2015.
 

23


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 September 30, 2016
Assets:
 
 
 
 
 
 
 
Impaired loans
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

Secured by real estate
$
252,000

 
$

 
$

 
$
252,000

Other Real Estate Owned
279,000

 

 

 
279,000

 
 
 
 
 
 
 
 
 
$
531,000

 
$

 
$

 
$
531,000

 
 
 
 
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 December 31, 2015
Assets:
 

 
 

 
 

 
 

Impaired loans
 

 
 

 
 

 
 

Commercial:
 

 
 

 
 

 
 

Secured by real estate
$
367,000

 
$

 
$

 
$
367,000

Consumer
 

 
 

 
 

 
 

Secured by real estate
84,000

 

 

 
84,000

Other Real Estate Owned
880,000

 

 

 
880,000

 
 
 
 
 
 
 
 
 
$
1,331,000

 
$

 
$

 
$
1,331,000

 
Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment value of $252,000, with no valuation allowance, resulting in no change to the provision for loan losses for the nine months ended September 30, 2016.
 
Collateral-dependent impaired loans measured for impairment using the fair value of the collateral had a recorded investment value of $461,000, with a valuation allowance of $10,000, resulting in an increase of the allocation for loan losses of $16,000 for the year ended December 31, 2015.
 
OREO, measured at fair value, had a recorded investment value of $299,000 with a $20,000 valuation allowance at September 30, 2016. At December 31, 2015, OREO had a recorded investment value of $880,000 with no valuation allowance. Additional valuation allowances of $20,000 were recorded during the nine months ended September 30, 2016. There were $170,000 additional valuation allowances recorded during the nine months ended September 30, 2015.
 

24


For the Level 3 assets measured at fair value on a non-recurring basis at September 30, 2016 and December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:
September 30, 2016
 
 
Fair
 
 
 
 
 
 
Assets
 
Value
 
Valuation Technique
 
Unobservable Inputs
 
Range
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
252,000

 
Comparable real estate sales and / or the income approach.
 
Adjustments for differences between comparable sales and income data available.
 
0% - 5%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Estimated selling costs.
 
7%
 
 
 
 
 
 
 
 
 
Other real estate owned
 
$
279,000

 
Comparable real estate sales and / or the income approach.
 
Adjustments for differences between comparable sales and income data available.
 
0% - 7%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Estimated selling costs.
 
7%
 
December 31, 2015
 
 
Fair
 
 
 
 
 
 
Assets
 
Value
 
Valuation Technique
 
Unobservable Inputs
 
Range
 
 
 
 
 
 
 
 
 
Impaired loans
 
$
451,000

 
Comparable real estate sales and / or the income approach.
 
Adjustments for differences between comparable sales and income data available.
 
5% - 9%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Estimated selling costs.
 
7%
 
 
 
 
 
 
 
 
 
Other real estate owned
 
$
990,000

 
Comparable real estate sales and / or the income approach.
 
Adjustments for differences between comparable sales and income data available.
 
0%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Estimated selling costs.
 
7%


25


Fair value estimates for the Corporation’s financial instruments 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 September 30, 2016
Financial assets:
 

 
 

 
 

 
 

Cash and cash equivalents
$
21,025,000

 
$
21,025,000

 
$

 
$

Securities available-for-sale
103,546,000

 
3,692,000

 
99,854,000

 

Securities held to maturity
54,179,000

 

 
54,987,000

 

FHLB-NY stock
2,425,000

 
N/A

 
N/A

 
N/A

Mortgage loans held for sale
300,000

 

 

 
300,000

Loans, net
543,846,000

 

 

 
553,594,000

 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

Deposits
646,084,000

 
493,839,000

 
152,921,000

 

FHLB-NY advances
35,000,000

 

 
35,206,000

 

Subordinated debentures and subordinated notes
23,235,000

 

 

 
23,295,000

 
 
 

 
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)
 
December 31, 2015
Financial assets:
 

 
 

 
 

 
 

Cash and cash equivalents
$
10,910,000

 
$
10,910,000

 
$

 
$

Securities available-for-sale
93,354,000

 
3,573,000

 
89,781,000

 

Securities held to maturity
60,738,000

 

 
61,281,000

 

FHLB-NY stock
2,608,000

 
N/A

 
N/A

 
N/A

Mortgage loans held for sale
1,522,000

 

 

 
1,522,000

Loans, net
517,556,000

 

 

 
527,479,000

 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

Deposits
604,753,000

 
459,327,000

 
145,560,000

 

FHLB-NY advances
40,000,000

 

 
40,222,000

 

Subordinated debentures and subordinated notes
23,186,000

 

 

 
23,206,000

Interest rate swap
62,000

 

 
62,000

 

 
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
 
Cash and cash equivalents – The carrying amount approximates fair value and is classified as Level 1.
 
Securities available-for-sale and held to maturity – The methods for determining fair values were described previously.
 

26


FHLB-NY stock - It is not practicable to determine the fair value of FHLB-NY stock due to restrictions placed on the transferability of the stock.
 
Mortgage loans held for sale – Loans in this category have been committed for sale to third party investors at the current carrying amount resulting in a Level 3 classification.

Loans, net – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as residential and commercial mortgages, commercial and other installment loans. The fair value of loans is estimated by discounting cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans resulting in a Level 3 classification. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable – The carrying amount approximates fair value.
 
Deposits – The fair value of deposits, with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of certificates of deposit is based on the discounted value of cash flows resulting in a Level 2 classification. The discount rate is estimated using market discount rates which reflect interest rate risk inherent in the certificates of deposit. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable deposits.
 
FHLB-NY advances – With respect to FHLB-NY borrowings, the fair value is based on the discounted value of cash flows. The discount rate is estimated using market discount rates which reflect the interest rate risk and credit risk inherent in the term borrowings resulting in a Level 2 classification.
 
Subordinated debentures and subordinated notes – The fair value of the Subordinated Debentures (see Note 6) and the Subordinated Notes (see Note 6) is based on the discounted value of the cash flows. The discount rate is estimated using market rates which reflect the interest rate and credit risk inherent in the Subordinated Debentures and the Subordinated Notes resulting in a Level 3 classification.
 
Accrued interest payable – The carrying amount approximates fair value.
 
Interest rate swap – The fair value of derivatives, which is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition, are based on valuation models using observable market data as of the measurement date (Level 2).
 
Commitments to extend credit – The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. At September 30, 2016 and December 31, 2015 the fair value of such commitments were not material.
 
Limitations
 
The preceding fair value estimates were made at September 30, 2016 and December 31, 2015 based on pertinent market data and relevant information concerning the financial instruments. These estimates do not include any premiums or discounts that could result from an offer to sell at one time the Corporation's entire holdings of a particular financial instrument or category thereof. Since no market exists for a substantial portion of the Corporation's financial instruments, fair value estimates were necessarily based on judgments with respect to future expected loss experience, current economic conditions, risk assessments of various financial instruments, and other factors. Given the subjective nature of these estimates, the uncertainties surrounding them and the matters of significant judgment that must be applied, these fair value estimates cannot be calculated with precision. Modifications in such assumptions could meaningfully alter these estimates.
 
Since these fair value approximations were made solely for on- and off-balance sheet financial instruments at September 30, 2016 and December 31, 2015, no attempt was made to estimate the value of anticipated future business.

27


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 5. Earnings Per Share
 
Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Common stock equivalents are not included in the calculation. Diluted earnings per share is computed similar to that of 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
September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net income
$
1,035,000

 
$
1,000,000

 
$
3,388,000

 
$
3,139,000

Dividends on preferred stock

 
114,000

 

 
456,000

Net income available to common stockholders
$
1,035,000

 
$
886,000

 
$
3,388,000

 
$
2,683,000

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
6,115,987

 
6,091,627

 
6,106,723

 
6,074,763

Effect of dilutive securities - stock options
N/A 

 
N/A 

 
N/A 

 
N/A 

Weighted average common shares outstanding - diluted
6,115,987

 
6,091,627

 
6,106,723

 
6,074,763

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.17

 
$
0.15

 
$
0.55

 
$
0.44

 
 
 
 
 
 
 
 
Diluted earnings per common share
$
0.17

 
$
0.15

 
$
0.55

 
$
0.44

 
There were no stock options to purchase shares of common stock for the three and nine months ended September 30, 2016 and 2015.
 
Note 6. Subordinated Debt
 
 
 
 
 
 
 
Carrying Amount
Issue
 
Maturity
 
Rate
 
September 30,
2016
 
December 31,
2015
 
 
 
 
 
 
 
 
 
9/17/2003
 
9/17/2033
 
Fixed / Floating Rate Junior Subordinated Debentures
 
$
7,217,000

 
$
7,217,000

8/28/2015
 
8/25/2025
 
Fixed Rate Subordinated Notes
 
16,018,000

 
15,969,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
23,235,000

 
$
23,186,000

 
In 2003, the Corporation formed Stewardship Statutory Trust I (the “Trust”), a statutory business trust, which on September 17, 2003 issued $7.0 million Fixed/Floating Rate Capital Securities (“Capital Securities”). The Trust used the proceeds to purchase from the Corporation, $7,217,000 of Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Subordinated Debentures”) maturing September 17, 2033. The Trust is obligated to distribute all proceeds of a redemption whether voluntary or upon maturity, to holders of the Capital Securities. The Corporation’s obligation with respect to the Capital Securities, and the Debentures, when taken together, provide a full and unconditional guarantee on a subordinated basis by the Corporation of the Trust’s obligations to pay amounts when due on the Capital Securities. The Corporation is not considered the primary beneficiary of this Trust (variable interest entity); therefore, the Trust is not consolidated in the Corporation’s consolidated financial statements, but rather the Subordinated Debentures are shown as a liability. Prior to September 17, 2008, the Capital Securities and the

28


Subordinated Debentures both had a fixed interest rate of 6.75%. Beginning September 17, 2008, the rate floats quarterly at a rate of three month LIBOR plus 2.95%. At September 30, 2016 and December 31, 2015, the rate on both the Capital Securities and the Subordinated Debentures was 3.81% and 3.48%, respectively. The Corporation has the right to defer payments of interest on the Subordinated Debentures by extending the interest payment period for up to 20 consecutive quarterly periods. The Subordinated Debentures may be included in Tier 1 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

On August 28, 2015, the Corporation completed a private placement of $16.6 million in aggregate principal amount of fixed rate subordinated notes (the “Subordinated Notes”) to certain institutional accredited investors pursuant to a Subordinated Note Purchase Agreement dated August 28, 2015 between the Corporation and such investors. The Subordinated Notes have a maturity date of August 28, 2025 and bear interest at the rate of 6.75% per annum, payable semi-annually, in arrears, on March 1 and September 1 of each year during the time that the Subordinated Notes remain outstanding. The Subordinated Notes include a right of prepayment, without penalty, on or after August 28, 2020 and, in certain limited circumstances, before that date. The indebtedness evidenced by the Subordinated Notes, including principal and interest, is unsecured and subordinate and junior in right of the Company's payment to general and secured creditors and depositors of the Bank. The Subordinated Notes have been structured to qualify as Tier 2 capital for regulatory purposes. The Subordinated Notes totaled $16.0 million at September 30, 2016, which includes $582,000 of remaining unamortized debt issuance costs. The debt issuance costs are being amortized over the contractual life of the issue. The net cash proceeds of the Subordinated Notes were used to redeem on September 1, 2015, the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Shares”). The Series B Preferred Shares were issued by the Corporation to the U.S. Department of the Treasury (the “Treasury) on September 1, 2011 in connection with the Corporation’s participation in the Treasury’s Small Business Lending Fund program (“SBLF”), a $30 million fund established under the Small Business Jobs Act of 2010 to encourage small business lending by providing capital to qualified community banks with assets of less than $10 billion.
 
Note 7. Accumulated Other Comprehensive Income
 
The components of comprehensive income, both gross and net of tax, are presented for the periods below:
 
 
Three Months Ended September 30,
 
2016
 
2015
 
Gross
 
Tax
Effect
 
Net
 
Gross
 
Tax
Effect
 
Net
 
 
 
 
 
 
 
 
 
 
 
 
Net income
$
1,618,000

 
$
(583,000
)
 
$
1,035,000

 
$
1,532,000

 
$
(532,000
)
 
$
1,000,000

Other comprehensive income (loss):
 

 
 

 
 

 
 

 
 

 
 

Change in unrealized holding gains (losses) on securities available-for-sale
(133,000
)
 
47,000

 
(86,000
)
 
422,000

 
(157,000
)
 
265,000

Reclassification adjustment for gains in net income
(6,000
)
 
3,000

 
(3,000
)
 

 

 

Accretion of loss on securities reclassified to held to maturity
65,000

 
(26,000
)
 
39,000

 
48,000

 
(19,000
)
 
29,000

Change in fair value of interest rate swap

 

 

 
64,000

 
(25,000
)
 
39,000

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss)
(74,000
)
 
24,000

 
(50,000
)
 
534,000

 
(201,000
)
 
333,000

 
 
 
 
 
 
 
 
 
 
 
 
Total comprehensive income
$
1,544,000

 
$
(559,000
)
 
$
985,000

 
$
2,066,000

 
$
(733,000
)
 
$
1,333,000



29


 
Nine Months Ended September 30,
 
2016
 
2015
 
Gross
 
Tax
Effect
 
Net
 
Gross
 
Tax
Effect
 
Net
Net income
$
5,299,000

 
$
(1,911,000
)
 
$
3,388,000

 
$
4,797,000

 
$
(1,658,000
)
 
$
3,139,000

Other comprehensive income:
 

 
 

 
 

 
 

 
 

 
 

Change in unrealized holding gains (losses) on securities available-for-sale
1,349,000

 
(519,000
)
 
830,000

 
648,000

 
(245,000
)
 
403,000

Reclassification adjustment for gains in net income
(62,000
)
 
24,000

 
(38,000
)
 
(152,000
)
 
61,000

 
(91,000
)
Accretion of loss on securities reclassified to held to maturity
178,000

 
(69,000
)
 
109,000

 
243,000

 
(93,000
)
 
150,000

Change in fair value of interest rate swap
62,000

 
(25,000
)
 
37,000

 
183,000

 
(73,000
)
 
110,000

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income
1,527,000

 
(589,000
)
 
938,000

 
922,000

 
(350,000
)
 
572,000

 
 
 
 
 
 
 
 
 
 
 
 
Total comprehensive income
$
6,826,000

 
$
(2,500,000
)
 
$
4,326,000

 
$
5,719,000

 
$
(2,008,000
)
 
$
3,711,000


30



The following tables present the after-tax changes in the balances of each component of accumulated other comprehensive income for the three and nine months ended September 30, 2016 and 2015.
 
 
Three Months Ended September 30, 2016
 
Components of Accumulated
Other Comprehensive Income (Loss)
 
Total
 
Unrealized Gains
and (Losses) on
Available-for-Sale
(AFS) Securities
 
Loss on securities
reclassified from
Available-for-Sale
to Held to Maturity
 
Unrealized
Gains and
(Losses) on
Derivatives
 
Accumulated
Other
Comprehensive
Income (Loss)
Balance at June 30, 2016
$
271,000

 
$
(128,000
)
 
$

 
$
143,000

Other comprehensive income before reclassifications
(86,000
)
 
39,000

 

 
(47,000
)
Amounts reclassified from other comprehensive income
(3,000
)
 

 

 
(3,000
)
 
 
 
 
 
 
 
 
Other comprehensive income
(89,000
)
 
39,000

 

 
(50,000
)
 
 
 
 
 
 
 
 
Balance at September 30, 2016
$
182,000

 
$
(89,000
)
 
$

 
$
93,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
Components of Accumulated
Other Comprehensive Income (Loss)
 
Total
 
Unrealized Gains
and (Losses) on
Available-for-Sale
(AFS) Securities
 
Loss on securities
reclassified from
Available-for-Sale
to Held to Maturity
 
Unrealized
Gains and
(Losses) on
Derivatives
 
Accumulated
Other
Comprehensive
Income (Loss)
Balance at December 31, 2015
$
(610,000
)
 
$
(198,000
)
 
$
(37,000
)
 
$
(845,000
)
Other comprehensive income before reclassifications
830,000

 
109,000

 
37,000

 
976,000

Amounts reclassified from other comprehensive income
(38,000
)
 

 

 
(38,000
)
 
 
 
 
 
 
 
 
Other comprehensive income, net
792,000

 
109,000

 
37,000

 
938,000

 
 
 
 
 
 
 
 
Balance at September 30, 2016
$
182,000

 
$
(89,000
)
 
$

 
$
93,000

 


31


 
Three Months Ended September 30, 2015
 
Components of Accumulated
Other Comprehensive Income (Loss)
 
Total
 
Unrealized Gains
and (Losses) on
Available-for-Sale
(AFS) Securities
 
Loss on securities
reclassified from
Available-for-Sale
to Held to Maturity
 
Unrealized
Gains and
(Losses) on
Derivatives
 
Accumulated
Other
Comprehensive
Income (Loss)
Balance at June 30, 2015
$
(345,000
)
 
$
(256,000
)
 
$
(117,000
)
 
$
(718,000
)
Other comprehensive income (loss) before reclassifications
265,000

 
29,000

 
39,000

 
333,000

Amounts reclassified from other comprehensive income

 

 

 

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net
265,000

 
29,000

 
39,000

 
333,000

 
 
 
 
 
 
 
 
Balance at September 30, 2015
$
(80,000
)
 
$
(227,000
)
 
$
(78,000
)
 
$
(385,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
 
Components of Accumulated
Other Comprehensive Income (Loss)
 
Total
 
Unrealized Gains
and (Losses) on
Available-for-Sale
(AFS) Securities
 
Loss on securities
reclassified from
Available-for-Sale
to Held to Maturity
 
Unrealized
Gains and
(Losses) on
Derivatives
 
Accumulated
Other
Comprehensive
Income (Loss)
Balance at December 31, 2014
$
(392,000
)
 
$
(377,000
)
 
$
(188,000
)
 
$
(957,000
)
Other comprehensive income before reclassifications
403,000

 
150,000

 
110,000

 
663,000

Amounts reclassified from other comprehensive income
(91,000
)
 

 

 
(91,000
)
 
 
 
 
 
 
 
 
Other comprehensive income, net
312,000

 
150,000

 
110,000

 
572,000

 
 
 
 
 
 
 
 
Balance at September 30, 2015
$
(80,000
)
 
$
(227,000
)
 
$
(78,000
)
 
$
(385,000
)
 

32



The following tables present amounts reclassified from each component of accumulated other comprehensive income on a gross and net of tax basis for the three and nine months ended September 30, 2016 and 2015.
 
 
 
Three Months Ended
 
Income
Components of Accumulated Other
 
September 30,
 
Statement
Comprehensive Income
 
2016
 
2015
 
Line Item
 
 
 
 
 
 
 
Unrealized gains on AFS securities before tax
 
$
6,000

 
$

 
Gains on securities transactions, net
Tax effect
 
(3,000
)
 

 
 
 
 
 
 
 
 
 
Total net of tax
 
3,000

 

 
 
 
 
 
 
 
 
 
Total reclassifications, net of tax
 
$
3,000

 
$

 
 

 
 
Nine Months Ended
 
Income
Components of Accumulated Other
 
September 30,
 
Statement
Comprehensive Income
 
2016
 
2015
 
Line Item
 
 
 
 
 
 
 
Unrealized gains on AFS securities before tax
 
$
62,000

 
$
152,000

 
Gains on securities transactions, net
Tax effect
 
(24,000
)
 
(61,000
)
 
 
 
 
 
 
 
 
 
Total net of tax
 
38,000

 
91,000

 
 
 
 
 
 
 
 
 
Total reclassifications, net of tax
 
$
38,000

 
$
91,000

 
 


33


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 “expect,” “believe”, “anticipate,” “should,” “plan,” “estimate,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of the Corporation that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include: changes in general, economic and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects the Corporation’s interest rate spread or other income anticipated from operations and investments. As used in this Form 10-Q, “we”, “us” and “our” refer to the Corporation and its consolidated subsidiary, Atlantic Stewardship Bank (the “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, 2015 included in the Corporation’s 2015 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 and the evaluation of deferred income taxes involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical accounting policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.
 
Allowance for Loan Losses. The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the loan portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Corporation’s loans are secured by real estate in the State of New Jersey. Accordingly, the collectability of a substantial portion of the carrying value of the Corporation’s loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the northern New Jersey area experience adverse economic changes. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Corporation’s control.
 
Deferred Income Taxes. The Corporation records income taxes in accordance with ASC 740, “Income Taxes,” as amended, using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant.
 

34


Financial Condition
 
Total assets increased $40.0 million to $757.9 million at September 30, 2016 from $717.9 million at December 31, 2015. Cash and cash equivalents increased $10.1 million to $21.0 million at September 30, 2016 from $10.9 million at December 31, 2015, reflecting some additional liquidity from deposit growth. Securities available-for-sale increased $10.2 million to $103.5 million while securities held to maturity decreased $6.6 million to $54.2 million. Net loans increased $26.3 million to $543.8 million at September 30, 2016 compared to $517.6 million at December 31, 2015, reflecting new loan originations, partially offset by normal principal amortization and payoffs.

Deposits totaled $646.1 million at September 30, 2016, an increase of $41.3 million from $604.8 million at December 31, 2015. The growth in deposits consisted of a $24.2 million increase in noninterest-bearing accounts and a $17.1 million increase in interest-bearing accounts.
 
Results of Operations
 
General
 
The Corporation reported net income available to common shareholders of $1.0 million, or $0.17 diluted earnings per common share for the three months ended September 30, 2016, compared to net income available to common shareholders of $900,000, or $0.15 diluted earnings per common share for the comparable prior year period. For the nine months ended September 30, 2016, the Corporation reported net income available to common shareholders of $3.4 million, or $0.55 diluted earnings per common share compared to net income available to common shareholders of $2.7 million, or $0.44 diluted earnings per common share for the comparable prior year period.
 
Net Interest Income
 
Net interest income, on a tax equivalent basis, for the three and nine months ended September 30, 2016 was $5.6 million and $16.9 million, respectively, compared to $5.5 million and $16.6 recorded in the prior year periods. The net interest rate spread and net yield on interest-earning assets for the three months ended September 30, 2016 were 2.85% and 3.07%, respectively, compared to 3.01% and 3.21% for the three months ended September 30, 2015. For the nine months ended September 30, 2016, the net interest rate spread and net yield on interest-earning assets were 2.97% and 3.18%, respectively, compared to 3.15% and 3.34% for the nine months ended September 30, 2015.
 
The declines in both the net interest rate spread and net yield on interest-earning assets include the impact of the $16.6 million of Subordinated Notes issued on August 28, 2015 to certain institutional accredited investors (see Note 6 to the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q). While the cost of the Subordinated Notes reduces net interest income, the increased interest expense for the quarter, on an after tax basis, is less than the dividends that would have accrued for the quarter on the Corporation’s Series B Preferred Shares which were redeemed by the Corporation using the net cash proceeds for the Subordinated Notes, resulting in an overall benefit to net income available to common shareholders for the quarter. The dividend rate on the Series B Preferred Shares would have accrued at a rate of 4.56% for January and February 2016 but, beginning on March 1, 2016 and for all dividend periods thereafter, the dividend rate would have increased to and become fixed at 9% per annum, making the issuance of the Subordinated Notes an even more positive impact to net income available to common shareholders in the future.
 
In general, the net interest rate spread and net yield on interest-earning assets for the current year periods reflects an overall decline in loan interest rates. These reduced loan yields primarily reflect the historically low market rates in the current environment.
 
The following tables reflect the components of the Corporation’s net interest income for the three and nine months ended September 30, 2016 and 2015 including: (1) average assets, liabilities and shareholders’ equity based on average daily balances, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities and (4) net yield on interest-earning assets. Nontaxable income from investment securities and loans is presented on a tax-equivalent basis assuming a statutory tax rate of 34% for the periods presented. This was accomplished by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes.


35


Analysis of Net Interest Income (Unaudited)
Three Months Ended September 30,
 
2016
 
2015
 
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)
$
543,866

$
5,842

4.27
%
 
$
512,411

$
5,699

4.41
%
Taxable investment securities (1)
150,587

712

1.88
%
 
138,978

593

1.69

Tax-exempt investment securities (1) (2)
10,507

128

4.85

 
13,568

180

5.26

Other interest-earning assets
19,781

27

0.54

 
12,574

10

0.32

Total interest-earning assets
724,741

6,709

3.68

 
677,531

6,482

3.80

Non-interest-earning assets:
 

 

 

 
 

 

 

Allowance for loan losses
(8,437
)
 

 

 
(9,372
)
 

 

Other assets
42,867

 

 

 
41,459

 

 

Total assets
$
759,171

 

 

 
$
709,618

 

 

 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 

 

 

 
 

 

 

Interest-bearing liabilities:
 

 

 

 
 

 

 

Interest-bearing demand deposits
$
240,353

$
145

0.24
%
 
$
217,039

$
145

0.27
%
Savings deposits
86,912

23

0.11

 
79,234

21

0.11

Time deposits
148,053

418

1.12

 
144,183

379

1.04

FHLB-NY borrowing
35,870

164

1.82

 
45,789

213

1.85

Subordinated debentures and subordinated notes
23,227

363

6.22

 
13,146

235

7.09

Total interest-bearing liabilities
534,415

1,113

0.83

 
499,391

993

0.79

Non-interest-bearing liabilities:
 

 

 

 
 

 

 

Demand deposits
171,169

 

 

 
151,226

 

 

Other liabilities
2,474

 

 

 
2,538

 

 

Stockholders' equity
51,113

 

 

 
56,463

 

 

Total liabilities and stockholders' equity
$
759,171

 

 

 
$
709,618

 

 

Net interest income (taxable equivalent basis)
 

5,596

 

 
 

5,489

 

Tax equivalent adjustment
 

(52
)
 

 
 

(70
)
 

Net interest income
 

$
5,544

 

 
 

$
5,419

 

Net interest spread (taxable equivalent basis)
 

 

2.85
%
 
 

 

3.01
%
Net yield on interest-earning assets (taxable equivalent basis) (3)
 

 

3.07
%
 
 

 

3.21
%
 
(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.


36


Analysis of Net Interest Income (Unaudited)
Nine Months Ended September 30,
 
2016
 
2015
 
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)
$
533,243

$
17,630

4.42
%
 
$
497,238

$
16,787

4.51
%
Taxable investment securities (1)
148,740

2,128

1.91
%
 
139,750

1,801

1.72

Tax-exempt investment securities (1) (2)
11,597

450

5.18

 
14,331

571

5.33

Other interest-earning assets
13,290

56

0.56

 
11,711

27

0.31

Total interest-earning assets
706,870

20,264

3.83

 
663,030

19,186

3.87

Non-interest-earning assets:
 

 

 

 
 

 

 

Allowance for loan losses
(8,674
)
 

 

 
(9,716
)
 

 

Other assets
42,341

 

 

 
41,749

 

 

Total assets
$
740,537

 

 

 
$
695,063

 

 

 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 

 

 

 
 

 

 

Interest-bearing liabilities:
 

 

 

 
 

 

 

Interest-bearing demand deposits
$
232,097

$
425

0.24
%
 
$
211,413

$
427

0.27
%
Savings deposits
85,973

67

0.10

 
78,568

63

0.11

Time deposits
147,167

1,212

1.10

 
139,696

1,013

0.97

FHLB-NY borrowing
39,040

568

1.94

 
49,025

640

1.75

Subordinated debentures and subordinated notes
23,211

1,138

6.55

 
9,215

485

7.04

Total interest-bearing liabilities
527,488

3,410

0.86

 
487,917

2,628

0.72

Non-interest-bearing liabilities:
 

 

 

 
 

 

 

Demand deposits
160,927

 

 

 
145,711

 

 

Other liabilities
2,358

 

 

 
2,548

 

 

Stockholders' equity
49,764

 

 

 
58,887

 

 

Total liabilities and stockholders' equity
$
740,537

 

 

 
$
695,063

 

 

Net interest income (taxable equivalent basis)
 

16,854

 

 
 

16,558

 

Tax equivalent adjustment
 

(179
)
 

 
 

(220
)
 

Net interest income
 

$
16,675

 

 
 

$
16,338

 

Net interest spread (taxable equivalent basis)
 

 

2.97
%
 
 

 

3.15
%
Net yield on interest-earning assets (taxable equivalent basis) (3)
 

 

3.18
%
 
 

 

3.34
%

(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.

37



For the three and nine months ended September 30, 2016, total interest income, on a tax equivalent basis, was $6.7 million and $20.3 million, respectively, compared to $6.5 million and $19.2 million for the same prior year periods. The increase reflects an increase in the average balance of interest-earning assets. Average interest-earning assets increased $47.2 million and $43.8 million for the three and nine months ended September 30, 2016, respectively, compared to the prior year periods. The change in average interest-earning assets primarily reflects an increase from the comparable prior year periods in average loans and, to a lesser extent, an increase in securities. Average loans increased $31.5 million and $36.0 million for the three and nine months ended September 30, 2016, respectively, while average securities increased $8.5 million and $6.3 million when compared to the prior year averages. The average rate earned on interest-earning assets was 3.68% and 3.83% for the three and nine months ended September 30, 2016, respectively, compared to an average rate of 3.80% and 3.87% for the three and nine months ended September 30, 2015, respectively.
 
Interest expense increased $120,000 and $782,000 for the three and nine months ended September 30, 2016, compared to the same periods for 2015. The issuance of the Subordinated Notes on August 28, 2015 had the effect of increasing average interest-bearing liabilities and added approximately $188,000 and $781,000 to interest expense for the current three and nine month periods. An increase in the other components of average interest-bearing liabilities also contributed to the increase in interest expense for the three and nine months ended September 30, 2016. The average balance of interest-bearing deposits increased $34.9 million and $35.6 million for the three and nine months ended September 30, 2016 from the comparable 2015 periods. Partially offsetting these increases, for the three and nine months ended September 30, 2016, FHLB-NY borrowings accounted for decreases of $9.9 million and $10.0 million, respectively, in average interest-bearing liabilities. For the three and nine months ended September 30, 2016, the total cost for interest-bearing liabilities was 0.83% and 0.86% compared to 0.79% and 0.72% for the comparable prior year periods. As noted previously, the issuance of the Subordinated Notes contributed to the overall increase in the current year period. Excluding the Subordinated Debentures and the Subordinated Notes, the cost for interest-bearing deposits and FHLB-NY borrowings was 0.58% and 0.60% for the three and nine months ended September 30, 2016, respectively, compared to 0.62% and 0.60% for the comparable prior year periods.
 
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 losses to be incurred associated with its loan portfolio. The Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves judgments. The adequacy of the allowance for loan losses is based upon management’s evaluation of the known and inherent risks in the portfolio, consideration of the size and composition of the loan portfolio, actual loan loss experience, the level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions.
 
The allowance for loan losses contains an unallocated reserve amount to cover inherent losses which may not otherwise have been measured. Due to the judgment in determining the estimated amount of allowance for loan losses, these unallocated reserves reflect management's attempt to ensure that the overall allowance reflects an appropriate level of reserves. During the nine months ended September 30, 2016, the Corporation’s unallocated reserves decreased by $62,000. Management believes that the reduction in unallocated reserves at September 30, 2016 is appropriate as the Corporation has demonstrated a sustained level of performance in the loan portfolio.
 
For the three and nine months ended September 30, 2016, the Corporation recorded a $250,000 and $1.1 million negative loan loss provision, respectively, compared to a $400,000 and a $1.1 million negative provision to loan losses for the three and nine months ended September 30, 2015. The negative provision for loan losses reflects the continued improvement in the credit quality of the portfolio. In addition, for the three and nine months ended September 30, 2016, the Corporation recorded net recoveries of $12,000 and $377,000, respectively. Nonperforming loans of $929,000 at September 30, 2016, or 0.17% of total gross loans, reflected a decrease from $1.9 million of nonperforming loans, or 0.36% of total gross loans, at December 31, 2015.
 
The allowance for loan losses was $8.2 million, or 1.48% of total gross loans, as of September 30, 2016 compared to $8.8 million, or 1.68% of total gross loans, as of December 31, 2015. The allowance for loan losses related to impaired loans decreased from $719,000 at December 31, 2015 to $617,000 at September 30, 2016. During the nine months ended September 30, 2016, the Corporation charged-off $166,000 of loan balances and recovered $543,000 in previously charged-off loans compared to $597,000 and $900,000, respectively, during the same period in 2015.
 

38


The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio, charge-off activity and general market conditions. There can be no assurances that the current level of no provision or additional releases of the allowance for loan losses will continue in the future.
 
See “Asset Quality” section below for a summary of the allowance for loan losses and nonperforming assets.

Noninterest Income
 
Noninterest income was $823,000 and $2.5 million for the three and nine months ended September 30, 2016, respectively, compared to $838,000 and $2.6 million for the prior year periods. The $163,000 decrease for the nine months ended September 30, 2016, reflects the fact that noninterest income included only $62,000 of gains on calls and sales of securities which is below the $152,000 recognized in the comparable prior year period. In addition, the nine months ended September 30, 2016 included only $6,000 of gains on sales of other real estate owned compared to $53,000 of gains during the nine months endedSeptember 30, 2015. Furthermore, gain on sales of mortgage loans were $70,000 for the nine months ended September 30, 2016 compared to gains of $117,000 realized in the same prior year period.
 
Noninterest Expense
 
Noninterest expenses for the three and nine months ended September 30, 2016 was $5.0 million and $14.9 million respectively, compared to $5.1 million and $15.3 million in the comparable prior year periods. The Corporation continues to appropriately control expenses.
 
Income Tax Expense
 
Income tax expense totaled $583,000 and $1.9 million for the three and nine months ended September 30, 2016, respectively, representing effective tax rates of 36.0% and 36.1%. For the three and nine months ended September 30, 2015, income tax expense totaled $532,000 and $1.7 million, respectively, equating to effective tax rates of 34.7% and 34.6%. For the 2016 periods, tax expense reflects a higher overall projected effective tax rate as a result of the Corporation’s tax exempt income representing a smaller percentage of pretax income.
 
Asset Quality
 
The Corporation’s principal earning asset is its loan portfolio. Inherent in the lending function is the risk of deterioration in the borrowers’ ability to repay loans under existing loan agreements. The Corporation manages this risk by maintaining reserves to absorb probable incurred loan losses. In determining the adequacy of the allowance for loan losses, management considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with general economic and real estate market conditions. Although management endeavors to establish a reserve sufficient to offset probable incurred losses in the portfolio, changes in economic conditions, regulatory policies and borrowers’ performance could require future changes to the allowance.

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


39


 
September 30,
2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
(Dollars in thousands)
Nonaccrual loans (1)
$
929

 
$
949

 
$
2,304

 
$
1,882

Loans past due 90 days or more and accruing (2)

 

 

 

Total nonperforming loans
929

 
949

 
2,304

 
1,882

Other real estate owned
834

 
834

 
1,013

 
880

Total nonperforming assets
$
1,763

 
$
1,783

 
$
3,317

 
$
2,762

Allowance for loan losses
$
8,150

 
$
8,388

 
$
8,540

 
$
8,823

Nonperforming loans to total gross loans
0.17
%
 
0.18
%
 
0.44
%
 
0.36
%
Nonperforming assets to total assets
0.23
%
 
0.24
%
 
0.46
%
 
0.38
%
Allowance for loan losses to total gross loans
1.48
%
 
1.56
%
 
1.62
%
 
1.68
%
 
(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.
 
A loan is generally placed on nonaccrual when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The identification of nonaccrual loans reflects careful monitoring of the loan portfolio. The Corporation is focused on resolving nonperforming loans and mitigating future losses in the portfolio. All delinquent loans continue to be reviewed by management.
 
At September 30, 2016, the balance of nonaccrual loans were comprised of six loans. During the nine months ended September 30, 2016, nonaccrual loans decreased approximately 50.6% to $929,000. The decrease reflects loan payoffs, payments received and loans returned to an accrual status.
 
Evaluation of all nonperforming loans includes the updating of appraisals and specific evaluation of such loans to determine estimated cash flows from business and/or collateral. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable losses to be incurred. All of our nonperforming loans at September 30, 2016 are secured by real estate collateral. We have continued to record appropriate charge-offs and the existing underlying collateral coverage for the nonperforming loans currently supports collection of our remaining principal.
 
For loans not included in nonperforming loans, at September 30, 2016, the level of loans past due 30-89 days was $542,000 compared to $1.0 million at December 31, 2015. We will continue to monitor delinquencies for early identification of new problem loans.

The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable losses to be incurred associated with its loan portfolio. The Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity and requires management to make difficult and subjective judgments.
 
The adequacy of the allowance for loan losses is based upon management’s evaluation of the known and inherent risks in the portfolio, consideration 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 loan loss allowance on the

40


remainder of its loan portfolio. The Corporation maintains a loan review system that allows for a periodic review of its loan portfolio and the early identification of potential problem loans. Such a system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers.
 
Allocations of specific loan loss allowances are established for identified loans based on a review of various information including appraisals of underlying collateral. Appraisals are performed by independent licensed appraisers to determine the value of impaired, collateral-dependent loans. Appraisals are periodically updated to ascertain any further decline in value. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loss experience, composition of the loan portfolio, current economic conditions and management’s judgment.
 
For the nine months ended September 30, 2016, a negative loan loss provision was recorded in the amount of $1.1 million compared to a similar negative loan loss provision recorded for the nine months ended September 30, 2015. The total allowance for loan losses of 1.48% of total loans was comparable to a ratio of 1.68% at December 31, 2015.
 
When management expects that some portion or all of a loan balance will not be collected, that amount is charged-off as a loss against the allowance for loan losses. For the three and nine months ended September 30, 2016 the Corporation recorded net recoveries of $12,000 and $377,000, respectively, were recorded compared to net charge-offs of $94,000 and net recoveries of $303,000 for the three and nine months ended September 30, 2015, respectively. Recorded charge-offs reflect partial writedowns or full charge-offs on nonaccrual loans due to the initial and ongoing evaluations of market values of the underlying real estate collateral in accordance with Accounting Standards Codification (“ASC”) 310-40. Regardless of our actions of recording partial and full charge-offs on loans, we continue to aggressively pursue collection, including legal action.
 
While regular monthly payments continue to be made on many of the nonaccrual loans, certain charge-offs result, nevertheless, from the borrowers’ inability to provide adequate documentation evidencing their ability to continue to service their debt. Therefore, consideration has been given to any underlying collateral and appropriate charge-offs recorded based, in general, on the deficiency of such collateral. In general, the charge-offs reflect partial writedowns and full charge-offs on nonaccrual loans due to the initial evaluation of market values of the underlying real estate collateral in accordance with ASC 310-40. Management believes the charge-off of these reserves provides a clearer indication of the value of nonaccrual loans.
 
At September 30, 2016 and December 31, 2015, the Corporation had $7.7 million and $10.2 million, respectively, of loans the terms of which have been modified in troubled debt restructurings. Of these loans, $7.4 million and $9.7 million were performing in accordance with their new terms at September 30, 2016 and December 31, 2015, respectively. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $617,000 and $708,000 have been allocated for the troubled debt restructurings at September 30, 2016 and December 31, 2015, respectively. As of September 30, 2016 and December 31, 2015, the Corporation had committed$178,000 and $138,000, respectively, of additional funds to these borrowers.
 
As of September 30, 2016, there were $5.9 million of other loans not included in the preceding table or discussion of troubled debt restructurings where credit conditions of borrowers, including real estate tax delinquencies, caused management to have concerns about the possibility of the borrowers not complying with the present terms and conditions of repayment and which may result in disclosure of such loans as nonperforming loans at a future date. These loans have been considered by management in conjunction with the analysis of the adequacy of the allowance for loan losses.
 
The 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 Board”). The Bank is subject to somewhat comparable but different capital adequacy requirements imposed by the Federal Deposit Insurance Corporation (the “FDIC”). The federal banking agencies have adopted risk-based capital guidelines for banks and bank holding companies. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets.

41


Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
 
Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. Leverage capital to average total assets is determined by dividing Tier 1 Capital as defined under the risk-based capital guidelines by average total assets (non-risk adjusted).
 
Guidelines for Banks
 
In December 2010 and January 2011, the Basel Committee on Banking Supervision (the “Basel Committee”) published the final texts of reforms on capital and liquidity, which are generally referred to as “Basel III”. The Basel Committee is a committee of central banks and bank supervisors and regulators from the major industrialized countries that develops broad policy guidelines for the regulation of banks and bank holding companies. In July 2013, the FDIC and the other federal bank regulatory agencies adopted final rules (the “Basel Rules”) to implement certain provisions of Basel III and the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Basel Rules revise the leverage and risk-based capital requirements and the methods for calculating risk-weighted assets. The Basel Rules apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $1 billion or more and top-tier savings and loan holding companies.
 
Among other things, the Basel Rules (a) establish a new common equity Tier 1 Capital (“CET1”) to risk-weighted assets ratio minimum of 4.5% of risk-weighted assets, (b) raise the minimum Tier 1 Capital to risk-based assets requirement (“Tier 1 Capital Ratio) from 4% to 6% of risk-weighted assets and (c) assign a higher risk weight of 150% to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities. The minimum ratio of Total Capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least 6% of the Total Capital is required to be “Tier 1 Capital”, which consists of common shareholders’ equity and certain preferred stock, less certain items and other intangible assets. The remainder, “Tier 2 Capital,” may consist of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) excess of qualifying preferred stock, (c) hybrid capital instruments, (d) debt, (e) mandatory convertible securities and (f) qualifying subordinated debt. “Total Capital” is the sum of Tier 1 Capital and Tier 2 Capital less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the federal banking regulatory agencies on a case-by-case basis or as a matter of policy after formal rule-making. A small bank holding company that has the highest regulatory examination rating and is not contemplating significant growth or expansion must maintain a minimum level of Tier 1 Capital to average total consolidated assets leverage ratio of at least 3%. All other bank holding companies are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum.
 
The Basel Rules also require unrealized gains and losses on certain available-for-sale securities to be included for purposes of calculating regulatory capital unless a one-time opt-out is exercised. Additional constraints are also imposed on the inclusion in regulatory capital of mortgage-servicing assets and deferred tax assets. The Basel Rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of CET1 to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The purpose of the capital conservation buffer is to ensure that banking organizations conserve capital when it is needed most, allowing them to weather periods of economic stress. Banking institutions with a CET1 Ratio, Tier 1 Capital Ratio and Total Capital Ratio above the minimum capital ratios but below the minimum capital ratios plus the capital conservation buffer will face constraints on their ability to pay dividends, repurchase equity and pay discretionary bonuses to executive officers based on the amount of the shortfall. The Basel Rules became effective for the Bank on January 1, 2015. The phase-in period for the capital conservation buffer requirement began on January 1, 2016 and will end on January 1, 2019, when the full capital conservation buffer requirement will be effective.

Bank assets are given risk-weights of 0%, 20%, 50%, 100%, and 150%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets. Most loans are assigned to the 100% risk category, except for performing first mortgage loans fully secured by residential property which carry a 50% risk-weighting. Loan exposures past due 90 days or more or on nonaccrual are assigned a risk-weighting of at least 100%. Most investment securities (including, primarily, general obligation claims of states or other political subdivisions of the United States) are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S.

42


government, which have a 0% risk-weight. In converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing nonfinancial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50% risk-weighting. Short-term undrawn commitments and commercial letters of credit with an initial maturity of under one year have a 20% risk-weighting and certain short-term unconditionally cancelable commitments are not risk-weighted.
 
Guidelines for Small Bank Holding Companies
 
In April 2015, the FRB Board updated and amended its Small Bank Holding Company Policy Statement. Under the revised Small Bank Holding Company Policy Statement, Basel III capital rules and reporting requirements will not apply to small bank holding companies (“SBHC”), such as the Corporation, that have total consolidated assets of less than $1 billion. The minimum risk-based capital requirements for a SBHC to be considered adequately capitalized are 4% for Tier 1 capital and 8% for total capital to risk-weighted assets.
 
The regulations for SBHCs classify risk-based capital into two categories: “Tier 1 Capital” which consists of common and qualifying perpetual preferred shareholders’ equity less goodwill and other intangibles and “Tier 2 Capital” which consists of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) the excess of qualifying preferred stock, (c) hybrid capital instruments, (d) debt, (e) mandatory convertible securities and (f) qualifying subordinated debt. Total qualifying capital consists of Tier 1 Capital and Tier 2 Capital less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the FRB on a case-by-case basis or as a matter of policy after formal rule-making. However, the amount of Tier 2 Capital may not exceed the amount of Tier 1 Capital. The Corporation must maintain a minimum level of Tier 1 Capital to average total consolidated assets leverage ratio of 3%, which is the leverage ratio reserved for top-tier bank holding companies having the highest regulatory examination rating and not contemplating significant growth or expansion.
 
Bank holding company assets are given risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets.
 
As of September 30, 2016, the Corporation and the Bank exceeded all regulatory capital requirements as follows:

 
Actual
 
Required for
Capital
Adequacy
Purposes
 
To Be Well
Capitalized
Under Prompt
Corrective
Action
Regulations
Tier 1 Leverage ratio
 

 
 

 
 

Corporation
7.69
%
 
4.00
%
 
N/A   

Bank
9.36
%
 
4.00
%
 
5.00
%
Risk-based capital
 

 
 

 
 

Common Equity Tier 1
 

 
 

 
 

Corporation
N/A   

 
N/A   

 
N/A   

Bank
11.82
%
 
4.50
%
 
6.50
%
Tier 1
 

 
 

 
 

Corporation
9.99
%
 
4.00
%
 
N/A   

Bank
11.82
%
 
6.00
%
 
8.00
%
Total
 

 
 

 
 

Corporation
13.98
%
 
8.00
%
 
N/A   

Bank
13.07
%
 
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

43


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 short-term investments, such as federal funds sold.
 
Cash and cash equivalents increased $10.1 million during the first nine months of 2016. Net operating and financing activities provided $4.0 million and $35.9 million, respectively, while investing activities used $29.8 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 Federal Home Loan Bank-NY (“FHLB-NY”). The Corporation’s overall borrowing capacity is contingent on available collateral to secure borrowings and the ability to purchase additional activity-based capital stock of the FHLB-NY. The Corporation may also borrow from the Discount Window of the Federal Reserve Bank of New York based on the market value of collateral pledged. In addition, the Corporation has available overnight variable repricing lines of credit with other correspondent banks totaling $38 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. On October 19, 2016, the Corporation announced that its Board of Directors had declared a $0.03 per share cash dividend payable on its common stock to shareholders of record as of November 1, 2016. The dividend is to be paid on November 15, 2016.

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 September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

44


Part II -- Other Information
 
 Item 6. Exhibits

See Exhibit Index following this report.

_____________________________________________________________

45


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: November 10, 2016
By:
/s/ Paul Van Ostenbridge
 
 
Paul Van Ostenbridge
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
Date: November 10, 2016
By:
/s/ Claire M. Chadwick
 
 
Claire M. Chadwick
 
 
Executive Vice President and Chief Financial Officer
 
 
(Principal Financial and Accounting Officer)

46


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
101

 
The following material from Stewardship Financial Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text[1]

__________________________________________
1 This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filing, except to the extent the Corporation specifically incorporates it by reference.


47