UNITED
STATES


SECURITIESAND 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, 2009


OR


o           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 0-21855





Stewardship
      Financial Corporation(Exact
      name of registrant as specified in its
charter)





New Jersey
            
            22-3351447(State
      of other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer 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:   None





Securities
registered under Section 12(g) of the Act:





Common Stock, no par
  valueTitle
      of each class





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes oNo 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 oNo 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 and Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes x   No
o





Indicate by check mark whether the registrant has
submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such
files).  YesoNoo





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. o





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





Large
      accelerated filer   o
            Accelerated
      filer                    
       oNon-accelerated
      filer     o
            Smaller
      reporting company    x





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


Yes o    No
x







1





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, as of June 30, 2009 was
$41,865,000.





As of
March 22, 2010, 5,842,367 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 2010 Annual Meeting of
Shareholders.




2


FORM10-K


STEWARDHSHIP
FINANCIAL CORPORATION


For
the Year Ended December 31, 2009





Table of
Contents


PART
      IItem
      1.
            Business
            5Item
      1A.
            Risk Factors
            11Item
      1B.
            Unresolved Staff Comments
            14Item
      2.
            Properties
            15Item
      3.
            Legal Proceedings
            15Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            16PART
      IIItem
      5.
            Market for the Registrant's Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
            16Item
      6.
            Selected Financial Data
            18Item
      7.
            Management's Discussion and Analysis of Financial Condition and
      Results of Operations
            19Item
      7A.
            Quantitative and Qualitative Disclosures About Market
      Risk
            35Item
      8.
            Financial Statements and Supplementary Data
            35Item
      9.
            Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
            71Item
      9A.
            Controls and Procedures
            71Item
      9B.
            Other Information
            71PART
      IIIItem
      10.
            Directors, Executive Officers and Corporate
      Governance
            71Item
      11.
            Executive Compensation
            72Item
      12.
            Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
            72Item
      13.
            Certain Relationships and Related Transactions, and Director
      Independence
            73Item
      14.
            Principal Accountant Fees and Services
            73PART
      IVItem
      15.
            Exhibits and Financial Statement Schedules
            73Signatures


3
 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”). Such statements are not historical facts
and include expressions about the Corporation’s confidence, strategies and
expectations about earnings, new and existing programs and products,
relationships, opportunities, technology and market conditions and are based on
current beliefs and are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond our
control.  In addition, these forward-looking statements are subject to
assumptions with respect to future business strategies and decisions that are
subject to change.   These statements may be identified by
forward-looking terminology such as “expect,” “believe,” or “anticipate,” or
expressions of confidence like “strong,” or “on-going,” or similar statements or
variations of such terms.  Factors that may cause actual results to
differ materially from those contemplated by such forward-looking statements
include, among others, the following possibilities:





§
            Impairment
      charges with respect to securities.


§
            Unanticipated
      costs in connection with new branch
openings.


§
            Further
      deterioration of the economy.


§
            Decline
      in commercial and residential real estate
  values.


§
            Unexpected
      changes in interest rates.


§
            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.


§
            Adverse
      effects of government regulation or different than anticipated effects
      from existing regulations.


§
            Passage
      by Congress of a law which unilaterally amends the terms of the Treasury’s
      investment in us in a way that adversely affects
  us.


§
            A
      decline in the levels of loan quality and origination
    volume.


§
            A
      decline in deposits.


§
            Other
      unexpected events.





The
Corporation undertakes no obligation to update or revise any forward-looking
statements in the future.


4
 Table of Contents


PartI





Item
1.  Business





General





Stewardship
Financial Corporation (the “Corporation” or “Registrant”) is a one-bank holding
company, which was incorporated under the laws of the State of New Jersey in
January 1995 to serve as a holding company for Atlantic Stewardship Bank (the
“Bank”).  The Corporation was organized at the direction of the Board
of Directors of the Bank for the purpose of acquiring all of the capital stock
of the Bank (the “Acquisition”).  Pursuant to the New Jersey Banking
Act of 1948, as amended (the “New Jersey Banking Act”), and pursuant to approval
of the shareholders of the Bank, the Corporation acquired the Bank and became
its holding company on November 22, 1996.  As part of the Acquisition,
shareholders of the Bank received one share of common stock, no par value
(“Common Stock”) of the Corporation for each outstanding share of the common
stock of 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.  At December 31, 2009 the Bank operated from its main office
at 630 Godwin Avenue, Midland Park, New Jersey, and its twelve
branches.





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 (“FDIC”) up to
applicable limits.  The operations of the Corporation and the Bank are
subject to the supervision and regulation of the FRB, the FDIC and the New
Jersey Department of Banking and Insurance (the “Department”).





Stewardship
Investment Corp. is a wholly-owned non-bank subsidiary of the Bank, whose
primary business is to own and manage an investment
portfolio.  Stewardship Realty, LLC is a 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
subsidiary of the Bank, whose primary business is insurance.  In
addition to the Bank, in 2003, the Corporation formed a second subsidiary,
Stewardship Statutory Trust I 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, and the telephone number is (201)
444-7100.





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 services including personal and business
checking accounts and time deposits, money market accounts and regular savings
accounts.  The Corporation structures its 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, mortgage, home equity and personal
loans.





In
addition, in forming the Bank, the members of the Board of Directors envisioned
a community-based institution which would serve the local communities
surrounding its branches, while also providing a return to its
shareholders.  This vision has been reflected in the Bank’s tithing
policy, under which the Bank tithes 10% of its pre-tax profits to worthy
Christian organizations and civic organizations in the communities where the
Bank maintains branches.





Service
Area





The
Corporation’s service area primarily consists of the Bergen, Passaic and Morris
counties in the New Jersey market, although the Corporation makes loans
throughout New Jersey.  At December 31, 2009, the Corporation operated
its main office in Midland Park, New Jersey and twelve existing branch offices
in Hawthorne (2), Ridgewood, Montville, North Haledon, Pequannock, Waldwick,
Wayne (3), Westwood and Wyckoff, New Jersey.


5
 Table of Contents


Competition





The
Corporation competes for deposits and loans with commercial banks, thrifts and
other financial institutions, many of which have greater financial resources
than the Corporation.  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 Corporation’s service
area.  Certain of these institutions have significantly higher lending
limits than the Corporation and provide services to their customers that the
Corporation does not offer.





Management
believes the Corporation 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 Corporation’s service area,
customers and business.





Employees





At
December 31, 2009 the Corporation employed 107 full-time employees and 33
part-time employees.  None of these employees is covered by a
collective bargaining agreement and the Corporation believes that its employee
relations are good.





Supervision
and Regulation





General





Bank
holding companies and banks are extensively regulated under both federal and
state law.  These laws and regulations are intended to protect
depositors, not stockholders.  To the extent that the following
information describes statutory and regulatory provisions, it is qualified in
its entirety by reference to the particular statutory and regulatory provisions
and is not intended to be an exhaustive description of the statutes or
regulations applicable to the Corporation’s business.  Any change in
the applicable law or regulation may have a material effect on the business and
prospects of the Corporation and the Bank.





Regulation
of the Corporation





BANK HOLDING COMPANY
ACT.As a bank holding company registered under the Bank
Holding Company Act of 1956, as amended (the “BHCA”), the Corporation is subject
to the regulation and supervision of the FRB.  The Corporation is
required to file with the FRB annual reports and other information showing that
its business operations and those of its subsidiaries are limited to banking,
managing or controlling banks, furnishing services to or performing services for
its subsidiaries or engaging in any other activity which the FRB determines to
be so closely related to banking or managing or controlling banks as to be
properly incident thereto.




The 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 a bank holding company, with certain limited exceptions, 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.





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


6
 Table of Contents


required
to commit resources to support such institutions in circumstances where it might
not do so absent such policy.  The FRB also has the authority under
the BHCA to require a bank holding company to terminate any activity or to
relinquish control of a non-bank subsidiary upon the FRB’s determination that
such activity or control constitutes a serious risk to the financial soundness
and stability of any bank subsidiary of the bank holding company.





CAPITAL ADEQUACY GUIDELINES FOR BANK
HOLDING COMPANIES.  The FRB has adopted risk-based capital
guidelines for bank holding companies.  The risk-based capital
guidelines are designed to make regulatory capital requirements more sensitive
to differences in risk profiles among banks and bank holding companies, to
account for off-balance sheet exposure, and to minimize disincentives for
holding liquid assets.  Under these guidelines, assets and off-balance
sheet items are assigned to broad risk categories, each with appropriate
weights.  The resulting capital ratios represent capital as a
percentage of total risk-weighted assets and off-balance sheet
items.





The
risk-based guidelines apply on a consolidated basis to bank holding companies
with consolidated assets of $150 million or more.  The minimum ratio
of total capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%.  At least 4% of
the total capital is required to be “Tier I” capital, consisting of common
stockholders’ equity and certain preferred stock, less certain goodwill items
and other intangible assets.  The remainder, “Tier II 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 I and Tier II
capital less reciprocal holdings of other banking organizations’ capital
instruments, investments in unconsolidated subsidiaries and any other deductions
as determined by the FRB (determined on a case-by-case basis or as a matter of
policy after formal rule-making).





Bank
holding company assets are given risk-weights of 0%, 20%, 50%, and
100%.  In addition, certain off-balance sheet items are given similar
credit conversion factors to convert them to asset equivalent amounts to which
an appropriate risk-weight will apply.  These computations result in
the total risk-weighted assets.  Most loans are assigned to the 100%
risk category, except for performing first mortgage loans fully secured by
residential property which carry a 50% risk-weighting. Most investment
securities (including, primarily, general obligation claims of states or other
political subdivisions of the United States) are assigned to the 20% category,
except for municipal or state revenue bonds, which have a 50% risk-weight, and
direct obligations of the U.S. treasury or obligations backed by the full faith
and credit of the U.S. Government, which have a 0% risk-weight.  In
converting off-balance sheet items, direct credit substitutes, including general
guarantees and standby letters of credit backing nonfinancial obligations, and
undrawn commitments (including commercial credit lines with an initial maturity
of more than one year) have a 50% risk-weighting.  Short term
commercial letters of credit have a 20% risk-weighting and certain short-term
unconditionally cancelable commitments have a 0% risk-weighting.





In
addition to the risk-based capital guidelines, the FRB has adopted a minimum
Tier I capital (leverage) ratio, under which a bank holding company must
maintain a minimum level of Tier I capital to average total consolidated assets
of at least 3% in the case of a bank holding company that has the highest
regulatory examination rating and is not contemplating significant growth or
expansion.  All other bank holding companies are expected to maintain
a leverage ratio of at least 100 to 200 basis points above the stated
minimum.





FINANCIAL SERVICES MODERNIZATION
LEGISLATION.On November 12, 1999, President Clinton signed
into law the Gramm-Leach-Bliley Financial Services Modernization Act of 1999
(“FSMA”).  The passage of the FSMA removes the barriers to
affiliations among financial service companies by repealing restrictions imposed
under the Glass-Steagall Act of 1933 on banks affiliating with securities firms
and by creating a new financial holding company (“FHC”) under the
BHCA.  A company may form an FHC if all of its insured depository
institution subsidiaries are considered well-capitalized and well-managed, and
hold a satisfactory rating under the Community Reinvestment Act of 1977, as
amended.  An FHC can engage in a prescribed list of financial
services, including insurance and securities underwriting and agency activities,
merchant banking, insurance company portfolio investment activities and
“complementary” financial activities.





To insure
consistency in the treatment of banks and other financial institutions, FSMA
reorganizes regulatory authority of federal agencies over securities and
investment activities.





In the
area of insurance, FSMA designates the insurance products that banks and
subsidiaries may provide, prohibits national banks from underwriting or selling
title insurance if they did not actively conduct those activities before FSMA
and permits national banks to sell title insurance in states where state banks
are specifically authorized to do so.  FSMA requires Federal banking
agencies to prescribe consumer protection regulations for insurance sales by
banks.  FSMA preempts state laws that interfere with affiliations
between banks and insurance companies.  It also initiates a process
for creating a uniformity in licensing of insurance agents on a national
level.


7
 Table of Contents


In
addition to enabling banks and their holding companies to conduct a wide range
of financial activities, the FSMA also contained a number of privacy
requirements with which banks and other financial institutions must
comply.  Under the FSMA, all financial institutions must adopt a
privacy policy and make its policy known to those who became new customers and
provide annual disclosure of its policy to all of its customers.  The
Bank had to provide initial privacy notices to all existing customers by July 1,
2001.  Prior to disclosing a consumers’ nonpublic personal information
(not covered by an exception) with nonaffiliated third parties, financial
institutions must provide a reasonable means and opportunity to opt out of
having information shared.  The exceptions include disclosures of
nonpublic personal information: (i) made in connection with certain processing
and servicing transactions; (ii) with the consent, or at the direction, of a
customer or consumer; (iii) to protect against potential fraud or unauthorized
transactions; (iv) to respond to judicial process; and (v) to provide the
information to an employee of the institution who happens also to be an employee
of a nonaffiliated third party.





The FSMA
also required the issuance of regulations establishing standards governing the
administrative, technical and physical safeguards of customer
information.  By July 1, 2001, all financial institutions had to have
an information security program.  Institutions are required to
identify and assess the risks that may threaten customer information, develop a
written plan containing policies and procedures to manage and control these
risks. implement and test the plan, and adjust the plan on a continuing basis to
account for changes in technology, sensitivity of customer information, and
internal or external threats to information security.





Additional
proposals to change the regulations and laws governing the banking and financial
services industry are frequently introduced in the state legislatures, before
various banking regulatory agencies, and in Congress.  The likelihood
and timing of any such changes and the impact of such changes might have on the
Corporation cannot be determined at this time.





Regulation
of the Bank





As a New
Jersey-chartered commercial bank, the Bank is subject to the regulation,
supervision, and control of the Department.  As a FDIC-insured
institution, the Bank is subject to regulation, supervision and control by the
FDIC, an agency of the federal government.  The regulations of the
FDIC and the Department impact virtually all activities of the Bank, including
the minimum level of capital the Bank must maintain, the ability of the Bank to
pay dividends, the ability of the Bank to expand through new branches or
acquisitions, and various other matters.





INSURANCE OF
DEPOSITS.  Substantially all of the deposits of the Bank are
insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the
FDIC and are subject to deposit insurance assessments to maintain the
DIF.  On October 3, 2008, the maximum amount insured under FDIC
deposit insurance was temporarily increased from $100,000 to $250,000 per
insured depositor through December 31, 2009.  This increase was part
of the Emergency Economic Stabilization Act of 2008.  In
May 2009, the increase was extended through December 31,
2013.  Additionally, the Bank has elected to participate in the FDIC’s
Temporary Liquidity Guarantee Program.  Under this voluntary program,
all non-interest bearing deposit transaction accounts at the Bank with balances
over $250,000 were fully insured through December 31, 2009 at an additional cost
to the Bank of 10 basis points per dollar over $250,000 on a per account
basis.  This program was extended through June 30, 2010 at an
additional cost to the Bank of 15 basis points per dollar over $250,000 on a per
account basis.





The FDIC
utilizes a risk-based assessment system whereby insured institutions are
assigned to one of four risk categories based on supervisory evaluations,
regulatory capital levels and certain other factors.  An institution’s
assessment rate depends on the category to which it is
assigned.  Assessment rates are determined by the FDIC and in 2009,
the annual insurance premiums on bank deposits insured by the DIF varied between
$.07 per $100 of deposits for banks classified in the highest capital and
supervisory evaluation categories to $.78 per $100 of deposits for banks
classified in the lowest capital and supervisory evaluation
categories.  The Bank was classified in the highest capital and
supervisory evaluation category.  The FDIC may increase or decrease
the assessment rate schedule on a semi-annual basis.





The FDIC
has set a designated reserve ratio of 1.25% ($1.25 against $100 of insured
deposits) for the DIF. The Federal Deposit Insurance Act of 2005 provides the
FDIC Board of Directors the authority to set the designated reserve ratio
between 1.15% and 1.50%.  The FDIC must adopt a restoration plan when
the reserve ratio falls below 1.15% and begin paying dividends when the reserve
ratio exceeds 1.35%.  The DIF reserve ratio calculated by the FDIC in
effect at September 30, 2009 was a negative .16%.





In
February 2009, the FDIC extended the length of the period during which the
reserve ratio must be restored to 1.15% from five years to seven
years.  The Bank paid a FDIC special assessment of approximately
$300,000 in 2009 in addition to higher premium rates.


8
 Table of Contents


In an
effort to restore capitalization levels and to ensure the DIF will adequately
cover projected losses from future bank failures, in October 2008 the FDIC
proposed a rule to alter the way in which it differentiates for risk in the
risk-based assessment system and to revise deposit insurance assessment rate,
including base assessment rates.  The interim assessment rates
increased the current rates uniformly by seven basis points for the assessment
for the first quarter of 2009 resulting in annualized assessment rates for Risk
Category I institutions ranging from 12 to 14 basis points.





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”) issued in connection with the failure of certain savings and loan
associations.  This payment is established quarterly and averaged 1.04
basis points and 1.12 basis points for the years ended December 31, 2009 and
2008, respectively.  The Corporation paid $54,000 under this
assessment for each of the years ended December 31, 2009 and
2008.  These assessments will continue until the FICO bonds mature in
2017.





On
November 12, 2009, the FDIC adopted a final rule requiring depository
institutions to prepay their estimated quarterly insurance premium for the
fourth quarter of 2009 and all of 2010, 2011 and 2012.  The Bank
prepaid $3.2 million of such premium on December 30, 2009.  The
expense related to this prepayment is anticipated to be recognized over the next
three years based on actual calculations of quarterly provisions.





DIVIDEND
RIGHTS.  Under the New Jersey Banking Act, a Bank may declare
and pay dividends only if, after payment of the dividend, the capital stock of
the Bank will be unimpaired and either the Bank will have a surplus of not less
than 50% of its capital stock or the payment of the dividend will not reduce the
Bank’s surplus.





CHECK CLEARING FOR THE
21STCENTURY
ACT.  (the “Check 21 Act”)  Effective October 28,
2004, the Federal Reserve adopted final amendments to Regulation CC and its
commentary to implement the Check 21 Act.  The Check 21 Act was
enacted on October 28, 2003, and became effective on October 28,
2005.





To
facilitate check truncation and electronic check exchange, the Check 21 Act
authorizes a new negotiable instrument called a “substitute check” and provides
that a properly prepared substitute check is the legal equivalent of the
original check for all purposes.  A substitute check is a paper
reproduction of the original check that can be processed just like the original
check.  The Check 21 Act does not require any bank to create
substitute checks or to accept checks electronically.  The Federal
Reserve’s amendments: (i) set forth the requirements of the Check 21 Act that
apply to all banks, including those that choose not to create substitute checks;
(ii) provide a model disclosure and model notices relating to substitute checks;
and (iii) set forth bank endorsement and identification requirements for
substitute checks.  The amendments to Regulation CC also clarify some
existing provisions of the rule and commentary.





USA PATRIOT ACT OF 2001. (the
“Patriot Act”)  On October 26, 2001, the Patriot Act was signed into
law.  Enacted in response to the terrorist attacks in New York,
Pennsylvania, and Washington D.C. on September 11, 2001, the Patriot Act is
intended to strengthen the ability of U.S. law enforcement and the intelligence
community to work cohesively to combat terrorism on a variety of
fronts.  The potential impact of the Patriot Act on financial
institutions of all kinds is significant and wide-ranging.  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.





Emergency
Economic Stabilization Act of 2008





On
October 3, 2008, in response to the financial crises affecting the banking
system and financial markets and going concern threats to investment banks and
other financial institutions, the Emergency Economic Stabilization Act of 2008
(the “EESA”) was signed into law.  Pursuant to the EESA, the U.S.
Treasury (the “Treasury”) was given the authority to, among other things,
purchase up to $700 billion of mortgages, mortgage-backed securities and certain
other financial instruments from financial institutions for the purpose of
stabilizing and providing liquidity to the U.S. financial
markets.  Pursuant to the EESA, the Treasury was initially authorized
to use $350 billion for the Troubled Asset Relief Program
(“TARP”).  On October 14, 2008, the Secretary of the U.S. Department
of the Treasury announced that the Treasury would purchase equity stakes in a
wide variety of banks and thrifts.  Under the program, known as the
Capital Purchase Program, from the $700 billion authorized by the EESA, the
Treasury made $250 billion of capital available to U.S. financial institutions
in the form of purchases of preferred stock.  In addition to the
preferred stock, the Treasury received, from participating financial
institutions, warrants to purchase common stock with an aggregate market price
equal to 15% of the preferred investment.  Participating financial
institutions were required to adopt the Treasury’s standards for executive
compensation and corporate governance for the period during which the Treasury
holds equity


9
 Table of Contents


issued
under the Capital Purchase Program.  Although we believed that our
capital position was sound, we concluded that the Capital Purchase Program would
allow us to raise additional capital on favorable terms in comparison with other
available alternatives.  Accordingly, we applied to participate in the
Capital Purchase Program.  As described elsewhere in this Annual
Report on Form 10-K, in January, 2009, the Treasury purchased $10 million of the
Corporation’s preferred stock (the “Preferred Shares”) under the TARP Capital
Purchase Program.





We
received $10 million in proceeds from the sale of 10,000 shares of cumulative
perpetual preferred stock with a liquidation value of $1,000 per share to the
Treasury on January 30, 2009.  The preferred stock issued to the
Treasury pays a dividend of 5% for the first five years and 9%
thereafter.  As part of the transaction, we also granted the Treasury
a ten-year warrant to purchase up to 133,475 shares of our common stock at an
exercise price of $11.24, adjusted for the 5% stock dividend paid in November
2009.





Under the
terms of the Capital Purchase Program, the Treasury’s consent will be required
for any increase in our dividends paid to common stockholders (above a quarterly
dividend of $0.090 per common share, adjusted for the 5% stock dividend paid in
November 2009) or the Corporation’s redemption, purchase or acquisition of
common stock or any trust preferred securities issued by the Corporation’s
capital trusts until the third anniversary of the senior preferred share
issuance to the Treasury unless prior to such third anniversary the senior
preferred shares are redeemed in whole or the Treasury has transferred all of
these shares to third parties.





Participants
in the Capital Purchase Program were required to accept several
compensation-related limitations associated with this Program.  In
January 2009, each of our senior executive officers agreed in writing to accept
the compensation standards in existence at that time under the Capital Purchase
Program and thereby cap or eliminate some of their contractual or legal
rights.  The provisions agreed to were as follows:





No Golden Parachute
Payments.    For purposes of the Capital Purchase
Program, “golden parachute payment” was defined to mean a severance payment
resulting from involuntary termination of employment or from a bankruptcy event
of the employer, which exceeds three times the terminated employee’s average
annual base salary over the five years prior to termination.  Our
senior executive officers have agreed to forego all golden parachute payments
for as long as two conditions remain true: they remain “senior executive
officers” (CEO, CFO and the next three highest-paid executive officers), and the
Treasury continues to hold our equity or debt securities issued under the
Capital Purchase Program.  The period during which the Treasury holds
those securities is the “Capital Purchase Program Covered Period.”





Recovery of Incentive Compensation
if Based on Certain Material Inaccuracies.    Our
senior executive officers have also agreed to a “clawback provision,” which
means that we can recover incentive compensation paid during the Capital
Purchase Program Covered Period that is later found to have been paid based on
materially inaccurate financial statements or other materially inaccurate
measurements of performance.





No Compensation Arrangements That
Encourage Excessive Risks.    During the Capital
Purchase Program Covered Period, we are not allowed to enter into compensation
arrangements that encourage senior executive officers to take “unnecessary and
excessive risks that threaten the value” of our Corporation.  To make
sure this does not happen, the Corporation’s Compensation Committee is required
to meet at least twice per year with our senior risk officer to review our
executive compensation arrangements in light of our risk management policies and
practices.  Our senior executive officers’ written agreements include
their obligation to accept any changes in our incentive compensation
arrangements resulting from the Compensation Committee’s review.





Limit on Federal Income Tax
Deductions.    During the Capital Purchase Program
Covered Period, we are not allowed to take federal income tax deductions for
compensation paid to senior executive officers in excess of $500,000 per year,
with certain exceptions that do not apply to our senior executive
officers.





On
February 17, 2009, President Obama signed the American Recovery and Reinvestment
Act of 2009 (the “Stimulus Act”) into law.  The Stimulus Act modified
the compensation-related limitations contained in the Capital Purchase Program
and created additional compensation-related limitations.  The
limitations in the Stimulus Act apply to all participants in the Troubled Asset
Relief Program (under which the Capital Purchase Program was created),
regardless of when participation commenced.  Thus, the newly enacted
compensation-related limitations are applicable to the Corporation, subject to
the Treasury Department’s issuance of implementing regulations.  The
compensation-related limitations applicable to the Corporation which have been
added or modified by the Stimulus Act are as follows:





No Severance
Payments.    Under the Stimulus Act, the definition
of “golden parachute” was expanded to include any severance payment resulting
from termination of employment, except for payments for services performed or
benefits accrued.  In addition, the Stimulus Act expanded the group of
employees to which such restrictions apply.  Consequently, under the
Stimulus Act, we are prohibited from making any severance payment to our
“senior


10
 Table of Contents


executive
officers” (defined in the Stimulus Act as the five highest paid senior executive
officers) and our next five most highly compensated employees during the Capital
Purchase Program Covered Period.





Recovery of Incentive Compensation
if Based on Certain Material Inaccuracies.    The
Stimulus Act also contains the “clawback provision” discussed above, but extends
its application to our next 20 most highly compensated employees.





No Compensation Arrangements That
Encourage Earnings Manipulation.    In addition to
the Capital Purchase Program prohibition on compensation arrangements that
encourage unnecessary and excessive risk, the Stimulus Act prohibits us during
the Capital Purchase Program Covered Period from entering into compensation
arrangements that encourage manipulation of reported earnings to enhance the
compensation of any of our employees.





Limit on Incentive
Compensation.    The Stimulus Act contains a
provision that prohibits the payment or accrual of any bonus, retention award or
incentive compensation to certain employees during the Capital Purchase Program
Covered Period, other than awards of long-term restricted stock that (i) do not
fully vest during the Capital Purchase Program Covered Period, (ii) have a value
not greater than one-third of the total annual compensation of the awardee and
(iii) are subject to such other restrictions as determined by the Secretary of
the Treasury.  The prohibition on bonus, incentive compensation and
retention awards does not preclude payments required under written employment
contracts entered into on or prior to February 11, 2009.  As a
recipient of less than $25 million of funds from the Capital Purchase Program,
the limit applies only to the most highly compensated employee.





Compensation Committee
Functions.    The Stimulus Act requires that our
Compensation Committee be comprised solely of independent directors and that it
meet at least semiannually to discuss and evaluate our employee compensation
plans in light of an assessment of any risk posed to us from such compensation
plans.





Compliance
Certifications.    The Stimulus Act also requires a
written certification by our Chief Executive Officer and Chief Financial Officer
of our compliance with the provisions of the Stimulus Act.





Treasury Review of Excessive Bonuses
Previously Paid.    The Stimulus Act directs the
Secretary of the Treasury to review all compensation paid to our senior
executive officers and the next 20 most highly compensated employees prior to
adoption of the Stimulus Act to determine whether any such payments were
inconsistent with the purposes of the Capital Purchase Program or the Stimulus
Act or were otherwise contrary to the public interest.  If the
Secretary of the Treasury makes such a finding, the Secretary of the Treasury is
directed to negotiate with the Capital Purchase Program recipient and the
employee recipient for appropriate reimbursements to the federal government with
respect to the compensation.





Say on
Pay.    Under the Stimulus Act, during the Capital
Purchase Program Covered Period, we must include in the proxy statement for our
annual meeting of shareholders a non-binding say on pay vote by the shareholders
on executive compensation.





Limitation on Luxury
Expenditures.    The Stimulus Act required us to
adopt a company-wide policy regarding excessive or luxury expenditures, such as
entertainment expenses, office or facility renovation expenses and
transportation services expenses.





Item1A.  Risk Factors





Investments
in the common stock of Stewardship Financial Corporation involve
risk.  The following discussion highlights the risks management
believes are material for our Corporation, but does not necessarily include all
risks that we may face.





Our
operations are subject to interest rate risk and changes in interest rates may
negatively affect financial performance.





Our
earnings and cash flows are largely dependent upon our net interest
income.  Net interest income is the difference between interest income
earned on interest-earning assets, such as loans and securities, and interest
expense paid on interest-bearing liabilities, such as deposits and borrowed
money.  To be profitable we must earn more interest from our
interest-earning assets than we pay on our interest-bearing
liabilities.  Changes in the general level of interest rates may have
an adverse affect on our business, financial condition and results of
operations.  Interest rates are highly sensitive to many factors that
are beyond our control, including general economic conditions and the policies
of governmental and regulatory agencies such as the Federal Reserve
Bank.  Changes in monetary policy and interest rates can also
adversely affect our ability to originate loans and deposits, the fair value of
financial assets and liabilities and the average duration of our assets and
liabilities.


11
 Table of Contents


Our
allowance for loan losses may be insufficient.





There are
inherent risks associated with our lending activities.  There are
risks inherent in making any loan, 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.





A
persistent economic recession and unstable financial markets have adversely
affected our industry and, because of our geographic concentration in northern
New Jersey, we could be impacted by adverse changes in local economic
conditions.





Our
success depends on the general economic conditions of the nation, the state of
New Jersey, and the northern New Jersey area.  The nation’s current
economic environment and the related volatility of the financial markets have
severely adversely affected the banking industry and may adversely affect our
business, financial condition, results of operations and stock
price.  We do not believe these difficult economic conditions are
likely to improve dramatically in the near term.  Unlike larger banks
that are more geographically diversified, we provide financial services to
customers primarily in the market areas in which we operate.  The
local economic conditions of these areas have a significant impact on our
commercial, real estate and construction loans, the ability of our borrowers to
repay these loans and the value of the collateral securing these
loans.  While we did not and do not have a sub-prime lending program,
any significant decline in the real estate market in our primary market area
would hurt our business and mean that collateral for our loans would have less
value. As a consequence, our ability to recover on defaulted loans by selling
the real estate securing the loan would be diminished and we would be more
likely to suffer losses on defaulted loans.  Any of the foregoing
events and conditions could have a material adverse effect on our business,
results of operations and financial condition.





Competition
within the financial services industry could adversely affect our
profitability.





We face
strong competition from banks, other financial institutions, money market mutual
funds and brokerage firms within the New York metropolitan area.  A
number of these entities have substantially greater resources and lending
limits, larger branch systems and a wider array of banking
services.  Competition among depository institutions for customer
deposits has increased significantly in the current difficult economic
situation.  If we are unsuccessful in competing effectively, we will
lose market share and may suffer a reduction in our margins and suffer adverse
consequences to our business, results of operations and financial
condition.





Federal
and State regulations could restrict our business and increase our costs and
non-compliance would result in penalties, litigation and damage to our
reputation.





We
operate in a highly regulated environment and are subject to extensive
regulation, supervision, and examination by the FDIC, the FRB and the State of
New Jersey.  The significant federal and state banking regulations
that we are subject to are described herein under “Item 1.
Business.”  Such regulation and supervision of the activities in which
an institution 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 we may offer and/or increase the ability of
non-banks to offer competing financial services and products, among other
things.  Due to our nation’s current economic recession and the lack
of confidence in the financial markets, it is highly probable new federal and/or
state laws and regulations of lending and funding practices and liquidity
standards will be forthcoming.  Bank regulatory agencies are expected
to be 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.  We may be required to pay even higher FDIC premiums
than the current level.  Our failure to comply


12
 Table of Contents


with law,
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 polices and
procedures designed to prevent any such violations, there can be no assurances
that such violations will not occur.





A
breach of information security or compliance breach by one of our vendors could
negatively affect our reputation and business.





We rely
upon a variety of computing platforms and networks over the internet for the
purpose of data processing, communication and information
exchange.  Despite the safeguards instituted by management, such
systems are susceptible to a breach of security.  In addition, we rely
on the service of a variety of third-party vendors to meet our processing
needs.  If confidential information is compromised, financial losses,
costs and damages could occur.  Such costs and or losses could
materially affect our earnings.  In addition, the negative affect on
our reputation could affect our ability to deliver products and services
successfully to new and existing customers.





The
trading volume of our stock remains low which could impact stock
prices.





The
trading history of our common stock has been characterized by relatively low
trading volume.  The value of a shareholder’s investment may be
subject to decreases due to the volatility of the price of our common stock
which trades on the Nasdaq Capital Market.





The
market price of our common stock may be volatile and subject to fluctuations 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 operating
results;


·
            changes
      in interest rates;


·
            changes
      in legal or regulatory environment;


·
            press
      releases, publicity, or
announcements;


·
            changes
      in expectation of our future financial
  performance;


·
            future
      sales of our common stock;


·
            changes
      in economic conditions; and


·
            other
      developments affecting us or our
competitors





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





Because
of our participation in the Treasury’s Capital Purchase Program, the Corporation
is subject to certain restrictions including limitations on the payment of
dividends on and the repurchase of our Common Stock.





The
Corporation has traditionally paid a quarterly cash dividend to
shareholders.  In the future, we may not be able to declare or pay
cash dividends other than regular quarterly cash dividends of not more than
$0.090 per share (adjusted for the 5% stock
dividend paid in November 2009), which was the amount of the last regular
quarterly dividend declared and paid by the Corporation before our participation
in the Capital Purchase Program, or even to declare or pay cash dividends at all
in accordance with past practice, due to restrictions on the payment of
dividends and the repurchase of our Common Stock contained in the Securities
Purchase Agreement between the Corporation and the Treasury.  These
restrictions on declaring or paying dividends could negatively effect the value
of our Common Stock.  Until the earlier of the third anniversary of
the Treasury’s investment in our Series A Preferred Stock or when all of the
shares of Series A Preferred Stock have been redeemed by us or transferred by
the Treasury to third parties, we may not, without the consent of the Treasury,
increase the cash dividend on our Common Stock or, purchase, redeem or otherwise
acquire for consideration shares of our Common Stock or any preferred stock
(other than the Series A Preferred Stock), subject to limited exceptions, most
significantly purchases in connection with benefit plans.  We are
prohibited from declaring dividend payments on common, junior preferred or pari
passu preferred shares unless we are current in our dividend payments on the
Series A Preferred Stock.  Further, common, junior preferred or pari
passu preferred shares may not be repurchased by us unless we are current in our
dividend payments on the Series A Preferred Stock.





Moreover,
our ability to pay dividends is always subject to legal and regulatory
restrictions.  Any payment of dividends in the future will depend, in
large part, on the Corporation’s earnings, capital requirements, financial
condition and other factors considered relevant by the Corporation’s Board of
Directors.  Although we have historically paid cash dividends on our
Common Stock, we are not required to do so and our Board of Directors could
reduce or eliminate our Common Stock dividend in the future.


13
 Table of Contents


If
we are unable to redeem the Series A Preferred Stock issued to the Treasury in
connection with our participation in the Treasury’s Capital Purchase Program
within five years, the cost of the capital received will increase
significantly.





The
Series A Preferred Stock pays cumulative dividends at the rate of 5% per annum
for the first five years and 9% per annum thereafter.  The Series A
Preferred Stock has no maturity date.  If we are unable to redeem the
Series A Preferred Stock prior to February 15, 2014, the dividend payable
thereon will increase on that date from 5% per annum ($500,000 annually) to 9%
per annum ($900,000 annually).  If we are unable to redeem our Series
A Preferred Stock by February 15, 2014, this increase in the annual dividend
rate on the Series A Preferred Stock could have a material negative effect on
our liquidity.





The
Series A Preferred Stock issued to the Treasury in connection with our
participation in the Treasury’s Capital Purchase Program reduces our net income
and earnings per share of Common Stock and the Warrant issued to the Treasury
may be dilutive to the ownership interests of holders of the Common
Stock.





The
shares of Series A Preferred Stock pay cumulative dividends at the rate of 5%
per annum for the first five years and 9% per annum thereafter.  These
dividends will reduce our net income and earnings per common
share.  The Series A Preferred Stock ranks senior to the Common Stock
and, as such, will receive preferential treatment in the event of liquidation,
dissolution or winding up of the Corporation.  In the event that the
Warrant issued to the Treasury is exercised in whole or part, the ownership
interest of our existing shareholders will be diluted
accordingly.  The shares of Common Stock underlying the warrant
represent approximately 2.2% of the shares of the Corporation’s Common Stock
outstanding as of December 31, 2009 (included in total shares outstanding are
the shares issuable upon exercise of the Warrant). The Treasury has agreed not
to vote any of the shares of Common Stock it receives upon exercise of the
Warrant, but any third party to which the Treasury transfers the Warrant or any
portion of the Warrant or any shares of Common Stock underlying the Warrant is
not similarly bound by this voting restriction.





Our
future deposit insurance premiums could be substantially higher, which could
have a material adverse effect on our future earnings.





The FDIC
insures deposits at FDIC insured financial institutions, including the
Bank.  The FDIC charges the insured financial institutions premiums to
maintain the Deposit Insurance Fund at an adequate level.  In light of
developments in the market, FDIC insurance premiums increased substantially in
2009.  The FDIC adopted a revised risk-based deposit insurance
assessment schedule during the first quarter of 2009, which raised regular
deposit insurance premiums.  The FDIC also implemented a five basis
point special assessment of each insured depository institution’s total assets
minus Tier 1 capital as of June 30, 2009.  The amount of this special
assessment for the Bank was approximately $300,000.  In December 2009
the FDIC required us to prepay our assessments for the fourth quarter of 2009
and for all of 2010, 2011 and 2012.  Notwithstanding this prepayment,
the FDIC may further increase the standard assessment rates and impose
additional special assessments in the future.





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 an inability to liquidate assets or obtain
adequate funding in 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
stockholders.





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; 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.





Item1B.  Unresolved Staff Comments





None.


14
 Table of Contents


Item2.  Properties





The
Corporation conducts its business through its main office located at 630 Godwin
Avenue, Midland Park, New Jersey and its twelve branch offices.  The
property located at 612 Godwin Avenue is to be used for future administrative
offices.  The property located at 121 Franklin Avenue is a remote
drive-up location.  The following table sets forth certain information
regarding the Corporation’s properties as of December 31, 2009.








Leased
            Date
      of LeaseLocation
            or Owned
            Expiration612
      Godwin Avenue
            Owned
            ---Midland
      Park, NJ630
      Godwin Avenue
            Owned
            ---Midland
      Park, NJ386
      Lafayette Avenue
            Owned
            ---Hawthorne,
      NJ87
      Berdan Avenue
            Leased
            06/30/14Wayne,
      NJ64
      Franklin Turnpike
            Owned
            ---Waldwick,
      NJ190
      Franklin Avenue
            Leased
            09/30/12Ridgewood,
      NJ121
      Franklin Avenue
            Leased
            01/31/15Ridgewood,
      NJ311
      Valley Road
            Leased
            11/30/13Wayne,
      NJ249
      Newark Pompton Turnpike
            Owned
            ---Pequannock,
      NJ1111
      Goffle Road
            Leased
            05/31/11Hawthorne,
      NJ400
      Hamburg Turnpike
            Leased
            04/30/14Wayne,
      NJ2
      Changebridge Road
            Leased
            06/30/15Montville,
      NJ378
      Franklin Avenue
            Leased
            05/31/26Wyckoff,
      NJ200
      Kinderkamack Road
            Leased
            05/20/26Westwood,
      NJ33
      Sicomac Avenue
            Leased
            10/31/14North
      Haledon, NJ





Item3.  Legal Proceedings





The
Corporation and the Bank are periodically parties to or otherwise involved in
legal proceedings arising in the normal course of business, 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


15
 Table of Contents


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.





Item4.  Submission of Matters to a Vote of Security
Holders





No
matters were submitted for a vote of the Registrant’s shareholders during the
fourth quarter of fiscal 2009.








PartII








Item
5.  Market for the Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities





Until
March 27, 2007, the Corporation’s Common Stock traded on the OTC Bulletin Board
under the symbol “SSFN”.  Since March 28, 2007, the Corporation’s
Common Stock has been traded on the Nasdaq Capital Market under the same
symbol.  As of December 31, 2009, there were approximately 1,000
shareholders of record of the Common Stock.





The
following table sets forth the quarterly high and low bid prices of the Common
Stock as reported on the Nasdaq Capital Market for the quarterly periods
presented.  The prices below reflect inter-dealer prices, without
retail markup, markdown or commissions, and may not represent actual
transactions.  The stock prices and cash dividends set forth below
also reflect adjustments related to 5% stock dividends paid in November, 2009
and 2008.





Bid
            
            
            CashHigh
            
            
            Low
            
            
            DividendYear
      Ended December 31, 2009Fourth
      quarter
            
            $
            10.50
            
            
            $
            8.26
            
            
            $
            0.090Third
      quarter
            
            
            10.45
            
            
            
            7.95
            
            
            
            0.090Second
      quarter
            
            
            11.21
            
            
            
            8.33
            
            
            
            0.090First
      quarter
            
            
            11.41
            
            
            
            7.09
            
            
            
            0.090





Year
      Ended December 31, 2008Fourth
      quarter
            
            $
            13.10
            
            
            $
            7.24
            
            
            $
            0.086Third
      quarter
            
            
            12.48
            
            
            
            10.89
            
            
            
            0.086Second
      quarter
            
            
            13.15
            
            
            
            11.09
            
            
            
            0.082First
      quarter
            
            
            13.61
            
            
            
            11.79
            
            
            
            0.082





The
Corporation may pay dividends as declared from time to time by the Corporation’s
Board of Directors out of funds legally available therefore, subject to certain
restrictions.  Since dividends from the Bank will be the Corporation’s
main source of income, any restriction on the Bank’s ability to pay dividends
will act as a restriction on the Corporation’s ability to pay
dividends.  Under the New Jersey Banking Act, the Bank may not pay a
cash dividend unless, following the payment of such dividend, the capital stock
of the Bank will be unimpaired and (i) the Bank will have a surplus of no less
than 50% of its capital stock or (ii) the payment of such dividend will not
reduce the surplus of the Bank.  In addition, the Bank cannot pay
dividends if doing so would reduce its capital below the regulatory imposed
minimums.





Also, our
ability to pay future cash dividends is subject to the provision contained in
the agreement that covers our participation in the Treasury’s Capital Purchase
Program.  Specifically, the Corporation may not declare a dividend
that exceeds $0.090 per common share until the earlier of the third anniversary
of the Treasury’s investment or our redemption or the transfer of our Preferred
Stock to a third party.





During
fiscal 2009, the Corporation paid quarterly cash dividends totaling $0.36 per
share for an annual dividend payout ratio of 58.2%.  During fiscal
2008 the Corporation paid quarterly cash dividends totaling $0.34 per share for
an annual dividend payout ratio of 56.2%.


16
 Table of Contents


STEWARDSHIP
FINANCIAL CORPORATION AND SUBSIDIARY


STOCK
PERFORMANCE GRAPH





The
following graph compares the cumulative total return on a hypothetical $100
investment made on December 31, 2004 in: (a) Stewardship Financial Corporation’s
common stock; (b) NASDAQ Composite; (c) NASDAQ Bank; (d) Peer Group 2008; and
(e) Peer Group 2009.  The Peer Group indices consist of New Jersey
based commercial banks with total asset size and operating performance
comparable with the Corporation.  The Peer Group 2008 index consists
of the following companies: 1st Constitution Bancorp, BCB Bancorp, Inc., Center
Bancorp, Central Jersey Bancorp, Community Bank of Bergen County, Parke Bancorp,
Inc., Peapack-Gladstone Financial Corporation, Somerset Hills Bancorp, Sterling
Banks, Inc., Sussex Bancorp, and Unity Bancorp, Inc.  The Peer Group
2009 index consists of the following companies: 1st Colonial Bancorp, Inc., 1st
Constitution Bancorp, Bancorp of New Jersey, Inc., BCB Bancorp, Inc., Center
Bancorp, Inc., Central Jersey Bancorp, Community Partners Bancorp, Parke
Bancorp, Inc., Somerset Hills Bancorp, Sussex Bancorp, and Unity Bancorp, Inc.
The information provided is not necessarily indicative of the Corporation’s
future performance.





STEWARDSHIP
FINANCIAL CORPORATION









Period
      EndingIndex
            
            12/31/04
            
            
            12/31/05
            
            
            12/31/06
            
            
            12/31/07
            
            
            12/31/08
            
            
            12/31/09Stewardship
      Financial Corporation
            
            $
            100.00
            
            
            $
            98.41
            
            
            $
            96.59
            
            
            $
            104.05
            
            
            $
            84.77
            
            
            $
            78.09NASDAQ
      Composite
            
            $
            100.00
            
            
            $
            101.37
            
            
            $
            111.03
            
            
            $
            21.92
            
            
            $
            72.49
            
            
            $
            104.31NASDAQ
      Bank
            
            $
            100.00
            
            
            $
            95.67
            
            
            $
            106.20
            
            
            $
            82.76
            
            
            $
            62.96
            
            
            $
            51.31Peer
      Group 2008
            
            $
            100.00
            
            
            $
            96.88
            
            
            $
            104.01
            
            
            $
            88.72
            
            
            $
            65.56
            
            
            $
            49.84Peer
      Group 2009
            
            $
            100.00
            
            
            $
            98.07
            
            
            $
            103.45
            
            
            $
            89.85
            
            
            $
            52.72
            
            
            $
            48.46


17
 Table of Contents


Item6.  Selected Financial Data


The
following selected consolidated financial data of the Corporation is qualified
in its entirety by, and should be read in conjunction with, the consolidated
financial statements, including notes, thereto, included elsewhere in this
document.





STEWARDSHIP
FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED


FINANCIAL
SUMMARY OF SELECTED FINANCIAL DATA





December
      31,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005(Dollars
      in thousands, except per share amounts)Earnings
      Summary:Net
      interest income
            
            $
            23,345
            
            
            $
            22,303
            
            
            $
            19,430
            
            
            $
            19,084
            
            
            $
            18,211Provision
      for loan losses
            
            
            (3,575
            )
            
            
            (3,585
            )
            
            
            (530
            )
            
            
            (264
            )
            
            
            (600
            )Net
      interest income after provision for loan losses
            
            
            19,770
            
            
            
            18,718
            
            
            
            18,900
            
            
            
            18,820
            
            
            
            17,611Noninterest
      income
            
            
            3,133
            
            
            
            4,217
            
            
            
            4,414
            
            
            
            4,189
            
            
            
            3,240Noninterest
      expense
            
            
            17,790
            
            
            
            17,986
            
            
            
            16,629
            
            
            
            15,629
            
            
            
            13,867Income
      before income tax expense
            
            
            5,113
            
            
            
            4,949
            
            
            
            6,685
            
            
            
            7,380
            
            
            
            6,984Income
      tax expense
            
            
            1,479
            
            
            
            1,448
            
            
            
            2,078
            
            
            
            2,627
            
            
            
            2,504Net
      income
            
            
            3,634
            
            
            
            3,501
            
            
            
            4,607
            
            
            
            4,753
            
            
            
            4,480Dividends
      on preferred stock and accretion
            
            
            504
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income available to common stockholders
            
            $
            3,130
            
            
            $
            3,501
            
            
            $
            4,607
            
            
            $
            4,753
            
            
            $
            4,480Common
      Share Data: (1)Basic
      net income
            
            $
            0.54
            
            
            $
            0.60
            
            
            $
            0.79
            
            
            $
            0.82
            
            
            $
            0.77Diluted
      net income
            
            
            0.54
            
            
            
            0.60
            
            
            
            0.79
            
            
            
            0.81
            
            
            
            0.77Cash
      dividends declared
            
            
            0.36
            
            
            
            0.34
            
            
            
            0.31
            
            
            
            0.26
            
            
            
            0.22Book
      value at year end
            
            
            7.50
            
            
            
            7.31
            
            
            
            7.02
            
            
            
            6.42
            
            
            
            5.78Average
      shares outstanding net of treasury stock
            
            
            5,832
            
            
            
            5,854
            
            
            
            5,836
            
            
            
            5,812
            
            
            
            5,778Shares
      outstanding at year end
            
            
            5,835
            
            
            
            5,854
            
            
            
            5,851
            
            
            
            5,809
            
            
            
            5,772Dividend
      payout ratio
            
            
            58.15
            %
            
            
            56.18
            %
            
            
            39.35
            %
            
            
            32.19
            %
            
            
            27.79
            %Selected
      Consolidated Ratios:Return
      on average assets
            
            
            0.57
            %
            
            
            0.58
            %
            
            
            0.86
            %
            
            
            0.96
            %
            
            
            1.00
            %Return
      on average stockholders' equity
            
            
            5.92
            %
            
            
            8.34
            %
            
            
            11.76
            %
            
            
            13.41
            %
            
            
            13.86
            %Average
      stockholders' equity as a percentage of
              average
      total assets
            
            
            8.23
            %
            
            
            6.98
            %
            
            
            7.34
            %
            
            
            7.19
            %
            
            
            7.20
            %Leverage
      (Tier-I) capital (2)
            
            
            9.22
            %
            
            
            8.01
            %
            
            
            8.56
            %
            
            
            8.85
            %
            
            
            8.71
            %Tier-I
      risk based capital (3)
            
            
            11.99
            %
            
            
            10.50
            %
            
            
            10.76
            %
            
            
            11.25
            %
            
            
            11.16
            %Total
      risk based capital (3)
            
            
            13.24
            %
            
            
            11.60
            %
            
            
            11.76
            %
            
            
            12.28
            %
            
            
            12.21
            %Allowance
      for loan loss to total loans
            
            
            1.50
            %
            
            
            1.18
            %
            
            
            1.06
            %
            
            
            1.11
            %
            
            
            1.11
            %Nonperforming
      loans to total loans
            
            
            4.98
            %
            
            
            1.46
            %
            
            
            0.11
            %
            
            
            0.41
            %
            
            
            0.15
            %Selected
      Year-end Balances:Total
      assets
            
            $
            663,844
            
            
            $
            611,816
            
            
            $
            571,905
            
            
            $
            519,749
            
            
            $
            482,727Total
      loans, net of allowance for loan loss
            
            
            453,119
            
            
            
            434,103
            
            
            
            415,690
            
            
            
            365,443
            
            
            
            341,976Total
      deposits
            
            
            529,930
            
            
            
            506,531
            
            
            
            472,299
            
            
            
            434,223
            
            
            
            403,466Stockholders'
      equity
            
            
            53,511
            
            
            
            42,796
            
            
            
            41,090
            
            
            
            37,306
            
            
            
            33,384




(1)
            All
      share and per share amounts have been restated to reflect 5% stock
      dividends paid November 2005, 2006, 2007, 2008 and 2009 and a 4 for 3
      stock split that occurred July
2005.


(2)
            As
      a percentage of average quarterly
assets.


(3)
            As
      a percentage of total risk-weighted
assets.


18
 Table of Contents


Item7.  Management’s Discussion and Analysis of Financial
Condition and Results of Operations





This
section provides an analysis of the Stewardship Financial Corporation’s (the
“Corporation”) consolidated financial condition and results of operations for
the years ended December 31, 2009 and 2008.  The analysis should be
read in conjunction with the related audited consolidated financial statements
and the accompanying notes presented elsewhere herein.





Cautionary
Note Regarding Forward-Looking Statements





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




Introduction




The
Corporation’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.  The
Corporation currently has 13 full service branches offices located in Bergen,
Passaic and Morris counties in New Jersey.  The Corporation conducts a
general commercial and retail banking business encompassing a wide range of
traditional deposit and lending functions along with the other customary banking
services.  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, along with a
strong focus on customer service, is used to attract customers and build
depositor relationships.  Challenges facing the organization are to
continue to grow the existing branch levels, provide adequate technology
enhancements to achieve efficiencies, offer a competitive product line, and
provide the highest level of customer service.





The
Corporation is affected by the overall economic conditions in northern New
Jersey, the interest rate and yield curve environment, and the overall national
economy.  These factors are relevant because they will affect 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 provides for solid coverage in both existing and new markets in
key towns in the three counties in which we operate.  The Corporation
continually evaluates the need to further develop the infrastructure to enable
the entity to continue to build franchise value, expand its customer base, and
offer appropriate products and services to its existing and future customer
base.  During 2007 the Corporation opened three new branch
locations.  Management has been encouraged by the positive reception
received for these three branches and believes that each of these branches
contribute to a strong branch network.  As the branches continue to
mature, they provide a strong diverse customer base of both consumer and
business customers.





In 2009,
the Corporation, like all financial institutions, continued to experience a
difficult and complicated economic and operating environment.  The
Corporation’s results have been affected by the economic downturn through higher
loan loss provisions.  In addition, competition in the northern New
Jersey market remained intense and the challenges of operating throughout the
year in a flat interest rate market continued to make it somewhat difficult to
attract deposits at appropriate interest rate levels.  Although the
area in which the bank operates has been somewhat shielded by the national
economic downturn, management continues to find it challenging to attract low
cost core deposits.  Furthermore, while the current economic
conditions and softness in the real estate market have contributed to
an


19
 Table of Contents


increase
in loan delinquencies, lending opportunities have been appropriately
addressed.  The Corporation has not been involved in the subprime
lending area.





In an
effort to address the strong competition in attracting deposit balances, in
mid-February 2009 we introduced our new Power Rate checking
product.  This new offering pays a premium rate of interest and
refunds ATM fees charged by other financial institutions.  In return,
the customer has simple monthly qualification factors such as enrolling in
online banking with electronic statements and minimum levels of debit card
usage.  This product contributed to the growth in deposits during 2009
as well as increased fee income related to debit cards and reduced expenses
related to statement rendition.





From time
to time the Corporation has utilized brokered certificates of deposit to
supplement deposit growth.  However, at December 31, 2009 the
Corporation had no brokered certificates of deposit compared to $30.7 million as
of December 31, 2008.





Improvements
and upgrades of our electronic / online banking products and services continued
to be a priority for 2009.  During 2009 we introduced an online
banking / cash management product as well as remote deposit capture services for
businesses.  Additional development and testing of technology,
including mobile banking, was performed in 2009 leading to a planned 2010
introduction.





In
addition to a focus on increasing non-interest income, in 2009 there was a
renewed emphasis on expense control.  However, substantial increases
of the FDIC insurance premium resulted in increased expenses incurred by the
Corporation during 2009l.  As a result of losses to the FDIC insurance
fund from recent bank failures as well as projected bank failures, the FDIC
increased its insurance premium rates to all banks in 2009.  In
addition, the FDIC imposed a 5 basis point special assessment on all banks,
based on June 30, 2009 total assets net of Tier 1 capital.  Total FDIC
insurance premium expense for 2009 represented an $807,000 increase over 2008
including the recording of approximately $300,000 of expense for the special
assessment.





In 2009,
the Corporation received $10 million as part of the United States Treasury
Capital Purchase Program (CPP).  The additional capital provided by
the CPP solidified our already well capitalized position, thereby enhancing our
ability to continue to grow assets and increasing our ability to make new
loans.  Accordingly, we can better serve the lending needs of
consumers and businesses in our market.





Despite
facing economic and unprecedented challenges in 2009, the Corporation continued
to perform well when compared with peer group performance.  The
Corporation will continue to concentrate its efforts on growing and maturing its
existing branch network, developing new products and services, capitalizing on
technology and focusing on improved efficiencies during 2010.





Recent
Accounting Pronouncements





A
discussion of recent pronouncements and their effect on the Corporation’s Audited Consolidated Financial Statements can be
found in Note 1 of theCorporation’s Audited Consolidated Financial Statements
contained elsewhere in this Annual Report on Form 10-K.





Critical
Accounting Policies And Estimates





“Management’s
Discussion and Analysis of Financial Condition and Results of Operation,” 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 accordance with accounting principles generally accepted in the
United States of America.  The preparation of these financial
statements requires the Corporation to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenues and
expenses.  Note 1 to the Corporation’s Audited Consolidated Financial
Statements for the year ended December 31, 2009 contains a summary of the
Corporation’s significant accounting policies.  Management believes
the Corporation’s policy with respect to the methodology for the determination
of the allowance for loan losses involves a higher degree of complexity and
requires management to make difficult and subjective judgments, which often
require assumptions or estimates about highly uncertain
matters.  Changes in these judgments, assumptions or estimates could
materially impact results of operations.  This critical policy and its
application are periodically reviewed with the Audit Committee and the Board of
Directors.





The
allowance for loan losses is based upon management’s evaluation of the adequacy
of the allowance, including an assessment of known and inherent risks in the
portfolio, giving consideration to the size and composition of the loan
portfolio, actual loan loss experience, level of delinquencies, detailed
analysis of individual loans for which full collectability may not be assured,
the existence and estimated net realizable value of any underlying collateral
and guarantees securing the loans, and current economic and market conditions.
Although management uses the best information available, the level of the
allowance for loan losses remains an estimate, which is subject to
significant


20
 Table of Contents


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 an adverse economic
shock.  Future adjustments to the allowance for loan losses may be
necessary due to economic, operating, regulatory and other conditions beyond the
Corporation’s control.





Earnings
Summary





The
Corporation reported net income of $3.6 million, or $0.54 diluted earnings per
common share, for the year ended December 31, 2009, compared to $3.5 million, or
$0.60 diluted earnings per common share recorded for 2008.  Results
for the current year include increased expense associated with a FDIC special
assessment.





The
return on average assets of 0.57% in 2009 was relatively unchanged from 0.58% in
2008.  The return on average equity decreased to 5.92% for 2009 from
8.34% in 2008.





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, 2009, net interest income, on a tax equivalent basis,
increased to $23.9 million from $22.8 million for the year ended December 31,
2008, reflecting an increase of $1.1 million, or 4.7%.  The increase
in the current year is due to an increase of $8.5 million, or 7.1%, in net
average interest-earning assets (average interest-earning assets less average
interest-bearing liabilities) partially offset by a decrease in the net yield on
interest-earning assets.  The net interest rate spread and net yield
on interest earning assets for the year ended December 31, 2009 were 3.45% and
3.89%, respectively, compared to 3.43% and 4.00% for the year ended December 31,
2008.  The net interest rate spread and net yield on interest earning
assets for the current year reflect a decline in loan interest rates and yields
on securities as well as a decline in the interest rates on deposits and
borrowings.  The Corporation attempted to proactively manage deposit
costs in an effort to mitigate the lower asset yields attributable to
historically low market rates.





For the
year ended December 31, 2009, total interest income, on a tax equivalent basis,
decreased $878,000, or 2.5%, when compared to the prior year.  The
decrease was due to a decrease in yields on interest-earning assets partially
offset by an increase in the average balance of interest-earning
assets.  The average rate earned on interest-earning assets decreased
58 basis points from 6.23% for the year ended December 31, 2008 to 5.65% in the
current year.  The decline in short-term interest rates during 2008
resulted in a Prime rate of 3.25% at December 31, 2008 compared to a Prime rate
of 7.25% in January of 2008 dropping to 5.00% in September 2008.  The
decline in short-term rates resulted in loans resetting during the past year at
lower interest rates, thereby contributing to the decline in yields on earning
assets.  Average interest-earning assets increased $43.2 million in
2009, or 7.6%, over the 2008 amount with average investment securities
increasing $37.9 million, reflecting the leverage strategy undertaken to invest
the $10 million in funds raised through the issuance of preferred stock under
the Capital Purchase Program (the “CPP”).





Interest
expense decreased $2.0 million, or 15.3%, during the year ended December 31,
2009 to $10.8 million.  The decrease was attributable to a decline in
the average rate paid on deposits and borrowings partially offset by an increase
in average interest-bearing liabilities.  The cost of interest-bearing
liabilities decreased to 2.20% for the year ended December 31, 2009 compared to
2.80% during 2008.  Average interest-bearing liabilities were $491.8
million for the year ended December 31, 2009, reflecting an increase of $35.0
million, or 7.7%, when compared to $456.8 million for the year ended December
31, 2008.  In addition to the Corporation’s expanding customer base,
the increase in average interest-bearing liabilities was a result of increased
borrowings to complete the leveraging of the $10 million of CPP
funds.  The Corporation continues to supplement its branch deposit
network with a mix of wholesale repurchase agreements and Federal Home Loan Bank
borrowings.  These alternative funding sources help to lower cost of
funds and provide for better management of interest rate risk.  There
were no brokered certificates of deposit for the majority of
2009.


21
 Table of Contents


The
following table reflects the components of the Corporation’s net interest income
for the years ended December 31, 2009 and 2008 including, (1) average assets,
liabilities and stockholders’ equity based on average daily balances, (2)
interest income earned on interest-earning assets and interest expense paid on
interest-bearing liabilities, (3) average yields earned on interest-earning
assets and average rates paid on interest-bearing liabilities, and (4) net yield
on interest-earning assets.  Nontaxable income from investment
securities and loans is presented on a tax-equivalent basis assuming a statutory
tax rate of 34% for the years presented.  This was accomplished by
adjusting non-taxable income upward to make it equivalent to the level of
taxable income required to earn the same amount after taxes.





2009
            
            
            2008
            
            
            2007Average
            
            
            
            
            
            
            
            
            Average
            
            
            
            
            
            
            
            
            AverageInterest
            
            
            Rates
            
            
            
            
            
            Interest
            
            
            Rates
            
            
            
            
            
            Interest
            
            
            RatesAverage
            
            
            Income/
            
            
            Earned/
            
            
            Average
            
            
            Income/
            
            
            Earned/
            
            
            Average
            
            
            Income/
            
            
            Earned/Balance
            
            
            Expense
            
            
            Paid
            
            
            Balance
            
            
            Expense
            
            
            Paid
            
            
            Balance
            
            
            Expense
            
            
            PaidAssetsInterest-earning
      assets:Loans
      (1)
            
            $
            445,586
            
            
            $
            26,981
            
            
            
            6.06
            %
            
            $
            437,812
            
            
            $
            28,664
            
            
            
            6.55
            %
            
            $
            385,954
            
            
            $
            27,517
            
            
            
            7.13
            %Taxable
      investment securities (1)
            
            
            138,514
            
            
            
            6,131
            
            
            
            4.43
            
            
            
            102,930
            
            
            
            5,377
            
            
            
            5.22
            
            
            
            93,732
            
            
            
            4,921
            
            
            
            5.25Tax-exempt
      investment securities (1) (2)
            
            
            30,057
            
            
            
            1,590
            
            
            
            5.29
            
            
            
            27,765
            
            
            
            1,482
            
            
            
            5.34
            
            
            
            23,372
            
            
            
            1,200
            
            
            
            5.13Other
      interest-earning assets
            
            
            124
            
            
            
            9
            
            
            
            7.26
            
            
            
            2,624
            
            
            
            66
            
            
            
            2.52
            
            
            
            631
            
            
            
            45
            
            
            
            7.13Total
      interest-earning assets
            
            
            614,281
            
            
            
            34,711
            
            
            
            5.65
            
            
            
            571,131
            
            
            
            35,589
            
            
            
            6.23
            
            
            
            503,689
            
            
            
            33,683
            
            
            
            6.69Non-interest-earning
      assets:Allowance
      for loan losses
            
            
            (6,193
            )
            
            
            
            
            
            
            
            
            
            
            (5,045
            )
            
            
            
            
            
            
            
            
            
            
            (4,184
            )Other
      assets
            
            
            34,474
            
            
            
            
            
            
            
            
            
            
            
            34,799
            
            
            
            
            
            
            
            
            
            
            
            34,084Total
      assets
            
            $
            642,562
            
            
            
            
            
            
            
            
            
            
            $
            600,885
            
            
            
            
            
            
            
            
            
            
            $
            533,589Liabilities
      and Stockholders' EquityInterest-bearing
      liabilities:Interest-bearing
      demand deposits
            
            $
            190,522
            
            
            $
            2,549
            
            
            
            1.34
            %
            
            $
            164,000
            
            
            $
            2,731
            
            
            
            1.67
            %
            
            $
            134,219
            
            
            $
            3,432
            
            
            
            2.56
            %Savings
      deposits
            
            
            42,328
            
            
            
            206
            
            
            
            0.49
            
            
            
            37,750
            
            
            
            237
            
            
            
            0.63
            
            
            
            37,171
            
            
            
            282
            
            
            
            0.76Time
      deposits
            
            
            191,738
            
            
            
            6,038
            
            
            
            3.15
            
            
            
            187,195
            
            
            
            7,566
            
            
            
            4.04
            
            
            
            181,973
            
            
            
            8,297
            
            
            
            4.56Repurchase
      agreements
            
            
            15,315
            
            
            
            754
            
            
            
            4.92
            
            
            
            16,259
            
            
            
            626
            
            
            
            3.85
            
            
            
            12,192
            
            
            
            505
            
            
            
            4.14FHLB
      borrowings
            
            
            44,651
            
            
            
            979
            
            
            
            2.19
            
            
            
            44,350
            
            
            
            1,145
            
            
            
            2.58
            
            
            
            20,379
            
            
            
            877
            
            
            
            4.30Subordinated
      debentures
            
            
            7,217
            
            
            
            285
            
            
            
            3.95
            
            
            
            7,217
            
            
            
            466
            
            
            
            6.46
            
            
            
            7,217
            
            
            
            487
            
            
            
            6.75Total
      interest-bearing liabilities
            
            
            491,771
            
            
            
            10,811
            
            
            
            2.20
            
            
            
            456,771
            
            
            
            12,771
            
            
            
            2.80
            
            
            
            393,151
            
            
            
            13,880
            
            
            
            3.53Noninterest-bearing
      liabilities:Demand
      deposits
            
            
            93,030
            
            
            
            
            
            
            
            
            
            
            
            97,316
            
            
            
            
            
            
            
            
            
            
            
            96,659Other
      liabilities
            
            
            4,870
            
            
            
            
            
            
            
            
            
            
            
            4,830
            
            
            
            
            
            
            
            
            
            
            
            4,624Stockholders'
      equity
            
            
            52,891
            
            
            
            
            
            
            
            
            
            
            
            41,968
            
            
            
            
            
            
            
            
            
            
            
            39,155Total
      liabilities and stockholders' equity
            
            $
            642,562
            
            
            
            
            
            
            
            
            
            
            $
            600,885
            
            
            
            
            
            
            
            
            
            
            $
            533,589Net
      interest income (taxable equivalent basis)
            
            
            
            
            
            
            23,900
            
            
            
            
            
            
            
            
            
            
            
            22,818
            
            
            
            
            
            
            
            
            
            
            
            19,803Tax
      equivalent adjustment
            
            
            
            
            
            
            (555
            )
            
            
            
            
            
            
            
            
            
            
            (515
            )
            
            
            
            
            
            
            
            
            
            
            (373
            )Net
      interest income
            
            
            
            
            
            $
            23,345
            
            
            
            
            
            
            
            
            
            
            $
            22,303
            
            
            
            
            
            
            
            
            
            
            $
            19,430Net
      interest spread (taxable equivalent basis)
            
            
            
            
            
            
            
            
            
            
            3.45
            %
            
            
            
            
            
            
            
            
            
            
            3.43
            %
            
            
            
            
            
            
            
            
            
            
            3.16
            %Net
      yield on interest-earningassets
      (taxable equivalent basis) (3)
            
            
            
            
            
            
            
            
            
            
            3.89
            %
            
            
            
            
            
            
            
            
            
            
            4.00
            %
            
            
            
            
            
            
            
            
            
            
            3.93
            %





(1)
            For
      purpose of these calculations, nonaccruing loans are included in the
      average balance. Fees are included in loan
  interest.


(2)
            The
      tax equivalent adjustments are based on a marginal tax rate of
      34%.  Loans and total interest-earning assets are net of
      unearned income. Securities are included at amortized
  cost.


(3)
            Net
      interest income (taxable equivalent basis) divided by average
      interest-earning assets.


22
 Table of Contents


The
following table analyzes net interest income in terms of changes in the volume
of interest-earning assets and interest-bearing liabilities and changes in
yields earned and rates paid on such assets and liabilities on a tax equivalent
basis.  The table reflects the extent to which changes in the
Corporation’s interest income and interest expense are attributable to changes
in volume (changes in volume multiplied by prior year rate) and changes in rate
(changes in rate multiplied by prior year volume).  Changes
attributable to the combined impact of volume and rate have been allocated
proportionately to changes due to volume and changes due to rate.





2009 Versus 2008
            
            
            2008 Versus 2007(In
      thousands)Increase
      (Decrease)
            
            
            
            
            
            Increase
      (Decrease)Due to Change in
            
            
            
            
            
            Due to Change inVolume
            
            
            Rate
            
            
            Net
            
            
            Volume
            
            
            Rate
            
            
            NetInterest
      income:Loans
            
            $
            502
            
            
            $
            (2,185
            )
            
            $
            (1,683
            )
            
            $
            3,509
            
            
            $
            (2,362
            )
            
            $
            1,147Taxable
      investment securities
            
            
            1,662
            
            
            
            (908
            )
            
            
            754
            
            
            
            481
            
            
            
            (25
            )
            
            
            456Tax-exempt
      investment securities
            
            
            121
            
            
            
            (13
            )
            
            
            108
            
            
            
            233
            
            
            
            49
            
            
            
            282Other
      interest-earning assets
            
            
            (103
            )
            
            
            46
            
            
            
            (57
            )
            
            
            66
            
            
            
            (45
            )
            
            
            21Total
      interest-earning assets
            
            
            2,182
            
            
            
            (3,060
            )
            
            
            (878
            )
            
            
            4,289
            
            
            
            (2,383
            )
            
            
            1,906Interest
      expense:Interest-bearing
      demand deposits
            
            $
            402
            
            
            
            (584
            )
            
            
            (182
            )
            
            
            658
            
            
            
            (1,359
            )
            
            
            (701
            )Savings
      deposits
            
            
            26
            
            
            
            (57
            )
            
            
            (31
            )
            
            
            4
            
            
            
            (49
            )
            
            
            (45
            )Time
      deposits
            
            
            180
            
            
            
            (1,708
            )
            
            
            (1,528
            )
            
            
            233
            
            
            
            (964
            )
            
            
            (731
            )Repurchase
      agreements
            
            
            (38
            )
            
            
            166
            
            
            
            128
            
            
            
            159
            
            
            
            (38
            )
            
            
            121FHLB
      borrowings
            
            
            8
            
            
            
            (174
            )
            
            
            (166
            )
            
            
            724
            
            
            
            (456
            )
            
            
            268Subordinated
      debentures
            
            
            -
            
            
            
            (181
            )
            
            
            (181
            )
            
            
            -
            
            
            
            (21
            )
            
            
            (21
            )Total
      interest-bearing liabilities
            
            
            578
            
            
            
            (2,538
            )
            
            
            (1,960
            )
            
            
            1,778
            
            
            
            (2,887
            )
            
            
            (1,109
            )Net
      change in net interest income
            
            $
            1,604
            
            
            $
            (522
            )
            
            $
            1,082
            
            
            $
            2,511
            
            
            $
            504
            
            
            $
            3,015





Provision
for Loan Losses





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





The loan
loss provision of $3.6 million for the year ended December 31, 2009 was
equivalent to the loan loss provision recorded for the year ended December 31,
2008.  The allowance for loan loss was $6.9 million, or 1.50% of total
loans as of December 31, 2009 compared to of $5.2 million, or 1.18% of total
loans a year earlier.





The loan
loss provision takes into account growth in the loan portfolio and an increase
in nonperforming loans.  Gross loans increased $20.8 million in 2009,
from $439.7 million at December 31, 2008 to $460.5 million at December 31, 2009,
with majority of the noted growth in the categories of commercial real estate
and commercial loans.  In determining the level of the allowance for
loan loss, the Corporation also considered the types of loans associated with
the growth, as well as the overall seasoning of the new loans to determine the
appropriate risk that was inherent in the portfolio.





Nonaccrual
loans increased from $4.2 million, or 0.96% of total loans, at December 31, 2008
to $19.7 million at December 31, 2009, or 4.27% of total loans.  After
factoring in the fair market value of the underlying collateral the allowance
for loan losses related to the impaired loans increased from $481,000 at
December 31, 2008 to $1.9 million at December 31, 2009.  In addition,
during the year ended December 31, 2009, the Corporation charged off loans
totaling $1.9 million compared to loans charged off of $2.9 million in the prior
year.  While the most significant portion of the increased loan losses
provision and chargeoffs for


23
 Table of Contents


2008 was
related to a group of loans to one borrower, the current year provision for loan
losses and chargeoffs is indicative of current economic conditions that have
contributed to an increase in loan delinquencies and the softness in the real
estate market.





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
in when considering the overall risk of the lending portfolio.  The
asset quality issues, caused by the economic downturn which began in 2008, and
the current year provision for loan losses is reflective of current economic
conditions that contributed to an increase in loan delinquencies and the
softness in the real estate market.  The Corporation monitors its loan
portfolio and intends to continue to provide for loan loss reserves based on its
ongoing periodic review of the loan portfolio and general market
conditions.





Noninterest
Income





Noninterest
income consists of all income other than interest income and is principally
derived from service charges on deposits, gain on sales of mortgage loans,
income derived from bank owned life insurance, merchant processing income and
income derived from debit cards and ATM usage.





When
comparing noninterest income of $3.1 million for the year ended December 31,
2009 to $4.2 million for the prior year, noninterest income decreased $1.1
million.  Noninterest income for the year ended December 31, 2008
included a gain of $509,000 related to the sale of the Corporation’s merchant
servicing portfolio.  In addition, as a result of the sale, a decline
of $1.3 million in the related noninterest income line as well as a $1.2 million
decline in the related noninterest expense line is reflected for the year ended
December 31, 2009.  After adjusting for all of the effects of the sale
of the merchant servicing portfolio, noninterest income for 2009 is actually
$724,000 greater than 2008.  Fees and service charge income increased
$514,000, or 38.6%.  The increase is partially due to the introduction
of the new Power Rate Checking product.  In addition, the increase
reflects revisions to policies for the assessment of fees as well as the changes
in and additions to the current fee structure.  Gains on calls and
sales of securities, net were $258,000 and $103,000 for the years ended December
31, 2009 and 2008, respectively.  Gains on sales of mortgage loans
were $294,000 for the year ended December 31, 2009, an increase when compared to
$193,000 for prior year reflecting an increase in mortgage activity in the
current year reflective of lower mortgage rates.  The increase in the
activity for the current year resulted in an increase in the volume of loans
sold and ultimately, an increase in gains on mortgages sold.





Noninterest
Expense





Noninterest
expense decreased by $196,000, or 1.1%, to $17.8 million for the year ended
December 31, 2009, compared to $18.0 million for the same period in
2008.  As previously reported, on December 31, 2008, the Corporation
sold its merchant servicing portfolio and, as a result, a $1.2 million decline
in the related noninterest expense line as well as a decline of $1.3 million in
the related noninterest income line is reflected for the year ended December 31,
2009.  The FDIC insurance premium expense reflects increases in the
FDIC insurance assessment rates as well as in increase in
deposits.  In addition, FDIC insurance premiums reflect the recording
of an industry-wide special assessment which amounted to $300,000 for the
Corporation for the year ended December 31, 2009.





In
accordance with our By-laws which provide for tithing of (10%) of the
Corporation’s pre-tax profits to various charities, the Corporation had
charitable contributions totaling $619,000 for the year ended December 31, 2009
compared to $627,000 for the same period in 2008.





Income
Taxes





Income
tax expense totaled $1.5 million for the year ended December 31, 2009, for an
effective tax rate of 28.9%, compared to $1.4 million, for an effective tax rate
of 29.3% for the year ended December 31, 2008.





Financial
Condition





Total
assets at December 31, 2009 were $663.8 million, an increase of $52.0 million,
or 8.5%, over the $611.8 million at December 31, 2008.  This increase
in assets reflects, among other things, a $31.9 million increase in securities
and a $19.0 million increase in portfolio loans.


24
 Table of Contents


Loan
Portfolio





The
Corporation’s loan portfolio at December 31, 2009, net of allowance for loan
losses, totaled $453.1 million, an increase of $19.0 million, or 4.4%, over the
$434.1 million at December 31, 2008.  Commercial real estate mortgage
loans consisting of $246.2 million, or 53.5% of the total portfolio, represented
the largest portion of the loan portfolio. This reflected an increase of $20.0
million from $226.2 million, or 51.4% of the total loan portfolio at December
31, 2008.  Commercial loans increased $14.6 million to $114.9 million,
representing 24.9% of the total loan portfolio. Consumer installment loans
decreased $10.3 million and residential real estate mortgages decreased $4.1
million. The Corporation continued its policy of selling the majority of its
residential real estate loans in the secondary market.  All of these
loans have been sold with servicing released.





The
Corporation’s lending activities are concentrated in loans secured by real
estate located in northern New Jersey and therefore collectability of the loan
portfolio is susceptible to changes in real estate market conditions in the
northern New Jersey market.  The Corporation has not made loans to
borrowers outside the United States.





At
December 31, 2009, there were no concentrations of loans exceeding 10% of total
loans outstanding.  Loan concentrations are considered to exist when
there are amounts loaned to a multiple number of borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
related conditions.





The
following table sets forth the classification of the Corporation’s loans by
major category at the end of the last five years:





December 31,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005(In
      thousands)Real
      estate mortgage:Residential
            
            $
            36,246
            
            
            $
            40,337
            
            
            $
            44,719
            
            
            $
            47,020
            
            
            $
            45,604Commercial
            
            
            246,212
            
            
            
            226,183
            
            
            
            209,082
            
            
            
            177,411
            
            
            
            163,309Commercial
      loans
            
            
            114,893
            
            
            
            100,282
            
            
            
            89,845
            
            
            
            72,606
            
            
            
            65,011Consumer
      loans:Installment
      (1)
            
            
            41,006
            
            
            
            51,290
            
            
            
            56,796
            
            
            
            52,389
            
            
            
            51,540Home
      equity
            
            
            21,779
            
            
            
            21,208
            
            
            
            19,723
            
            
            
            20,010
            
            
            
            20,271Other
            
            
            340
            
            
            
            356
            
            
            
            424
            
            
            
            560
            
            
            
            506Total
      gross loans
            
            
            460,476
            
            
            
            439,656
            
            
            
            420,589
            
            
            
            369,996
            
            
            
            346,241Less:
      Allowance for loan losses
            
            
            6,920
            
            
            
            5,166
            
            
            
            4,457
            
            
            
            4,101
            
            
            
            3,847Deferred
      loan fees
            
            
            437
            
            
            
            387
            
            
            
            442
            
            
            
            452
            
            
            
            418Net
      loans
            
            $
            453,119
            
            
            $
            434,103
            
            
            $
            415,690
            
            
            $
            365,443
            
            
            $
            341,976(1) Includes
      automobile, home improvement, second mortgages and unsecured
      loans. Credit card loans are also included for December 31,
      2005.





The
following table sets forth certain categories of gross loans as of December 31,
2009 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
            
            $
            45,804
            
            
            $
            8,100
            
            
            $
            228,554
            
            
            $
            282,458Commercial
            
            
            56,682
            
            
            
            33,509
            
            
            
            24,702
            
            
            
            114,893Consumer
            
            
            1,719
            
            
            
            4,977
            
            
            
            56,429
            
            
            
            63,125Total
      gross loans
            
            $
            104,205
            
            
            $
            46,586
            
            
            $
            309,685
            
            
            $
            460,476


25
 Table of Contents


The
following table sets forth the dollar amount of all gross loans due one year or
more after December 31, 2009, which have predetermined interest rates or
floating or adjustable interest rates:





Predetermined
              Rates
            
            
            Floating or Adjustable
Rates
            
            
            Total(In
      thousands)Real
      estate mortgage
            
            $
            37,502
            
            
            $
            199,152
            
            
            $
            236,654Commercial
            
            
            26,255
            
            
            
            31,956
            
            
            
            58,211Consumer
            
            
            41,205
            
            
            
            20,201
            
            
            
            61,406$
            104,962
            
            
            $
            251,309
            
            
            $
            356,271





Asset
Quality





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





The
Corporation utilizes a two tier approach by (1) identifying problem loans and
allocating specific loss allowances on such loans and (2) establishing a general
valuation allowance on the remainder of its loan portfolio.  The
Corporation maintains a loan review system that allows for a periodic review of
its loan portfolio and the early identification of potential problem
loans.  Such a system takes into consideration, among other things,
delinquency status, size of loans, type of collateral and financial condition of
the borrowers.  Allocations of specific loan loss allowances are
established for identified loans based on a review of such information and/or
appraisals of underlying collateral.  General loan loss allowances are
based upon a combination of factors including, but not limited to, actual loss
experience, composition of loan portfolio, current economic conditions and
management’s judgment.




The
Corporation’s accounting policies are set forth in Note 1 to the Corporation’s Audited Consolidated Financial
Statements.  The application of some of these policies requires
significant management judgment and the utilization of
estimates.  Actual results could differ from these judgments and
estimates resulting in a significant impact on the financial
statements.  A critical accounting policy for the Corporation is the
policy utilized in determining the adequacy of the allowance for loan
losses.  Although management uses the best information available, the
level of the allowance for loan losses remains an estimate which is subject to
significant judgment and short-term change.  Various regulatory
agencies, as an integral part of their examination process, periodically review
the Corporation’s allowance for loan losses.  Such agencies may
require the Corporation to make additional provisions for loan losses based upon
information available to them at the time of their
examination.  Furthermore, the majority of the Corporation’s loans are
secured by real estate in the State of New Jersey.  Future adjustments
to the allowance may be necessary due to economic, operating, regulatory, and
other conditions beyond the Corporation’s control.  The allowance for
loan losses represents 1.50% of total loans, or 30.2% of non-performing loans at
December 31, 2009, compared with 1.18% of total loans or 80.2% of non-performing
loans at December 31, 2008.  In management’s opinion, the allowance
for loan losses totaling $6.9 million is adequate to cover probable incurred
losses inherent in the portfolio at December 31, 2009.





Nonperforming
Assets





Nonperforming
assets include nonaccrual loans, restructured loans, loans past due 90 days or
more and accruing, and other real estate owned.  There were no other
real estate owned assets for the periods presented.  The Corporation’s
loans are generally placed in a nonaccrual status when they become past due in
excess of 90 days as to payment of principal and interest.  Interest
previously accrued on these loans and not yet paid is charged against income
during the current period.  Interest earned thereafter is only
included in income to the extent that it is received in cash.  Loans
past due 90 days or more and accruing represent those loans which are
sufficiently collateralized and management believes all interest and principal
owed will be collected.  Restructured loans are loans that have been
renegotiated to permit a borrower, who has incurred adverse financial
circumstances, to continue to perform.  Management can reduce the
contractual interest rates to below market rates or make significant concessions
to the terms of the loan in order for the borrower to continue to make
payments.


26
 Table of Contents


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 31,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005(Dollars
      in thousands)Nonaccrual
      loans: (1)Construction
            
            $
            8,581
            
            
            $
            2,575
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Residential
      real estate
            
            
            1,131
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
      real estate
            
            
            5,109
            
            
            
            291
            
            
            
            73
            
            
            
            123
            
            
            
            122Commercial
            
            
            3,638
            
            
            
            825
            
            
            
            307
            
            
            
            167
            
            
            
            258Consumer
            
            
            1,197
            
            
            
            539
            
            
            
            75
            
            
            
            154
            
            
            
            92Total
      nonaccrual loans
            
            
            19,656
            
            
            
            4,230
            
            
            
            455
            
            
            
            444
            
            
            
            472Loans
      past due 90 days or more and accruing: (2)Construction
            
            
            415
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
      real estate
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            840
            
            
            
            -Commercial
            
            
            -
            
            
            
            353
            
            
            
            25
            
            
            
            241
            
            
            
            -Consumer
            
            
            -
            
            
            
            -
            
            
            
            1
            
            
            
            9
            
            
            
            55Total
      loans past due ninety days or more and
              accruing
            
            
            415
            
            
            
            353
            
            
            
            26
            
            
            
            1,090
            
            
            
            55Restructured
      loans:Commercial
      real estate
            
            
            665
            
            
            
            1,483
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
            
            
            2,181
            
            
            
            372
            
            
            
            -
            
            
            
            -
            
            
            
            -Consumer
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      restructured loans
            
            
            2,846
            
            
            
            1,855
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      nonperforming loans
            
            $
            22,917
            
            
            $
            6,438
            
            
            $
            481
            
            
            $
            1,534
            
            
            $
            527Nonaccrual
      loans to total gross loans
            
            
            4.27
            %
            
            
            0.96
            %
            
            
            0.11
            %
            
            
            0.12
            %
            
            
            0.14
            %Nonperforming
      loans to total gross loans
            
            
            4.98
            %
            
            
            1.46
            %
            
            
            0.11
            %
            
            
            0.41
            %
            
            
            0.15
            %Nonperforming
      loans to total assets
            
            
            3.45
            %
            
            
            1.05
            %
            
            
            0.08
            %
            
            
            0.30
            %
            
            
            0.11
            %Allowance
      for loan losses to nonperforming loans
            
            
            30.20
            %
            
            
            80.24
            %
            
            
            926.61
            %
            
            
            267.34
            %
            
            
            729.98
            %


(1)
            Restructured
      loans classified in the nonaccrual category totaled $23,000, $22,000 and
      $73,000 for the years ended December 31, 2009, December 31, 2008 and
      December 31, 2007, respectively. There were no restructured loans
      classified as nonaccrual for the year ended December 31,
      2006.  Restructured loans classified in the nonaccrual category
      totaled $152,000 for the year ended December 31,
  2005.





(2)
            There
      were no restructured loans classified in the past due 90 days or more and
      accruing for any years presented.





As of
December 31, 2009 there were $14.0 million of other loans not included in the
above table, where credit conditions of borrowers caused management to have
concerns about the possibility of the borrowers not complying with the present
terms and conditions of repayment and which may result in disclosure of such
loans at a future date.  These loans have been considered by
management in conjunction with the analysis of the adequacy of the allowance for
loan losses.





For the
year ended December 31, 2009, gross interest income which would have been
recorded had the restructured and non-accruing loans been current in accordance
with their original terms amounted to $1.7 million, of which $0.6 million was
included in interest income for the year ended December 31,
2009.


27
 Table of Contents


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
      31,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005(Dollars
      in thousands)Balance
      at beginning of period
            
            $
            5,166
            
            
            $
            4,457
            
            
            $
            4,101
            
            
            $
            3,847
            
            
            $
            3,299Loans
      charged off:Construction
            
            
            1,003
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Residential
      real estate
            
            
            85
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
            
            
            623
            
            
            
            2,841
            
            
            
            82
            
            
            
            7
            
            
            
            -Consumer
            
            
            215
            
            
            
            61
            
            
            
            103
            
            
            
            33
            
            
            
            57Total
      loans charged off
            
            
            1,926
            
            
            
            2,902
            
            
            
            185
            
            
            
            40
            
            
            
            57Recoveries
      of loans previously charged off:Commercial
            
            
            93
            
            
            
            -
            
            
            
            -
            
            
            
            23
            
            
            
            -Consumer
            
            
            12
            
            
            
            26
            
            
            
            11
            
            
            
            7
            
            
            
            5Total
      recoveries of loans previously charged off
            
            
            105
            
            
            
            26
            
            
            
            11
            
            
            
            30
            
            
            
            5Net
      loans charged off
            
            
            1,821
            
            
            
            2,876
            
            
            
            174
            
            
            
            10
            
            
            
            52Provisions
      charged to operations
            
            
            3,575
            
            
            
            3,585
            
            
            
            530
            
            
            
            264
            
            
            
            600Balance
      at end of period
            
            $
            6,920
            
            
            $
            5,166
            
            
            $
            4,457
            
            
            $
            4,101
            
            
            $
            3,847Net
      charge offs during the period to average loans
              outstanding
      during the period
            
            
            0.41
            %
            
            
            0.66
            %
            
            
            0.05
            %
            
            
            0.00
            %
            
            
            0.02
            %Balance
      of allowance for loan losses at the end of
              year
      to gross year end loans
            
            
            1.50
            %
            
            
            1.18
            %
            
            
            1.06
            %
            
            
            1.11
            %
            
            
            0.11
            %





The
following table sets forth the allocation of the allowance for loan losses, for
each of the preceding five years, as indicated by loan categories:





2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Amount
            
            
            Percent to Total(1)
            
            
            Amount
            
            
            Percent to Total(1)
            
            
            Amount
            
            
            Percent to Total(1)
            
            
            Amount
            
            
            Percent to Total(1)
            
            
            Amount
            
            
            Percent to Total(1)(Dollars
      in thousands)Real
      estate –
              residential
            
            $
            155
            
            
            
            7.9
            %
            
            $
            245
            
            
            
            9.2
            %
            
            $
            256
            
            
            
            10.6
            %
            
            $
            298
            
            
            
            12.7
            %
            
            $
            320
            
            
            
            13.2
            %Real
      estate –
              commercial
            
            
            2,677
            
            
            
            53.5
            %
            
            
            2,164
            
            
            
            51.4
            %
            
            
            1,900
            
            
            
            49.7
            %
            
            
            1,705
            
            
            
            48.0
            %
            
            
            1,562
            
            
            
            47.1
            %Commercial
            
            
            3,148
            
            
            
            24.9
            %
            
            
            2,086
            
            
            
            22.8
            %
            
            
            1,640
            
            
            
            21.4
            %
            
            
            1,407
            
            
            
            19.6
            %
            
            
            1,192
            
            
            
            18.8
            %Consumer
            
            
            940
            
            
            
            13.7
            %
            
            
            671
            
            
            
            16.6
            %
            
            
            661
            
            
            
            18.3
            %
            
            
            691
            
            
            
            19.7
            %
            
            
            773
            
            
            
            20.9
            %Total
      allowance
              for
      loan losses
            
            $
            6,920
            
            
            
            100.0
            %
            
            $
            5,166
            
            
            
            100.0
            %
            
            $
            4,457
            
            
            
            100.0
            %
            
            $
            4,101
            
            
            
            100.0
            %
            
            $
            3,847
            
            
            
            100.0
            %(1) Represents
      percentage of loan balance in category to total gross
    loans.





Investment
Portfolio





The
Corporation maintains an investment portfolio to enhance its yields and to
provide a secondary source of liquidity.  The portfolio is comprised
of U.S. Treasury securities, U.S. government and agency obligations,
mortgage-backed securities, state and political subdivision obligations and
other equity investments, and has been classified as held to maturity or
available for sale.  Investments in debt securities that the
Corporation has the positive intent and the ability to hold to maturity are
classified as held to maturity securities and reported at amortized
cost.  All other securities are classified as available for sale
securities and reported at fair value, with unrealized holding gains or losses
reported in a separate component of stockholders’ equity.  Securities
in the available for sale category may be held for indefinite periods of time
and include securities that management intends to use as part of its
Asset/Liability strategy or that may be sold in response to changes in interest
rates, changes in prepayment risks, the need to provide liquidity, the need to
increase regulatory capital or similar factors.  Securities available
for sale increased to $103.0 million at December 31, 2009, from $90.0 million at
December 31, 2008, an increase of $13.0 million, or 14.4%. Securities held to
maturity increased $18.9 million, or 38.6%, to $67.7 million at December 31,
2009 from $48.9 million at December 31, 2008.


28
 Table of Contents


The
following table sets forth the classification of the Corporation’s investment
securities by major category at the end of the last three years:





December 31,2009
            
            
            2008
            
            
            2007Carrying Value
            
            
            Percent
            
            
            Carrying Value
            
            
            Percent
            
            
            Carrying Value
            
            
            Percent(Dollars
      in thousands)Securities
      available for sale:U.S.
      government-sponsored agencies
            
            $
            32,286
            
            
            
            31.3
            %
            
            $
            49,660
            
            
            
            55.2
            %
            
            $
            35,693
            
            
            
            46.4
            %Obligations
      of state andpolitical
      subdivisions
            
            
            5,397
            
            
            
            5.3
            
            
            
            5,820
            
            
            
            6.4
            
            
            
            2,903
            
            
            
            3.8Mortgage-backed
      securities-residential
            
            
            62,228
            
            
            
            60.4
            
            
            
            31,670
            
            
            
            35.2
            
            
            
            37,131
            
            
            
            48.2Other
      equity investments
            
            
            3,115
            
            
            
            3.0
            
            
            
            2,873
            
            
            
            3.2
            
            
            
            1,230
            
            
            
            1.6Total
            
            $
            103,026
            
            
            
            100.0
            %
            
            $
            90,023
            
            
            
            100.0
            %
            
            $
            76,957
            
            
            
            100.0
            %Securities
      held to maturity:U.S.
      Treasury
            
            $
            -
            
            
            
            -
            %
            
            $
            -
            
            
            
            -
            %
            
            $
            501
            
            
            
            1.2
            %U.S.
      government-sponsored agencies
            
            
            19,921
            
            
            
            29.4
            
            
            
            10,290
            
            
            
            21.0
            
            
            
            12,331
            
            
            
            29.9Obligations
      of state andpolitical
      subdivisions
            
            
            27,038
            
            
            
            39.9
            
            
            
            23,048
            
            
            
            47.2
            
            
            
            22,569
            
            
            
            54.8Mortgage-backed
      securities-residential
            
            
            20,758
            
            
            
            30.7
            
            
            
            15,518
            
            
            
            31.8
            
            
            
            5,788
            
            
            
            14.1Total
            
            $
            67,717
            
            
            
            100.0
            %
            
            $
            48,856
            
            
            
            100.0
            %
            
            $
            41,189
            
            
            
            100.0
            %





The
following table sets forth the maturity distribution and weighted average yields
(calculated on the basis of stated yields to maturity, considering applicable
premium or discount) of the Corporation’s securities available for sale as of
December 31, 2009.  Issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.  This might
cause actual maturities to differ from contractual maturities.





Within
              1
      Year
            
            
            After
      1 Year Through
              5
      Years
            
            
            After
              5
      Years
              Through
              10
      Years
            
            
            After
              10
      Years
            
            
            Total(Dollars
      in thousands)U.S.
      government-sponsored agencies :Carrying
      value
            
            $
            -
            
            
            $
            6,646
            
            
            $
            12,682
            
            
            $
            12,958
            
            
            $
            32,286Yield
            
            
            -
            
            
            
            2.83
            %
            
            
            3.83
            %
            
            
            5.13
            %
            
            
            4.15
            %Obligations
      of state and political subdivisions :Carrying
      value
            
            
            -
            
            
            
            310
            
            
            
            3,072
            
            
            
            2,015
            
            
            
            5,397Yield
            
            
            -
            
            
            
            3.26
            %
            
            
            3.55
            %
            
            
            3.99
            %
            
            
            3.70
            %Mortgage-backed
      securities-residential:Carrying
      value
            
            
            653
            
            
            
            2,042
            
            
            
            3,609
            
            
            
            55,924
            
            
            
            62,228Yield
            
            
            3.77
            %
            
            
            4.24
            %
            
            
            4.68
            %
            
            
            4.47
            %
            
            
            47
            %Other
      equity investments:Carrying
      value
            
            
            3,115
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,115Yield
            
            
            4.02
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4.02
            %Total
      carrying value
            
            $
            3,768
            
            
            $
            8,998
            
            
            $
            19,363
            
            
            $
            70,897
            
            
            $
            103,026Weighted
      average yield
            
            
            3.98
            %
            
            
            3.16
            %
            
            
            3.94
            %
            
            
            4.58
            %
            
            
            4.31
            %


29
 Table of Contents


The
following table sets forth the maturity distribution and weighted average yields
(calculated on the basis of stated yields to maturity, considering applicable
premium or discount) of the Corporation’s securities held to maturity as of
December 31, 2009.  Issuers may have the right to call or prepay
obligations with or without call or prepayment penalties. This might cause
actual maturities to differ from contractual maturities.





Within
      1 Year
            
            
            After
      1 Year Through
              5
      Years
            
            
            After
              5
      Years
              Through
              10
      Years
            
            
            After
              10
      Years
            
            
            Total(Dollars
      in thousands)U.S.
      government-sponsored agencies :Carrying
      value
            
            $
            -
            
            
            $
            4,202
            
            
            $
            9,265
            
            
            $
            6,454
            
            
            $
            19,921Yield
            
            
            -
            %
            
            
            3.02
            %
            
            
            4.09
            %
            
            
            4.42
            %
            
            
            3.97
            %Obligations
      of state and  political subdivisions:Carrying
      value
            
            
            879
            
            
            
            8,331
            
            
            
            13,490
            
            
            
            4,338
            
            
            
            27,038Yield
            
            
            3.05
            %
            
            
            2.88
            %
            
            
            3.62
            %
            
            
            3.97
            %
            
            
            3.43
            %Mortgage-backed
      securities-residential :Carrying
      value
            
            
            200
            
            
            
            426
            
            
            
            6,322
            
            
            
            13,810
            
            
            
            20,758Yield
            
            
            4.35
            %
            
            
            5.15
            %
            
            
            3.86
            %
            
            
            4.61
            %
            
            
            4.39
            %Total
      carrying value
            
            $
            1,079
            
            
            $
            12,959
            
            
            $
            29,077
            
            
            $
            24,602
            
            
            $
            67,717Weighted
      average yield
            
            
            3.29
            %
            
            
            3.00
            %
            
            
            3.82
            %
            
            
            4.45
            %
            
            
            3.88
            %





Deposits





The
Corporation had deposits at December 31, 2009 totaling $529.9 million, an
increase of $23.4 million, or 4.6%, over the comparable period of 2008, when
deposits totaled $506.5 million.  The Corporation relied on its branch
network and current competitive products and services to provide growth during
2009.  During 2008 the economic and interest rate environment made it
difficult to attract core deposits and the Corporation utilized the brokered
certificate of deposit market.  As of December 31, 2008 there was
$30.7 million included in the time deposit balances.





The
following table sets forth the classification of the Corporation’s deposits by
major category as of December 31 of each of the three preceding
years:





December
      31,2009
            
            
            2008
            
            
            2007Amount
            
            
            Percent
            
            
            Amount
            
            
            Percent
            
            
            Amount
            
            
            Percent(Dollars
      in thousands)Noninterest-bearing
      demand
            
            $
            88,427
            
            
            
            16.7
            %
            
            $
            99,099
            
            
            
            19.6
            %
            
            $
            101,993
            
            
            
            21.6
            %Interest-bearing
      demand
            
            
            218,284
            
            
            
            41.2
            %
            
            
            160,768
            
            
            
            31.7
            %
            
            
            153,713
            
            
            
            32.6
            %Saving
      deposits
            
            
            45,783
            
            
            
            8.6
            %
            
            
            39,627
            
            
            
            7.8
            %
            
            
            37,010
            
            
            
            7.8
            %Certificates
      of deposit
            
            
            177,436
            
            
            
            33.5
            %
            
            
            207,037
            
            
            
            40.9
            %
            
            
            179,583
            
            
            
            38.0
            %Total
            
            $
            529,930
            
            
            
            100.0
            %
            
            $
            506,531
            
            
            
            100.0
            %
            
            $
            472,299
            
            
            
            100.0
            %





As of
December 31, 2009, the aggregate amount of outstanding time deposits issued in
amounts of $100,000 or more, broken down by time remaining to maturity, was as
follows (In thousands):








Three
      months or less
            
            $
            34,232Four
      months through six months
            
            
            16,505Seven
      months through twelve months
            
            
            15,508Over
      twelve months
            
            
            20,872Total
            
            $
            87,117





Borrowings





Although
deposits are the Corporation’s primary source of funds, the Corporation’s policy
has been to utilize borrowings to the extent that they are a less
costly source of funds, when the Corporation desires additional capacity to fund
loan demand, or to extend the life of its liabilities as a means of managing
exposure to interest rate risk.  The Corporation’s borrowings





30
 Table of Contents




are a
combination of advances from the FHLB, including overnight repricing lines of
credit, and, to a lesser extent, securities sold under agreement to
repurchase.





Interest
Rate Sensitivity





Interest
rate movements have made managing the Corporation’s interest rate sensitivity
increasingly important.  The Corporation attempts to maintain stable
net interest margins by generally matching the volume of interest-earning assets
and interest-bearing liabilities maturing, or subject to repricing, by adjusting
interest rates to market conditions, and by developing new
products.  One method of measuring the Corporation’s exposure to
changes in interest rates is the maturity and repricing gap
analysis.  The difference or mismatch between the amount of assets and
liabilities that mature or reprice in a given period is defined as the interest
rate sensitivity gap.  A “negative” gap results when the amount of
interest-bearing liabilities within a specified time period exceeds the amount
of interest-earning assets maturing or repricing within the same period of
time.  Conversely, a “positive” gap results when the amount of
interest-earning assets maturing or repricing exceed the amount of
interest-bearing liabilities mature or are repricing in the same given time
frame.  The smaller the gap, the less the effect of the market
volatility on net interest income.  During a period of rising interest
rates, an institution with a negative gap position would not be in as favorable
a position, as compared to an institution with a positive gap, to invest in
higher yielding assets.  This may result in yields on its assets
increasing at a slower rate than the increase in its costs of interest-bearing
liabilities than if it had a positive gap.  During a period of falling
interest rates, an institution with a negative gap would experience a repricing
of its assets at a slower rate than its interest-bearing liabilities, which
consequently may result in its net interest income growing at a faster rate than
an institution with a positive gap position.


31
 Table of Contents


The
following table sets forth estimated maturity/repricing structure of the
Corporation’s interest-earning assets and interest-bearing liabilities as of
December 31, 2009.  The amounts of assets or liabilities shown which
reprice or mature during a particular period were determined in accordance with
the contractual terms of each asset or liability and adjusted for prepayment
assumptions where applicable.  The table does not necessarily indicate
the impact of general interest rate movements on the Corporation’s net interest
income because the repricing of certain categories of assets and liabilities,
for example, prepayments of loans and withdrawal of deposits, is beyond the
Corporation’s control.  As a result, certain assets and liabilities
indicated as repricing within a period may in fact reprice at different times
and at different rate levels.





Three Months or Less
            
            
            More than Three Months Through One
      Year
            
            
            After One Year
            
            
            Noninterest Sensitive
            
            
            Total(Dollars
      in thousands)Assets:Loans:Real
      estate mortgage
            
            $
            40,932
            
            
            $
            32,291
            
            
            $
            209,235
            
            
            $
            -
            
            
            $
            282,458Commercial
            
            
            57,184
            
            
            
            15,668
            
            
            
            42,041
            
            
            
            -
            
            
            
            114,893Consumer
            
            
            21,812
            
            
            
            4,222
            
            
            
            37,091
            
            
            
            -
            
            
            
            63,125Mortgage
      loans held for sale
            
            
            660
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            660Investment
      securities (1)
            
            
            27,843
            
            
            
            37,172
            
            
            
            108,955
            
            
            
            -
            
            
            
            173,970Other
      assets
            
            
            31
            
            
            
            -
            
            
            
            -
            
            
            
            28,707
            
            
            
            28,738Total
      assets
            
            $
            148,462
            
            
            $
            89,353
            
            
            $
            397,322
            
            
            $
            28,707
            
            
            $
            663,844Source
      of funds:Interest-bearing
      demand
            
            $
            218,284
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            218,284Savings
            
            
            45,783
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            45,783Certificate
      of deposit
            
            
            60,264
            
            
            
            65,019
            
            
            
            52,153
            
            
            
            -
            
            
            
            177,436FHLB
      of NY advances
            
            
            18,600
            
            
            
            -
            
            
            
            36,000
            
            
            
            -
            
            
            
            54,600Repurchase
      agreements
            
            
            15,396
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            15,396Subordinated
      debenture
            
            
            -
            
            
            
            -
            
            
            
            7,217
            
            
            
            -
            
            
            
            7,217Other
      liabilities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            91,617
            
            
            
            91,617Stockholders'
      equity
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            53,511
            
            
            
            53,511Total
      source of funds
            
            $
            358,327
            
            
            $
            65,019
            
            
            $
            95,370
            
            
            $
            145,128
            
            
            $
            663,844Interest
      rate sensitivity gap
            
            $
            (209,865
            )
            
            $
            24,334
            
            
            $
            301,952
            
            
            $
            (116,421
            )Cumulative
      interest rate sensitivity gap
            
            $
            (209,865
            )
            
            $
            (185,531
            )
            
            $
            116,421
            
            
            $
            -Ratio
      of GAP to total assets
            
            
            -31.6
            %
            
            
            3.6
            %
            
            
            45.5
            %
            
            
            -17.5
            %Ratio
      of cumulative GAP assets to total assets
            
            
            -31.6
            %
            
            
            -28.0
            %
            
            
            17.5
            %
            
            
            -
            %(1) Includes
      securities held to maturity, securities available for sale and FHLB-NY
      stock.





The
Corporation also uses a simulation model to analyze the sensitivity of net
interest income to movements in interest rates.  The simulation model
projects net interest income, net income, net interest margin, and capital to
asset ratios based on various interest rate scenarios over a twelve-month
period.  The model is based on the actual maturity and repricing
characteristics of all rate sensitive assets and
liabilities.  Management incorporates into the model certain
assumptions regarding prepayments of certain assets and
liabilities.  Assumptions have been built into the model for
prepayments for assets and decay rates for nonmaturity deposits such as savings
and interest bearing demand.  The model assumes an immediate rate
shock to interest rates without management’s ability to proactively change the
mix of assets or liabilities.  According to the reports generated for
December 31, 2009, an immediate interest rate increase of 200 basis points
results in a decrease in net interest income of 18.8%, or $5.0 million, while an
immediate interest rate decrease of 200 basis points resulted in an increase in
net interest income of 0.7% or $183,000.  Management cannot provide
any assurance about the actual effect of changes in interest rates on the
Corporation’s net interest income.





Liquidity





The
Corporation’s primary sources of funds are deposits, amortization and
prepayments of loans and mortgage-backed securities, maturities of investment
securities and funds provided by operations.  While scheduled loan and
mortgage-backed securities amortization and maturities of investment securities
are a relatively predictable source of funds,


32
 Table of Contents


deposit
flow and prepayments on loans and mortgage-backed securities are greatly
influenced by market interest rates, economic conditions, and
competition.





The
Corporation’s liquidity, represented by cash and cash equivalents, is a product
of its operating, investing and financing activities.  These
activities are summarized below:





Years Ended December 31,2009
            
            
            2008(In
      thousands)Cash
      and cash equivalents – beginning
            
            $
            12,814
            
            
            $
            11,932Operating
      activities:Net
      income
            
            
            3,634
            
            
            
            3,501Adjustments
      to reconcile net income to net cash provided by operating
      activities
            
            
            113
            
            
            
            2,947Net
      cash provided by operating activities
            
            
            3,747
            
            
            
            6,448Net
      cash used in investing activities
            
            
            (56,406
            )
            
            
            (43,640
            )Net
      cash provided by financing activities
            
            
            48,716
            
            
            
            38,074Net
      (decrease) increase in cash and cash equivalents
            
            
            (3,943
            )
            
            
            882Cash
      and cash equivalents – ending
            
            $
            8,871
            
            
            $
            12,814




Cash was
generated by operating activities in each of the above periods.  The
primary source of cash from operating activities during each period was net
income.




Liquidity
management is both a daily and long-term function of business
management.  Excess liquidity is generally invested in short-term
investments, such as federal funds sold.





The
Corporation enters into commitments to extend credit, such as letters of credit,
which are not reflected in the Corporation’s
Audited Consolidated Financial Statements.





The
Corporation has various contractual obligations that may require future cash
payments.  The following table summarizes the Corporation’s
contractual obligations at December 31, 2009 and the effect such obligations are
expected to have on our liquidity and cash flows in future periods.





Total
              
              
              Less than 1 Year
              
              
              1 – 3 Years
              
              
              4 – 5 Years
              
              
              After 5 Years(In
      thousands)Contractual
      obligationsOperating
      lease obligations
              
              $
              6,966
              
              
              $
              935
              
              
              $
              1,855
              
              
              $
              1,531
              
              
              $
              2,645Total
      contracted cost obligations
              
              $
              6,966
              
              
              $
              935
              
              
              $
              1,855
              
              
              $
              1,531
              
              
              $
              2,645Other
      long-term liabilities/long-term debtTime
      deposits
              
              $
              177,436
              
              
              $
              125,283
              
              
              $
              44,092
              
              
              $
              8,061
              
              
              $
              -Federal
      Home Loan Bank advances
              
              
              54,600
              
              
              
              18,600
              
              
              
              6,000
              
              
              
              15,000
              
              
              
              15,000Subordinated
      debentures
              
              
              7,217
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              7,217Total
      other long-term liabilities/long-term debt
              
              $
              239,253
              
              
              $
              143,883
              
              
              $
              50,092
              
              
              $
              23,061
              
              
              $
              22,217Other
      commitments - off balance sheetLetter
      of credit
              
              $
              3,167
              
              
              $
              2,954
              
              
              $
              213
              
              
              $
              -
              
              
              $
              -Commitments
      to extend credit
              
              
              19,406
              
              
              
              19,406
              
              
              
              -
              
              
              
              -
              
              
              
              -Unused
      lines of credit
              
              
              74,964
              
              
              
              74,964
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      off balance sheet arrangements and contractual obligations
              
              $
              97,537
              
              
              $
              97,324
              
              
              $
              213
              
              
              $
              -
              
              
              $
              -





Management
believes that a significant portion of the time deposits will remain with the
Corporation.  In addition, management does not believe that all of the
unused lines of credit will be exercised.  The Corporation anticipates
that it will have sufficient funds available to meet its current contractual
commitments.  Should the Corporation need temporary funding, the
Corporation has an overnight line of credit and a one-month overnight repricing
line of credit with the FHLB-NY, each in the amount of $64.3
million.  In addition, the Corporation had available overnight
variable repricing lines of credit with other correspondent banks totaling $23
million on an unsecured basis.


33
 Table of Contents


The
Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments.  The Corporation uses the same credit policies in
making commitments and conditional obligations as it does for on-balance sheet
instruments.





Of the
$3.2 million commitments under standby and commercial letters of credit, $3.0
million expires within one year.  Should any letter of credit be drawn
on, the interest rate charged on the resulting note would fluctuate with the
Corporation's base rate. Commitments to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in the
contract.  Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee.  Since many of
the commitments may expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements.  The
Corporation evaluates each customer's creditworthiness on a case-by-case
basis.  The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based on management's credit evaluation
of the counter-party.  Collateral held varies, but may include
accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.





Standby
and commercial letters of credit are conditional commitments issued by the
Corporation to guarantee payment or performance of a customer to a third
party.  Those guarantees are primarily issued to support public and
private borrowing arrangements, including commercial paper, bond financing and
similar transactions.  The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to
customers.  The Corporation obtains collateral supporting those
commitments for which collateral is deemed necessary.





At
December 31, 2009, the Corporation had residential mortgage commitments to
extend credit aggregating approximately $1.9 million at variable rates averaging
5.50% and $3.3 million at fixed rates averaging 4.92%.  All these loan
commitments will be sold to investors upon closing.  Commercial,
construction, and home equity loan commitments of approximately $10.7 million
were extended with variable rates averaging 6.49% and $3.5 million were extended
at fixed rates averaging 6.27%.  Generally, commitments were due to
expire within approximately 120 days.





The
unused lines of credit consist of $19.4 million relating to a home equity line
of credit program and an unsecured line of credit program (cash reserve), $4.3
million relating to an unsecured overdraft protection program, and $51.3 million
relating to commercial and construction lines of credit.  Amounts
drawn on the unused lines of credit are predominantly assessed interest at rates
which fluctuate with the base rate.





Capital





Banks and
bank holding companies are subject to regulatory capital requirements
administered by federal banking agencies.  Capital adequacy guidelines
and, additionally for banks, prompt corrective action regulations, involve
quantitative measures of assets, liabilities, and certain off-balance-sheet
items calculated under regulatory accounting practices.  Capital
amounts and classifications are also subject to qualitative judgments by
regulators.  Failure to meet capital requirements can initiate
regulatory action.  Regulations of the Board of Governors of the FRB
require bank holding companies to maintain minimum levels of regulatory
capital.  Under the regulations in effect at December 31, 2009, the
Corporation was required to maintain (i) a minimum leverage ratio of Tier 1
capital to total adjusted assets of 4.0% and (ii) minimum ratios of Tier 1 and
total capital to risk-weighted assets of 4.0% and 8.0%,
respectively.  The Bank must comply with substantially similar capital
regulations promulgated by the FDIC.  The following table summarizes
the capital ratios for the Corporation and the Bank at December 31,
2009.







Required
            
            
            Actual
            
            
            ExcessLeverage
      ratio*Corporation
            
            
            4.00
            %
            
            
            9.22
            %
            
            
            5.22
            %Bank
            
            
            4.00
            %
            
            
            8.51
            %
            
            
            4.51
            %Risk-based
      capital:Tier
      1Corporation
            
            
            4.00
            %
            
            
            11.99
            %
            
            
            7.99
            %Bank
            
            
            4.00
            %
            
            
            11.02
            %
            
            
            7.02
            %TotalCorporation
            
            
            8.00
            %
            
            
            13.24
            %
            
            
            5.24
            %Bank
            
            
            8.00
            %
            
            
            12.27
            %
            
            
            4.27
            %





*  The
minimum leverage ratio set by the FRB and the FDIC is
3.00%.  Institutions, which are not “top-rated”, will be expected to
maintain a ratio of approximately 100 to 200 basis points above this
ratio.


34
 Table of Contents


On
January 30, 2009, the Corporation received $10 million as part of the United
States Treasury Department’s Troubled Asset Relief Program – Capital Purchase
Program. In exchange, the Corporation issued 10,000 Senior Preferred shares and
a warrant to purchase 133,475 of common shares.





The
Senior Preferred Shares pay a cumulative dividend of 5% per annum for the first
five years and 9% per annum thereafter.  Dividends are payable
quarterly in arrears and the Corporation accrues the preferred dividends as
earned over the period the Senior Preferred Shares are outstanding.





The
warrant has an exercise price of $11.24 per share.  The exercise price
for the warrant was calculated based on the average of the closing prices of the
Corporation’s common stock on the 20 trading days ending on the last trading day
prior to the date of the Treasury’s approval of the Corporation’s application
under the program.





Of the
$10 million of proceeds, $9.7 million was allocated to the Senior Preferred
Shares and $269,000 was allocated to the warrant based on their estimated
relative fair values as of January 30, 2009.  The resulting discount
on the Senior Preferred Shares of $269,000 is being accreted through a charge to
retained earnings over an estimated five year life of the stock offering using
an effective yield method.  The Senior Preferred Shares and warrant
issued under the CPP are includable in Tier I capital for regulatory
capital.





The
Corporation may repay the funds provided under the CPP without regard to whether
the Corporation has replaced such funds from any other source or to any waiting
period, subject to regulatory approval.  Until the earlier of the
third anniversary of the Treasury’s investment in the Senior Preferred Shares or
when all of the Senior Preferred Shares have been redeemed by the Corporation or
transferred by the Treasury to third parties, the Corporation may not, without
the consent of the Treasury, increase the common stock cash
dividend.





Item7A.  Quantitative and Qualitative Disclosures About
Market Risk





Not
applicable to smaller reporting companies.





Item8.  Financial Statements and Supplementary
Data


35
 Table of Contents


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








Board of
Directors and Shareholders


Stewardship
Financial Corporation and Subsidiary


Midland
Park, New Jersey








We have
audited the accompanying consolidated statements of financial condition of
Stewardship Financial Corporation and Subsidiary as of December 31, 2009 and
2008 and the related consolidated statements of income, changes in stockholders'
equity, comprehensive income (loss) and cash flows for the years then
ended.  These financial statements are the responsibility of the
Corporation’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting.  Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting.  Accordingly, we express no such
opinion.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Stewardship Financial Corporation
and Subsidiary as of December 31, 2009 and 2008 and the results of their
operations and their cash flows for the years then ended in conformity with
U.S. generally accepted accounting principles.








Crowe
      Horwath LLP





Livingston,
New Jersey


March 26,
2010


36
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Consolidated
Statements of Financial Condition


December 31,2009
            
            
            2008AssetsCash
      and due from banks
            
            $
            8,840,000
            
            
            $
            12,719,000Other
      interest-earning assets
            
            
            31,000
            
            
            
            95,000Cash
      and cash equivalents
            
            
            8,871,000
            
            
            
            12,814,000Securities
      available for sale
            
            
            103,026,000
            
            
            
            90,023,000Securities
      held to maturity; estimated fair valueof
      $68,765,000 (2009) and $49,150,000 (2008)
            
            
            67,717,000
            
            
            
            48,856,000Federal
      Home Loan Bank of New York stock, at cost
            
            
            3,227,000
            
            
            
            2,420,000Mortgage
      loans held for sale
            
            
            660,000
            
            
            
            394,000Loans,
      net of allowance for loan losses of $6,920,000 (2009)and
      $5,166,000 (2008)
            
            
            453,119,000
            
            
            
            434,103,000Premises
      and equipment, net
            
            
            6,861,000
            
            
            
            7,470,000Accrued
      interest receivable
            
            
            3,167,000
            
            
            
            3,371,000Bank
      owned life insurance
            
            
            9,488,000
            
            
            
            8,599,000Other
      assets
            
            
            7,708,000
            
            
            
            3,766,000Total
      assets
            
            $
            663,844,000
            
            
            $
            611,816,000Liabilities
      and Stockholders' equityLiabilitiesDeposits:Noninterest-bearing
            
            $
            88,427,000
            
            
            $
            99,099,000Interest-bearing
            
            
            441,503,000
            
            
            
            407,432,000Total
      deposits
            
            
            529,930,000
            
            
            
            506,531,000Federal
      Home Loan Bank of New York Advances
            
            
            54,600,000
            
            
            
            36,900,000Securities
      sold under agreements to repurchase
            
            
            15,396,000
            
            
            
            15,160,000Subordinated
      debentures
            
            
            7,217,000
            
            
            
            7,217,000Accrued
      interest payable
            
            
            1,193,000
            
            
            
            1,582,000Accrued
      expenses and other liabilities
            
            
            1,997,000
            
            
            
            1,630,000Total
      liabilities
            
            
            610,333,000
            
            
            
            569,020,000Commitments
      and contingenciesStockholders'
      equityPreferred
      stock, no par value; 2,500,000 shares authorized;10,000
      shares issued and outstanding at December 31, 2009.Liquidation
      preference of $10,000,000
            
            
            9,736,000
            
            
            
            -Common
      stock, no par value; 10,000,000 shares authorized;5,834,515
      and 5,575,095 shares issued andoutstanding
      at December 31, 2009 and 2008, respectively
            
            
            40,415,000
            
            
            
            37,962,000Treasury
      stock, 20,000 shares at December 31, 2008
            
            
            -
            
            
            
            (272,000
            )Retained
      earnings
            
            
            2,922,000
            
            
            
            4,383,000Accumulated
      other comprehensive income, net
            
            
            438,000
            
            
            
            723,000Total
      Stockholders' equity
            
            
            53,511,000
            
            
            
            42,796,000Total
      liabilities and Stockholders' equity
            
            $
            663,844,000
            
            
            $
            611,816,000





See
accompanying notes to consolidated financial statements.


37
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Consolidated
Statements of Income





Years
      Ended December 31,2009
            
            
            2008Interest
      income:Loans
            
            $
            26,934,000
            
            
            $
            28,617,000Securities
      held to maturity:Taxable
            
            
            1,946,000
            
            
            
            751,000Nontaxable
            
            
            879,000
            
            
            
            840,000Securities
      available for sale:Taxable
            
            
            4,060,000
            
            
            
            4,470,000Nontaxable
            
            
            203,000
            
            
            
            174,000FHLB
      dividends
            
            
            125,000
            
            
            
            156,000Other
      interest-earning assets
            
            
            9,000
            
            
            
            66,000Total
      interest income
            
            
            34,156,000
            
            
            
            35,074,000Interest
      expense:Deposits
            
            
            8,793,000
            
            
            
            10,534,000Borrowed
      money
            
            
            2,018,000
            
            
            
            2,237,000Total
      interest expense
            
            
            10,811,000
            
            
            
            12,771,000Net
      interest income before provision for loan losses
            
            
            23,345,000
            
            
            
            22,303,000Provision
      for loan losses
            
            
            3,575,000
            
            
            
            3,585,000Net
      interest income after provision for loan losses
            
            
            19,770,000
            
            
            
            18,718,000Noninterest
      income:Fees
      and service charges
            
            
            1,847,000
            
            
            
            1,333,000Bank
      owned life insurance
            
            
            322,000
            
            
            
            326,000Gain
      on calls and sales of securities, net
            
            
            258,000
            
            
            
            103,000Gain
      on sales of mortgage loans
            
            
            294,000
            
            
            
            193,000Merchant
      processing
            
            
            118,000
            
            
            
            1,417,000Gain
      on sale of merchant portfolio
            
            
            -
            
            
            
            509,000Miscellaneous
            
            
            294,000
            
            
            
            336,000Total
      noninterest income
            
            
            3,133,000
            
            
            
            4,217,000Noninterest
      expense:Salaries
      and employee benefits
            
            
            8,264,000
            
            
            
            8,129,000Occupancy,
      net
            
            
            1,858,000
            
            
            
            1,802,000Equipment
            
            
            1,087,000
            
            
            
            1,127,000Data
      processing
            
            
            1,218,000
            
            
            
            1,209,000Advertising
            
            
            505,000
            
            
            
            487,000FDIC
      insurance premium
            
            
            1,124,000
            
            
            
            317,000Charitable
      contributions
            
            
            619,000
            
            
            
            627,000Stationery
      and supplies
            
            
            253,000
            
            
            
            399,000Merchant
      processing
            
            
            108,000
            
            
            
            1,258,000Bank-card
      related services
            
            
            383,000
            
            
            
            317,000Miscellaneous
            
            
            2,371,000
            
            
            
            2,314,000Total
      noninterest expenses
            
            
            17,790,000
            
            
            
            17,986,000Income
      before income tax expense
            
            
            5,113,000
            
            
            
            4,949,000Income
      tax expense
            
            
            1,479,000
            
            
            
            1,448,000Net
      income
            
            
            3,634,000
            
            
            
            3,501,000Dividends
      on preferred stock and accretion
            
            
            504,000
            
            
            
            -Net
      Income available to common stockholders
            
            $
            3,130,000
            
            
            $
            3,501,000Basic
      earnings per common share
            
            $
            0.54
            
            
            $
            0.60Diluted
      earnings per common share
            
            $
            0.54
            
            
            $
            0.60Weighted
      average number of common shares outstanding
            
            
            5,832,186
            
            
            
            5,853,562Weighted
      average number of diluted common shares outstanding
            
            
            5,836,739
            
            
            
            5,865,126





See
accompanying notes to consolidated financial statements.


38
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Consolidated
Statements of Changes in Stockholders' Equity





Years Ended December 31, 2009
      and 2008AccumulatedOtherComprehensivePreferred
            
            
            Common Stock
            
            
            Retained
            
            
            Treasury Stock
            
            
            Income
      (Loss),Stock
            
            
            Shares
            
            
            Amount
            
            
            Earnings
            
            
            Shares
            
            
            Amount
            
            
            Net
            
            
            TotalBalance
      -- December 31, 2007
            
            $
            -
            
            
            
            5,306,828
            
            
            $
            34,871,000
            
            
            $
            5,943,000
            
            
            
            -
            
            
            $
            -
            
            
            $
            276,000
            
            
            $
            41,090,000Cash
      dividends declared ($0.34 per share)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,965,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,965,000
            )Payment
      of discount on dividend
              reinvestment
      plan
            
            
            -
            
            
            
            -
            
            
            
            (45,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (45,000
            )5%
      Stock dividend
            
            
            -
            
            
            
            255,420
            
            
            
            2,995,000
            
            
            
            (3,096,000
            )
            
            
            9,896
            
            
            
            99,000
            
            
            
            -
            
            
            
            (2,000
            )Common
      stock issued under stock
              plans
            
            
            -
            
            
            
            1,667
            
            
            
            21,000
            
            
            
            -
            
            
            
            1,603
            
            
            
            20,000
            
            
            
            -
            
            
            
            41,000Stock
      option compensation expense
            
            
            -
            
            
            
            -
            
            
            
            48,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            48,000Stock
      options exercised
            
            
            -
            
            
            
            11,180
            
            
            
            70,000
            
            
            
            -
            
            
            
            (1,499
            )
            
            
            (21,000
            )
            
            
            -
            
            
            
            49,000Tax
      benefit on stock options exercised
            
            
            -
            
            
            
            -
            
            
            
            2,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,000Repurchase
      common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (30,000
            )
            
            
            (370,000
            )
            
            
            -
            
            
            
            (370,000
            )Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,501,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,501,000Change
      in unrealized holding gains
              on
      securities available for sale
              arising
      during the period (net of
              taxes
      of $260,000)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            383,000
            
            
            
            383,000Reclassification
      adjustment for gains
              in
      net income (net of taxes of
              $39,000)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            64,000
            
            
            
            64,000Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,948,000Balance
      -- December 31, 2008
            
            
            -
            
            
            
            5,575,095
            
            
            
            37,962,000
            
            
            
            4,383,000
            
            
            
            (20,000
            )
            
            
            (272,000
            )
            
            
            723,000
            
            
            
            42,796,000Proceeds
      from issuance of preferred
              stock
      and a warrant
            
            
            9,731,000
            
            
            
            -
            
            
            
            269,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            10,000,000Preferred
      stock issuance costs
            
            
            (48,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (48,000
            )Cash
      dividends declared ($0.36 per share)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,110,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,110,000
            )Payment
      of discount on dividend
              reinvestment
      plan
            
            
            -
            
            
            
            -
            
            
            
            (44,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (44,000
            )5%
      Stock dividend
            
            
            -
            
            
            
            249,129
            
            
            
            2,114,000
            
            
            
            (2,472,000
            )
            
            
            28,502
            
            
            
            356,000
            
            
            
            -
            
            
            
            (2,000
            )Cash
      dividends accrued on preferred
              stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (460,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (460,000
            )Common
      stock issued under stock
              plans
            
            
            -
            
            
            
            2,288
            
            
            
            22,000
            
            
            
            -
            
            
            
            2,566
            
            
            
            23,000
            
            
            
            -
            
            
            
            45,000Stock
      option compensation expense
            
            
            -
            
            
            
            -
            
            
            
            48,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            48,000Stock
      options exercised
            
            
            -
            
            
            
            8,003
            
            
            
            44,000
            
            
            
            -
            
            
            
            (3,568
            )
            
            
            (32,000
            )
            
            
            -
            
            
            
            12,000Repurchase
      of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,500
            )
            
            
            (75,000
            )
            
            
            -
            
            
            
            (75,000
            )Accretion
      of discount on preferred
              stock
            
            
            44,000
            
            
            
            -
            
            
            
            -
            
            
            
            (44,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
      of issuance costs
            
            
            9,000
            
            
            
            -
            
            
            
            -
            
            
            
            (9,000
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,634,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,634,000Change
      in unrealized holding gains
              on
      securities available for sale
              arising
      during the period (net of tax
              benefit
      of $183,000)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (286,000
            )
            
            
            (286,000
            )Reclassification
      adjustment for gains
              in
      net income (net of taxes of
              $102,000)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            156,000
            
            
            
            156,000Change
      in fair value of interest rate
              swap
      (net of tax benefit of
              $103,000)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (155,000
            )
            
            
            (155,000
            )Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,349,000Balance
      -- December 31, 2009
            
            $
            9,736,000
            
            
            
            5,834,515
            
            
            $
            40,415,000
            
            
            $
            2,922,000
            
            
            
            -
            
            
            $
            -
            
            
            $
            438,000
            
            
            $
            53,511,000





See
accompanying notes to consolidated financial statements.


39
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Consolidated
Statements of Comprehensive Income (Loss)





Years
      Ended December 31,2009
              
              
              2008Change
      in unrealized holding gains (losses on securities
                available
      for sale arising during the period)
              
              $
              47,000
              
              
              $
              849,000Reclassification
      adjustment for gains in net income
              
              
              258,000
              
              
              
              103,000Net
      unrealized gains (losses)
              
              
              (211,000
              )
              
              
              746,000Tax
      effect
              
              
              (81,000
              )
              
              
              299,000Net
      unrealized gains (losses), net of tax amount
              
              
              (130,000
              )
              
              
              447,000Change
      in fair value of interest rate swap
              
              
              (258,000
              )
              
              
              -Tax
      effect
              
              
              (103,000
              )
              
              
              -Change
      in fair value of interest rate swap, net of tax amount
              
              
              (155,000
              )
              
              
              -Total
      other comprehensive income (loss)
              
              $
              (285,000
              )
              
              $
              447,000The
      following is a summary of the accumulated other comprehensive income
      balances, net of tax:At
      December 31,2009
              
              
              
              2008Unrealized
      gain on securities available for sale
              
              $
              593,000
              
              
              $
              723,000Unrealized
      loss on fair value of interest rate swap
              
              
              (155,000
              )
              
              
              -Accumulated
      other comprehensive income, net
              
              $
              438,000
              
              
              $
              723,000





See
accompanying notes to consolidated financial statements.


40
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Consolidated
Statements of Cash Flows






Years Ended December 31,2009
            
            
            2008Cash
      flows from operating activities:Net
      income
            
            $
            3,634,000
            
            
            $
            3,501,000Adjustments
      to reconcile net income tonet
      cash provided by operating activities:Depreciation
      and amortization of premises and equipment
            
            
            841,000
            
            
            
            918,000Amortization
      of premiums and accretion of discounts, net
            
            
            628,000
            
            
            
            125,000Accretion
      of deferred loan fees
            
            
            (235,000
            )
            
            
            (283,000
            )Provision
      for loan losses
            
            
            3,575,000
            
            
            
            3,585,000Originations
      of mortgage loans held for sale
            
            
            (36,076,000
            )
            
            
            (19,665,000
            )Proceeds
      from sale of mortgage loans
            
            
            36,104,000
            
            
            
            20,748,000Gain
      on sale of loans
            
            
            (294,000
            )
            
            
            (193,000
            )Gains
      on sales and calls of securities
            
            
            (258,000
            )
            
            
            (103,000
            )Loss
      on sale of equipment
            
            
            -
            
            
            
            12,000Deferred
      income tax benefit
            
            
            (1,210,000
            )
            
            
            (365,000
            )Amortization
      of intangible assets
            
            
            32,000
            
            
            
            33,000Decrease
      (increase) in accrued interest receivable
            
            
            204,000
            
            
            
            (259,000
            )Decrease
      in accrued interest payable
            
            
            (389,000
            )
            
            
            (498,000
            )Increase
      in bank owned life insurance
            
            
            (322,000
            )
            
            
            (326,000
            )Nonqualified
      stock option expense
            
            
            48,000
            
            
            
            48,000Increase
      in other assets
            
            
            (3,133,000
            )
            
            
            (197,000
            )Increase
      (decrease) in other liabilities
            
            
            598,000
            
            
            
            (633,000
            )Net
      cash provided by operating activities
            
            
            3,747,000
            
            
            
            6,448,000Cash
      flows from investing activities:Purchase
      of securities available for sale
            
            
            (69,388,000
            )
            
            
            (45,353,000
            )Proceeds
      from maturities and principal repayments on securities available for
      sale
            
            
            15,444,000
            
            
            
            7,095,000Proceeds
      from sales and calls on securities available for sale
            
            
            40,654,000
            
            
            
            24,945,000Purchase
      of securities held to maturity
            
            
            (42,913,000
            )
            
            
            (17,210,000
            )Proceeds
      from maturities and principal repayments on securities held to
      maturity
            
            
            7,093,000
            
            
            
            4,715,000Proceeds
      from calls of securities held to maturity
            
            
            16,666,000
            
            
            
            4,770,000Purchase
      of FHLB-NY stock
            
            
            (807,000
            )
            
            
            (437,000
            )Net
      increase in loans
            
            
            (22,356,000
            )
            
            
            (21,715,000
            )Additions
      to premises and equipment
            
            
            (232,000
            )
            
            
            (454,000
            )Sale
      of equipment
            
            
            -
            
            
            
            4,000Purchase
      of BOLI
            
            
            (567,000
            )
            
            
            -Net
      cash used in investing activities
            
            
            (56,406,000
            )
            
            
            (43,640,000
            )Cash
      flows from financing activities:Net
      decrease in noninterest-bearing deposits
            
            
            (10,672,000
            )
            
            
            (2,894,000
            )Net
      increase in interest-bearing deposits
            
            
            34,071,000
            
            
            
            37,126,000Net
      increase (decrease) increase in securities sold under agreement to
      repurchase
            
            
            236,000
            
            
            
            (2,123,000
            )Net
      increase (decrease) increase in short term borrowings
            
            
            11,700,000
            
            
            
            (9,900,000
            )Proceeds
      from long term borrowings
            
            
            6,000,000
            
            
            
            65,000,000Payments
      on long term borrowings
            
            
            -
            
            
            
            (46,845,000
            )Proceeds
      from issuance of preferred stock and warrants
            
            
            9,951,000
            
            
            
            -Cash
      dividends paid on common stock
            
            
            (2,112,000
            )
            
            
            (1,967,000
            )Cash
      dividends paid on preferred stock
            
            
            (396,000
            )
            
            
            -Payment
      of discount on dividend reinvestment plan
            
            
            (44,000
            )
            
            
            (45,000
            )Purchase
      of treasury stock
            
            
            (75,000
            )
            
            
            (370,000
            )Exercise
      of stock options
            
            
            12,000
            
            
            
            49,000Tax
      benefit of stock plans
            
            
            -
            
            
            
            2,000Issuance
      of common stock
            
            
            45,000
            
            
            
            41,000Net
      cash provided by financing activities
            
            
            48,716,000
            
            
            
            38,074,000Net
      (decrease) increase in cash and cash equivalents
            
            
            (3,943,000
            )
            
            
            882,000Cash
      and cash equivalents - beginning
            
            
            12,814,000
            
            
            
            11,932,000Cash
      and cash equivalents - ending
            
            $
            8,871,000
            
            
            $
            12,814,000Supplemental
      disclosures of cash flow information:Cash
      paid during the year for interest
            
            $
            11,200,000
            
            
            $
            13,269,000Cash
      paid during the year for income taxes
            
            $
            1,831,000
            
            
            $
            2,453,000





See
accompanying notes to consolidated financial statements.


41
 Table of Contents


Stewardship
Financial Corporation and Subsidiary


Notes
to Consolidated Financial Statements








Note
1.  SIGNIFICANT ACCOUNTING POLICIES





Nature
of operations and principles of consolidation





The
consolidated financial statements include the accounts of Stewardship Financial
Corporation and its wholly owned subsidiary, Atlantic Stewardship Bank (‘the
Bank”), together referred to as “the Corporation”.  Atlantic
Stewardship Bank includes its wholly owned subsidiaries, Stewardship Investment
Corporation (whose primary business is to own and manage an investment
portfolio), Stewardship Realty LLC (whose primary business is to own and manage
property at 612 Godwin Avenue, Midland Park, New Jersey) and Atlantic
Stewardship Insurance Company, LLC (whose primary business is
insurance).  The Bank’s subsidiaries have an insignificant impact on
the daily operations.  All significant intercompany transactions and
balances are eliminated in the consolidated financial
statements.  Certain prior period amounts have been reclassified to
conform to the current presentation.





The
Corporation provides financial services through the Bank’s offices in Bergen,
Passaic, and Morris Counties, New Jersey.  Its primary products are
checking, savings, and term certificate accounts, and its primary lending
products are commercial, residential mortgage and installment
loans.  Substantially all loans are secured by specific items of
collateral including business assets, consumer assets, and commercial and
residential real estate.  Commercial loans are expected to be repaid
from cash flow generated from the operations of businesses.  There are
no significant concentrations of loans to any one industry or
customer.  However, the customers’ ability to repay their loans is
dependent on the real estate and general economic conditions in the
area.  The Corporation’s lending activities are concentrated in loans
secured by real estate located in northern New Jersey and therefore
collectability of the loan portfolio is susceptible to changes in real estate
market conditions in the northern New Jersey market.  The Corporation
has not made loans to borrowers outside the United States.





Basis
of consolidated financial statements presentation





The
consolidated financial statements of the Corporation have been prepared in
conformity with U.S. generally accepted accounting principles.  In
preparing the financial statements, management is required to make estimates and
assumptions, based on available information, that affect the amounts reported in
the financial statements and the disclosures provided.  Actual results
could differ significantly from those estimates.  The allowance for
loan losses and fair values of financial instruments are particularly subject to
change.





Cash
flows





Cash and
cash equivalents include cash and deposits with other financial institutions
under 90 days and interest-bearing deposits in other banks under 90
days.  Net cash flows are reported for customer loan and deposit
transactions, and short term borrowings and securities sold under agreement to
repurchase.





Securities
available for sale and held to maturity





The
Corporation classifies its securities as held to maturity or available for
sale.  Investments in debt securities that the Corporation has the
positive intent and ability to hold to maturity are classified as securities
held to maturity and are carried at amortized cost.  All other
securities are classified as securities available for
sale.  Securities available for sale may be sold prior to maturity in
response to changes in interest rates or prepayment risk, for asset/liability
management purposes, or other similar factors.  These securities are
carried at fair value with unrealized holding gains or losses reported in a
separate component of stockholders’ equity, net of the related tax
effects.





Interest
income includes amortization of purchase premium or
discount.  Premiums and discounts on securities are amortized on the
level-yield method without anticipating prepayments except for mortgage-backed
securities where prepayments are anticipated.  Gains and losses on
sales are recorded on the trade date and determined using the specific
identification method.





Declines
in the fair value of securities below their cost that are other than temporary
are reflected as realized losses.  In estimating other-than-temporary
losses, management considers the length of time and extent that fair value has
been less than cost, the financial condition and near term prospects of the
issuer, whether the Corporation has the intent to sell the security or more
likely than not will be required to sell the security before it’s anticipated
recovery.


42
 Table of Contents


Federal
Home Loan Bank (“FHLB”) stock





The Bank
is a member of the FHLB system.  Members are required to own a certain
amount of stock based on the level of borrowings and other
factors.  FHLB stock is carried at cost, classified as a restricted
security, and periodically evaluated for impairment based on the ultimate
recovery of par value.  Cash dividends are reported as
income.





Mortgage
loans held for sale





Mortgage
loans originated and intended for sale in the secondary market are carried at
the lower of cost or fair value on an aggregate basis.  Mortgage loans
held for sale are carried net of deferred fees, which are recognized as income
at the time the loans are sold to permanent investors.  Gains or
losses on the sale of mortgage loans held for sale are recognized at the
settlement date and are determined by the difference between the net proceeds
and the amortized cost.  All loans are sold with servicing rights
released to the buyer.





Loans





Loans
that management has the intent and ability to hold for the foreseeable future or
until maturity or payoff are reported at the principal amount outstanding, net
of unearned interest, deferred loan fees and costs and an allowance for loan
losses.  Interest income is accrued on the unpaid principal
balance.  Loan origination fees, net of certain direct origination
costs, are deferred and recognized in interest income using the level-yield
method without anticipating prepayments.





Interest
income on loans is discontinued at the time the loan is 90 days delinquent
unless the loan is well-secured and in process of collection.  Past
due status is based on the contractual terms of the loan.  In all
cases, loans are placed on nonaccrual or are charged-off at an earlier date if
collection of principal or interest is considered doubtful.





All
interest accrued but not received for loans placed on nonaccrual is reversed
against interest income.  Interest received on such loans is accounted
for on the cash-basis or cost-recovery method, until qualifying for return to
accrual.  Loans are returned to an accrual status when all the
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.





Allowance
for loan losses





The
allowance for loan losses is a valuation allowance for probable incurred credit
losses.  Loan losses are charged against the allowance when management
believes the uncollectability of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.  Management estimates the allowance balance required using
past loan loss experience, the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values, economic
conditions and other factors.  Allocations of the allowance may be
made for specific loans, but the entire allowance is available for any loan
that, in management’s judgment, should be charged off.





The
allowance consists of specific and general components.  The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful.  The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors.





A loan is
considered impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the loan
agreement.  Loans for which the terms have been modified and for which
the borrower is experiencing financial difficulties are considered troubled debt
restructuring and classified as impaired.  Factors considered by
management in determining impairment include payment status, collateral value,
and the probability of collecting scheduled principal and interest payments when
due.  Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired.  Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of
the shortfall in relation to the principal and interest
owed.  Impairment is measured on a loan by loan basis by either the
present value of expected future cash flows discounted at the loan’s effective
interest rate, the loans obtainable market price, or the fair value of the
collateral if the loan is collateral dependent.  Large groups of
smaller balance homogeneous loans, such as consumer and residential real estate
loans are collectively evaluated for impairment and accordingly, they are not
separately identified for impairment disclosures.


43
 Table of Contents


Premises
and equipment





Land is
stated at cost.  Buildings and improvements and furniture, fixtures
and equipment are stated at cost, less accumulated depreciation computed on the
straight-line method over the estimated lives of each type of
asset.  Estimated useful lives are three to forty years for buildings
and improvements and three to twenty-five years for furniture, fixtures and
equipment.  Leasehold improvements are stated at cost less accumulated
amortization computed on the straight-line method over the shorter of the term
of the lease or useful life.





Intangible
assets





Gross
intangible assets totaled $750,000 with accumulated amortization of $745,000 and
$713,000 at December 31, 2009 and 2008, respectively.  Intangible
assets represent the excess of the fair value of liabilities assumed over the
fair value of tangible assets acquired through a branch acquisition, completed
in 1995, which did not qualify as a business
combination.   Intangible assets, net of accumulated amortization
amounted to $5,000 and $37,000 at December 31, 2009 and 2008, respectively, and
are amortized on a straight-line method over a period of fifteen
years.





Long-Term
Assets





Premises
and equipment, core deposit and other intangible assets, and other long-term
assets are reviewed for impairment when events indicate their carrying amount
may not be recovered from future undiscounted cash flows.  If
impaired, the assets are recorded at fair value.





Bank
owned life insurance





The
Corporation has purchased life insurance policies on certain key
officers.  Bank owned life insurance is recorded at the amount that
can be realized under the insurance contract at the balance sheet date, which is
the cash surrender value adjusted for other charges or other amounts due that
are probable at settlement.





Treasury
Stock





Repurchases
of common stock are recorded as treasury stock at cost. Treasury stock is
reissued using the first in first out method. Treasury stock may be reissued for
exercise of stock options, dividend reinvestment plans, stock dividends or other
stock issuances. The difference between the cost and the market value at the
time the treasury stock is reissued is shown as an adjustment to common
stock.





Stock
Dividends





Stock
dividends for 20% or less are reported by transferring the fair value, as of the
ex-dividend date, of the stock issued from retained earnings to common stock and
additional paid-in capital.  Fractional share amounts are paid in cash
with a reduction in retained earnings.





Dividend
Reinvestment Plan





The
Corporation offers shareholders the opportunity to participate in a dividend
reinvestment plan. Plan participants may reinvest cash dividends to purchase new
shares of stock at 95% of the market value, based on the most recent
trades.  The Corporation purchases shares for the dividend
reinvestment plan participants on the open market through an approved broker.
The Corporation uses the cash dividends due the plan participants to purchase
shares from the broker.  The Corporation reimburses the broker for the
5% discount when the purchase of the Corporation’s stock is
completed.





Stock-based
compensation





Stock-based
compensation cost is recognized using the fair value
method.  Compensation cost is recognized for stock options issued
based on the fair value of these awards at the date of grant. A Black-Scholes
model is utilized to estimate the fair value of stock options. Compensation cost
is recognized over the required service period, generally defined as the vesting
period.





Income
taxes





Income
tax expense is the total of the current year income tax due or refundable and
the change in deferred tax assets and liabilities.  Deferred tax
assets and liabilities are the expected future tax amounts for the temporary
differences


44
 Table of Contents


between
carrying amounts and tax bases of assets and liabilities, computed using enacted
tax rates.  A valuation allowance, if needed, reduces deferred tax
assets to the amount expected to be realized.  The Corporation
recognizes interest and/or penalties related to income tax matters in income tax
expense.





A tax
position is recognized as a benefit only if it is “more likely than not” that
the tax position would be sustained in a tax examination, with a tax examination
being presumed to occur.  The amount recognized is the largest amount
of tax benefit that is greater than 50% likely of being realized on
examination.  For tax positions not meeting the “more likely than not”
test, no tax benefit is recorded.





Comprehensive
income





Comprehensive
income consists of net income and other comprehensive income.  Other
comprehensive income includes unrealized gains and losses on securities
available for sale, and unrealized gains or losses on cash flow hedges, net of
tax, which are also recognized as separate components of equity.





Earnings
per common share





Basic
earnings per common share is calculated by dividing net income available to
commons stockholders by the weighted average number of common shares outstanding
during the period.  Common stock equivalents are not included in the
calculation.





Diluted
earnings per share is computed similar to that of the basic earnings per share
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if all potential dilutive common
shares and common stock warrants were issued.





All share
and per share amounts have been restated to reflect a 5% stock dividend paid
November, 2009 and 2008.





Loss
contingencies





Loss
contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable
and an amount or range of loss can be reasonably
estimated.  Management does not believe there are such matters that
will have a material effect on the financial statements.





Dividend
restriction





Banking
regulations require maintaining certain capital levels and may limit the
dividends paid by the bank to the holding company or by the holding company to
shareholders.





Derivatives





Derivative
financial instruments are recognized as assets or liabilities at fair
value.  The Corporation’s derivative consists of an interest rate swap
agreement, which is used as part of its asset liability management to help
manage interest rate risk related to its Subordinated Debentures.  The
Corporation does not use derivatives for trading purposes.





The
Corporation designated the hedge as a cash flow hedge, which is a hedge of a
forecasted transaction or the variability of cash flows to be received or paid
related to a recognized asset or liability.  For a cash flow hedge,
the gain or loss on the derivative is reported in other comprehensive income
and, if ineffective, is reclassified into earnings in the same periods during
which the hedged transaction affects earnings.  Net cash settlements
on derivatives that qualify for hedge accounting are recorded in interest income
or interest expense, based on the item being hedged.





The
Corporation formally documented the risk-management objective and the strategy
for undertaking the hedge transaction at the inception of the hedging
relationship.  This documentation includes linking the fair value of
cash flow hedge to a specific liability on the balance sheet.  The
Corporation formally assessed, both at the hedge’s inception and on an ongoing
basis, whether the derivative instrument used is highly effective in offsetting
changes in fair values or cash flows of the hedged items.





When a
cash flow hedge is discontinued but the hedged cash flows or forecasted
transactions are still expected to occur, gains or losses that would be
accumulated in other comprehensive income are amortized into earnings over the
same periods which the hedged transactions will affect
earnings.


45
 Table of Contents


Fair
value of financial instruments





Fair
values of financial instruments are estimated using relevant market information
and other assumptions, as more fully disclosed in a separate
note.  Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments, and
other factors, especially in the absence of broad markets for particular
items.  Changes in assumptions or in market conditions could
significantly affect the estimates.





Adoption
of New Accounting Standards





In June
2009, the Financial Accounting Standards Board (the “FASB”) issued Statement No.
168, “The FASB Accounting
Standards CodificationTM(“ASC” or the
“Codification”)and the
Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB
Statement No. 162”.  This Codification has become the source of
authoritative U.S. generally acceptedaccounting principles
(GAAP) recognized by the FASB to be applied by nongovernmental
entities.  The Board will not issue new standards in the form of
Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts, but
will, instead, issue Accounting Standards Updates.  The adoption of
the Codification did not have a material effect on the Corporation’s results of
operations or financial position.


In April
2009, the FASB issued Staff Position 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset and Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, which was
codified into ASC 820-10.  This guidance emphasizes that even if there
has been a significant decrease in the volume and level of activity, the
objective of a fair value measurement remains the same.  Fair value is
the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction (that is, not a forced liquidation or
distressed sale) between market participants.  The guidance provides a
number of factors to consider when evaluating whether there has been a
significant decrease in the volume and level of activity for an asset or
liability in relation to normal market activity.   In addition,
when transactions or quoted prices are not considered orderly, adjustments to
those prices based on the weight of available information may be needed to
determine the appropriate fair value.  The guidance also requires
increased disclosures.  The adoption did not have a material effect on
the Corporation’s results of operations or financial position.





In April
2009, the FASB issued Staff Position No. 115-2 and FAS 124-2, Recognition and presentation of
Other-Than-Temporary Impairments, which were codified into ASC
320-10.  This guidance amends existing guidance for determining
whether impairment is other-than-temporary for debt securities.  This
guidance requires an entity to access whether it intends to sell, or it is more
likely than not that it will be required to sell a security in an unrealized
loss position before recovery of its amortized cost basis.  If either
of these criteria is met, the entire difference between amortized cost and fair
value is recognized in earnings.  For securities that do not meet the
aforementioned criteria, the amount of impairment recognized in earnings is
limited to the amount related to credit losses, while impairment related to
other factors is recognized in other comprehensive
income.    Additionally, this guidance expands and increases
the frequency of existing disclosures about other-than-temporary impairments for
debt and equity securities.  The adoption did not have a material
effect on the Corporation’s results of operations or financial
position.





In April
2009, the FASB issued Staff Position No. 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments, which were codified into ASC
825-10.  This guidance amends FASB Statement No. 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
that were previously only required in annual financial
statements.  The adoption did not have a material effect on the
Corporation’s results of operations or financial position.





In March
2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of SFAS No. 133”, which
was codified into ASC 815-10.  This guidance amends and expands the
disclosure requirements of SFAS 133 for derivative instruments and hedging
activities.  This guidance requires qualitative disclosure about
objectives and strategies for using derivative and hedging instruments,
quantitative disclosures about fair value amounts of the instruments and gains
and losses on such instruments, as well as disclosures about credit-risk
features in derivative agreements.  The adoption did not have a
material effect on the Corporation’s results of operations or financial
position.





In
December 2007, the FASB issued Statement No. 160, “Noncontrolling Interest in
Consolidated Financial Statements, an amendment of ARB No. 51”,
which was codified into ASC 810-10.  This guidance changes the
accounting and reporting for minority interests, which are now re-characterized
as noncontrolling interests and classified as a component of equity within the
consolidated balance sheet.  The adoption did not have a significant impact
on the Corporation’s results of operations or financial position.





In
December 2007, the FASB issued Statement No. 141 (revised 2007), “Business Combinations”, which
was codified into ASC 805.  This guidance establishes principles and
requirements for how an acquirer recognizes and measures in


46
 Table of Contents


its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in an acquiree, including the recognition and
measurement of goodwill acquired in a business combination.  The
adoption did not have a material effect on the Corporation’s results of
operations or financial position.





Recently
Issued But Not Yet Effective Accounting Standards





In June
2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No.
46(R)”, which was codified into ASC 810.  The objective of this
guidance is to improve financial reporting by corporations involved with
variable interest entities.  This standard has not yet been
incorporated into the Codification.  The guidance is effective for
interim and annual reporting periods ending after November 15,
2009.  Early adoption is not permitted.  The adoption,
planned for the first quarter of 2010, is not expected to have a material effect
on the Corporation’s results of operations or financial position.





In June
2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial
Assets—an amendment of FASB Statement No. 140”, which was codified into ASC
810.  The objective of this guidance is to improve the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a transfer of financial
assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement in
transferred financial assets.  This standard has not yet been
incorporated into the Codification.  The guidance is effective for
interim and annual reporting periods ending after November 15,
2009.  Early adoption is not permitted.  The adoption,
planned for the first quarter of 2010, is not expected to have a material effect
on the Corporation’s results of operations or financial position.





Note
2.  RESTRICTIONS ON CASH AND DUE FROM BANKS





Cash
reserves are required to be maintained on deposit with the Federal Reserve Bank
based on the Bank’s deposits.  The average amounts of the reserves on
deposit for the years ended December 31, 2009 and 2008 were approximately
$225,000 and $300,000, respectively.


47
 Table of Contents


Note
3.  SECURITIES - AVAILABLE FOR SALE AND HELD TO MATURITY





The fair
value of the available for sale securities and the related gross unrealized
gains and losses recognized in accumulated other comprehensive income were as
follows:





December 31, 2009Amortized
            
            
            Gross Unrealized
            
            
            FairCost
            
            
            Gains
            
            
            Losses
            
            
            ValueU.S.
      government-sponsored agencies:After
      one year through five years
            
            $
            6,707,000
            
            
            $
            5,000
            
            
            $
            66,000
            
            
            $
            6,646,000After
      five years through ten years
            
            
            12,754,000
            
            
            
            56,000
            
            
            
            128,000
            
            
            
            12,682,000After
      ten years
            
            
            13,181,000
            
            
            
            31,000
            
            
            
            254,000
            
            
            
            12,958,00032,642,000
            
            
            
            92,000
            
            
            
            448,000
            
            
            
            32,286,000Obligations
      of state and politicalsubdivisions:After
      one year through five years
            
            
            303,000
            
            
            
            7,000
            
            
            
            -
            
            
            
            310,000After
      five years through ten years
            
            
            2,981,000
            
            
            
            92,000
            
            
            
            1,000
            
            
            
            3,072,000After
      ten years
            
            
            2,000,000
            
            
            
            23,000
            
            
            
            8,000
            
            
            
            2,015,0005,284,000
            
            
            
            122,000
            
            
            
            9,000
            
            
            
            5,397,000Mortgage-backed
      securities-residential:Within
      one year
            
            
            648,000
            
            
            
            5,000
            
            
            
            -
            
            
            
            653,000After
      one year through five years
            
            
            1,991,000
            
            
            
            51,000
            
            
            
            -
            
            
            
            2,042,000After
      five years through ten years
            
            
            3,465,000
            
            
            
            144,000
            
            
            
            -
            
            
            
            3,609,000After
      ten years
            
            
            54,956,000
            
            
            
            1,223,000
            
            
            
            255,000
            
            
            
            55,924,00061,060,000
            
            
            
            1,423,000
            
            
            
            255,000
            
            
            
            62,228,000Total
      debt securities
            
            
            98,986,000
            
            
            
            1,637,000
            
            
            
            712,000
            
            
            
            99,911,000Other
      equity investments
            
            
            3,058,000
            
            
            
            66,000
            
            
            
            9,000
            
            
            
            3,115,000$
            102,044,000
            
            
            $
            1,703,000
            
            
            $
            721,000
            
            
            $
            103,026,000





December 31, 2008Amortized
            
            
            Gross Unrealized
            
            
            FairCost
            
            
            Gains
            
            
            Losses
            
            
            ValueU.S.
      government-sponsored agencies:After
      one year through five years
            
            $
            1,499,000
            
            
            $
            14,000
            
            
            $
            -
            
            
            $
            1,513,000After
      five years through ten years
            
            
            21,380,000
            
            
            
            499,000
            
            
            
            1,000
            
            
            
            21,878,000After
      ten years
            
            
            26,070,000
            
            
            
            228,000
            
            
            
            29,000
            
            
            
            26,269,00048,949,000
            
            
            
            741,000
            
            
            
            30,000
            
            
            
            49,660,000Obligations
      of state and politicalsubdivisions:Within
      one year
            
            
            711,000
            
            
            
            1,000
            
            
            
            -
            
            
            
            712,000After
      one year through five years
            
            
            304,000
            
            
            
            3,000
            
            
            
            -
            
            
            
            307,000After
      five years through ten years
            
            
            2,237,000
            
            
            
            2,000
            
            
            
            59,000
            
            
            
            2,180,000After
      ten years
            
            
            2,752,000
            
            
            
            -
            
            
            
            131,000
            
            
            
            2,621,0006,004,000
            
            
            
            6,000
            
            
            
            190,000
            
            
            
            5,820,000Mortgage-backed
      securities-residential:After
      one year through five years
            
            
            4,199,000
            
            
            
            46,000
            
            
            
            7,000
            
            
            
            4,238,000After
      five years through ten years
            
            
            4,315,000
            
            
            
            142,000
            
            
            
            -
            
            
            
            4,457,000After
      ten years
            
            
            22,455,000
            
            
            
            528,000
            
            
            
            8,000
            
            
            
            22,975,00030,969,000
            
            
            
            716,000
            
            
            
            15,000
            
            
            
            31,670,000Total
      debt securities
            
            
            85,922,000
            
            
            
            1,463,000
            
            
            
            235,000
            
            
            
            87,150,000Other
      equity investments
            
            
            2,908,000
            
            
            
            -
            
            
            
            35,000
            
            
            
            2,873,000$
            88,830,000
            
            
            $
            1,463,000
            
            
            $
            270,000
            
            
            $
            90,023,000





Cash
proceeds realized from sales and calls of securities available for sale for the
years ended December 31, 2009 and 2008 were $40,654,000 and $24,945,000,
respectively.  There were gross gains totaling $237,000 and no gross
losses realized on sales or calls during the year ended December 31,
2009.  The tax provision related to these realized


48
 Table of Contents


gains was
$86,000.  There were gross gains totaling $79,000 and no gross losses
realized on sales or calls during the year ended December 31,
2008.  The tax provision related to these realized gains was
$30,000.





The fair
value of available for sale securities pledged to secure treasury tax and loan
deposits for the year ending December 31, 2009 was $500,000.  See also
Note 7 to the consolidated financial statements regarding securities pledged as
collateral for Federal Home Loan Bank of New York advances and securities sold
under agreements to repurchase.





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





December
      31, 2009Amortized
            
            
            Gross
      UnrecognizedCost
            
            
            Gains
            
            
            Losses
            
            
            Fair
      ValueU.S.
      government-sponsored agencies:After
      one year through five years
            
            $
            4,202,000
            
            
            $
            35,000
            
            
            $
            -
            
            
            $
            4,237,000After
      five years through ten years
            
            
            9,265,000
            
            
            
            14,000
            
            
            
            258,000
            
            
            
            9,021,000After
      ten years
            
            
            6,454,000
            
            
            
            41,000
            
            
            
            93,000
            
            
            
            6,402,00019,921,000
            
            
            
            90,000
            
            
            
            351,000
            
            
            
            19,660,000Obligations
      of state and politicalsubdivisions:Within
      one year
            
            
            879,000
            
            
            
            11,000
            
            
            
            -
            
            
            
            890,000After
      one year through five years
            
            
            8,331,000
            
            
            
            219,000
            
            
            
            18,000
            
            
            
            8,532,000After
      five years through ten years
            
            
            13,490,000
            
            
            
            533,000
            
            
            
            51,000
            
            
            
            13,972,000After
      ten years
            
            
            4,338,000
            
            
            
            108,000
            
            
            
            15,000
            
            
            
            4,431,00027,038,000
            
            
            
            871,000
            
            
            
            84,000
            
            
            
            27,825,000Mortgage-backed
      securities-residential:Within
      one year
            
            
            200,000
            
            
            
            4,000
            
            
            
            -
            
            
            
            204,000After
      one year through five years
            
            
            426,000
            
            
            
            19,000
            
            
            
            -
            
            
            
            445,000After
      five years through ten years
            
            
            6,322,000
            
            
            
            218,000
            
            
            
            -
            
            
            
            6,540,000After
      ten years
            
            
            13,810,000
            
            
            
            306,000
            
            
            
            25,000
            
            
            
            14,091,00020,758,000
            
            
            
            547,000
            
            
            
            25,000
            
            
            
            21,280,000$
            67,717,000
            
            
            $
            1,508,000
            
            
            $
            460,000
            
            
            $
            68,765,000





December
      31, 2008Amortized
            
            
            Gross
      UnrecognizedCost
            
            
            Gains
            
            
            Losses
            
            
            Fair
      ValueU.S.
      government-sponsored agencies:After
      one year through five years
            
            $
            399,000
            
            
            $
            32,000
            
            
            $
            -
            
            
            $
            431,000After
      five years through ten years
            
            
            3,009,000
            
            
            
            37,000
            
            
            
            -
            
            
            
            3,046,000After
      ten years
            
            
            6,882,000
            
            
            
            148,000
            
            
            
            -
            
            
            
            7,030,00010,290,000
            
            
            
            217,000
            
            
            
            -
            
            
            
            10,507,000Obligations
      of state and politicalsubdivisions:Within
      one year
            
            
            1,149,000
            
            
            
            4,000
            
            
            
            -
            
            
            
            1,153,000After
      one year through five years
            
            
            2,392,000
            
            
            
            19,000
            
            
            
            -
            
            
            
            2,411,000After
      five years through ten years
            
            
            13,981,000
            
            
            
            87,000
            
            
            
            131,000
            
            
            
            13,937,000After
      ten years
            
            
            5,526,000
            
            
            
            -
            
            
            
            170,000
            
            
            
            5,356,00023,048,000
            
            
            
            110,000
            
            
            
            301,000
            
            
            
            22,857,000Mortgage-backed
      securities-residential:Within
      one year
            
            
            60,000
            
            
            
            -
            
            
            
            -
            
            
            
            60,000After
      one year through five years
            
            
            801,000
            
            
            
            11,000
            
            
            
            -
            
            
            
            812,000After
      five years through ten years
            
            
            1,575,000
            
            
            
            55,000
            
            
            
            -
            
            
            
            1,630,000After
      ten years
            
            
            13,082,000
            
            
            
            205,000
            
            
            
            3,000
            
            
            
            13,284,00015,518,000
            
            
            
            271,000
            
            
            
            3,000
            
            
            
            15,786,000$
            48,856,000
            
            
            $
            598,000
            
            
            $
            304,000
            
            
            $
            49,150,000





Cash
proceeds realized from calls of securities held to maturity for the years ended
December 31, 2009 and 2008 were $16,666,000 and $4,770,000,
respectively.  Gross gains totaling $21,000 and no losses were
realized from calls for the year ended December 31, 2009.  The tax
provision related to these realized gains was $9,000.  Gross gains
totaling $24,000 and no losses were realized from calls during the year ended
December 31, 2008.  The tax provision related to these realized gains
was $9,000.


49
 Table of Contents


The
amortized cost of held to maturity securities pledged to secure public deposits
for the two years ending December 31, 2009 and 2008 were $700,000 and $700,000,
respectively.  The amortized cost of securities pledged to secure
treasury tax and loan deposits for the year ending December 31, 2009 was
$364,000.  See also Note 7 to the consolidated financial statements
regarding securities pledged as collateral for Federal Home Loan Bank of New
York advances and securities sold under agreements to repurchase.





Issuers
may have the right to call or prepay obligations with or without call or
prepayment penalties.  This might cause actual maturities to differ
from the contractual maturities summarized above.





Mortgage-backed
securities are comprised primarily of government agencies such as the Government
National Mortgage Association and government sponsored agencies such as the
Federal National Mortgage Association ("FNMA"), the Federal Home Loan Banks and
the Federal Home Loan Mortgage Corporation.  At year end 2009 and
2008, there were no holdings of securities of any one issuer other than the U.S.
government and its agencies in an amount greater than 10% of stockholders'
equity.





The
following tables summarize the fair value and unrealized losses of those
investment securities which reported an unrealized loss at December 31, 2009 and
2008, and if the unrealized loss position was continuous for the twelve months
prior to December 31, 2009 and 2008.





Available
for Sale


2009
            
            Less than 12 Months
            
            
            12 Months or Longer
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesU.S.
      government-sponsored
      agencies
            
            $
            23,282,000
            
            
            $
            (361,000
            )
            
            $
            2,913,000
            
            
            $
            (87,000
            )
            
            $
            26,195,000
            
            
            $
            (448,000
            )Obligations
      of state and politicalsubdivisions
            
            
            373,000
            
            
            
            (2,000
            )
            
            
            443,000
            
            
            
            (7,000
            )
            
            
            816,000
            
            
            
            (9,000
            )Mortgage-backed
      securities-residential
            
            
            15,156,000
            
            
            
            (255,000
            )
            
            
            -
            
            
            
            -
            
            
            
            15,156,000
            
            
            
            (255,000
            )Other
      equity investments
            
            
            -
            
            
            
            -
            
            
            
            33,000
            
            
            
            (9,000
            )
            
            
            33,000
            
            
            
            (9,000
            )Total
      temporarily impaired securities
            
            $
            38,811,000
            
            
            $
            (618,000
            )
            
            $
            3,389,000
            
            
            $
            (103,000
            )
            
            $
            42,200,000
            
            
            $
            (721,000
            )





2008
            
            Less than 12 Months
            
            
            12 Months or Longer
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesU.S.
      government-sponsored
      agencies
            
            $
            7,464,000
            
            
            $
            (30,000
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            7,464,000
            
            
            $
            (30,000
            )Obligations
      of state and politicalsubdivisions
            
            
            4,709,000
            
            
            
            (190,000
            )
            
            
            -
            
            
            
            -
            
            
            
            4,709,000
            
            
            
            (190,000
            )Mortgage-backed
      securities-residential
            
            
            1,651,000
            
            
            
            (8,000
            )
            
            
            438,000
            
            
            
            (7,000
            )
            
            
            2,089,000
            
            
            
            (15,000
            )Other
      equity investments
            
            
            40,000
            
            
            
            (4,000
            )
            
            
            2,742,000
            
            
            
            (31,000
            )
            
            
            2,782,000
            
            
            
            (35,000
            )Total
      temporarily impaired securities
            
            $
            13,864,000
            
            
            $
            (232,000
            )
            
            $
            3,180,000
            
            
            $
            (38,000
            )
            
            $
            17,044,000
            
            
            $
            (270,000
            )


50
 Table of Contents


Held
to Maturity


2009
            
            Less than 12 Months
            
            
            12 Months or Longer
            
            
            TotalFair
            
            
            Unrecognized
            
            
            Fair
            
            
            Unrecognized
            
            
            Fair
            
            
            UnrecognizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesU.S.
      government-sponsored
      agencies
            
            $
            12,529,000
            
            
            $
            (351,000
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            12,529,000
            
            
            $
            (351,000
            )Obligations
      of state and politicalsubdivisions
            
            
            4,504,000
            
            
            
            (69,000
            )
            
            
            401,000
            
            
            
            (15,000
            )
            
            
            4.905,000
            
            
            
            (84,000
            )Mortgage-backed
      securities-residential
            
            
            1,949,000
            
            
            
            (25,000
            )
            
            
            -
            
            
            
            -
            
            
            
            1,949,000
            
            
            
            (25,000
            )Total
      temporarily impaired securities
            
            $
            18,982,000
            
            
            $
            (445,000
            )
            
            $
            401,000
            
            
            $
            (15,000
            )
            
            $
            19,383,000
            
            
            $
            (460,000
            )





2008
            
            Less than 12 Months
            
            
            12 Months or Longer
            
            
            TotalFair
            
            
            Unrecognized
            
            
            Fair
            
            
            Unrecognized
            
            
            Fair
            
            
            UnrecognizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesU.S.
      government-sponsored
      agencies
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Obligations
      of state and politicalsubdivisions
            
            
            13,440,000
            
            
            
            (301,000
            )
            
            
            -
            
            
            
            -
            
            
            
            13,440,000
            
            
            
            (301,000
            )Mortgage-backed
      securities-residential
            
            
            2,715,000
            
            
            
            (3,000
            )
            
            
            -
            
            
            
            -
            
            
            
            2,715,000
            
            
            
            (3,000
            )Total
      temporarily impaired securities
            
            $
            16,155,000
            
            
            $
            (304,000
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            16,155,000
            
            
            $
            (304,000
            )





Other-Than-Temporary-Impairment





Management
evaluates securities for other-than-temporary impairment (“OTTI”) at least on a
quarterly basis, and more frequently when economic or market conditions warrant
such an evaluation.  The investment securities portfolio is evaluated
for OTTI by applying the appropriate OTTI model.  Investment
securities classified as available for sale or held to maturity are evaluated
for OTTI under generally accepted accounting principles (“GAAP”).





In
determining OTTI under GAAP, management considers many factors, including: (1)
the length of time and the extent to which the fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, (3)
whether the market decline was affected by macroeconomic conditions, and (4)
whether the entity has the intent to sell the debt security or more likely than
not will be required to sell the debt security before its anticipated
recovery.  The assessment of whether an other-than-temporary decline
exists involves a high degree of subjectivity and judgment and is based on the
information available to management at a point in time.





When OTTI
occurs, the amount of the OTTI recognized in earnings depends on whether an
entity intends to sell the security or it is more likely than not it will be
required to sell the security before recovery of its amortized cost basis, less
any current-period credit loss.  If an entity intends to sell or it is
more likely than not it will be required to sell the security before recovery of
its amortized cost basis, less any current-period credit loss, the OTTI shall be
recognized in earnings equal to the entire difference between the investment’s
amortized cost basis and its fair value at the balance sheet date.  If
an entity does not intend to sell the security and it is not more likely than
not that the entity will be required to sell the security before recovery of its
amortized cost basis less any current-period loss, the OTTI shall be separated
into the amount representing the credit loss and the amount related to all other
factors.  The amount of the total OTTI related to the credit loss is
determined based on the present value of cash flows expected to be collected and
is recognized in earnings.  The amount of the total OTTI related to
other factors is recognized in other comprehensive income, net of applicable
taxes. The previous amortized cost basis less the OTTI recognized in earnings
becomes the new amortized cost basis of the investment.





At
December 31, 2009 there were three U. S. government sponsored agency securities,
three fixed rate municipal obligation securities, and certain equity investments
in a continuous loss position for 12 months or longer.  The market
value, and therefore the loss position, for each type of security responds
differently to market conditions.  In management’s opinion, those
market conditions are temporary in nature and provide the basis for the
Corporation’s belief that the declines are temporary.  The
Corporation’s unrealized losses are primarily due to the changes in interest
rates.  These securities have not been considered other than
temporarily impaired as scheduled principal and interest payments have been made
and management anticipates collecting the entire principal balance as
scheduled.  Because


51
 Table of Contents


the
decline in fair value is attributable to changes in market conditions, and not
credit quality, and because the Corporation does not have the intent to sell
these securities and it is likely that it will not be required to sell the
securities before their anticipated recovery, the Corporation does not consider
these securities to be other-than-temporarily impaired at December 31,
2009.





Note
4.  LOANS AND NONPERFORMING LOANS





The loan
portfolio consisted of the following:





December 31,2009
            
            
            2008Mortgage:Residential
            
            $
            36,246,000
            
            
            $
            40,337,000Commercial
            
            
            246,212,000
            
            
            
            226,183,000Commercial
            
            
            114,893,000
            
            
            
            100,282,000Home
      Equity
            
            
            21,779,000
            
            
            
            21,208,000Installment
            
            
            41,006,000
            
            
            
            51,290,000Other
            
            
            340,000
            
            
            
            356,000Total
      gross loans
            
            
            460,476,000
            
            
            
            439,656,000Less: 
       Deferred loan fees, net of costs
            
            
            437,000
            
            
            
            387,000Allowance
      for loan losses
            
            
            6,920,000
            
            
            
            5,166,0007,357,000
            
            
            
            5,553,000Loans,
      net
            
            $
            453,119,000
            
            
            $
            434,103,000





At
December 31, 2009 and 2008 loans participated by the Corporation to other
organizations totaled approximately $31,710,000 and $28,642,000,
respectively.





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





December 31,2009
            
            
            2008Balance,
      beginning
            
            $
            5,166,000
            
            
            $
            4,457,000Provision
      charged to operations
            
            
            3,575,000
            
            
            
            3,585,000Recoveries
      of loans charged off
            
            
            105,000
            
            
            
            26,000Loans
      charged off
            
            
            (1,926,000
            )
            
            
            (2,902,000
            )Balance,
      ending
            
            $
            6,920,000
            
            
            $
            5,166,000





The
Corporation has entered into lending transactions in the ordinary course of
business with directors, executive officers and principal stockholders of the
Corporation and their affiliates.  At December 31, 2009 and 2008,
these loans aggregated approximately $2,413,000 and $2,683,000,
respectively.  During the year ended December 31, 2009, new loans
totaling $1,393,000 were granted and repayments totaled approximately
$1,663,000.  The loans, at December 31, 2009, were current as to
principal and interest payments.





Nonperforming
loans include the following:


December
      31,2009
            
            
            2008Nonaccrual
      loans
            
            $
            19,656,000
            
            
            $
            4,230,000Loans
      past due 90 days or more and accruing
            
            
            415,000
            
            
            
            353,000Restructured
      loans
            
            
            2,846,000
            
            
            
            1,855,000Total
      nonperforming loans
            
            $
            22,917,000
            
            
            $
            6,438,000


52
 Table of Contents


Nonaccrual
loans and loans past due 90 days or more and accruing included both smaller
balance homogeneous loans that are collectively evaluated for impairment and
individually classified loans. Restructured loans classified as nonaccrual for
the years ended December 31, 2009 and December 31, 2008 were $23,000 and
$22,000, respectively.





The
following information is presented for loans classified as nonaccrual and
restructured:





Year ended December 31,2009
            
            
            2008Income
      that would have been recorded under
              contractual
      terms
            
            $
            1,696,000
            
            
            $
            400,000Less
      interest income received
            
            
            627,000
            
            
            
            222,000Lost
      income on loans during the year
            
            $
            1,069,000
            
            
            $
            178,000





Impaired
loans consisted of the following:





December 31,2009
            
            
            2008Impaired
      LoansWith
      related allowance for loan loss
            
            $
            8,668,000
            
            
            $
            2,762,000Without
      related allowance for loan loss
            
            
            13,834,000
            
            
            
            3,323,000Total
      impaired loans
            
            $
            22,502,000
            
            
            $
            6,085,000Related
      allowance for possible credit losses
            
            $
            1,903,000
            
            
            $
            481,000Average
      investment in impaired loans
            
            $
            13,700,000
            
            
            $
            2,609,000Interest
      recognized on impaired loans
            
            $
            182,000
            
            
            $
            73,000





Note
5.  PREMISES AND EQUIPMENT, NET





December 31,2009
            
            
            2008Land
            
            $
            2,999,000
            
            
            $
            2,999,000Buildings
      and improvements
            
            
            2,928,000
            
            
            
            2,893,000Leasehold
      improvements
            
            
            2,178,000
            
            
            
            2,188,000Furniture,
      fixtures and equipment
            
            
            3,627,000
            
            
            
            4,292,00011,732,000
            
            
            
            12,372,000Less:
      accumulated depreciation and amortization
            
            
            4,871,000
            
            
            
            4,902,000Total
      premises & equipment, net
            
            $
            6,861,000
            
            
            $
            7,470,000





Amounts
charged to net occupancy expense for depreciation and amortization of banking
premises and equipment amounted to $841,000 and $918,000 in 2009 and 2008,
respectively.


53
 Table of Contents


Note
6.  DEPOSITS





December 31, 2009
            
            
            December 31, 2008Weighted Average Rate
            
            
            Amount
            
            
            Weighted Average Rate
            
            
            AmountNoninterest-bearing
      demand
            
            
            -
            %
            
            $
            88,427,000
            
            
            
            -
            %
            
            $
            99,099,000NOW
      accounts
            
            
            1.66
            %
            
            
            133,270,000
            
            
            
            0.86
            %
            
            
            73,176,000Money
      market accounts
            
            
            0.98
            %
            
            
            85,014,000
            
            
            
            1.95
            %
            
            
            87,592,000Total
      interest-bearing demand
            
            
            1.40
            %
            
            
            218,284,000
            
            
            
            1.45
            %
            
            
            160,768,000Statement
      savings and clubs
            
            
            0.42
            %
            
            
            41,366,000
            
            
            
            0.58
            %
            
            
            36,447,000Business
      savings
            
            
            0.40
            %
            
            
            4,417,000
            
            
            
            0.49
            %
            
            
            3,180,000Total
      savings
            
            
            0.42
            %
            
            
            45,783,000
            
            
            
            0.57
            %
            
            
            39,627,000IRA
      investment and variable rate savings
            
            
            3.65
            %
            
            
            33,905,000
            
            
            
            4.04
            %
            
            
            30,073,000Brokered
      certificates
            
            
            -
            %
            
            
            -
            
            
            
            3.06
            %
            
            
            30,698,000Money
      market certificates
            
            
            2.37
            %
            
            
            143,531,000
            
            
            
            3.39
            %
            
            
            146,266,000Total
      certificates of deposit
            
            
            2.61
            %
            
            
            177,436,000
            
            
            
            3.44
            %
            
            
            207,037,000Total
      interest-bearing deposits
            
            
            1.78
            %
            
            
            441,503,000
            
            
            
            2.38
            %
            
            
            407,432,000Total
      deposits
            
            
            1.49
            %
            
            $
            529,930,000
            
            
            
            1.91
            %
            
            $
            506,531,000





Certificates
of deposit with balances of $100,000 or more at December 31, 2009 and 2008,
totaled $87,117,000 and $80,326,000, respectively.





The
scheduled maturities of certificates of deposit were as follows:





December
      31, 20092010
            
            $
            125,283,0002011
            
            
            31,992,0002012
            
            
            12,100,0002013
            
            
            6,817,0002014
            
            
            1,244,000$
            177,436,000


54
 Table of Contents


Note
7.  BORROWINGS





Federal
Home Loan Bank of New York Advances





The
following table presents Federal Home Loan Bank of New York ("FHLB-NY") advances
by maturity date:





December 31,
      2009
            
            
            December 31,
      2008Weighted
      Average
            
            
            
            
            
            Weighted
      AverageAdvances maturing
            
            Amount
            
            
            Rate
            
            
            Amount
            
            
            RateWithin
      one year
            
            $
            18,600,000
            
            
            
            0.32
            %
            
            $
            6,900,000
            
            
            
            0.44
            %After
      one year, but within two years
            
            
            3,000,000
            
            
            
            2.28
            %
            
            
            -
            
            
            
            -
            %After
      two years, but within three years
            
            
            3,000,000
            
            
            
            2.86
            %
            
            
            -
            
            
            
            -
            %After
      three years, but within four years
            
            
            15,000,000
            
            
            
            3.30
            %
            
            
            -
            
            
            
            -
            %After
      four years, but within five years
            
            
            -
            
            
            
            -
            %
            
            
            15,000,000
            
            
            
            3.30
            %After
      five years
            
            
            15,000,000
            
            
            
            1.98
            %
            
            
            15,000,000
            
            
            
            1.98
            %$
            54,600,000
            
            
            
            1.84
            %
            
            $
            36,900,000
            
            
            
            2.23
            %





During
the years 2009 and 2008, the maximum amount of FHLB-NY advances outstanding at
any month end was $64.1 million and $64.0 million, respectively.  The
average amount of advances outstanding during the year ended December 31, 2009
and 2008 was $44.5 million and $44.3 million, respectively.





Advances
totaling $30.0 million have quarterly call features, of which $5.0 million have
not yet reached their first call date.  Each advance is payable at its
maturity date, with a prepayment penalty for fixed rate advances.





Advances
from the FHLB-NY are all fixed rate borrowings and are secured by a blanket
assignment of the Corporation's unpledged, qualifying mortgage loans and by
mortgage-backed securities or investment securities.  The loans remain
under the control of the Corporation.  Securities are maintained in
safekeeping with the FHLB-NY. As of December 31, 2009 and 2008, the advances
were collateralized by $21.7 million and $28.5 million, respectively, of first
mortgage loans under the blanket lien arrangement.  Additionally, the
advances were collateralized by $42.9 million and $44.2 million of investment
securities as of December 31, 2009 and 2008 respectively.  Based on
the collateral the Corporation was eligible to borrow up to a total of $64.6
million at December 31, 2009 and $72.7 million at December 31,
2008.





At
December 31, 2009, the Corporation had available an overnight line of credit and
a one-month overnight repricing line of credit with the FHLB-NY, each in the
amount of $64.3 million.  In addition, the Corporation had available
overnight variable repricing lines of credit with other correspondent banks
totaling $23 million on an unsecured basis.  There were no borrowings
under these lines of credit at December 31, 2009 and 2008.





Securities
Sold Under Agreements to Repurchase





Securities
sold under agreements to repurchase represent financing
arrangements.





At
December 31, 2009 and 2008, included in the balance of securities sold under
agreements to repurchase is a wholesale repurchase agreement with a broker to
borrow $14 million with a maturity in 2014.  The borrowing had a fixed
interest rate of 3.25% for the first year and then converted to a floating rate
at 9.00% minus 3-month LIBOR measured on a quarterly basis with a 5.15% cap and
a 0.0% floor.  This repurchase agreement is collateralized by agency
securities maintained in safekeeping with the broker.  The remaining
balances at December 31, 2009 as well as the balances at December 31, 2008 were
securities sold to Bank customers at fixed rates with maturities varying from 91
days to one year.  These securities were maintained in a separate
safekeeping account within the Corporation's control.





At
December 31, 2009 and 2008, securities sold under agreements to repurchase were
collateralized by U.S. Treasury and agency securities having a carrying value of
approximately $19,270,000 and $19,433,000, respectively.


55
 Table of Contents


Information
concerning securities sold under agreements to repurchase is summarized as
follows:





December
      31,2009
            
            
            2008Balance
            
            $
            15,396,000
            
            
            $
            15,160,000Weighted
      average interest rate at year end
            
            
            4.72
            %
            
            
            5.00
            %Weighted
      average length of maturity
            
            6.4
      years
            
            
            6.5
      yearsMaximum
      amount outstanding at any month endduring
      the year
            
            $
            16,019,000
            
            
            $
            16,599,000Average
      amount outstanding during the year
            
            $
            15,316,000
            
            
            $
            16,259,000Average
      interest rate during the year
            
            
            4.92
            %
            
            
            3.85
            %





Note
8.  SUBORDINATED DEBENTURES





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





Prior to
September 17, 2008, the Capital Securities and the Debentures both had a fixed
interest rate of 6.75%.  Beginning September 17, 2008, the rate floats
quarterly at a rate of three month London Interbank Offered Rate (LIBOR) plus
2.95%.  At December 31, 2009 and 2008 the rate on both the Capital
Securities and the Debentures was 3.20% and 4.82%, respectively. The Corporation
has the right to defer payments of interest on the subordinated debentures by
extending the interest payment period for up to 20 consecutive quarterly
periods.





The
subordinated debentures may be included in Tier I capital (with certain
limitations applicable) under current regulatory guidelines and
interpretations.


56
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Note
9.  REGULATORY CAPITAL REQUIREMENTS





Banks and
bank holding companies are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and,
additionally for banks, prompt corrective action regulations, involve
quantitative measures of assets, liabilities, and certain off-balance-sheet
items calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by regulators. Failure
to meet capital requirements can initiate regulatory action. Regulations of the
Board of Governors of the Federal Reserve System require bank holding companies
to maintain minimum levels of regulatory capital. Under the regulations in
effect at December 31, 2009, the Corporation was required to maintain (i) a
minimum leverage ratio of Tier 1 capital to total adjusted assets of 4.0% and
(ii) minimum ratios of Tier 1 and total capital to risk-weighted assets of 4.0%
and 8.0%, respectively. The Bank must comply with substantially similar capital
regulations promulgated by the FDIC.





Prompt
corrective action regulations provide five classifications: well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized, and
critically undercapitalized, although these terms are not used to represent
overall financial condition. If adequately capitalized, regulatory approval is
required to accept brokered deposits. If undercapitalized, capital distributions
are limited, as is asset growth and expansion, and capital restoration plans are
required.





At year
end 2009 and 2008, the most recent regulatory notifications categorized the Bank
as well capitalized under the regulatory framework for prompt corrective action.
There are no conditions or events since that notification that management
believes changed the institution's category.





Management
believes that, as of December 31, 2009 the Bank and the Corporation have met all
capital adequacy requirements to which they are subject. The following is a
summary of the Corporation's and the Bank's actual capital amounts and ratios as
of December 31, 2009 and 2008 compared to the minimum capital adequacy
requirements and the requirements for classification as a well capitalized
institution under the prompt corrective action regulations:





Actual
            
            
            Required for Capital Adequacy
      Purposes
            
            
            To Be Well Capitalized Under Prompt Corrective
      Action RegulationsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioDecember
      31, 2009Leverage
      (Tier 1) capitalConsolidated
            
            $
            60,067,000
            
            
            
            9.22
            %
            
            $
            26,065,000
            
            
            
            4.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            55,049,000
            
            
            
            8.51
            %
            
            
            25,881,000
            
            
            
            4.00
            %
            
            $
            32,352,000
            
            
            
            5.00
            %Risk-based
      capital:Tier
      1Consolidated
            
            
            60,067,000
            
            
            
            11.99
            %
            
            
            20,041,000
            
            
            
            4.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            55,049,000
            
            
            
            11.02
            %
            
            
            19,986,000
            
            
            
            4.00
            %
            
            
            29,979,000
            
            
            
            6.00
            %TotalConsolidated
            
            
            66,338,000
            
            
            
            13.24
            %
            
            
            40,081,000
            
            
            
            8.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            61,303,000
            
            
            
            12.27
            %
            
            
            39,972,000
            
            
            
            8.00
            %
            
            
            49,965,000
            
            
            
            10.00
            %December
      31, 2008Leverage
      (Tier 1) capitalConsolidated
            
            $
            49,014,000
            
            
            
            8.01
            %
            
            $
            24,480,000
            
            
            
            4.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            44,069,000
            
            
            
            7.26
            %
            
            
            24,288,000
            
            
            
            4.00
            %
            
            $
            30,360,000
            
            
            
            5.00
            %Risk-based
      capital:Tier
      1Consolidated
            
            
            49,014,000
            
            
            
            10.50
            %
            
            
            18,680,000
            
            
            
            4.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            44,069,000
            
            
            
            9.46
            %
            
            
            18,630,000
            
            
            
            4.00
            %
            
            
            27,945,000
            
            
            
            6.00
            %TotalConsolidated
            
            
            54,180,000
            
            
            
            11.60
            %
            
            
            37,360,000
            
            
            
            8.00
            %
            
            
            N/A
            
            
            
            N/ABank
            
            
            49,234,000
            
            
            
            10.57
            %
            
            
            37,259,000
            
            
            
            8.00
            %
            
            
            46,574,000
            
            
            
            10.00
            %


57
 Table of Contents


Note
10.  PREFERRED STOCK





On
January 30, 2009, the Corporation received $10 million as part of the United
States Treasury Department’s Troubled Asset Relief Program – Capital Purchase
Program. In exchange, the Corporation issued 10,000 Senior Preferred shares and
a warrant to purchase 133,475 of common shares.





The
Senior Preferred Shares pay a cumulative dividend of 5% per annum for the first
five years and 9% per annum thereafter.  Dividends are payable
quarterly in arrears and the Corporation accrues the preferred dividends as
earned over the period the Senior Preferred Shares are outstanding.





The
warrant has an exercise price of $11.24 per share.  The exercise price
for the warrant was calculated based on the average of the closing prices of the
Corporation’s common stock on the 20 trading days ending on the last trading day
prior to the date of the Treasury’s approval of the Corporation’s application
under the program.





Of the
$10 million of proceeds, $9.7 million was allocated to the Senior Preferred
Shares and $269,000 was allocated to the warrant based on their estimated
relative fair values as of January 30, 2009.  The resulting discount
on the Senior Preferred Shares of $269,000 is being accreted through a charge to
retained earnings over an estimated five year life of the stock offering using
an effective yield method.  The Senior Preferred Shares and warrant
issued under the CPP are includable in Tier I capital for regulatory
capital.





The
Corporation may repay the funds provided under the CPP without regard to whether
the Corporation has replaced such funds from any other source or to any waiting
period, subject to regulatory approval.  Until the earlier of the
third anniversary of the Treasury’s investment in the Senior Preferred Shares or
when all of the Senior Preferred Shares have been redeemed by the Corporation or
transferred by the Treasury to third parties, the Corporation may not, without
the consent of the Treasury, increase the common stock cash
dividend.





Note
11.  BENEFIT PLANS





The
Corporation has a noncontributory profit sharing plan covering all eligible
employees.  Contributions are determined by the Corporation’s Board of
Directors on an annual basis.  Total profit sharing plan expense for
the years ended December 31, 2009 and 2008 amounted to approximately $255,000
and $281,000, respectively.





The
Corporation also has a 401(k) plan which covers all eligible
employees.  Participants may elect to contribute up to 15% of their
salaries, not to exceed the applicable limitations as per the Internal Revenue
Code.  The Corporation, on an annual basis, may elect to match 50% of
the participant’s first 5% contribution.  Total 401(k) expense for the
years ended December 31, 2009 and 2008 amounted to approximately $112,000 and
$70,000, respectively.





During
1996, the Corporation adopted an Employee Stock Purchase Plan which allows all
eligible employees to authorize a specific payroll deduction from his or her
base compensation.  Total stock purchases amounted to 5,096 and 3,605
shares during 2009 and 2008, respectively.  At December 31, 2009 the
Corporation had 217,041 shares reserved for issuance under this
plan.





Note
12.  STOCK-BASED COMPENSATION





At
December 31, 2009, the Corporation had various types of stock award
programs.





Director
Stock Plan





The
Director Stock Plan permits members of the Board of Directors of the Bank to
receive any monthly Board of Directors’ fees in shares of the Corporation’s
common stock, rather than in cash.  Shares are purchased for Directors
in the open market and resulted in purchases of 3,720 and 6,937 shares for 2009
and 2008, respectively.  At December 31, 2009 the Corporation had
553,026 shares reserved for issuance under this plan.


58
 Table of Contents


Employee
Stock Option Plan





The
Employee Stock Option Plan provided for options to purchase shares of common
stock to be issued to employees of the Corporation at the discretion of the
Compensation Committee.  There were no options granted during 2009 or
2008.  While there are still options outstanding under this plan, the
plan does not allow for additional grants after May 2006.  Under the
plan, the exercise price of options may be paid in cash or with shares already
owned.  During 2009 and 2008, 3,746 and 1,574 shares, respectively,
were used to satisfy the exercise of options.  A summary of the status
of the qualified stock options as of December 31, 2009 and changes during the
year then ended is presented as follows:







2009WeightedAverageExerciseShares
            
            
            PriceOutstanding
      at beginning of year
            
            
            28,646
            
            
            $
            7.50Exercised
            
            
            (8,370
            )
            
            
            5.31Forfeited
            
            
            (563
            )
            
            
            11.19Outstanding
      at end of year
            
            
            19,713
            
            
            $
            8.33Intrinsic
      value at year end
            
            $
            27,223Options
      exercisable at year end
            
            
            19,713Intrinsic
      value of options exercisable
            
            $
            27,223Weighted-average
      remaining contractual term (years)
            
            
            1.72





The
intrinsic value of options exercised was $23,000 and $80,000 for the years ended
December 31, 2009 and 2008, respectively.  The Corporation received
cash from the exercise of options in the amount of $12,000 and $22,000 for the
years ended December 31, 2009 and 2008, respectively.





The
following table summarizes information about the qualified employee stock
options outstanding and exercisable at December 31, 2009:





Number
            
            
            Weighted-AverageExercise
            
            
            Outstanding
            
            
            RemainingPrice
            
            
            at 12/31/09
            
            
            Life$
            5.83
            
            
            
            10,520
            
            
            0.13
      years11.19
            
            
            
            9,193
            
            
            
            3.54$
            8.33
            
            
            
            19,713
            
            
            1.72 years





Non-Employee
Directors Stock Option Plans





The 2001
Stock Option Plan for Non-Employee Directors provided for options to purchase
shares of common stock to be granted to Directors of the
Corporation.  The options granted under the plan have exercise prices
which represented market price of the stock at the date of grant.  No
options have been granted since 2005.  While there are still options
outstanding under this plan, the plan does not allow for additional grants after
May 2006.  The plan allows for the exercise price of options to be
paid in cash or with shares already owned.





The 2006
Stock Option Plan for Non-Employee Directors provides for options to purchase
shares of common stock to be granted to Non-Employee Directors of the
Corporation.  Under this plan, options vest in equal installments over
a period of five years on an annual basis.  Options expire on the
earlier of the sixth anniversary of the date of the grant or May 15,
2012.  Options were granted in 2006 to all Non-Employee
Directors.  During the year ended December 31, 2009, 2,431 options
were granted.  At December 31, 2009 the Corporation had 9,724 shares
reserved for issuance under this plan.





Total
compensation cost that has been charged against income for these plans was
$48,000 for both the years ended December 31, 2009 and 2008.


59
 Table of Contents


A summary
of the status of the nonqualified stock options issued under the 2001 and 2006
Stock Option Plan for Non-Employee Directors as of December 31, 2009 is
presented below:







2009WeightedAverageExerciseShares
            
            
            PriceOutstanding
      at beginning of year
            
            
            60,904
            
            
            $
            11.20Granted
            
            
            2,431
            
            
            
            9.00Outstanding
      at end of year
            
            
            63,335
            
            
            $
            11.12Intrinsic
      value at year end
            
            $
            -Options
      exercisable at year end
            
            
            36,594Intrinsic
      value of options exercisable
            
            $
            -Weighted-average
      remaining contractual term (years)
            
            
            2.22





The fair
value of each option award is estimated on the date of grant using a closed form
option valuation (Black-Scholes) model that uses the assumptions noted in the
table below.  Expected volatility is based on the historical
volatility of the Corporation’s common stock.  The Corporation uses
historical data to estimate option exercise and post-vesting termination
behavior.  The expected term of options granted is based on historical
data and represents the period of time that options granted are expected to be
outstanding, which takes into account that the options are not
transferable.  The risk-free interest rate for the expected term of
the option is based on the U.S. Treasury yield curve in effect at the time of
the grant.





The fair
value of options granted for the year ended December 31, 2009 were determined
using the following weighted-average assumptions as of the grant
date:





Risk-free
      interest rate
            0.88%Expected
      term
            2.42
      yearsExpected
      stock price volatility
            42.13%Dividend
      yield
            3.88%





No
options were exercised under either the 2001 Stock Option Plan for Non-Employee
Directors or the 2006 Stock Option Plan for Non-Employee Directors during the
year ended December 31, 2009.  For the year ended December 31, 2008
the Corporation received cash from the exercise of options in the amount of
$27,000.  The Corporation realized a tax benefit from the options
exercised in the year ended December 31, 2008 of $2,000.





The
following table summarizes information about the nonqualified Non-Employee
Director stock options outstanding and exercisable at December 31,
2009:








Number
            
            
            Weighted-Average
            
            
            NumberExercise
            
            
            Outstanding
            
            
            Remaining
            
            
            ExercisablePrice
            
            
            at
      12/31/09
            
            
            Life
            
            
            at
      12/31/09$
            12.07
            
            
            
            6,205
            
            
            0.80
      years
            
            
            
            6,20511.11
            
            
            
            54,699
            
            
            
            2.37
            
            
            
            30,3899.00
            
            
            
            2,431
            
            
            
            2.37
            
            
            
            -$
            11.12
            
            
            
            63,335
            
            
            2.22
      years
            
            
            
            36,594





Unrecognized
compensation expense totaled $70,000 and will be recognized over the next 1.4
years.


60
 Table of Contents


Note
13:  EARNINGS PER COMMON SHARE





The
following reconciles the income available to common shareholders (numerator) and
the weighted average common stock outstanding (denominator) for both basic and
diluted earnings per share for 2009 and 2008:





2009
            
            
            2008Net
      income
            
            $
            3,634,000
            
            
            $
            3,501,000Dividends
      on preferred stock and accretion
            
            
            504,000
            
            
            
            -Net
      income available to common stockholders
            
            $
            3,130,000
            
            
            $
            3,501,000Weighted
      average common shares outstanding - basic
            
            
            5,832,186
            
            
            
            5,853,562Effect
      of dilutive securities - stock options
            
            
            4,553
            
            
            
            11,564Weighted
      average common shares outstanding - diluted
            
            
            5,836,739
            
            
            
            5,865,126Earnings
      per common share:Basic
            
            $
            0.54
            
            
            $
            0.60Diluted
            
            $
            0.54
            
            
            $
            0.60





Stock
options granting 70,368 and 62,308 shares of common stock for the years ended
December 31, 2009 and 2008, respectively, were not considered in computing
diluted earnings per common share because they were antidilutive.  A
common stock warrant to purchase 122,504
 average shares of
common stock was not considered in computing diluted earnings per common share
for the year ended December 31, 2009 because it was antidilutive.





Note
14.  INCOME TAXES





The
components of income tax expense (benefit) are summarized as
follows:





Year ended December 31,2009
            
            
            2008Current
      tax expense:Federal
            
            $
            2,045,000
            
            
            $
            1,364,000State
            
            
            644,000
            
            
            
            449,0002,689,000
            
            
            
            1,813,000Deferred
      tax benefit:Federal
            
            
            (938,000
            )
            
            
            (293,000
            )State
            
            
            (278,000
            )
            
            
            (89,000
            )Valuation
      allowance
            
            
            6,000
            
            
            
            17,000(1,210,000
            )
            
            
            (365,000
            )$
            1,479,000
            
            
            $
            1,448,000


61
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The
following table presents a reconciliation between the reported income taxes and
the income taxes which would be computed by applying the normal federal income
tax rate (34%) to income before income taxes:





Year Ended December 31,2009
            
            
            2008Federal
      income tax
            
            $
            1,738,000
            
            
            $
            1,683,000Add
      (deduct) effect of:State
      income taxes, net of federal income tax effect
            
            
            246,000
            
            
            
            245,000Nontaxable
      interest income
            
            
            (398,000
            )
            
            
            (375,000
            )Life
      insurance
            
            
            (113,000
            )
            
            
            (108,000
            )Nondeductible
      expenses
            
            
            24,000
            
            
            
            28,000Change
      in valuation reserve – federal
            
            
            -
            
            
            
            (7,000
            )Other
      items, net
            
            
            (18,000
            )
            
            
            (18,000
            )Effective
      federal income taxes
            
            $
            1,479,000
            
            
            $
            1,448,000





The tax
effects of existing temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as
follows:





December
      31,2009
            
            
            2008Deferred
      tax assets:Allowance
      for loan losses
            
            $
            2,764,000
            
            
            $
            2,063,000Accrued
      reserves
            
            
            17,000
            
            
            
            27,000Stock
      compensation
            
            
            79,000
            
            
            
            60,000Nonaccrual
      loan interest
            
            
            489,000
            
            
            
            75,000Depreciation
            
            
            268,000
            
            
            
            167,000Contribution
      carry forward
            
            
            183,000
            
            
            
            206,000State
      capital loss carry forward
            
            
            83,000
            
            
            
            96,0003,883,000
            
            
            
            2,694,000Valuation
      reserve
            
            
            (105,000
            )
            
            
            (111,000
            )3,778,000
            
            
            
            2,583,000Deferred
      tax liabilities:Unrealized
      gains on securities available for sale
            
            
            294,000
            
            
            
            470,000Other
            
            
            34,000
            
            
            
            50,000328,000
            
            
            
            520,000Net
      deferred tax assets
            
            $
            3,450,000
            
            
            $
            2,063,000





The
Corporation has provided a full valuation allowance relating to all of the state
tax benefits of both net operating loss carryforwards and contribution
carryforwards.  The Corporation has also provided a federal valuation
allowance against some of its contribution carryforwards.  Management
has determined that it is more likely than not that it will not be able to
realize the deferred tax benefits described above.





There
were no unrecognized tax benefits during the year or at the year ending December
31, 2009 and 2008. There were no tax interest and penalties recorded in the
income statement for the year ended December 31, 2009 and 2008.  There
were no tax interest and penalties accrued for the year ended December 31, 2009
and 2008.





The
Corporation and its subsidiaries are subject to U.S. federal income tax as well
as income tax of the state of New Jersey.





The
Corporation is no longer subject to examination by taxing authorities for years
before 2006.





Note
15.  COMMITMENTS AND CONTINGENCIES





Loan
Commitments





The
Corporation is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit and standby


62
 Table of Contents


letters
of credit.  Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated financial statements.  The contract or notional amounts
of those instruments reflect the extent of involvement the Corporation has in
particular classes of financial instruments.





The
Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments.  The Corporation uses the same credit policies in
making commitments and conditional obligations as it does for on-balance sheet
instruments.





At
December 31, 2009, the Corporation had residential mortgage commitments to
extend credit aggregating approximately $1.9 million at variable rates averaging
5.50% and $3.3 million at fixed rates averaging 4.92%.  All these loan
commitments will be sold to investors upon closing. Commercial, construction,
and home equity loan commitments of approximately $10.7 million were extended
with variable rates averaging 6.49% and $3.5 million were extended at fixed
rates averaging 6.27%.  Generally, commitments were due to expire
within approximately 120 days.





Additionally,
at December 31, 2009, the Corporation was committed for approximately $75.0
million of unused lines of credit, consisting of $19.4 million relating to a
home equity line of credit program and an unsecured line of credit program (cash
reserve), $4.3 million relating to an unsecured overdraft protection program,
and $51.3 million relating to commercial and construction lines of credit.
Amounts drawn on the unused lines of credit are predominantly assessed interest
at rates which fluctuate with the base rate.





Commitments
under standby and commercial letters of credit aggregated approximately $3.2
million at December 31, 2009, of which $3.0 million expires within one
year.  Should any letter of credit be drawn on, the interest rate
charged on the resulting note would fluctuate with the Corporation's base rate.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the
contract.  Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee.  Since many of
the commitments may expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements.  The
Corporation evaluates each customer's creditworthiness on a case-by-case
basis.  The amount of collateral obtained, if deemed necessary by the
Corporation upon extension of credit, is based on management's credit evaluation
of the counter-party.  Collateral held varies, but may include
accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.





Standby
and commercial letters of credit are conditional commitments issued by the
Corporation to guarantee payment or performance of a customer to a third
party.  Those guarantees are primarily issued to support public and
private borrowing arrangements, including commercial paper, bond financing and
similar transactions.  The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to
customers.  The Corporation obtains collateral supporting those
commitments for which collateral is deemed necessary.





Lease
Commitments





Rental
expense under long-term operating lease for branch offices amounted to
approximately $1,059,000 and $980,000 during the years ended December 31, 2009
and 2008, respectively.  At December 31, 2009, the minimum rental
commitments on the noncancellable leases with an initial term of one year and
expiring thereafter as follows:





Year
      Ending December 31
            
            Minimum
      Rent2010
            
            $
            935,0002011
            
            
            936,0002012
            
            
            919,0002013
            
            
            891,0002014
            
            
            640,000Thereafter
            
            
            2,645,000$
            6,966,000





Contingencies





The
Corporation is also subject to litigation which arises primarily in the ordinary
course of business.  In the opinion of management the ultimate
disposition of such litigation should not have a material adverse effect on the
financial position of the Corporation.


63
 Table of Contents


Note
16.  DIVIDEND LIMITATION





The
Corporation's ability to pay cash dividends is based on its ability to receive
cash from its bank subsidiary.  Banking regulations limit the amount
of dividends that may be paid without prior approval of regulatory
agencies.  Under these regulations, the amount of dividends that may
be paid in any calendar year is limited to the current year's profits, combined
with the retained net profits of the proceeding two years.  At
December 31, 2009 the Bank could have paid dividends totaling approximately $5.0
million.  At December 31, 2009, this restriction did not result in any
effective limitation in the manner in which the Corporation is currently
operating.  As noted in Note 10, until the earlier of the third
anniversary of the Treasury’s investment in the Senior Preferred Shares or when
all of the Senior Preferred Shares have been redeemed by the Corporation or
transferred by the Treasury to third parties, the Corporation may not, without
the consent of the Treasury, increase the common stock cash
dividend.





Note
17.  INTEREST RATE SWAP





The
Corporation utilizes interest rate swap agreements as part of its asset
liability management strategy to help manage its interest rate risk
position.  The notional amount of the interest rate swaps does not
represent amounts exchanged by the parties.  The amount exchanged is
determined by reference to the notional amount and the other terms of the
individual interest rate swap agreements.





Interest Rate Swap
Designated as Cash Flow Hedge:  During the second quarter of
2009, the Corporation entered into a swap with an effective date of March 17,
2010.  An interest rate swap with a notional amount of $7 million as
of December 31, 2009 was designated as a cash flow hedge of the Subordinated
Debentures and was determined to be fully effective during the year ended
December 31, 2009.  As such, no amount of ineffectiveness has been
included in net income.  Therefore, the aggregate fair value of the
swap is recorded in other assets (liabilities) with changes in fair value
recorded in other comprehensive income (loss).  The amount included in
accumulated other comprehensive income (loss) would be reclassified to current
earnings should the hedge no longer be considered effective.  The
Corporation expects the hedge to remain fully effective during the remaining
terms of the swap.  As of December 31, 2009, the interest rate swap is
secured by investment securities with a fair value of $493,000.





Summary
information about the interest-rate swap designated as a cash flow hedge as of
December 31, 2009 is as follows:





Notional
      amount
            $7,000,000Pay
      rate
            7.00%Receive
      rate
            3
      month LIBOR plus 2.95%Maturity
            March
      17, 2016Unrealized
      loss
            $258,000





The fair
value of the interest rate swap of $258,000 was included in Accrued expenses and
other liabilities on the Consolidated Statements of Financial
Condition.





The
      Effect of Derivative Instruments on the Consolidated Income
      Statementfor
      the year ended December 31, 2009Amount
      of Loss,net
      of taxes,Recognized
      in OCIon
      DerivativeCash Flow Hedging
    Relationship
            
            (Effective
      Portion)Cash
      flow hedge
            
            $
            155,000





Note
18.  FAIR VALUE OF FINANCIAL INSTRUMENTS





Fair
value is the exchange price that would be received for an asset or paid to
transfer a liability (exit price) in an orderly transaction between market
participants on the measurement date.  There are three levels of
inputs that may be used to measure fair value:


64
 Table of Contents


Level 1:
Quoted prices (unadjusted) or identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.





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





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





The fair
values of investment securities are determined by matrix pricing, which is a
mathematical technique widely used in the industry to value debt securities
without relying exclusively on quoted prices for the specific securities but
rather by relying on the securities’ relationship to other benchmark quoted
securities (Level 2 inputs).





The
interest rate swaps are reported at fair values obtained from brokers who
utilize internal models with observable market data inputs to estimate the
values of these instruments (Level 2 inputs).





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





Assets and Liabilities
Measured on a Recurring Basis





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





Fair Value Measurements
    UsingCarrying Value
            
            
            Quoted Prices in Active Markets for Identical
      Assets
              (Level 1)
            
            
            Significant Other Observable Inputs (Level
      2)
            
            
            Significant Unobservable
Inputs
              (Level 3)December 31, 2009Assets:Available
      for sale securitiesU.S.
      government -sponsored
      agencies
            
            $
            32,286,000
            
            
            $
            -
            
            
            $
            32,286,000
            
            
            $
            -Obligations
      of state and
            
            
            
            
            
            
            -political
      subdivisions
            
            
            5,397,000
            
            
            
            -
            
            
            
            5,397,000
            
            
            
            -Mortgage-backed
      securities-residential
            
            
            62,228,000
            
            
            
            -
            
            
            
            62,228,000
            
            
            
            -Other
      equity investments
            
            
            3,115,000
            
            
            
            -
            
            
            
            3,115,000
            
            
            
            -Total
      available forsale
      securities
            
            $
            103,026,000
            
            
            $
            -
            
            
            $
            103,026,000
            
            
            $
            -Liabilities:Interest
      rate swap
            
            $
            258,000
            
            
            $
            -
            
            
            $
            258,000
            
            
            $
            -





December 31, 2008Assets:Available
      for sale securitiesU.S.
      government -sponsored
      agencies
            
            $
            49,660,000
            
            
            $
            -
            
            
            $
            49,660,000
            
            
            $
            -Obligations
      of state andpolitical
      subdivisions
            
            
            5,820,000
            
            
            
            -
            
            
            
            5,820,000
            
            
            
            -Mortgage-backed
      securities-residential
            
            
            31,670,000
            
            
            
            -
            
            
            
            31,670,000
            
            
            
            -Other
      equity investments
            
            
            2,873,000
            
            
            
            -
            
            
            
            2,873,000
            
            
            
            -Total
      available forsale
      securities
            
            $
            90,023,000
            
            
            $
            -
            
            
            $
            90,023,000
            
            
            $
            -


65
 Table of Contents


Assets and Liabilities
Measured on a Non-Recurring Basis





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





Fair
      Value Measurements UsingCarrying
      Value
            
            
            Quoted
      Prices in Active Markets for Identical Assets
              (Level
      1)
            
            
            Significant
      Other Observable Inputs (Level 2)
            
            
            Significant
      Unobservable Inputs
              (Level
      3)December
      31, 2009Assets:Impaired
      loans
            
            $
            6,765,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            6,765,000December
      31, 2008Assets:Impaired
      loans
            
            $
            2,281,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            2,281,000





Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $8,668,000, with a
valuation allowance of $1,903,000, resulting in an additional provision for loan
losses of $1,422,000 for the year ended December 31, 2009.





Impaired
loans, had a carrying amount of $2,762,000, with a valuation allowance of
$481,000, resulting in an additional provision for loan losses of $442,000 for
the year ended December 31, 2008.





Fair
value estimates, methods and assumptions are set forth below, for items not
previously presented, for the Corporation’s financial instruments.





December 31,2009
            
            
            2008Carrying
            
            
            Estimated
            
            
            Carrying
            
            
            EstimatedAmount
            
            
            Fair Value
            
            
            Amount
            
            
            Fair ValueFinancial
      Assets:Cash
      and cash equivalents
            
            $
            8,871,000
            
            
            $
            8,871,000
            
            
            $
            12,814,000
            
            
            $
            12,814,000Securities
      available for sale
            
            
            103,026,000
            
            
            
            103,026,000
            
            
            
            90,023,000
            
            
            
            90,023,000Securities
      held to maturity
            
            
            67,717,000
            
            
            
            68,765,000
            
            
            
            48,856,000
            
            
            
            49,150,000FHLB-NY
      stock
            
            
            3,227,000
            
            
            
            N/A
            
            
            
            2,420,000
            
            
            
            N/ANet
      loans
            
            
            453,119,000
            
            
            
            453,813,000
            
            
            
            434,103,000
            
            
            
            436,193,000Accrued
      interest receivable
            
            
            3,167,000
            
            
            
            3,167,000
            
            
            
            3,371,000
            
            
            
            3,371,000Financial
      liabilities:Deposits
            
            
            529,930,000
            
            
            
            531,230,000
            
            
            
            506,531,000
            
            
            
            508,325,000FHLB-NY
      Advances
            
            
            54,600,000
            
            
            
            51,949,000
            
            
            
            36,900,000
            
            
            
            34,973,000Securities
      sold under agreements
              to
      repurchase
            
            
            15,396,000
            
            
            
            15,396,000
            
            
            
            15,160,000
            
            
            
            15,160,000Subordinated
      debenture
            
            
            7,217,000
            
            
            
            5,943,000
            
            
            
            7,217,000
            
            
            
            7,399,000Accrued
      interest payable
            
            
            1,193,000
            
            
            
            1,193,000
            
            
            
            1,582,000
            
            
            
            1,582,000





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





Cash
and cash equivalents


The
carrying amount approximates fair value.





Securities
available for sale and held to maturity


The
methods for determining the fair values for securities were described
previously.





FHLB-NY
stock


It is not
practicable to determine the fair value of FHLB-NY stock due to restrictions
placed on the transferability of the stock.


66
 Table of Contents


Net
loans


Fair
values are estimated for portfolios of loan with similar financial
characteristics.  Loans are segregated by type such as residential and
commercial mortgages, commercial and other installment.  The fair
value of loans is estimated by discounting cash flows using estimated market
discount rates which reflect the credit and interest rate risk inherent in the
loans.





Accrued
interest receivable


The
carrying amount approximates fair value.





Deposits


The fair
value of deposits, with no stated maturity, such as noninterest-bearing demand
deposits, savings, NOW and money market accounts, is equal to the amount payable
on demand.  The fair value of the certificates of deposit is based on
the discounted value of cash flows.  The discount rate is estimated
using market discount rates which reflect interest rate risk inherent in the
certificates of deposit.





Securities
sold under agreements to repurchase


The
carrying value approximates fair value due to the relatively short time before
maturity.





Other
borrowings


The
carrying amount of the borrowings which mature in one day approximates fair
value.  For the borrowings with a longer maturity, the fair value is
based on the discounted value of cash flows.  The discount rate is
estimated using market discount rates which reflect the interest rate risk
inherent in the term borrowings.





Subordinated
debenture


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





Accrued
interest payable


The
carrying amount approximates fair value.





Commitments
to extend credit


The fair
value of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present credit worthiness of the counter parties, and at December 31,
2009 and 2008 the fair value of such commitments were not material.





Limitations


The
preceding fair value estimates were made at December 31, 2009 and 2008, based on
pertinent market data and relevant information on the financial
instruments.  These estimates do not include any premium or discount
that could result from an offer to sell at one time the Corporation's entire
holdings of a particular financial instrument or category
thereof.  Since no market exists for a substantial portion of the
Corporation's financial instruments, fair value estimates were necessarily based
on judgments with respect to future expected loss experience, current economic
conditions, risk assessments of various financial instruments, and other
factors.  Given the subjective nature of these estimates, the
uncertainties surrounding them and the matters of significant judgment that must
be applied, these fair value estimates cannot be calculated with
precision.  Modifications in such assumptions could meaningfully alter
these estimates.





Since
these fair value approximations were made solely for on and off balance sheet
financial instruments at December 31, 2009 and 2008, no attempt was made to
estimate the value of anticipated future business.  Furthermore,
certain tax implications related to the realization of unrealized gains and
losses could have a substantial impact on these fair value estimates and have
not been incorporated into the estimates.


67
 Table of Contents


Note
19.  PARENT COMPANY ONLY





The
Corporation was formed in January, 1995, to operate its subsidiary, Atlantic
Stewardship Bank. The earnings of the Bank are recognized by the Corporation
using the equity method of accounting.  Accordingly, the Bank
dividends paid reduce the Corporation's investment in the subsidiary. Condensed
financial statements are presented below:





Condensed
Statements of Financial Condition





December 31,2009
            
            
            2008AssetsCash
      and due from banks
            
            $
            294,000
            
            
            $
            131,000Securities
      available for sale
            
            
            3,436,000
            
            
            
            2,582,000Securities
      held to maturity
            
            
            992,000
            
            
            
            1,992,000Investment
      in subsidiary
            
            
            55,689,000
            
            
            
            44,833,000Accrued
      interest receivable
            
            
            30,000
            
            
            
            45,000Other
      assets
            
            
            528,000
            
            
            
            466,000Total
      assets
            
            $
            60,969,000
            
            
            $
            50,049,000Liabilities
      and Stockholders’ EquitySubordinated
      debentures
            
            $
            7,217,000
            
            
            $
            7,217,000Other
      liabilities
            
            
            241,000
            
            
            
            36,000Stockholders'
      equity
            
            
            53,511,000
            
            
            
            42,796,000Total
      liabilities and Stockholders' equity
            
            $
            60,969,000
            
            
            $
            50,049,000





Condensed
Statements of Income





Years
      ended December 31,2009
            
            
            2008Interest
      income - securities available for sale
            
            $
            103,000
            
            
            $
            126,000Interest
      income - securities held to maturity
            
            
            104,000
            
            
            
            110,000Dividend
      income
            
            
            3,000,000
            
            
            
            2,100,000Other
      income
            
            
            24,000
            
            
            
            18,000Total
      income
            
            
            3,231,000
            
            
            
            2,354,000Interest
      expense
            
            
            285,000
            
            
            
            466,000Other
      expenses
            
            
            319,000
            
            
            
            216,000Total
      expenses
            
            
            604,000
            
            
            
            682,000Income
      before income tax benefit
            
            
            2,627,000
            
            
            
            1,672,000Tax
      benefit
            
            
            (125,000
            )
            
            
            (144,000
            )Income
      before equity in undistributed earnings of subsidiary
            
            
            2,752,000
            
            
            
            1,816,000Equity
      in undistributed earnings of subsidiary
            
            
            882,000
            
            
            
            1,685,000Net
      income
            
            
            3,634,000
            
            
            
            3,501,000Dividends
      on preferred stock and accretion
            
            
            504,000
            
            
            
            -Net
      income available to common stockholders
            
            $
            3,130,000
            
            
            $
            3,501,000


68
 Table of Contents


Condensed
Statements of Cash Flows




Years
      ended December 31,2009
              
              
              2008Cash
      flows from operating activities:Net
      income
              
              $
              3,634,000
              
              
              $
              3,501,000Adjustments
      to reconcile net income tonet
      cash provided by operating activities:Equity
      in undistributed earnings of subsidiary
              
              
              (882,000
              )
              
              
              (1,685,000
              )Amortization
      of premiums and accretion of discounts, net
              
              
              4,000
              
              
              
              (1,000
              )Gain
      on calls and sales of securities
              
              
              (13,000
              )
              
              
              -Decrease
      (increase) in accrued interest receivable
              
              
              15,000
              
              
              
              (2,000
              )Increase
      in other assets
              
              
              (33,000
              )
              
              
              (49,000
              )(Decrease)
      increase in other liabilities
              
              
              (13,000
              )
              
              
              3,000Net
      cash provided by operating activities
              
              
              2,712,000
              
              
              
              1,767,000Cash
      flows from investing activities:Purchase
      of securities available for sale
              
              
              (3,028,000
              )
              
              
              (998,000
              )Proceeds
      from principal repayments on securities available for sale
              
              
              98,000
              
              
              
              -Proceeds
      from calls on securities available for sale
              
              
              2,000,000
              
              
              
              1,000,000Proceeds
      from calls on securities held to maturity
              
              
              1,000,000
              
              
              
              -Investment
      in subsidiary bank
              
              
              (10,000,000
              )
              
              
              -Net
      cash (used in) provided by investing activities
              
              
              (9,930,000
              )
              
              
              2,000Cash
      flows from financing activities:Proceeds
      from issuance of preferred stock and warrants
              
              
              9,951,000
              
              
              
              -Cash
      dividends paid on common stock
              
              
              (2,112,000
              )
              
              
              (1,967,000
              )Cash
      dividends paid on preferred stock
              
              
              (396,000
              )
              
              
              -Payment
      of discount on dividend reinvestment plan
              
              
              (44,000
              )
              
              
              (45,000
              )Purchase
      of treasury stock
              
              
              (75,000
              )
              
              
              (370,000
              )Exercise
      of stock options
              
              
              12,000
              
              
              
              49,000Tax
      benefit of stock plans
              
              
              -
              
              
              
              2,000Issuance
      of common stock
              
              
              45,000
              
              
              
              41,000Net
      cash provided by (used in) financing activities
              
              
              7,381,000
              
              
              
              (2,290,000
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              163,000
              
              
              
              (521,000
              )Cash
      and cash equivalents - beginning
              
              
              131,000
              
              
              
              652,000Cash
      and cash equivalents - ending
              
              $
              294,000
              
              
              $
              131,000
  69
 Table of Contents




Note
20.  QUARTERLY FINANCIAL DATA (Unaudited)





The
following table contains quarterly financial data for the years ended December
31, 2009 and 2008 (Dollars in thousands).




First
      Quarter
            
            
            Second
      Quarter
            
            
            Third
      Quarter
            
            
            Fourth
      Quarter
            
            
            TotalYear
      ended December 31, 2009:Interest
      income
            
            $
            8,473
            
            
            $
            8,542
            
            
            $
            8,610
            
            
            $
            8,531
            
            
            $
            34,156Interest
      expense
            
            
            2,875
            
            
            
            2,722
            
            
            
            2,634
            
            
            
            2,580
            
            
            
            10,811Net
      interest income before provision for loan losses
            
            
            5,598
            
            
            
            5,820
            
            
            
            5,976
            
            
            
            5,951
            
            
            
            23,345Provision
      for loan losses
            
            
            150
            
            
            
            1,025
            
            
            
            1,200
            
            
            
            1,200
            
            
            
            3,575Net
      interest income after provision for loan losses
            
            
            5,448
            
            
            
            4,795
            
            
            
            4,776
            
            
            
            4,751
            
            
            
            19,770Noninterest
      income
            
            
            707
            
            
            
            949
            
            
            
            821
            
            
            
            656
            
            
            
            3,133Noninterest
      expenses (a)
            
            
            4,408
            
            
            
            4,684
            
            
            
            4,346
            
            
            
            4,352
            
            
            
            17,790Income
      before income tax expense
            
            
            1,747
            
            
            
            1,060
            
            
            
            1,251
            
            
            
            1,055
            
            
            
            5,113Income
      tax expense
            
            
            560
            
            
            
            280
            
            
            
            358
            
            
            
            281
            
            
            
            1,479Net
      income
            
            
            1,187
            
            
            
            780
            
            
            
            893
            
            
            
            774
            
            
            
            3,634Dividends
      on preferred stock and accretion
            
            
            92
            
            
            
            137
            
            
            
            138
            
            
            
            137
            
            
            
            504Net
      income available to common stockholders
            
            $
            1,095
            
            
            $
            643
            
            
            $
            755
            
            
            $
            637
            
            
            $
            3,130Basic
      earnings per share
            
            $
            0.19
            
            
            $
            0.11
            
            
            $
            0.13
            
            
            $
            0.11
            
            
            $
            0.54Diluted
      earnings per share
            
            $
            0.19
            
            
            $
            0.11
            
            
            $
            0.13
            
            
            $
            0.11
            
            
            $
            0.54First
            
            
            Second
            
            
            Third
            
            
            FourthQuarter
            
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            TotalYear
      ended December 31, 2008:Interest
      income
            
            $
            8,657
            
            
            $
            8,710
            
            
            $
            8,910
            
            
            $
            8,797
            
            
            $
            35,074Interest
      expense
            
            
            3,495
            
            
            
            3,154
            
            
            
            3,100
            
            
            
            3,022
            
            
            
            12,771Net
      interest income before provision for loan losses
            
            
            5,162
            
            
            
            5,556
            
            
            
            5,810
            
            
            
            5,775
            
            
            
            22,303Provision
      for loan losses (b)
            
            
            100
            
            
            
            260
            
            
            
            1,175
            
            
            
            2,050
            
            
            
            3,585Net
      interest income after provision for loan losses
            
            
            5,062
            
            
            
            5,296
            
            
            
            4,635
            
            
            
            3,725
            
            
            
            18,718Noninterest
      income (c)
            
            
            976
            
            
            
            1,017
            
            
            
            894
            
            
            
            1,330
            
            
            
            4,217Noninterest
      expenses
            
            
            4,479
            
            
            
            4,562
            
            
            
            4,362
            
            
            
            4,583
            
            
            
            17,986Income
      before income tax expense
            
            
            1,559
            
            
            
            1,751
            
            
            
            1,167
            
            
            
            472
            
            
            
            4,949Income
      tax expense
            
            
            498
            
            
            
            572
            
            
            
            329
            
            
            
            49
            
            
            
            1,448Net
      income
            
            $
            1,061
            
            
            $
            1,179
            
            
            $
            838
            
            
            $
            423
            
            
            $
            3,501Basic
      earnings per share
            
            $
            0.18
            
            
            $
            0.20
            
            
            $
            0.14
            
            
            $
            0.08
            
            
            $
            0.60Diluted
      earnings per share
            
            $
            0.18
            
            
            $
            0.20
            
            
            $
            0.14
            
            
            $
            0.08
            
            
            $
            0.60





(a)  Second
Quarter of 2009 includes the recording of an industry-wide FDIC special
assessment which amounted to $300,000 for the Corporation.


(b)  Third
Quarter and Fourth Quarter of 2008 includes increased provision for loan losses
primarily related to a group of loans to one borrower.


(c)  Fourth
Quarter of 2008 amount includes a gain on sale of the merchant
portfolio.


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Item9.  Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure





None.





Item9A .  Controls and Procedures





(a)           Evaluation
of internal controls and procedures





Based on
their evaluation as of the end of the period covered by this Annual Report on
Form 10-K, our principal executive officer and principal financial officer have
concluded that our internal controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange
Act”)) are effective to ensure that information required to be disclosed by us
in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission’s rules and forms.




b)           Management's
Report on Internal Control over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) of the Exchange
Act. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements and can only provide
reasonable assurance with respect to financial statement preparation. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.





We
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009.  In making this assessment, we used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) inInternal
Control—Integrated Framework. Based on our assessment using those criteria, our
management (including our Chief Executive Officer and Principal Accounting
Officer) concluded that our internal control over financial reporting was
effective as of December 31, 2009.





This
Annual Report on Form 10-K does not include an attestation report of the
Corporation’s independent registered public accounting firm regarding internal
control over financial reporting.  Management’s report was not subject to
attestation by the Corporation’s independent registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Corporation to provide only management’s report in this Annual Report
on Form 10-K.





(c)           Changes
in internal controls





There
were no significant changes in our internal control over financial reporting or
in other factors that could significantly affect these controls subsequent to
the date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses during the quarter ended
December 31, 2009 that have materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





Item9B.  Other Information





None.





PartIII





Item
10.  Directors, Executive Officers and Corporate
Governance





Information
concerning directors and executive officers contained under the captions
“Election of Directors: and “Compliance with Section 16(a) Beneficial Ownership
Reporting,” in the Proxy Statement for the Corporation’s 2010 Annual Meeting of
Shareholders is incorporated herein by reference.





Code
of Ethics





The
Corporation has adopted a Code of Ethical Conduct for Senior Financial Managers
that applies to its principal executive officer, principal financial officer,
principal accounting officer, controller and any other person performing similar
functions.  The Corporation’s Code of Ethical Conduct for Senior
Financial Managers is posted on its website, www.asbnow.com.  The
Corporation intends to satisfy the disclosure requirement under Item 5.05 of
Form 8-K


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 Table of Contents


regarding
an amendment to, or waiver from, a provision of its Code of Ethical Conduct for
Senior Financial Managers by filing an 8-K and by posting such information on
its website.





Audit
Committee and Audit Committee Financial Expert





The
members of our audit committee as of December 31, 2009 were Howard Yeaton
(Chairman), Harold Dyer, John L. Steen and Michael Westra.  The Audit
Committee determined that Howard Yeaton and Michael Westra were “audit committee
financial experts” as defined by the Securities and Exchange
Commission.  All members of our audit committee are “independent” as
defined under Rule 6320A of FINRA’s listing standards.





Item11.  Executive Compensation





Information
concerning executive compensation under the caption “Executive Compensation” in
the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders is
incorporated herein by reference.





Item12.  Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters





The
following table provides information with respect to the equity securities that
are authorized for issuance under our compensation plans as of December 31,
2009:





Equity
      Compensation Plan InformationNumber
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
            
            
            Weighted-average
      exercise price of outstanding options, warrants and rights
            
            
            Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))(a)
            
            
            (b)
            
            
            (c)Equity
      compensation plans approved by
              security
      holders
            
            
            83,048
            
            
            $
            10.46
            
            
            
            269,530Equity
      compensation plans not approved by
              security
      holders
            
            
            -
            
            
            
            -
            
            
            
            553,026Total
            
            
            83,048
            
            
            $
            10.46
            
            
            
            822,556





The only
equity compensation plan not approved by security holders is the Directors Stock
Plan.  The Director Stock Plan permits members of the Board of
Directors to receive any monthly Board of Directors’ fees in shares of the
Corporation’s common stock, rather than in cash.  The Corporation
purchased 3,720 shares in the open market during 2009 for the benefit of the
Director Stock Plan.





Information
concerning security ownership of certain beneficial owners and management under
the caption “Stock Ownership of Management and Principal Shareholders” in the
Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders is
incorporated herein by reference.


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 Table of Contents


Item13.  Certain Relationships and Related Transactions,
and Director Independence





Information
concerning certain relationships and related transactions under the captions
“Election of Directors” and “Certain Relationships and Related Transactions,” in
the Proxy Statement for the Corporation’s 2010 Annual Meeting of Shareholders is
incorporated herein by reference.





Item14.  Principal Accountant Fees and
Services





Information
concerning principal accountant fees and services under the caption “Fees Billed
by Accountants During Fiscal 2009 and Fiscal 2008,” in the Proxy Statement for
the Corporation’s 2010 Annual Meeting of Shareholders is incorporated herein by
reference.





PartIV





Item
15.  Exhibits and Financial Statement Schedules





(a)  Exhibits





ExhibitNumber
            Description of Exhibits3(i)
            Restated
      Certificate of Incorporation of Stewardship Financial Corporation
      (1)3(ii).1
            By-Laws of Stewardship Financial Corporation
      (2)3(ii).2
            Amendment to By-Laws of Stewardship Financial
      Corporation (3)4(i)
            Form
      of Certificate for the Series A Preferred Shares (4)4(ii)
            Warrant
      to Purchase up to 127,119 Shares of Common Stock (5)10(i)
            1995
      Incentive Stock Option Plan (6)10(ii)
            1995
      Employee Stock Purchase Plan (7)10
      (iii)
            Stewardship
      Financial Corporation Dividend Reinvestment Plan (8)10
      (iv)
            Stewardship
      Financial Corporation Director Stock Plan (9)[10(v)
            Amended
      and Restated 1995 Stock Option Plan (9)10(vi)
            Amended
      and Restated Director Stock Plan (10)10(vii)
            Dividend
      Reinvestment Plan (11)10(viii)
            2001
      Stock Option Plan For Non-Employee Directors (12)10(ix)
            Dividend
      Reinvestment Plan (13)10(x)
            2006
      Stock Option Plan for Non-Employee Directors (14)10(xi)
            Letter
      Agreement, dated January 30, 2009, including Securities Purchase Agreement
      – Standard Terms incorporated by reference therein, between Stewardship
      Financial Corporation and the Treasury (15)10(xii)
            Form
      of Waiver, executed by each of Paul Van Ostenbridge, Claire M. Chadwick,
      Julie E. Holland and Robert C. Vliet (16)13
            Annual
      Report to Shareholders for the year ended December 31,
  200921
            Subsidiaries
      of the Registrant23 Consent of Crowe Horwath LLP31.1
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Section
      906 of the Sarbanes-Oxley Act of 2002.99.1
            Certification of Chief Executive Officer pursuant
      to the Emergency EconomicStability Act of 200899.2
            Certification of Chief Financial Officer pursuant
      to the Emergency EconomicStability Act of
  2008





-----------------------------------------------------------------


(1)
            Incorporated
      by reference from Exhibit 3(i).1 to the Corporation’s Quarterly Report on
      Form 10-Q, filed May 15, 2009.




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 Table of Contents


(2)
            Incorporated by reference from Exhibit 3(ii) to the Corporation’s
      Registration Statement on Form 8-B, Registration No. 0-21855, filed on
      December 10, 1996.




(3)
            Incorporate by reference from Exhibit 3.1 to the Corporation’s
      Current Report on Form 8-K, filed on December 27,
2007.




(4)
            Incorporated by reference from Exhibit 4.1 to the Corporation’s
      Current Report on Form 8-K, filed February 4,
2009.




(5)
            Incorporated
      by reference from Exhibit 4.2 to the Corporation’s Current Report on Form
      8-K, filed February 4, 2009.




(6)
            Incorporated
      by reference from Exhibit 5(B)(10)(a) to the Corporation’s Registration
      Statement on Form 8-B, Registration No. 0-21855, filed December 10,
      1996.




(7)
            Incorporated
      by reference from Exhibits 4(c) to 23(d) from the Corporation’s
      Registration Statement on Form S-8, Registration No. 333-20793, filed
      January 31, 1997.




(8)
            Incorporated
      by reference from Exhibit 4(a) from the Corporation’s Registration
      Statement on Form S-3, Registration No. 333-20699, filed January 30,
      1997.




(9)
            Incorporated
      by reference from Exhibit 4(a) from the Corporation’s Registration
      Statement on Form S-8, Registration No. 333-31245,filed July 11,
      1997.




(10)
            Incorporated
      by reference from Exhibits 10(vii) and 10(viii) from the Corporation’s
      Annual Report on Form 10-KSB, filed March 31,
  1999.




(11)
            Incorporated
      by reference from Exhibit 4(a) from the Corporation’s Registration
      Statement on Form S-3, Registration No. 333-54738, filed January 31,
      2001.




(12)
            Incorporated by reference from Exhibit 4(b) from the Corporation’s
      Registration Statement on Form S-8, Registration No. 333-87842, filed May
      8, 2002.




(13)
            Incorporated by reference from Exhibit 4(a) from the Corporation’s
      Registration Statement on Form S-3, Registration No. 333-133632, filed
      April 28, 2006.




(14)
            Incorporated
      by reference from Exhibit 5(a) from the Corporation’s Registration
      Statement on Form S-8, Registration No. 333-135462, filed June 29,
      2006.




(15)
            Incorporated
      by reference from Exhibit 10.1 to the Corporation’s Current Report on Form
      8-K, filed February 4, 2009.




(16)
            Incorporated
      by reference from Exhibit 10.2 to the Corporation’s Current Report on Form
      8-K, filed February 4, 2009.




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 Table of Contents


SIGNATURES





Pursuant to the requirements of Section
13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.








STEWARDSHIP
      FINANCIAL CORPORATIONBy
      :
            /s/  Paul Van
      OstenbridgePaul
      Van OstenbridgeChief
      Executive Officer and Director


Dated:  March
26, 2009





Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.








Name
            
            Title
            
            Date/s/  Paul Van
      Ostenbridge
            
            Chief
      Executive Officer
            
            March
      26, 2010Paul
      Van Ostenbridge
            
            and
      Director(Principal
      Executive Officer)/s/  Claire M.
      Chadwick
            
            Chief
      Financial Officer
            
            March
      26, 2010Claire
      M. Chadwick
            
            (Principal
      Financial Officer andPrincipal
      Accounting Officer)/s/ Richard W. Culp
            
            Director
            
            March
      26, 2010Richard
      W. Culp/s/  Harold Dyer
            
            Director
            
            March
      26, 2010Harold
      Dyer/s/  William
Hanse
            
            Chairman
      of the Board
            
            March
      26, 2010William
      Hanse/s/  Margo Lane
            
            Director
            
            March
      26, 2010Margo
      Lane/s/  Arie
    Leegwater
            
            Director
            
            March
      26, 2010Arie
      Leegwater/s/  John L.
Steen
            
            Director
            
            March
      26, 2010John
      L. Steen/s/  Robert
Turner
            
            Secretary
      and Director
            
            March
      26, 2010Robert
      Turner/s/  William J.
      VanderEems
            
            Director
            
            March
      26, 2010William
      J. VanderEems/s/  Abe Van
      Wingerden
            
            Director
            
            March
      26, 2010Abe
      Van Wingerden/s/  Michael
    Westra
            
            Vice
      Chairman of the Board
            
            March
      26, 2010Michael
      Westra/s/  Howard
Yeaton
            
            Director
            
            March
      26, 2010Howard
      Yeaton






75