Annual Report (10-k)

Date : 03/15/2019 @ 7:45PM
Source : Edgar (US Regulatory)
Stock : Stewardship Financial Corp (SSFN)
Quote : 9.6  0.0 (0.00%) @ 9:00PM
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Annual Report (10-k)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 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 of other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
 
 
630 Godwin Avenue, Midland Park, NJ
07432
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (201) 444-7100
 
Securities registered pursuant to Section 12(b) of the Act: Common Stock, no par value
 
Securities registered under Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
 
 
 
 Yes ¨        No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
 
 
 
 
Yes ¨        No x
Note –  Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
 
 
 
 
 
Indicate by check mark whether the registrant: (1) has filed reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 
 
 
Yes x        No ¨
Indicate by check mark whether the registrant 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 ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
 
 
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
 
Accelerated filer  
x
Non-accelerated filer  
¨
 
Smaller reporting company 
x
Emerging growth company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
 
 
 
  Yes ¨        No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, as of June 30, 2018, was $90,707,000. As of March 13, 2019 , 8,684,456 shares of the registrant’s common stock, net of treasury stock, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

PART III INCORPORATES CERTAIN INFORMATION BY REFERENCE FROM THE REGISTRANT’S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT’S 2019 ANNUAL MEETING OF SHAREHOLDERS.




FORM 10-K
STEWARDSHIP FINANCIAL CORPORATION
For the Year Ended December 31, 2018

Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Cautionary Note Regarding Forward-Looking Statements
 
This Annual Report on Form 10-K may contain certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations and business of Stewardship Financial Corporation (the “Corporation”) and its wholly owned subsidiary, Atlantic Stewardship Bank (the "Bank"). In some cases, you can identify forward-looking statements by the following words: “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Forward-looking statements are not historical facts and are subject to risks and uncertainties. Forward-looking statements are not a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time the statements are made and involve known and unknown risks, uncertainties and other factors that may cause our results, levels of activity, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements. These factors include:

changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or the Bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;
monetary and fiscal policies of the Board of Governors of the Federal Reserve System and the U.S. Government and other government initiatives affecting the financial services industry;
results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our reserve for loan losses or to write-down assets;
failures of or interruptions in the communications and information systems on which we rely to conduct our business could reduce our revenues, increase our costs or lead to disruptions in our business;
general economic conditions including unemployment rates, whether national or regional, and conditions in the lending markets in which we participate that may hinder our ability to increase lending activities or have an adverse effect on the demand for our loans and other products, our credit quality and related levels of nonperforming assets and loan losses, and the value and salability of the real estate that we own or that is the collateral for our loans;
impairment charges with respect to securities;
unanticipated costs in connection with new branch openings;
acts of war, acts of terrorism, cyber-attacks and natural disasters;
fluctuation in interest rates;
risks related to the concentration in commercial real estate, commercial business loans and commercial construction loans;
concentration of credit exposure;
declines in commercial and residential real estate values;
inability to manage growth in commercial loans;
unexpected loan prepayment volume;
unanticipated exposure to credit risks;
insufficient allowance for loan losses;
competition from other financial institutions;
a decline in the levels of loan quality and origination volume; and
a decline in deposits.

The Corporation undertakes no obligation to update or revise any forward-looking statements in the future based upon future events or circumstances, new information or otherwise.




Part I
 
Item 1. Business
 
General
 
Stewardship Financial Corporation (the “Corporation”) is a one-bank holding company, which was incorporated under the laws of the State of New Jersey in January 1995 to serve as a holding company for Atlantic Stewardship Bank (the “Bank”). The only significant activity of the Corporation is ownership and supervision of the Bank.
 
The Bank is a commercial bank formed under the laws of the State of New Jersey on April 26, 1984. The Bank operates from its main office at 630 Godwin Avenue, Midland Park, New Jersey, and its current eleven additional branches located in the State of New Jersey.
 
The Corporation is subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (the “FRB”). The Bank’s deposits are insured by the Federal Deposit Insurance Corporation, an agency of the federal government (the “FDIC”), up to applicable limits. The operations of the Corporation and the Bank are subject to the supervision and regulation of the FRB, the FDIC and the New Jersey Department of Banking and Insurance (the “NJDOBI”).
 
Stewardship Investment Corp. is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is to own and manage an investment portfolio. Stewardship Realty, LLC is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is to own and manage property at 612 Godwin Avenue, Midland Park, New Jersey. Atlantic Stewardship Insurance Company, LLC is a wholly-owned, non-bank subsidiary of the Bank, whose primary business is insurance. The Bank also has several other wholly-owned, non-bank subsidiaries formed to hold title to properties acquired through foreclosure or deed in lieu of foreclosure. In addition to the Bank, in 2003, the Corporation formed, Stewardship Statutory Trust I, a wholly-owned, non-bank subsidiary for the purpose of issuing trust preferred securities.

The principal executive offices of the Corporation are located at 630 Godwin Avenue, Midland Park, New Jersey 07432. Our telephone number is (201) 444-7100 and our website address is www.asbnow.bank .
 
The Corporation has adopted a Code of Ethical Conduct for Senior Financial Managers that applies to its principal executive officer, principal financial officer, principal accounting officer, controller and any other person performing similar functions. The Corporation’s Code of Ethical Conduct for Senior Financial Managers is posted on our website, www.asbnow.bank . The Corporation intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of its Code of Ethical Conduct for Senior Financial Managers by filing an 8-K and by posting such information on our website.

Business of the Corporation
 
The Corporation’s primary business is the ownership and supervision of the Bank. The Corporation, through the Bank, conducts a traditional commercial banking business, and offers deposit services including personal and business checking accounts and time deposits, money market accounts and regular savings accounts. The Corporation structures the Bank’s specific products and services in a manner designed to attract the business of the small and medium-sized business and professional community as well as that of individuals residing, working and shopping in Bergen, Morris and Passaic Counties, New Jersey. The Corporation engages in a wide range of lending activities and offers commercial, consumer, residential real estate, home equity and personal loans.
 
In forming the Bank, the members of its Board of Directors envisioned a community-based institution which would serve the local communities surrounding its branches, while also providing a return to its shareholders. This vision has been reflected in the Bank’s tithing policy, under which the Bank tithes 10% of its pre-tax profits to worthy Christian and civic organizations primarily in the communities where the Bank maintains branches.
 




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Service Area
 
The Bank’s service area primarily consists of Bergen, Morris and Passaic Counties in New Jersey, although the Corporation makes loans throughout New Jersey. Throughout 2018 , the Bank operated from its main office in Midland Park, New Jersey and eleven additional branch offices in Hawthorne, Ridgewood, Montville, Morristown, North Haledon, Pequannock, Waldwick, Wayne (2), Westwood and Wyckoff, New Jersey.

Competition
 
The market for banking services remains highly competitive. The Bank competes for deposits and loans with commercial banks, thrifts and other financial institutions, many of which have greater financial resources than the Bank. Many large financial institutions in New York City and other parts of New Jersey compete for the business of New Jersey residents and companies located in the Bank’s service area. Certain of these institutions have significantly higher lending limits and expend greater resources on marketing and advertising than the Bank and provide services to their customers that the Bank does not offer.
 
Management believes the Bank is able to compete on a substantially equal basis with its competitors because it provides responsive, personalized services through management’s knowledge and awareness of the Bank’s service area, customers and business.
 
Employees
 
At December 31, 2018 , the Corporation employed 119 full-time employees and 28 part-time employees. None of these employees are covered by a collective bargaining agreement and the Corporation believes that its employee relations are good.
 
Supervision and Regulation
 
General
 
Bank holding companies and banks are extensively regulated under both federal and state law. These laws and regulations are intended to protect depositors, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions and is not intended to be an exhaustive description of the statutes or regulations applicable to the Corporation’s and the Bank's business. Any change in the applicable law or regulation may have a material effect on the business and prospects of the Corporation and the Bank.
 
Dodd-Frank Act
 
The scope of the laws and regulations and the intensity of supervision to which our business is subject have increased in the decade after the financial crisis, in large part, as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), and its implementing regulations, most of which are now in place. Provisions in the Dodd-Frank Act and related rules that affect deposit insurance assessments, payment of interest on demand deposits, and interchange fees have increased the costs associated with deposits as well as place limitations on certain revenues that those deposits may generate. The Corporation is subject to the requirements of the Dodd-Frank Act, which includes provisions that, among other things, have:

centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”), responsible for implementing, examining, and enforcing compliance with federal consumer financial laws;
applied to most bank holding companies, the same leverage and risk-based capital requirements applicable to insured depository institutions. The Corporation’s existing trust preferred securities continue to be treated as Tier 1 capital;




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changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling on the size of the Deposit Insurance Fund (“DIF”) and increased the floor on the size of the DIF, which generally requires an increase in the level of assessments for institutions with assets in excess of $10 billion;
implemented corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions;
made permanent the $250,000 limit for federal deposit insurance;
repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts; and
restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater.

The Economic Growth Act, as defined and described below, could result in meaningful regulatory changes for community banks and their holding companies. However, the Corporation and the Bank remain subject to extensive regulation and supervision.

2018 Regulatory Reform

In May 2018, Congress enacted the Economic Growth, Regulatory and Consumer Protection Act (the “Economic Growth Act”) to modify or remove certain post-financial crisis financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. The Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, but amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion.

The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “community bank leverage ratio” of between 8% and 10%. Any qualifying depository institution or its holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules

In addition, the Economic Growth Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the proprietary trading prohibition known as the Volcker Rule (as discussed below), mortgage disclosures and risk weights for certain high-risk commercial real estate loans. The Economic Growth Act also expands the category of holding companies that may rely on the “Small Bank Holding Company Policy Statement” by raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion and excluding such holding companies from the minimum capital requirements of the Dodd-Frank Act.

It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and its yet-to-be-written implementing rules and regulations will have on us and other community banks.

Volcker Rule

In December 2013, federal banking and securities regulators adopted final rules to implement the Volcker Rule contained in Section 619 of the Dodd-Frank Act. The Volcker Rule prohibits an insured depository institution and its affiliates (referred to as "banking entities") from engaging in “proprietary trading” and investing in or sponsoring certain types of funds subject to certain limited exceptions. The Volcker Rule also effectively prohibits short-term trading strategies by any U.S. banking entity if those strategies involve instruments other than those specifically permitted for trading and prohibits the use of some hedging strategies. Based upon management’s review of the Bank's securities portfolio, management believes that there are no securities in our portfolio that are impacted by the Volcker Rule. Consistent with the Economic Growth Act, federal banking agencies have proposed to exclude community banks, such as us,




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with $10 billion or less in total consolidated assets and total trading assets and liabilities of 5% or less of total consolidated assets from the restrictions of the Volcker Rule.
 
Bank Holding Company Act
 
As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”), the Corporation is subject to the regulation, supervision, examination and inspection of the FRB. The Corporation is required to file with the FRB annual reports and other information demonstrating that its business operations and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity which the FRB determines to be so closely related to banking or managing or controlling banks as to be properly incident thereto. The FRB may also conduct examinations of the Corporation and its subsidiaries.
 
The BHCA requires, among other things, the prior approval of the FRB in any case where a bank holding company proposes to (i) acquire all or substantially all of the assets of any other bank, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank (unless it owns a majority of such bank’s voting shares), or (iii) merge or consolidate with any other bank holding company. The FRB will not approve any merger, acquisition, or consolidation that would have a substantially anti-competitive effect, unless the anti-competitive impact of the proposed transaction is clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also considers capital adequacy and other financial and managerial resources and future prospects of the companies and the banks concerned, together with the convenience and needs of the community to be served.
 
Additionally, the BHCA prohibits, with certain limited exceptions, a bank holding company from (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company, or (ii) engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries; unless such non-banking business is determined by the FRB to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such determinations, the FRB is required to weigh the expected benefits to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.
 
The BHCA prohibits depository institutions whose deposits are insured by the FDIC and bank holding companies, among others, from transferring and sponsoring and investing in private equity funds and hedge funds.
 
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance funds in the event the depository institution becomes in danger of default. Under a policy of the FRB with respect to bank holding company operations, a bank holding company is required to commit resources to support such institutions in circumstances where it might not do so absent such a policy. The FRB also has the authority under the BHCA to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
 
Capital Adequacy Guidelines for Banks and Bank Holding Companies
 
The Corporation is subject to capital adequacy guidelines promulgated by the FRB. The Bank is subject to somewhat comparable but different capital adequacy requirements imposed by 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. 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.




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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 Act. The Basel Rules revised 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) established a new common equity Tier 1 Capital (“CET1”) to risk-weighted assets ratio minimum of 4.5% of risk-weighted assets, (b) raised the minimum Tier 1 Capital to risk-based assets requirement (“Tier 1 Capital Ratio) from 4% to 6% of risk-weighted assets and (c) assigned 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, as defined under the rules, 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 was 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 a minimum risk-based capital requirement. 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 or 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 capital conservation buffer requirement of 0.625% became effective January 1, 2016 and was phased in annually through January 1, 2019, when the full capital conservation buffer requirement of 2.50% became effective. At December 31, 2018, the Bank's capital conservation buffer requirement was 1.875%, and the actual capital conservation buffer was 5.54%.
 
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%. High volatility commercial real estate ("HVCRE") loan exposures are assigned to the 150% category; provided, however, Section 214 of the Economic Growth Act, prohibits federal banking agencies from requiring the financial institution to




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assign heightened risk weights to HVCRE loans unless the loan is related to real estate acquisition, development and construction (“HVCRE ADC”). Under the Basel III capital rules, HVCRE ADC loans are assigned a higher risk weight than other commercial real estate loans. Most investment securities (including, primarily, general obligation claims of states or other political subdivisions of the United States) are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S. government, which have a 0% risk-weight. In converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing nonfinancial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50% risk-weighting. Short-term undrawn commitments and commercial letters of credit with an initial maturity of under one year have a 50% risk-weighting and certain short-term unconditionally cancelable commitments are not risk-weighted.

Community Bank Leverage Ratio

The recently enacted Economic Growth Act requires federal banking agencies to develop a “community bank leverage ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under prompt corrective action rules. The federal banking agencies may consider an institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The minimum capital for the new community bank leverage ratio must be set at not less than 8% and not more than 10%. A financial institution can elect to be subject to this new definition. The Economic Growth Act requires the federal banking agencies to consult with state banking regulators and notify the applicable state banking regulator of any qualifying community bank that exceeds or no longer exceeds the Community Bank Leverage Ratio.
 
Guidelines for Small Bank Holding Companies
 
The Dodd-Frank Act required the FRB to establish for all bank and savings and loan holding companies minimum consolidated capital requirements that are as stringent as those required for the insured depository subsidiaries. The FRB has updated and amended its Small Bank Holding Company Policy Statement to extend to bank and savings and loan holding companies the applicability of the “Small Bank Holding Company” exception to its consolidated capital requirements and, as a result of the Economic Growth Act, increased the threshold for the exception from $1.0 billion in consolidated assets to $3.0 billion in consolidated assets. As a result of the revised Small Bank Holding Company Policy Statement, Basel III capital rules and reporting requirements do not apply to small bank holding companies (“SBHC”), such as the Corporation, that have total consolidated assets of less than $3 billion unless otherwise advised by the FRB. 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 December 31, 2018 , the Corporation and the Bank exceeded all regulatory capital requirements. 




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Regulation of the Bank by the FDIC and the NJDOBI
 
As a New Jersey-chartered commercial bank, the Bank is subject to the regulation, supervision, and control of the NJDOBI. As an FDIC-insured institution, the Bank is also subject to regulation, supervision and control by the FDIC. The regulations of the FDIC and the NJDOBI impact virtually all activities of the Bank, including the minimum level of capital the Bank must maintain, the ability of the Bank to pay dividends, the ability of the Bank to expand through new branches or acquisitions, and various other matters.
 
Insurance of Deposits
 
Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The Dodd-Frank Act permanently raised the standard maximum deposit insurance amount to $250,000.
 
The FDIC redefined its deposit insurance premium assessment base to be an institution’s average consolidated total assets minus average tangible equity as required by the Dodd-Frank Act and revised deposit insurance assessment rate schedules in light of the changes to the assessment base. The rate schedule and other revisions to the assessment rules, which were adopted by the FDIC Board of Directors on February 7, 2011, became effective April 1, 2011 and were first used to calculate the June 30, 2011 assessment. The assessment rules were further modified in November, 2014; the revisions became effective on January 1, 2015. Further modified as of September 30, 2016, the Bank’s assessment rate averaged $0.03 per $100 in assessable assets minus average tangible equity.
 
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation (“FICO”) in connection with the failure of certain savings and loan associations. This payment obligation is established quarterly and averaged 0.31% and 0.52% of the assessment base for the years ended December 31, 2018 and 2017 , respectively. The Corporation paid $25,000 and $40,000 under this assessment for the years ended December 31, 2018 and 2017 , respectively. These assessments will continue until the FICO bonds mature in 2019.
 
FDIC’s Capital Adequacy Guidelines for Banks
 
Similar to the FRB, the FDIC has promulgated risk-based capital guidelines for banks that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. These guidelines are substantially the same as those put in place by the FRB for bank holding companies.
 
Dividend Rights
 
Under the New Jersey Banking Act of 1948, as amended (the "New Jersey Banking Act"), a bank may declare and pay dividends only if, after payment of the dividend, the capital stock of the bank will be unimpaired and either the bank will have a surplus of not less than 50% of its capital stock or the payment of the dividend will not reduce the bank’s surplus.
 
Federal Securities Laws and Listing Requirements

The common stock of the Corporation is registered with the United States Securities Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is listed on the Nasdaq Capital Market under the symbol “SSFN.” The Corporation is subject to the reporting, information disclosure, corporate governance, proxy solicitation, insider trading and other requirements imposed on public companies by the SEC under the Exchange Act as well as the Securities Act. As a company listed on the Nasdaq Capital Market, we are also subject to the standards for Nasdaq-listed companies. The SEC and the Nasdaq have adopted regulations under the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act intended to improve corporate governance and the reliability of disclosures in SEC filings and provide enhanced penalties for financial reporting fraud. The Corporation’s insiders are subject to limits on sales of our common stock and must file insider ownership reports with the SEC. The Corporation is currently




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a “smaller reporting company”, which allows us to provide certain simplified and scaled disclosures in our SEC filings. In June 2018, the SEC adopted rule amendments that raised the thresholds for a company to be eligible to provide scaled disclosures as a smaller reporting company to $250 million of public float. As such, the Corporation will remain a smaller reporting company for so long as the market value of the Corporation’s common stock held by non-affiliates as of the end of its most recently completed second fiscal quarter is less than $250 million. Although we remain a smaller reporting company, we have become an “accelerated filer” because our public float exceeds $75 million.

USA Patriot Act of 2001
 
On October 26, 2001, the USA Patriot Act of 2001 (the “Patriot Act”) was signed into law. Enacted in response to the terrorist attacks in New York, Pennsylvania, and Washington, D.C. on September 11, 2001, the Patriot Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including, but not limited to: (a) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons; (b) standards for verifying customer identification at account opening; (c) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (d) reports of nonfinancial trades and business filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (e) filing of suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
 
Regulations promulgated under the Patriot Act impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. Failure of the Corporation or the Bank to comply with the Patriot Act’s requirements could have serious legal consequences for us and adversely affect our reputation.
 
Item 1A. Risk Factors
 
Investments in the common stock, no par value, of the Corporation (the "Common Stock") involve risk. The following discussion highlights the risks management believes are material for the Corporation, but does not necessarily include all risks that we may face.

Our operations are subject to interest rate risk and changes in interest rates may negatively affect financial performance.
 
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed money. To be profitable we must earn more interest from our interest-earning assets than we pay on our interest-bearing liabilities. Changes in the general level of interest rates may have an adverse effect on our business, financial condition and results of operations. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions, competitive factors and the policies of governmental and regulatory agencies such as the Federal Reserve Bank. Changes in monetary policy and interest rates can also adversely affect customer demand for our products and services and, thus, our ability to originate loans and deposits, the fair value of financial assets and liabilities and the average duration of our assets and liabilities. We are subject to interest rate risk to the degree that our interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than our interest-earning assets.

At December 31, 2018 , $45.7 million of the total $65.7 million of our Federal Home Loan Bank borrowings, including $12.7 million of overnight borrowings, will mature during 2019. As these borrowings mature, we will need to either renew the borrowings at a potentially higher rate of interest, which would negatively impact our net interest income, or repay such borrowings. If we sell securities or other assets to fund the repayment of such borrowings, any decline in estimated market value with respect to the securities or assets sold would be realized and could result in a loss upon such sale.





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Interest rates do and will continue to fluctuate. Although we cannot predict future Federal Open Market Committee (“FOMC”), or FRB actions or other factors that will cause rates to change, the FOMC indicates that in light of global economic and financial developments and muted inflation pressures, the FOMC will be patient as it determines what future adjustments to the federal funds rate may be appropriate to support a sustained economic expansion, strong labor market conditions and price stability. Despite the increases in short term interest rates experienced during 2018, short term rates remain relatively low and the yield curve remains extremely flat. The continued flat yield curve may adversely impact our net interest rate spread and net interest margin. No assurance can be given that changes in interest rates will not have a negative impact on our net interest income, net interest rate spread or net interest margin.

Our lending is concentrated to local markets and a decline in real estate markets and the local economy could adversely impact our financial condition and results of operations.
At December 31, 2018 , our gross loan portfolio amounted to $733.8 million, 82.2% of which consisted of mortgage loans secured predominantly by real estate in Northern New Jersey. The majority of these real estate loans were secured by commercial real estate, amounting to $504.5 million or 68.8% of our loan portfolio at December 31, 2018 . In addition, commercial loans amounted to $93.8 million or 12.8% of the gross loan portfolio at December 31, 2018 and commercial construction loans amounted to $9.8 million or 1.3% of the gross loan portfolio at such date. Commercial real estate mortgage loans, commercial loans and construction loans are generally viewed as exposing the lender to a greater risk of loss than fully underwritten one-to-four family residential mortgage loans and typically involve higher principal amounts per loan. Commercial real estate mortgage loans are typically dependent upon the successful operation of the related property. If the cash flow from the property is reduced, the borrower’s ability to repay the loan may be impaired. If the borrower defaults, our only remedy may be to foreclose on the property, for which the market value may be less than the balance due on the related mortgage loan. The repayment of commercial business loans (the increased origination of which is part of management’s strategy), is contingent on the successful operation of the related business. Repayment of construction loans is contingent upon the successful completion and operation of the project. Changes in local economic conditions and government regulations, which are outside the control of the borrower or lender, also could affect the value of the security for the loan or the future cash flow of the affected properties. Accordingly, a decline in local economic conditions would likely have an adverse impact on our financial condition and results of operations due to our lending concentration and lack of geographic diversity.
Declines in value may adversely impact our investment portfolio .
As of December 31, 2018 , the Corporation had approximately $108.8 million and $62.3 million in available for sale and held-to-maturity investment securities, respectively. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary.  Numerous factors, including lack of liquidity for sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough it could affect the ability of the Bank to upstream dividends to the Corporation, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios.
An improved economy but a prolonged economic recovery has adversely affected the financial services industry and, because of our geographic concentration in northern New Jersey, we could be impacted by adverse changes in local economic conditions.
 
Our success depends on the general economic conditions of the nation, the State of New Jersey, and the northern New Jersey area. Although the nation’s economy has improved, a prolonged economic recovery has severely adversely affected the banking industry and may adversely affect our business, financial condition, results of operations and stock price. Unlike larger banks that are more geographically diversified, we provide financial services to customers primarily in the market areas in which we operate. The local economic conditions of these areas have a significant impact on our commercial, real estate and construction loans, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. While we did not and do not have a sub-prime lending program, any significant decline in the real estate market in our primary market area would hurt our business and mean that collateral




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for our loans would have less value. As a consequence, our ability to recover on defaulted loans by selling the real estate securing the loan would be diminished and we would be more likely to suffer losses on defaulted loans. Any of the foregoing events and conditions could have a material adverse effect on our business, results of operations and financial condition.

Our allowance for loan losses may be insufficient.
 
There are risks inherent in our lending activities, including dealing with individual borrowers, nonpayment, uncertainties as to the future value of collateral and changes in economic and industry conditions. We attempt to mitigate and manage credit risk through prudent loan underwriting and approval procedures, monitoring of loan concentrations and periodic independent review of outstanding loans. We cannot be assured that these procedures will reduce credit risk inherent in the business.
 
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and assets serving as collateral for loan repayments. In determining the size of our allowance for loan loss, we rely on our experience and our evaluation of economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient to cover probable incurred loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our portfolio. Significant additions to our allowance for loan losses would materially decrease our net income. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination.

If bank regulators impose limitations on the Bank’s commercial real estate lending activities, earnings could be adversely affected.
In 2006, the FDIC, the OCC and the FRB (collectively, the “Agencies”) issued joint guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” (the “CRE Guidance”) intended to reinforce sound risk-management practices for financial institutions with high and increasing concentrations of commercial real estate loans on their balance sheets. Although the CRE Guidance did not establish specific lending limits, it provides that a bank’s commercial real estate lending exposure may receive increased supervisory scrutiny where total non-owner occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate and construction and land loans, represent 300% or more of an institution’s total risk-based capital and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more during the preceding 36 months. The Bank’s level of non-owner occupied commercial real estate equaled 290% of total risk-based capital at December 31, 2018 . Including owner-occupied commercial real estate, the ratio of commercial real estate loans to total risk-based capital ratio would be 491% at December 31, 2018 . At December 31, 2018 , commercial real estate loans amounted to $528.5 million compared to $363.0 million at December 31, 2015, an increase of $165.5 million or 46% over such 36 month period.

In December 2015, the Agencies released a new statement on prudent risk management for commercial real estate lending that expressed the Agencies concerns about easing commercial real estate underwriting standards, direct financial institutions to maintain underwriting discipline and exercise risk management practices to identify, measure and monitor lending risks, and indicate that the Agencies will continue “to pay special attention” to commercial real estate lending activities and concentrations going forward. If the FDIC were to impose restrictions on the amount of commercial real estate loans that the Bank can hold in its portfolio, or require higher capital ratios as a result of the level of commercial real estate loans held, the Bank’s earnings would be adversely affected.
The Corporation’s future growth may require the Corporation to raise additional capital in the future, but that capital may not be available when it is needed or may be available only at an excessive cost.
The Corporation is required by regulatory authorities to maintain adequate levels of capital to support its operations. The Corporation anticipates that current capital levels will satisfy regulatory requirements for the foreseeable future. The Corporation, however, may at some point choose to raise additional capital to support its continued growth. The




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Corporation’s ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside of the Corporation’s control. Accordingly, the Corporation may be unable to raise additional capital, if and when needed, on terms acceptable to the Corporation, or at all. If we cannot raise additional capital when needed, our ability to further expand operations through internal growth and acquisitions could be materially impacted. In the event of a material decrease in the Corporation’s stock price, future issuances of equity securities could result in dilution of existing shareholder interests.
A decrease in our ability to borrow funds could adversely affect our liquidity.
Our ability to obtain funding from the Federal Home Loan Bank or through our overnight federal funds lines with other banks could be negatively affected if we experienced a substantial deterioration in our financial condition or if such funding becomes restricted due to deterioration in the financial markets. While we have a contingency funds management plan to address such a situation if it were to occur (such plan includes deposit promotions, the sale of securities and the curtailment of loan growth, if necessary), a significant decrease in our ability to borrow funds could adversely affect our liquidity.
Our inability to fulfill minimum capital requirements could limit our ability to conduct or expand our business or pay a dividend and impact our financial condition, results of operations and the market price of our Common Stock.

In July 2013, the FDIC and other federal bank regulatory agencies adopted final rules that established a new comprehensive capital framework for U.S. banking organizations. These rules, generally referred to as the “Basel Rules,” create a new regulatory capital standard based on Tier 1 common equity, increase the minimum leverage and risk-based capital ratios applicable to all banking organizations and change how certain regulatory capital components are calculated. See “Capital Adequacy Guidelines for Banks and Bank Holding Companies” under Item 1 for a detailed description of the various capital requirements to which the Corporation and the Bank are, and in the future may be, subject to. Compliance with these regulatory capital requirements may limit our ability to engage in operations that require the intensive use of capital and could adversely affect our ability to maintain our current level of business or expand our business. Furthermore, if we fail to comply with these regulatory capital requirements, the FRB could place limits or conditions on the operation of our business and subject us to a variety of enforcement remedies, including limiting our ability to pay dividends.

External factors, many of which we cannot control, may result in liquidity concerns for us.

Liquidity risk is the potential that the Corporation will be unable to: meet its obligations as they come due; capitalize on growth opportunities as they arise; or pay regular dividends, because of the Corporation’s inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances.

Liquidity is required to fund various obligations, including credit commitments to borrowers, loan originations, withdrawals by depositors, repayment of borrowings, operating expenses, capital expenditures and dividends to shareholders.

Liquidity is derived primarily from deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; borrowing capacity; net cash provided from operations and access to other funding sources.

Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a prolonged economic downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.





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Competition within the financial services industry and from non-banks could adversely affect our profitability.

We face strong competition from banks, other financial institutions, money market mutual funds, brokerage firms and non-banks within the New York metropolitan area. A number of these entities have substantially greater marketing and advertising resources and lending limits, larger branch systems and a wider array of banking services. Competition among depository institutions for customer deposits has increased significantly and will likely continue in the current economic environment. Our success depends upon our ability to serve our clients in a more responsive manner than our competitors. If we are unsuccessful in competing effectively, we will lose market share and may suffer a reduction in our margins and adverse consequences to our business, results of operations and financial condition.

The unexpected loss of management or key personnel could impair the Corporation’s future success.
The Corporation’s future success depends in part on the continued service of its executive officers, other key management, and staff, as well as its ability to continue to attract, motivate, and retain additional highly qualified employees. The loss of services of one or more of the Corporation’s key personnel or its inability to timely recruit replacements for such personnel, or to otherwise attract, motivate, or retain qualified personnel could have an adverse effect on the Corporation’s business, operating results and financial condition.
If we cannot keep pace with technological changes in the financial services industry, we may not be able to compete effectively.

The financial services industry continues to undergo rapid technological changes, including developments in internet-based and mobile banking, with the aim to better serve customers and reduce costs. Our ability to compete successfully in the future will depend, in part, upon our ability to anticipate and respond to customer demands for technology-driven banking products and services and to invest the resources required to implement, maintain and upgrade the technology required to provide these products and services. Many of our competitors have substantially greater resources to invest in these technological improvements. Although we continually invest in new technology, we cannot provide assurance that we will have sufficient resources to remain competitive in the future. Our inability to keep pace with technological changes could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
 
Federal and State regulations could restrict our business and increase our costs and non-compliance would result in penalties, litigation and damage to our reputation.
 
We operate in a highly regulated environment and are subject to extensive regulation, supervision, and examination by the FDIC, the FRB and the State of New Jersey. The significant federal and state banking regulations that we are subject to are described herein under “Item 1. Business.” The regulation and supervision of the activities in which bank and bank holding companies may engage is primarily intended for the protection of the depositors and the federal deposit insurance funds. These regulations affect our lending practices, capital structure, investment practices, dividend policy and overall operations. These statutes, regulations, regulatory policies, and interpretations of policies and regulations are constantly evolving and may change significantly over time. Any such changes could subject the Corporation to additional costs, limit the types of financial services and products the Bank may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. New federal and/or state laws and regulations of lending and funding practices and liquidity standards continue to be implemented and bank regulatory agencies are being very aggressive in responding to concerns and trends identified in bank examinations with respect to bank capital requirements. Any increased government oversight may increase our costs and limit our business opportunities. Our failure to comply with laws, regulations or policies applicable to our business could result in sanctions against us by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurances that such violations will not occur.

The Dodd-Frank Act requires lenders to make a reasonable, good faith determination of a borrower’s ability to repay a mortgage. The CFPB has promulgated a safe harbor rule for any loan that constitutes a “qualified mortgage.” Loans




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that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including: excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans); interest-only payments; negative-amortization; and terms longer than 30 years. Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or require that we invest significantly greater resources to make these loans and, therefore, limit our growth and adversely affect our profitability. The recently enacted Economic Growth Act provides for a new safe harbor category of qualified mortgage loans originated by institutions with less than $10 billion in total consolidated assets under existing qualified mortgage and ability to pay rules, which when promulgated by the CFSB should afford to community banks the ability to exercise greater discretion in lending decisions.
 
A breach of our information systems through a system failure, cyber-security breach, computer virus or disruption or interruption of service or a compliance breach by one of our vendors could negatively affect our reputation, our business and our earnings.
 
Information technology systems are critical to our business. The financial services industry has experienced an increase in both the number and severity of reported cyber-attacks aimed at gaining unauthorized access to bank systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. We rely heavily upon a variety of computing platforms and networks over the Internet for the purpose of data processing, communication and information exchange and to conduct and manage various aspects of our business and provide our customers with the ability to bank online. We have business continuity and data security systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems and controls in place to monitor vendor risks. Despite the safeguards instituted by management, our systems may be vulnerable to a breach of security through unauthorized access, phishing schemes, computer viruses and other security problems, as well as failures and disruptions of services resulting from power outages and other circumstances.
 
The Corporation maintains policies and procedures to prevent or limit the impact of system failures, interruptions and security breaches (including privacy breaches), but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not fully protect our systems from compromises or breaches of security.
 
Our information technology environment/network, including disaster recovery and business continuity planning, are outsourced to a third party hosted environment. In addition, we rely on the service of a variety of third-party vendors to meet our data processing needs. If any of these third-party providers encounters a system failure, cyber-security breach or other difficulties, or if we have difficulty communicating with any of these third-party providers, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
 
The occurrence of any system failures, interruption or breach of security involving us or our vendors could result in the compromise of our confidential information and the confidential information of our customers, employees and others. In such event, we could be exposed to claims, litigation, financial losses, costs and damages. Such damages could materially affect our earnings. In addition, any failure, interruption or breach in security could also result in failures or disruptions in our general ledger, deposit, loan and other systems and could subject us to additional regulatory scrutiny. In addition, the negative affect on our reputation could affect our ability to deliver products and services successfully to existing customers and to attract new customers. Any of the foregoing events and conditions could have a material adverse effect on our business, results of operations and financial condition. The Corporation has not experienced any cyber incidents that are, individually or in the aggregate, material.  The Corporation outsources certain cyber security functions, such as penetration testing, to third party service providers but does not outsource any cyber security function that has material cybersecurity risk.




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We may not be able to sustain or increase the market price of our Common Stock.

The trading history of our Common Stock, which trades on the Nasdaq Capital Market, has been characterized by relatively low trading volume. The limited trading market for our Common Stock may cause fluctuations in the market value of our Common Stock to be exaggerated and lead to price volatility in excess of that which would occur in a more active trading market. The current market price of our Common Stock may not be indicative of future market prices and we may be unable to sustain or increase the value of an investment in our Common Stock. Volatility in the market price of our Common Stock may occur in response to numerous factors, including, but not limited to, the factors discussed in the other risk factors and the following:

actual or anticipated fluctuation in our operating and financial results;
press releases, publicity, or announcements concerning us, our competitors or the banking industry;
changes in expectations as to future financial performance, including estimates by securities analysts and investors;
changes in accounting standards, policies, guidance, interpretations or principles;
future sales of our Common Stock or other equity securities;
developments in laws or regulations or new interpretations of existing laws or regulations affecting us or our competitors; and
general domestic economic and market conditions.

These factors may adversely affect the trading price of our Common Stock, regardless of our actual operating performance, and could prevent a shareholder from selling our Common Stock at or above the current market price.

We may be unable to generate sufficient cash to service our Subordinated Notes and other debt obligations.
 
The Corporation’s principal source of cash flow is dividends and distributions from the Bank; however, we cannot be assured that the Bank will, in any circumstances, pay dividends to us. Various federal and state statutes, regulations and rules limit, directly or indirectly, the amount of dividends that the Bank may pay to us without regulatory approval. There can be no assurances that we would receive such approval if required. If the Bank fails to make dividend payments to us, and sufficient cash is not otherwise available, we may be unable to make principal and interest payments on the Subordinated Notes (see discussion of the Subordinated Notes in Note 8 to the consolidated financial statements included in this annual report) and our other debt obligations.
 
Our ability to make payments on and to refinance our indebtedness, including the Subordinated Notes, will depend on our financial and operating performance. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness, including the Subordinated Notes. If our cash flows and capital resources, and the dividends we receive from the Bank, are insufficient to fund our debt service obligations, we may be unable to provide new loans, other products or to fund our obligations to existing customers and otherwise implement our business plans. As a result, we may be unable to meet our scheduled debt service obligations. In the absence of sufficient operating results and resources, we could face substantial liquidity issues and we might be required to dispose of material assets or operations to meet our debt service and other obligations, or seek to restructure our indebtedness, including the Subordinated Notes. In such event, there could be no assurance that we would be able to consummate these transactions, and proceeds of such transactions might not be adequate to meet our debt service obligations then due.
 
If we fail to make interest and principal payments on the Subordinated Notes, the terms of the Subordinated Notes will restrict us from paying dividends to our common shareholders and this may adversely affect the market price of our Common Stock.

If we fail to make payments of principal or interest on the Subordinated Notes or a default occurs under the Subordinated Notes, the Corporation is not permitted to pay or declare dividends or distributions on or redeem, purchase, acquire or make a liquidation payments with respect to our Common Stock.
 




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Further, our ability to pay dividends to our shareholders is always subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Corporation’s earnings, capital requirements, financial condition and other factors considered relevant by the Corporation’s Board of Directors. Although we have historically paid cash dividends on our Common Stock, we are not required to do so and our Board of Directors could reduce or eliminate our Common Stock dividend in the future. Our shareholders bear the risk that no dividends will be paid on our Common Stock in future periods or that, if paid, such dividends will be reduced, which may negatively impact the market price of our Common Stock.
 
Anti-takeover provisions in our Restated Certificate of Incorporation, our Amended and Restated By-Laws and New Jersey law could discourage a change of control that our shareholders may favor, which could negatively affect the market price of our Common Stock.

Provisions in our Restated Certificate of Incorporation and our Amended and Restated By-Laws and applicable provisions of the New Jersey Business Corporation Act may make it more difficult and expensive for a third party to remove our directors and acquire control of us even if a change of control would be beneficial to the interests of our shareholders. These provisions could discourage potential takeover attempts and could adversely affect the market price of our Common Stock. For example, applicable provisions of the New Jersey Business Corporation Act may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested shareholder for a period of five years after the person becomes an interested shareholder. Our Restated Certificate of Incorporation provides for staggered terms for our directors and authorizes the issuance of blank check preferred stock that could be issued by our Board of Directors to thwart a takeover attempt and requires super-majority voting by our shareholders to effect amendments to certain provisions of our Restated Certificate of Incorporation. In addition, our Amended and Restated By-Laws limit who may call special meetings of both the board of directors and shareholders and establish advance notice requirements for nominating candidates for election to the Board of Directors or for proposing matters that can be acted upon by shareholders at shareholders’ meetings. 

Federal banking laws limit the acquisition and ownership of our Common Stock.

Because we are a bank holding company, any purchaser of 5% or more of our Common Stock may be required to file a notice with or obtain the approval of the FRB under the Change in Bank Control Act of 1978, as amended. Specifically, under regulations adopted by the FRB, (1) any other bank holding company may be required to obtain the approval of the FRB before acquiring 5% or more of our Common Stock and (2) any person other than a bank holding company may be required to file a notice with and not be disapproved by the FRB to acquire 10% or more of our Common Stock.
 
Possible replacement of the LIBOR benchmark interest rate may have an impact on our business, financial condition or results of operations.

On July 27, 2017, the Financial Conduct Authority (FCA), a regulator of financial services firms in the United Kingdom, announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The FCA and submitting LIBOR banks have indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate. In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee of the Federal Reserve Board. Other financial services regulators and industry groups are evaluating the possible phase-out of LIBOR and the development of alternate reference rate indices or reference rates. Our assets and liabilities that are indexed to LIBOR are very limited. Nevertheless, we are evaluating the potential impact of the possible replacement of the LIBOR benchmark interest rate, but are not able to predict whether LIBOR will cease to be available after 2021, whether the alternative rates the Federal Reserve Board proposes to publish will become market benchmarks in place of LIBOR, or what the impact of such a transition will have on our business, financial condition, or results of operations.

Item 1B. Unresolved Staff Comments

None.




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Item 2. Properties
 
The Corporation conducts its business through its main office located at 630 Godwin Avenue, Midland Park, New Jersey and its current eleven branch offices. The property located at 612 Godwin Avenue is used for administrative offices, primarily for commercial lending functions. The following table sets forth certain information regarding the Corporation’s properties as of December 31, 2018 :
 
Location
Leased
or Owned
Date of Lease
Expiration
 
 
 
612 Godwin Avenue
Owned
---
Midland Park, NJ
 
 
 
 
 
630 Godwin Avenue
Owned
---
Midland Park, NJ
 
 
 
 
 
386 Lafayette Avenue
Owned
---
Hawthorne, NJ
 
 
 
 
 
87 Berdan Avenue
Leased
6/30/24
Wayne, NJ
 
 
 
 
 
64 Franklin Turnpike
Owned
---
Waldwick, NJ
 
 
 
 
 
190 Franklin Avenue
Leased
9/30/22
Ridgewood, NJ
 
 
 
 
 
311 Valley Road
Leased
11/30/23
Wayne, NJ
 
 
 
 
 
249 Newark Pompton Turnpike
Owned
---
Pequannock, NJ
 
 
 
 
 
2 Changebridge Road
Leased
7/31/20
Montville, NJ
 
 
 
 
 
378 Franklin Avenue
Leased
5/31/26
Wyckoff, NJ
 
 
 
 
 
200 Kinderkamack Road
Leased
5/30/26
Westwood, NJ
 
 
 
 
 
33 Sicomac Road
Leased
10/31/20
North Haledon, NJ
 
 
 
 
 
43 S. Park Place
Leased
06/30/22
Morristown, NJ
 
 
_____________________
 
We believe that our properties are in good condition, well maintained and adequate for the present and anticipated needs of our business.
 




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Item 3. Legal Proceedings
 
The Corporation and the Bank are parties to or otherwise involved in legal proceedings arising in the normal course of business from time to time, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to the Bank’s business. Management does not believe that there is any pending or threatened proceeding against the Corporation or the Bank which, if determined adversely, would have a material effect on the business or financial position of the Corporation or the Bank.
 
Item 4. Mine Safety Disclosures
 
Not applicable.
 
Part II
 
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
The Corporation’s Common Stock trades on the Nasdaq Capital Market under the symbol “SSFN”. As of March 13, 2019, there were approximately 1,000 shareholders of record of the Common Stock.
 
During the years ended December 31, 2018 and 2018, the Corporation paid quarterly dividends of $0.03 per share. The amount of future dividends, if any, will be determined by our Board of Directors and will depend on our earnings, most of which are generated by the Bank, our financial condition and other factors considered by our Board of Directors to be relevant.

We rely on the Bank to pay dividends to us to fund our dividend payments to our shareholders. The Bank’s ability to pay dividends to us will depend primarily upon its earnings, financial condition, and need for funds, as well as applicable governmental policies. Even if the Bank has earnings in an amount sufficient to distribute cash to us to enable us to pay dividends to our shareholders, the Bank’s Board of Directors may determine to retain earnings for the purpose of funding the Bank’s growth. The Bank generally pays us a dividend to provide funds for debt service on our outstanding indebtedness, dividends that we pay our shareholders and other expenses.

Under the New Jersey Banking Act, the Bank may not pay a cash dividend unless, following the payment of such dividend, the capital stock of the Bank will be unimpaired and (i) the Bank will have a surplus of no less than 50% of its capital stock or (ii) the payment of such dividend will not reduce the surplus of the Bank. In addition, the Bank cannot pay dividends if doing so would reduce its capital below the regulatory imposed minimums.
 
As of December 31, 2018 , we had $23.6 million aggregate principal amount of indebtedness outstanding, consisting of a subordinated debenture in the principal amount of $7.0 million scheduled to mature in 2033 and $16.6 million aggregate principal amount of 6.75% Fixed-to-Floating Rate Subordinated Notes due in 2025. The agreements under which our indebtedness was issued prohibit us from paying any dividends on our Common Stock or making any other distributions to our shareholders at any time when there shall have occurred and be continuing an event of default under the applicable agreement.

Events of default generally consist of, among other things, our failure to pay any principal or interest on the subordinated debenture or subordinated notes, as applicable, when due, our failure to comply with certain agreements, terms and covenants under the agreement (without curing such default following notice), and certain events of bankruptcy, insolvency or liquidation relating to us.

If an event of default were to occur and we did not cure it, we would be prohibited from paying any dividends or making any other distributions to our shareholders or from redeeming or repurchasing any of our Common Stock, which would likely have a material adverse effect on the market value of our Common Stock. Moreover, without notice to and consent from the holders of our Common Stock, we may enter into additional financing arrangements that may limit our ability to purchase or to pay dividends or distributions on our Common Stock.




17




We paid cash dividends of $0.12 per share for each of the years ended December 31, 2018 and 2017 . We did not repurchase any shares of our Common Stock during the years ended December 31, 2018 and 2017 .

Item 6. Selected Financial Data
 
The following selected consolidated financial data of the Corporation is qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements, including notes, thereto, included elsewhere in this annual report.

STEWARDSHIP FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED
FINANCIAL SUMMARY OF SELECTED FINANCIAL DATA  
 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands, except per share amounts)
 
 
 
 
 
 
 
 
 
 
Selected Balance Sheet Data at Year End:
 
 
 
 
 
 
 
 
 
Total assets
$
955,630

 
$
928,766

 
$
795,535

 
$
717,888

 
$
693,551

Total interest-earning assets
912,022

 
886,479

 
759,805

 
685,141

 
661,672

Total investment securities (including FHLB stock)
176,732

 
169,172

 
154,428

 
156,700

 
183,792

Total loans, net of allowance for loan loss
725,404

 
702,561

 
595,952

 
517,556

 
467,699

Total deposits
782,091

 
764,099

 
658,930

 
604,753

 
556,476

Total borrowings
89,082

 
87,077

 
82,452

 
63,186

 
73,917

Shareholders' equity
80,150

 
73,665

 
51,387

 
47,573

 
58,969

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings Summary:
 

 
 

 
 

 
 

 
 

Net interest income
$
28,163

 
$
26,372

 
$
22,572

 
$
21,783

 
$
21,727

Provision for loan losses
(1,615
)
 
655

 
(1,350
)
 
(1,375
)
 
(50
)
Net interest income after provision for loan losses
29,778

 
25,717

 
23,922

 
23,158

 
21,777

Noninterest income
3,417

 
3,307

 
3,411

 
3,493

 
2,960

Noninterest expense
22,145

 
20,301

 
19,902

 
20,179

 
20,233

Income before income tax expense
11,050

 
8,723

 
7,431

 
6,472

 
4,504

Income tax expense
3,020

 
4,776

 
2,695

 
2,272

 
1,419

Net income
8,030

 
3,947

 
4,736

 
4,200

 
3,085

Dividends on preferred stock and accretion

 

 

 
456

 
683

Net income available to common shareholders
$
8,030

 
$
3,947

 
$
4,736

 
$
3,744

 
$
2,402

 
 
 
 
 
 
 
 
 
 
Common Share Data:
 

 
 

 
 

 
 

 
 

Basic and diluted net income
$
0.93

 
$
0.50

 
$
0.78

 
$
0.62

 
$
0.40

Cash dividends declared
0.12

 
0.12

 
0.11

 
0.08

 
0.05

Book value at year end
9.23

 
8.51

 
8.39

 
7.82

 
7.29

Weighted average shares outstanding (in thousands)
8,673

 
7,907

 
6,110

 
6,078

 
6,004

Shares outstanding at year end (in thousands)
8,680

 
8,653

 
6,121

 
6,086

 
6,035

 
 
 
 
 
 
 
 
 
 
Performance Ratios:
 

 
 

 
 

 
 

 
 

Return on average assets
0.86
 %
 
0.45
 %
 
0.63
 %
 
0.60
 %
 
0.46
%
Return on average common shareholders' equity
10.54
 %
 
5.86
 %
 
9.43
 %
 
8.14
 %
 
5.77
%
 
 
 
 
 
 
 
 
 
 




18


 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands, except per share amounts)
 
 
 
 
 
 
 
 
 
 
Net interest margin
3.14
 %
 
3.13
 %
 
3.18
 %
 
3.30
 %
 
3.46
%
Yield on average interest-earning assets
4.02
 %
 
3.83
 %
 
3.81
 %
 
3.87
 %
 
3.96
%
Cost of average interest-bearing liabilities
1.17
 %
 
0.91
 %
 
0.85
 %
 
0.77
 %
 
0.68
%
Net interest spread
2.85
 %
 
2.92
 %
 
2.96
 %
 
3.10
 %
 
3.28
%
Loans to deposits
93.77
 %
 
93.09
 %
 
91.64
 %
 
87.04
 %
 
85.77
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset Quality:
 
 
 
 
 
 
 
 
 
Total non-accrual loans
$
1,544

 
$
1,194

 
$
606

 
$
1,882

 
$
3,628

Other nonperforming assets
$

 
$

 
$
401

 
$
880

 
$
1,308

Allowance for loan loss to total loans
1.08
 %
 
1.23
 %
 
1.31
 %
 
1.68
 %
 
2.01
%
Nonperforming loans to total loans
0.21
 %
 
0.17
 %
 
0.10
 %
 
0.36
 %
 
0.76
%
Nonperforming assets to total assets
0.16
 %
 
0.13
 %
 
0.13
 %
 
0.38
 %
 
0.71
%
Net charge-offs (recoveries) to average loans
(0.11
)%
 
(0.03
)%
 
(0.08
)%
 
(0.12
)%
 
0.06
%
 
 
 
 
 
 
 
 
 
 
Consolidated Capital Ratios:
 
 
 
 
 
 
 
 
 
Average shareholders' equity as a percentage of average total assets
8.12
 %
 
7.61
 %
 
6.69
 %
 
7.98
 %
 
8.42
%
Leverage (Tier 1) capital (1)
9.33
 %
 
8.88
 %
 
7.65
 %
 
7.67
 %
 
9.45
%
Tier 1 risk based capital (2)
11.33
 %
 
10.96
 %
 
9.35
 %
 
10.16
 %
 
13.04
%
Total risk based capital (2)
14.39
 %
 
14.29
 %
 
13.10
 %
 
14.34
 %
 
14.30
%
 
 
 
 
 
 
 
 
 
 
Other Data:
 
 
 
 
 
 
 
 
 
Number of banking centers (including main branch)
12

 
12

 
11

 
12

 
12

Full time equivalent employees
133

 
130

 
130

 
134

 
140

 

(1) As a percentage of average quarterly assets.
(2) As a percentage of total risk-weighted assets.




19


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This section provides an analysis of the Corporation’s consolidated financial condition and results of operations for the years ended December 31, 2018 and 2017 . The analysis should be read in conjunction with the related audited consolidated financial statements and the accompanying notes presented elsewhere herein.
 
As used in this annual report, “we”, “us” and “our” refer to Stewardship Financial Corporation and its consolidated subsidiary, Atlantic Stewardship Bank, depending on the context.

Introduction
 
The Corporation’s primary business is the ownership and supervision of the Bank and, through the Bank, the Corporation has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. As of December 31, 2018 , the Corporation had 12 full service branch offices located in Bergen, Passaic and Morris Counties in New Jersey. The Corporation, through the Bank, conducts a general commercial and retail banking business encompassing a wide range of traditional deposit and lending functions along with other customary banking services. The Corporation earns income and generates cash primarily through the deposit gathering activities of the branch network. These deposits gathered from the general public are then utilized to fund the Corporation’s lending and investing activities.
 
The Corporation has developed a strong deposit base with good franchise value. A mix of a variety of different deposit products and electronic services, along with a strong focus on customer service, is used to attract customers and build depositor relationships. Challenges facing the Corporation include our ability to continue to grow the branch deposit levels, provide adequate technology enhancements to achieve efficiencies, offer a competitive product line, and provide the highest level of customer service.
 
The Corporation is affected by the overall economic conditions in northern New Jersey, the interest rate and yield curve environment, and, to a lesser extent, the overall national economy. Each of these factors has an impact on our ability to attract specific deposit products, our ability to invest in loan and investment products, and our ability to earn acceptable profits without incurring increased risks.
 
When evaluating the financial condition and operating performance of the Corporation, management reviews historical trends, peer comparisons, asset and deposit concentrations, interest margin analysis, adequacy of loan loss reserve and loan quality performance, adequacy of capital under current positions as well as to support future expansion, adequacy of liquidity, and overall quality of earnings performance.
 
The branch network coupled with our online services provides for solid coverage in both existing and new markets in key towns in the three counties in which we operate. The Corporation continually evaluates the need to further develop its infrastructure, including electronic products and services, to enable it to continue to build franchise value and expand its existing and future customer base.
 
The level of consumers and businesses looking to borrow remained steady in 2018 . The managing of credit risk continues to be relatively steady for the Bank and is reflected in our stable asset quality measurements. All new lending opportunities continue to be appropriately evaluated. The Corporation has never engaged in subprime lending.
 
Competition in the northern New Jersey market remains intense and the challenges of operating in a prolonged, relatively flat interest rate market has continued to make it somewhat difficult to attract deposits when interest rate levels, although rising, are still generally low. In an effort to address the strong competition in attracting deposit balances, the Corporation continues to evaluate product and services offerings. Improvements and upgrades of our electronic / online banking products and services continue to be a priority. Management believes that the Corporation offers the majority of the services that our competitors offer and what today’s customers require. Electronic products and services available to our customers include: online banking / cash management, with remote deposit capture services for businesses, applications for smartphones and tablets, mobile deposit capabilities, online deposit account opening, pay other people payment service and Apple Pay. These electronic banking products and services continue to provide our customers with additional means to access their accounts conveniently. Our security for online banking customers




20


includes a multi-factor authentication sign-on. In addition, the Corporation has the technology and procedures to enable instant debit card issuance for new customers and existing customers.
 
We remained committed to managing our infrastructure and containing costs and expenses while growing the balance sheet. Nevertheless, the Corporation continues to balance the need to control expenses with its focus on quality loan growth and an awareness of the customers’ desire for convenient banking – all being addressed while continuing to be compliant with regulations and remaining up-to-date on all levels of security.
 
During 2019, the Corporation will continue to concentrate its efforts on the origination of loans funded with appropriate deposit growth. In addition, capitalizing on technology and improving efficiencies will remain a focus for 2019.

Recent Accounting Pronouncements
 
A discussion of recent accounting pronouncements and their effect on the Corporation’s Audited Consolidated Financial Statements can be found in Note 1 of the Corporation’s Audited Consolidated Financial Statements contained in this Annual Report on Form 10-K.
 
Critical Accounting Policies and Estimates
 
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures found elsewhere in this Annual Report on Form 10-K, are based upon the Corporation’s Audited Consolidated Financial Statements, which have been prepared in conformity 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, 2018 contains a summary of the Corporation’s significant accounting policies. Management believes the Corporation’s policies with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make significant and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.
 
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.
 
Earnings Summary
 
The Corporation reported net income of $8.0 million, or $0.93 per diluted common share, for the year ended December 31, 2018 , compared to net income of $3.9 million, or $0.50 per diluted common share, for the year ended December 31, 2017 . The results for the year ended December 31, 2017 were impacted by a charge of $1.4 million as a result of the enactment of comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act ("Tax Act") on December 22, 2017.




21


The Tax Act, among other things, reduced the Federal statutory tax rate for corporations from 35% to 21% effective in 2018. While the Tax Act lowered the Corporation’s future tax rate, it also required the Corporation to revalue its net deferred tax assets to account for the future impact of the lower corporate tax rate. As a result, for the year ended December 31, 2017, the Corporation recognized a charge of $1.4 million related to the revaluation of the net deferred tax assets. Excluding the impact of the Tax Act, net income for the year ended December 31, 2017 was $5.4 million, or $0.68 per diluted common share.

The reported return on average assets was 0.86% in 2018 compared to 0.45% in 2017 . The return on average common equity was 10.54% for 2018 as compared to 5.86% in 2017 . Excluding the Tax Act, return on average assets and return on average common equity for the year ended December 31, 2017 were 0.61% and 7.96%, respectively.
 
Results of Operations
 
Net Interest Income
 
The Corporation’s principal source of revenue is the net interest income derived from the Bank, which represents the difference between the interest earned on assets and interest paid on funds acquired to support those assets. Net interest income is affected by the balances and mix of interest-earning assets and interest-bearing liabilities, changes in their corresponding yields and costs, and by the volume of interest-earning assets funded by noninterest-bearing deposits. The Corporation’s principal interest-earning assets are loans made to businesses and individuals and investment securities.
 
For the year ended December 31, 2018 , net interest income, on a tax equivalent basis, increased to $28.2 million from $26.5 million for the year ended December 31, 2017 . The net interest rate spread and net yield on interest-earning assets for the year ended December 31, 2018 were 2.85% and 3.14%, respectively, compared to 2.92% and 3.13% for the year ended December 31, 2017 .
 
In general, the net interest rate spread and net yield on interest-earning assets for the current year is reflective of the balance sheet growth - primarily loan growth funded by deposits.
 
For the year ended December 31, 2018 , total interest income, on a tax equivalent basis, was $36.0 million compared to $32.4 million for the prior year. The increase was due to an increase in the average balance of interest-earning assets coupled with an increase in the overall yield on interest-earning assets. Average interest-earning assets increased $51.4 million in 2018 over the 2017 amount. The change in average interest-earning assets primarily reflects a $45.2 million increase from the comparable prior year in average loans. In addition, 2018 reflects a $6.8 million increase in average investment securities. The year ended December 31, 2018 included approximately $348,000 of interest recoveries and prepayment premiums on loan payoffs compared to $229,000 for the same prior year period. The average rate earned on interest-earning assets increased 0.19% from 3.83% for the year ended December 31, 2017 to 4.02% in the 2018 fiscal year.
 
Interest expense increased $2.0 million during the year ended December 31, 2018 to $7.8 million. For the year ended December 31, 2018 , the average balance of interest-bearing deposits increased $54.2 million and average FHLB-NY borrowings decreased $22.1 million. For the year ended December 31, 2018 , the total cost for interest-bearing liabilities was 1.17% compared to 0.91% for the prior year. In December 2018, the FDIC adopted a final rule related to the treatment of reciprocal deposits. The final rule implements Section 202 of the Economic Growth Act to exempt certain reciprocal deposits from being considered as brokered deposits for well-capitalized institutions. At December 31, 2018 and 2017 , the Corporation had $37.1 million and $25.9 million, respectively, in aggregate deposits that were classified as brokered deposits by regulatory agencies.

The following table reflects the components of the Corporation’s net interest income for the years ended December 31, 2018 , 2017 and 2016 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 21% for 2018 and 34% for both 2017 and 2016. This was accomplished




22


by adjusting non-taxable income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes.
 
 
2018
 
2017
 
2016
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Rates
Earned/
Paid
 
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)
$
718,510

 
$
31,532

 
4.39
%
 
$
673,314

 
$
28,421

 
4.22
%
 
$
541,918

 
$
23,762

 
4.38
%
Taxable investment securities
166,249

 
4,192

 
2.52
%
 
156,917

 
3,485

 
2.22
%
 
148,852

 
2,904

 
1.95
%
Tax-exempt investment securities (2)
6,003

 
186

 
3.10
%
 
8,574

 
375

 
4.37
%
 
11,229

 
566

 
5.04
%
Other interest-earning assets
6,910

 
138

 
2.00
%
 
7,515

 
106

 
1.41
%
 
13,981

 
79

 
0.57
%
Total interest-earning assets
897,672

 
36,048

 
4.02
%
 
846,320

 
32,387

 
3.83
%
 
715,980

 
27,311

 
3.81
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest-earning assets:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Allowance for loan losses
(8,459
)
 
 

 
 

 
(8,412
)
 
 

 
 

 
(8,546
)
 
 

 
 

Other assets
48,959

 
 

 
 

 
47,181

 
 

 
 

 
42,751

 
 

 
 

Total assets
$
938,172

 
 

 
 

 
$
885,089

 
 

 
 

 
$
750,185

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing demand deposits
$
310,014

 
$
2,147

 
0.69
%
 
$
259,637

 
$
709

 
0.27
%
 
$
234,847

 
$
558

 
0.24
%
Savings deposits
83,731

 
84

 
0.10
%
 
89,586

 
92

 
0.10
%
 
86,804

 
90

 
0.10
%
Time deposits
203,109

 
3,062

 
1.51
%
 
193,397

 
2,388

 
1.23
%
 
149,067

 
1,644

 
1.10
%
FHLB-NY borrowings
52,377

 
968

 
1.85
%
 
74,440

 
1,177

 
1.58
%
 
38,288

 
716

 
1.87
%
Subordinated Debentures and Subordinated Notes
23,350

 
1,575

 
6.75
%
 
23,285

 
1,492

 
6.41
%
 
23,219

 
1,505

 
6.48
%
Total interest-bearing liabilities
672,581

 
7,836

 
1.17
%
 
640,345

 
5,858

 
0.91
%
 
532,225

 
4,513

 
0.85
%
Non-interest bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
185,406

 
 

 
 

 
173,936

 
 

 
 

 
165,348

 
 

 
 

Other liabilities
4,005

 
 

 
 

 
3,413

 
 

 
 

 
2,396

 
 

 
 

Shareholders' equity
76,180

 
 

 
 

 
67,395

 
 

 
 

 
50,216

 
 

 
 

Total liabilities and Shareholders' equity
$
938,172

 
 

 
 

 
$
885,089

 
 

 
 

 
$
750,185

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income (taxable
equivalent basis)
 

 
28,212

 
 

 
 

 
26,529

 
 

 
 

 
22,798

 
 

Tax equivalent adjustment
 

 
(49
)
 
 

 
 

 
(157
)
 
 

 
 

 
(226
)
 
 

Net interest income
 

 
$
28,163

 
 

 
 

 
$
26,372

 
 

 
 

 
$
22,572

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread (taxable
equivalent basis)
 

 
 

 
2.85
%
 
 

 
 

 
2.92
%
 
 

 
 

 
2.96
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net yield on interest-earning
assets (taxable equivalent basis) (3)
 

 
 

 
3.14
%
 
 

 
 

 
3.13
%
 
 

 
 

 
3.18
%
 
(1) For purpose of these calculations, nonaccrual loans are included in the average balance. Fees are included in loan interest.
(2) The tax equivalent adjustments are based on a marginal tax rate of 21% for 2018 and 34% for 2017 and 2016. Loans and total interest-earning assets are net of
unearned income. Securities are included at amortized cost.
(3) Net interest income (taxable equivalent basis) divided by average interest-earning assets.




23


The following table compares net interest income for the years ended December 31, 2018 and 2017 over the respective prior years in terms of changes from the prior year in the volume of interest-earning assets and interest-bearing liabilities and changes in yields earned and rates paid on such assets and liabilities on a tax-equivalent basis. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate) and changes in rate (changes in rate multiplied by prior year volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately to changes due to volume and changes due to rate.
 
2018 Versus 2017
 
2017 Versus 2016
 
Increase (Decrease)
Due to Change in
 
 
 
Increase (Decrease)
Due to Change in
 
 
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
(In thousands)
Interest income:
 

 
 

 
 

 
 

 
 

 
 

Loans
$
1,944

 
$
1,167

 
$
3,111

 
$
5,575

 
$
(916
)
 
$
4,659

Taxable investment securities
216

 
491

 
707

 
164

 
416

 
580

Tax-exempt investment securities
(96
)
 
(93
)
 
(189
)
 
(122
)
 
(69
)
 
(191
)
Other interest-earning assets
2

 
30

 
32

 
(49
)
 
76

 
27

Total interest-earning assets
2,066

 
1,595

 
3,661

 
5,568

 
(493
)
 
5,075

 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing demand deposits
159

 
1,279

 
1,438

 
63

 
88

 
151

Savings deposits
(8
)
 

 
(8
)
 
3

 
(1
)
 
2

Time deposits
122

 
552

 
674

 
531

 
213

 
744

FHLB borrowings
(388
)
 
179

 
(209
)
 
586

 
(125
)
 
461

  Subordinated Debentures and
Subordinated Notes
4

 
79

 
83

 
4

 
(17
)
 
(13
)
Total interest-bearing liabilities
(111
)
 
2,089

 
1,978

 
1,187

 
158

 
1,345

Net change in net interest income
$
2,177

 
$
(494
)
 
$
1,683

 
$
4,381

 
$
(651
)
 
$
3,730


Provision for Loan Losses
 
The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable incurred losses associated with its loan portfolio. On an ongoing basis, management analyzes the adequacy of this allowance by considering the nature and volume of the Corporation’s loan activity, financial condition of the borrower, fair value of underlying collateral, and changes in general market conditions. Additions to the allowance for loan losses are charged to operations in the appropriate period. Actual loan losses, net of recoveries, reduce the allowance. The appropriate level of the allowance for loan losses is based on estimates, and ultimate losses may vary from current estimates.
 
The Corporation recorded a negative provision for loan losses of $1.6 million for the year ended December 31, 2018 compared to a provision of $655,000 for the year ended December 31, 2017 . While growth in the loan portfolio generally requires the establishment of additional reserves, the negative loan loss provision in the current year reflects net recoveries of previously charged off loan balances of $779,000 for the year ended December 31, 2018. The negative loan loss provision also reflects the continued improvement in the economic conditions and overall real estate climate in the primary business markets in which the Corporation operates. The allowance for loan loss was $7.9 million, or 1.08% of total loans, as of December 31, 2018 compared to $8.8 million, or 1.23% of total loans, a year earlier.
 
The loan loss provision takes into account any growth or contraction in the loan portfolio and any changes in nonperforming loans as well as the impact of net charge-offs. In determining the level of the allowance for loan loss, the Corporation also considered the types of loans as well as the overall seasoning of loans to determine the risk that was inherent in the portfolio.




24


 
Nonperforming loans of $1.5 million at December 31, 2018 , or 0.21% of total gross loans, reflected a slight increase from $1.2 million of nonperforming loans, or 0.17% of total gross loans, at December 31, 2017 . During the year ended December 31, 2018 , the Corporation charged-off $31,000 of loan balances and recovered $810,000 in previously charged-off loans compared to $4,000 and $206,000, respectively, in the prior year. The allowance for loan losses related to the impaired loans increased from $609,000 at December 31, 2017 to $649,000 at December 31, 2018 .
 
In addition to these factors, the Corporation evaluated the economic conditions and overall real estate climate in the primary business markets in which it operates when considering the overall risk of the lending portfolio. Recent years showed improvement in the economy and the real estate market, which is reflected in a reduced level of charge-offs and loan delinquencies. The Corporation monitors its loan portfolio and intends to continue to provide for loan loss reserves based on its ongoing periodic review of the loan portfolio and general market conditions.
 
See “Asset Quality” section below for further information concerning the allowance for loan losses and nonperforming assets.
 
Noninterest Income
 
Noninterest income consists of all income other than interest income and is principally derived from service charges on deposits, income derived from bank-owned life insurance, gains from calls and sales of securities, gains and losses on sales of loans, unrealized gains on equity investments and income derived from debit cards and ATM usage. In addition, gains on sales of other real estate owned (“OREO”) are reflected as noninterest income.
 
Noninterest income was $3.4 million for the year ended December 31, 2018 as compared to $3.3 million for the prior year. The year ended December 31, 2018 reflected $193,000 of gains from the sale of the guaranteed portion of newly originated Small Business Administration ("SBA") loans. The year ended December 31, 2018 also included a positive $80,000 mark to market adjustment of a Community Reinvestment Act ("CRA") investment which is classified as an equity security. Such security has been owned for years for CRA purposes, but in connection with the adoption of ASU 2016-01, equity securities now require a quarterly mark to market through the income statement. Offsetting these increases, for the year ended December 31, 2018, the Corporation realized a $186,000 loss on calls and sales of securities primarily due to the sale of approximately $2.0 million of the CRA investment which is classified as an equity security. In addition, gain on sales of mortgage loans were $70,000 for the year ended December 31, 2018 compared to gains of $178,000 realized in the prior year. Finally, the year ended December 31, 2018 included no gains on sales of OREO compared to $13,000 of gains during the year ended December 31, 2017 .
 
Noninterest Expense
 
For the years ended December 31, 2018 and 2017 , total noninterest expense was $22.1 million and $20.3 million, respectively. The Corporation continues to appropriately control expenses. Increases in various expenses were offset by decreases in other expenses. The Corporation's largest expense is salaries and employee benefits, which increased $1.2 million. Such increase represented an increase in staff to support the Corporation's operations and continued growth, including costs associated with the establishment of of an SBA Lending Department in late 2017.
 
Income Taxes
 
Income tax expense totaled $3.0 million and $4.8 million for the years ended December 31, 2018 and 2017 , respectively, representing effective tax rates of 27.3% and 54.8%. For the year ended December 31, 2017, tax expense reflects the previously discussed one-time charge related to the revaluation of the net deferred tax assets resulting from the enactment of the Tax Act.
 
Financial Condition
 
Total assets at December 31, 2018 were $955.6 million, an increase of $26.8 million, or 2.9%, over the $928.8 million at December 31, 2017 . Securities available-for-sale were relatively unchanged while securities held-to-maturity increased $9.9 million to $62.3 million. Net loans increased $22.8 million to $725.4 million at December 31, 2018




25


compared to $702.6 million at December 31, 2017 , reflecting continued improvement in loan demand. There were no loans held for sale at December 31, 2018 compared to $370,000 at December 31, 2017 .

Loan Portfolio
 
The Corporation’s loan portfolio at December 31, 2018 , net of allowance for loan losses, totaled $725.4 million, an increase of $22.8 million, or a 3.3% increase over the $702.6 million at December 31, 2017 . Residential real estate mortgages increased $3.3 million. Although certain residential real estate loans were placed into the portfolio to partially compensate for payoffs and normal amortization, the Corporation continued its policy of selling the majority of its residential real estate loans in the secondary market. Of the loans sold in 2018, all but $2.3 million of loans have been sold with servicing of the loan transferring to the purchaser. Commercial real estate mortgage loans consisting of $520.9 million, or 71.0% of the total portfolio, represent the largest portion of the loan portfolio. These loans reflected an increase of $16.8 million from $504.0 million, or 70.8% of the total loan portfolio, at December 31, 2017 . Commercial loans increased $4.7 million to $93.8 million, representing 12.8% of the total loan portfolio. Consumer installment loans and home equity loans increased $3.8 million to $36.5 million.
 
The Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey. The Corporation has not made loans to borrowers outside the United States.
 
At December 31, 2018 , aside from the real estate concentration described above, there were no concentrations of loans exceeding 10% of total loans outstanding. Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other related conditions.

The following table sets forth the classification of the Corporation’s loans by major category at the end of each of the last five years:
 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(In thousands)
Real estate mortgage:
 

 
 

 
 

 
 

 
 

Residential
$
82,491

 
$
85,760

 
$
84,321

 
$
82,955

 
$
77,836

Commercial (1)
520,868

 
504,028

 
407,226

 
348,724

 
295,278

 
 
 
 
 
 
 
 
 
 
Commercial loans
93,755

 
89,056

 
82,065

 
64,860

 
75,852

 
 
 
 
 
 
 
 
 
 
Consumer loans:
 

 
 

 
 

 
 

 
 

Installment (2)
17,799

 
15,089

 
10,713

 
10,262

 
12,174

Home equity
18,685

 
17,548

 
19,566

 
19,425

 
15,950

Other
189

 
239

 
192

 
251

 
230

 
 
 
 
 
 
 
 
 
 
Total gross loans
733,787

 
711,720

 
604,083

 
526,477

 
477,320

Less: Allowance for loan losses
7,926

 
8,762

 
7,905

 
8,823

 
9,602

Deferred loan costs (fees)
457

 
397

 
226

 
98

 
19

Net loans
$
725,404

 
$
702,561

 
$
595,952

 
$
517,556

 
$
467,699

 
(1) Includes construction loans and Government Guaranteed loans - guaranteed portion.
(2) Includes automobile, home improvement, second mortgages, and unsecured loans.
 




26


The following table sets forth certain categories of gross loans as of December 31, 2018 by contractual maturity. Borrowers may have the right to prepay obligations with or without prepayment penalties. This might cause actual maturities to differ from the contractual maturities summarized below.
 
Within 1 Year
 
After 1 Year But
Within 5 Years
 
After 5
Years
 
Total
 
(In thousands)
 
 
 
 
 
 
 
 
Real estate mortgage
$
15,589

 
$
43,423

 
$
544,347

 
$
603,359

Commercial
43,701

 
26,449

 
23,605

 
93,755

Consumer
151

 
1,610

 
34,912

 
36,673

Total gross loans
$
59,441

 
$
71,482

 
$
602,864

 
$
733,787

 
The following table sets forth the dollar amount of all gross loans due one year or more after December 31, 2018 , which have predetermined interest rates or floating or adjustable interest rates:
 
Predetermined
Rates
 
Adjustable
Rates
 
Total
 
(In thousands)
 
 
 
 
 
 
Real estate mortgage
$
132,057

 
$
455,713

 
$
587,770

Commercial
15,144

 
34,910

 
50,054

Consumer
17,804

 
18,718

 
36,522

Total gross loans
$
165,005

 
$
509,341

 
$
674,346


Asset Quality
 
The Corporation’s principal earning asset is its loan portfolio. Inherent in the lending function is the risk of deterioration in a borrower’s ability to repay loans under existing loan agreements. The Corporation manages this risk by maintaining reserves to absorb probable incurred loan losses. In determining the adequacy of the allowance for loan losses, management considers the risks inherent in its loan portfolio and changes in the nature and volume of its loan activities, along with general economic and real estate market conditions. Although management endeavors to establish a reserve sufficient to offset probable incurred losses in the portfolio, changes in economic conditions, regulatory policies and borrower’s performance could require future changes to the allowance.
 
In establishing the allowance for loan losses, the Corporation utilizes a two-tiered approach by (1) identifying problem loans and allocating specific loss allowances to such loans and (2) establishing a general loan loss allowance on the remainder of its loan portfolio. The Corporation maintains a loan review system that allows for a periodic review of its loan portfolio and the early identification of potential problem loans. Such a system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers.
 
Allocations of specific loan loss allowances are established for identified loans based on a review of various information including appraisals of underlying collateral. Appraisals are performed by independent licensed appraisers to determine the value of impaired, collateral-dependent loans. Appraisals are periodically updated to ascertain any further decline in value. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loss experience, composition of the loan portfolio, current economic conditions and management’s judgment.
 
Management continually reviews and makes enhancements, as appropriate, to its process over measuring the general portion of the allowance for loan losses. In connection with its periodic risk assessment and monitoring process, the Corporation evaluates a number of assumptions supporting the methodology, including the look-back period used to evaluate the historical loss factors for its portfolios, as well as performing a study of its loss emergence period data. Given these evaluations, management reassesses its qualitative and environmental factors to align with the model assumptions. These reviews had no material impact on the overall allowance.
 




27


The Corporation’s accounting policies are set forth in Note 1 to the Corporation’s Audited Consolidated Financial Statements. The application of some of these policies requires significant management judgment and the utilization of estimates. Actual results could differ from these judgments and estimates resulting in a significant impact on the financial statements. A critical accounting policy for the Corporation is the policy utilized in determining the adequacy of the allowance for loan losses. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and changes. Various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the Corporation’s lending activities are concentrated in loans secured by real estate located in northern New Jersey. Accordingly, the collectability of a substantial portion of the Corporation’s loan portfolio is susceptible to changes in real estate market conditions in northern New Jersey. Future adjustments to the allowance may be necessary due to economic, operating, regulatory, and other conditions beyond the Corporation’s control. In management’s opinion, the allowance for loan losses totaling $7.9 million is adequate to cover probable incurred losses inherent in the portfolio at December 31, 2018 .
 
Nonperforming Assets
 
Risk elements include nonaccrual loans, past due and restructured loans, potential problem loans, loan concentrations and other real estate owned (i.e., property acquired through foreclosure or deed in lieu of foreclosure). The Corporation’s loans are generally placed on a nonaccrual status when they become past due in excess of 90 days as to payment of principal and interest or earlier if collection of principal or interest is considered doubtful. Interest previously accrued on these loans and not yet paid is reversed against income during the current period. Interest earned thereafter may only be included in income to the extent that it is received in cash. Loans past due 90 days or more and accruing represent those loans which are in the process of collection, adequately collateralized and management believes all interest and principal owed will be collected. Restructured loans are loans that have been renegotiated to permit a borrower, who has incurred adverse financial circumstances, to continue to perform. Management can make concessions to the terms of the loan or reduce the contractual interest rates to below market rates in order for the borrower to continue to make payments.
 




28


The following table sets forth certain information regarding the Corporation’s nonperforming assets as of December 31 of each of the preceding five years:
 
 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands)
Nonaccrual loans (1):
 

 
 

 
 

 
 

 
 

Residential real estate
$
576

 
$
295

 
$

 
$

 
$
96

Commercial real estate
574

 
701

 
528

 
484

 
1,284

Commercial
394

 
136

 

 
1,314

 
1,923

Consumer

 
62

 
78

 
84

 
325

Total nonaccrual loans
1,544

 
1,194

 
606

 
1,882

 
3,628

 
 
 
 
 
 
 
 
 
 
Total nonperforming loans
1,544

 
1,194

 
606

 
1,882

 
3,628

Other real estate owned

 

 
401

 
880

 
1,308

Total nonperforming assets (2)
$
1,544

 
$
1,194

 
$
1,007

 
$
2,762

 
$
4,936

 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
$
7,926

 
$
8,762

 
$
7,905

 
$
8,823

 
$
9,602

 
 
 
 
 
 
 
 
 
 
Nonperforming loans to total gross loans
0.21
%
 
0.17
%
 
0.10
%
 
0.36
%
 
0.76
%
 
 
 
 
 
 
 
 
 
 
Nonperforming assets to total assets
0.16
%
 
0.13
%
 
0.13
%
 
0.38
%
 
0.71
%
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses to total gross loans
1.08
%
 
1.23
%
 
1.31
%
 
1.68
%
 
2.01
%
 
(1) Restructured loans classified in the nonaccrual category totaled $509,000, $610,000, $528,000, $552,000, and $824,000 for the years ended December 31, 2018 , 2017 , 2016 , 2015 , and 2014 , respectively.
(2) There were no loans past due ninety days or more and accruing for any years presented.

A loan is generally placed on nonaccrual when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The identification of nonaccrual loans reflects careful monitoring of the loan portfolio. The Corporation is focused on resolving nonperforming loans and mitigating future losses in the portfolio. All delinquent loans continue to be reviewed by management.
 
At December 31, 2018 , the balance of nonaccrual loans were comprised of two residential real estate loans, two commercial real estate loans and two commercial loans. During the year ended December 31, 2018 , nonaccrual loans have increased $350,000 to $1,544,000. The increase reflects the addition of two loans to nonaccrual status partially offset by the payoff of two nonaccrual loans, one charge-off, one loan returning to accruing status and principal payments received.
 
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 December 31, 2018 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 the collection of our remaining principal.
 
For loans not included in nonperforming loans, at December 31, 2018 , the level of loans past due 30-89 days increased to $2,251,000 from $704,000 at December 31, 2017 , primarily due to one loan which was brought current in January 2019. We will continue to monitor delinquencies for early identification of new problem loans.
 




29


The Corporation maintains an allowance for loan losses at a level considered by management to be adequate to cover the probable losses to be incurred associated with its loan portfolio. The Corporation’s policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity and requires management to make difficult and subjective judgments.
 
The adequacy of the allowance for loan losses is based upon management’s evaluation of the known and inherent risks in the portfolio, consideration of the size and composition of the loan portfolio, actual loan loss experience, the level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions.
 
The allowance for loan losses contains an unallocated reserve amount to cover inherent imprecision of the overall loss estimation process. Due to the complexity in determining the estimated amount of allowance for loan losses, these unallocated reserves reflect management's attempt to ensure that the overall allowance reflects an appropriate level of reserves. The Corporation continues to refine and enhance, as appropriate, its assessment of the adequacy of the allowance by reviewing the look-back periods, updating the loss emergence periods, and enhancing the analysis of qualitative factors. These refinements have increased the level of precision in the allowance and the unallocated portion has declined. During the year ended December 31, 2018 , the Corporation increased its unallocated allowance for loan losses by $4,000 to $11,000. Management believes that the increase in unallocated reserves at December 31, 2018 is appropriate as, in addition to the above discussion, the Corporation has demonstrated a sustained level of performance in the loan portfolio.
 
For the year ended December 31, 2018 , a negative provision for loan loss was recorded in the amount of $1.6 million compared to a provision for loan loss of $655,000 for the year ended December 31, 2017 . The total allowance for loan losses of $7.9 million represented 1.08% of total gross loans at December 31, 2018 compared to $8.8 million, or a ratio of 1.23%, at December 31, 2017 .
 
At December 31, 2018 and 2017 , the Corporation had $6.3 million and $6.6 million, respectively, of loans whose terms have been modified in troubled debt restructurings. Of these loans, $5.7 million and $5.9 million had demonstrated a reasonable period of performance in accordance with their new terms at December 31, 2018 and 2017 , respectively, and not included in the preceding table. The remaining troubled debt restructurings are reported as nonaccrual loans. Specific reserves of $649,000 and $582,000 have been allocated for the troubled debt restructurings at December 31, 2018 and 2017 , respectively. As of December 31, 2018 and 2017 , the Corporation had no additional funds committed to these borrowers. The balance in performing restructured loans also includes loans that are current under their restructured terms, but because of the below market rate of interest and other forbearance agreements, continue to be reflected as restructured loans and impaired loans in accordance with accounting practices. For the year ended December 31, 2018 , gross interest income which would have been recorded had the restructured and non-accruing loans been current in accordance with their original terms amounted to $345,000, of which $292,000 was included in interest income for the year ended December 31, 2018 .
 
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. The net charge-offs reflect partial or full charge-offs on nonaccrual loans due to the initial and ongoing evaluations of market values of the underlying real estate collateral in accordance with Accounting Standards Codification (“ASC”) 310-40. While regular monthly payments continue to be made on many of the nonaccrual loans, certain charge-offs result, nevertheless, from the borrowers’ inability to provide adequate documentation evidencing their ability to continue to service their debt. Management believes the charge-off of these loan balances against reserves provides a clearer indication of the recoverable value of nonaccrual loans. Regardless of our actions of recording partial and full charge-offs on loans, we continue to aggressively pursue collection, including legal action.
 
As of December 31, 2018 and 2017 , there were $10.8 and $12.1 million, respectively, 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. Management continues to monitor performance and credit conditions.




30


 
The following table sets forth, for each of the preceding five years, the historical relationships among the amount of loans outstanding, the allowance for loan losses, the provision for loan losses, the amount of loans charged-off and the amount of loan recoveries:
 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(Dollars in thousands)
Allowance for loan losses:
 

 
 

 
 

 
 

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