STBK Sterling Banks (MM)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

____________

FORM 10-K

(Mark One)

 

[X]  Annual report pursuant to section 13 or 15 (d) of the Securities Exchange Act of 1934

For the fiscal year ended   December 31, 2008           

-OR-

[  ]   Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ___________ to _____________.

Commission File No. 333-133649

STERLING  BANKS, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant's telephone number, including area code:   (856) 273-5900

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES __  NO _ X _

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.  YES __  NO _ X _

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

Indicate by check mark if disclosure of delinquent filers in response 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. [ ]

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

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

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES __  NO   X  

The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the sale price of the registrant's Common Stock as of June 30 , 2008 , was $21,789,880 ($4.30 per share times 5,067,414 shares of Common Stock held by non-affiliates).

As of March 13, 2009, there were 5,843,362 outstanding shares of the registrant's Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

1.	Portions of the registrant’s Definitive Proxy Statement to Shareholders for the 2009 Annual Meeting of Shareholders are incorporated by reference to Part III of this Annual Report.

PART I

Forward-Looking Statements

Sterling Banks, Inc. (the “Company”) may from time to time make written or oral "forward-looking statements," including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions, which are subject to change based on various important factors (some of which are beyond the Company’s control).  The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; the effect that maintaining regulatory capital requirements could have on the growth of the Company; inflation; changes in prevailing short term and long term interest rates; national and global liquidity of the banking system; changes in loan portfolio quality; adequacy of loan loss reserves; changes in the rate of deposit withdrawals; changes in the volume of loan refinancings; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance), including the recently announced increase in the cost of FDIC insurance; technological changes; changes in consumer spending and saving habits; changes in the local competitive landscape, including the acquisition of local and regional banks in the Company’s geographic marketplace; possible impairment of intangible assets, specifically core deposit premium from the Company’s acquisition of Farnsworth;  the ability of our borrowers to repay their loans; the uncertain credit environment in which the Company operates;  the ability of the Company to manage the risk in its loan and investment portfolios; the ability of the Company to reduce noninterest expenses and increase net interest income, its growth, results of possible collateral collections and subsequent sales; and the success of the Company at managing the risks resulting from these factors.

The Company cautions that the above-listed factors are not exclusive.  The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

 

Item 1.  Description of Business.

General

The Company is a bank holding company headquartered in Burlington County, New Jersey, with assets of $379.1 million as of December 31, 2008.  Our main office is located in Mount Laurel, New Jersey with nine other Community Banking Centers located in Burlington and Camden Counties, New Jersey.  We believe that this geographic area represents an attractive banking market with a diversified economy.  We began operations in December 1990 with the purpose of serving consumers and small to medium-sized businesses in our market area.  We have chosen to focus on the higher growth areas of western Burlington County and eastern Camden County.  We believe that understanding the character and nature of the local communities that we serve, and having first-hand knowledge of customers and their needs for financial services enable us to compete effectively and efficiently.  All references to “we,” “us,” “our,” and “ours” and similar terms in this report refers to the Company and its subsidiaries, collectively, except where the context otherwise requires.

Our growth and the strength of our asset quality result from our implementation of a carefully developed strategic planning process that provides the basis for our activities and direction.  We are guided by a series of important principles that provides the focus from which we continue to effectively and systematically manage our operations.  These principles include: attracting core deposits; developing a cohesive branch network; maintaining a community focus; emphasizing local loan generation; providing attentive and highly-personalized service; vigorously controlling and monitoring asset quality; and attracting and empowering highly-experienced personnel.

The Company is the successor registrant to Sterling Bank (the “Bank”) pursuant to the Plan of Reorganization by and between the Company and the Bank that was completed on March 16, 2007, whereby the Bank became a wholly-owned subsidiary of the Company.  Additionally, on March 16, 2007, the Bank, the Company and Farnsworth Bancorp, Inc. (“Farnsworth”) completed the merger (the “Merger”) in which Farnsworth merged with and into the Company, with the Company as the surviving corporation.  Subsequent to the Merger, Peoples Savings Bank, a wholly-owned subsidiary of Farnsworth, was merged with and into the Bank, with the Bank as the surviving Bank.  As a result of the merger of Peoples Savings Bank, the Bank acquired four new branches, one of which was subsequently closed.

Development of the Branch Network.   We have achieved our growth by expanding our branch presence into markets we have identified as growth opportunities.  We began a period of facility expansion in September 1996 with the opening of our second branch in Cherry Hill, New Jersey.  This was followed by the opening of new branches in Southampton Township-Vincentown (December 1998), Maple Shade (May 1999), Medford (May 2000), Voorhees (November 2005), and Delran (June 2007).  In addition, as a result of the Merger, we have acquired three branches in Bordentown, Florence and Evesham Township-Marlton (March 2007).  Each of these full-service Community Banking Centers is carefully positioned to deliver competitively priced and personalized products and services with customer convenient banking hours during both traditional and non-traditional hours of availability.  We continue to evaluate possible sites for the establishment of new branches, but we have no definitive plans to open any branches in the near future.

Maintaining a Community Focus.   We offer a wide array of banking products and services specifically designed for the consumer and the small to medium-sized business, informed and friendly professional staff, customer convenient operating hours, consistently-applied credit policies, and local and timely decision making.

 

Our market area has a concentration of national and regional financial institutions that have increasingly focused on large corporate customers and standardized loan and deposit products.  We believe that many customers of these financial institutions are dissatisfied.  As a result, we believe that there exists a significant opportunity to attract and retain those customers dissatisfied with their current banking relationship.

Emphasizing Core Deposit Generation.   We seek to attract core deposits as the starting point of a relationship development process.  We generally do not pay above-market rates on deposits.  We endeavor to attract loyal depositors by offering fairly priced financial services, convenient banking hours and a relationship-focused approach.  We believe that our growth is driven by our ability to generate stable core deposits that in turn are used to fund local, quality loans.  Our approach contrasts with that of some banks, where a priority on loan generation drives a need to obtain sources of funds.  Our approach and philosophy allows management to have more control in managing both our net interest margin and the quality of our loan portfolio.

Emphasizing Local Loan Generation.   Our management team’s depth of experience in commercial lending has been an important factor in our efforts to increase our lending to consumers and small to medium-sized businesses in the southern New Jersey region.  The Company generates substantially all of its loans in its immediate market area.  Our knowledge of our market has enabled us to identify niche markets that are similar to those in which we currently operate.  For example, we have formed two specific groups: the Specialized Lending and the Private Banking Group.  The Specialized Lending Group focuses on construction loans.  Our Private Banking Group targets wealthy individuals and families in our markets and offers flexible, responsive service.

Providing Attentive and Personalized Service.   We believe that a very attractive niche exists serving consumers and small to medium-sized businesses that, in our management’s view, are not adequately served by larger competitors.  We believe that this segment of the market responds very positively to the attentive and highly personalized service that we provide.

Vigorous Control of Asset Quality.   Historically, we have maintained high overall credit quality through the establishment and observance of prudent lending policies and practices.  The current economic environment, particularly the significant softening in the real estate market and associated declines in real estate values, has resulted in a deterioration of asset quality in some of our real estate backed loans.  As a result, the Company has developed and implemented an enhanced process to identify deteriorating credit situations.  The Board of Directors and management continue to be actively involved in maintaining efforts to work with borrowers whenever possible to remediate troubled loans. 

Experienced Personnel.   The members of our executive management have an average of 33 years of banking experience in providing quality service to consumers and businesses in the southern New Jersey region.

In addition, all of our executive officers have experience with larger institutions and have chosen to affiliate with a community-oriented organization serving consumers and small to medium-sized businesses.  Our ability to meet market service expectations with skilled locally based and experienced staff has significantly enhanced the market acceptance of our service-centered approach.

 

Lending Activities

Loan Portfolio

General. We engage in a variety of lending activities, which are primarily categorized as commercial and consumer lending.  Commercial lending (consisting of commercial real estate, commercial business, construction and other commercial lending) is currently our main lending focus.  Sources to fund loans are derived primarily from deposits.

We generate substantially all of our loans in the State of New Jersey, with a significant portion in Burlington and Camden Counties.  At December 31, 2008, our loan portfolio totaled approximately $305.6 million.

At December 31, 2008, our lending limit to one borrower under applicable regulations was approximately $6.1 million, or approximately 15% of capital funds.

Loans are generated through marketing efforts, our present customers, walk-in customers and referrals.  We have established and observed prudent lending policies and practices in an effort to achieve sound credit quality.  We have established a written loan policy for each category of loans.  These loan policies have been adopted by the Board of Directors and are reviewed annually.  All loans to directors (and their affiliates) must be approved by the Board of Directors in accordance with federal law.

In managing the growth of our loan portfolio, we have focused on: (i) the application of prudent underwriting criteria; (ii) active involvement by senior management and the Board of Directors in the loan approval process; (iii) monitoring of loans to ensure that repayments are made in a timely manner and to identify potential problem loans; and (iv) the review of selected aspects of our loan portfolio by independent consultants.

Analysis of Loan Portfolio.   Set forth below is selected data relating to the composition of the Company's loan portfolio by type of loan at the dates indicated.  The table does not include loan fees.

Loan Maturity. The following table sets forth the contractual maturity of the Company's loan portfolio at December 31, 2008.

The following table sets forth the dollar amount of all loans due after December 31, 2009, which have predetermined interest rates and which have floating or adjustable interest rates.

Commercial Loans

Our commercial loan portfolio consists primarily of commercial business loans and leases to small and medium-sized businesses and individuals for business purposes and commercial real estate and construction loans.  Commercial loans and leases that exceed established lending limits are accomplished through participations with other local commercial banks.

We have established written underwriting guidelines for commercial loans and leases.  In granting commercial loans and leases, we look primarily to the borrowers’ cash flow as the principal source of loan repayment.  Collateral and personal guarantees may be secondary sources of repayment.  A credit report and/or Dun & Bradstreet report is typically obtained on all prospective borrowers, and a real estate appraisal is required on all commercial real estate loans.  Generally, the maximum loan-to-value ratio on commercial real estate loans at origination is 75%.  All appraisals are performed by a state licensed or certified, independent appraiser.  We typically require the personal guarantees of the principals of the entities to whom we lend.

Commercial loans are often larger and may involve greater risks than other types of lending.  Because payments on   such loans are often dependent on the successful operation of the property or business involved, repayment of such loans may be more sensitive than other types of loans to adverse conditions in the real estate market or the economy.  Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself and the general economic environment.  If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired.

Construction   loans involve additional risks because loan funds are advanced based on   the security of the project under construction.  The majority of these loans are to fund single family residential construction projects which have permanent financing provided by other financial institutions.  We seek to minimize these risks through underwriting guidelines.  There can be no assurances, however, that we will be successful in our efforts to minimize these risks.

 

Commercial Business Loans and Leases.   Commercial business loans and leases are usually made to finance the purchase of inventory, new or used equipment, or to provide short-term working capital.  Generally, these loans and leases are secured, but some loans are sometimes granted on an unsecured basis.  To further enhance our security position, we generally require personal guarantees of principal owners.  These loans and leases are made either on a line of credit basis or on a fixed-term basis ranging from one to five years in duration.

Construction Loans.   Construction loans are made on a short-term basis for both residential and non-residential properties and are secured by land and improvements.  Construction loans are usually for a term of 9 to 21 months.  The Company has a general policy of not providing interest reserves for construction loans advanced.  However, each loan structure includes a 5% contingency/holdback reserve created to provide for successful project completion, and/or unanticipated project developments.  Interest reserves are a means through which a lender builds in, as a part of the loan approval, the amount of the monthly interest for a specified period of time.  While the capitalization of interest on loans is not part of the Company’s standard underwriting practice, we have, on some occasions, allowed interest to be capitalized as a part of the contingency/holdback reserve allocation associated with the project.  As of December 31, 2008, the Company had no loans outstanding for which the 5% contingency/holdback reserve has been drawn upon.  This portfolio includes what we commonly refer to as “spot lot” construction loans.  These loans represent approximately 79% of the real estate – construction loan portfolio as of December 31, 2008.

Commercial Real Estate Loans.   Commercial real estate loans are made for the acquisition of new property or the refinancing of existing property.  These loans are typically related to commercial business loans and secured by the underlying real estate used in these businesses or real property of the principal.  These loans are offered on a fixed or variable rate basis with 3 to 5 year maturity and a 15 to 20 year amortization schedule.

Residential Mortgage Loans

Our residential mortgage loan portfolio consists of home equity lines of credit and loans, and primary and first lien residential mortgages.  We generate substantially all of our residential mortgage loans in our market area and maintain strict underwriting guidelines throughout the residential mortgage portfolio.

Consumer Installment Loans

We offer a full range of consumer installment loans.  Consumer installment loans consist of automobile loans, boat loans, mobile home loans, personal loans, and overdraft protection.

Investment Portfolio

Our investment portfolio consists primarily of U.S. Government securities, mortgage-backed securities, and municipal securities.  Government regulations limit the type and quality of instruments in which we may invest our funds.

We have established a written investment policy, which is reviewed annually.  The investment policy identifies investment criteria and states specific objectives in terms of risk, interest rate sensitivity and liquidity.  We emphasize the quality, term and marketability of the securities acquired for our investment portfolio.

We conduct our asset liability management through consultation with members of the Board of Directors, senior management and outside financial advisors.  We have an Investment Committee, which is composed of certain members of the Board of Directors.  The Investment Committee can propose changes to the investment policy to be approved by the Board of Directors, which changes may be adopted without a vote of shareholders. This Investment Committee, in consultation with the Asset/Liability Management Committee, is responsible for the review of interest rate risk and evaluates future liquidity needs over various time periods.  In this capacity, the Investment Committee is responsible for monitoring our investment portfolio and ensuring that investments comply with our investment policy.

The Investment Committee may from time to time consult with investment advisors.  Our President and another senior executive officer may purchase or sell securities for the Company’s portfolio in accordance with the guidelines of the Investment Committee.  The Board of Directors reviews our investment portfolio on a quarterly basis.

Sources of Funds

Deposits and Other Sources of Funds.   Deposits are the primary source of funds used by us in lending and other general business purposes.  In addition to deposits, we can derive additional funds from principal repayments on loans, the sale of loans and investment securities, and borrowings from other financial institutions or the Federal Home Loan Bank of New York (“FHLB”), which functions as a credit facility for member institutions within its assigned region.  Loan amortization payments have historically been a relatively predictable source of funds.  The level of deposit liabilities can vary significantly and is influenced by prevailing interest rates, money market conditions, general economic conditions and competition.

Our deposits consist of checking accounts, regular savings accounts, money market accounts and certificates of deposit.  We also offer Individual Retirement Accounts (“IRAs”).  Deposits are obtained from individuals, partnerships, corporations and unincorporated businesses in our market area.  We attempt to control the flow of deposits primarily by pricing our accounts to remain generally competitive with other financial institutions in our market area, although we do not necessarily seek to match the highest rates paid by competing institutions.

Borrowings.   Deposits are the primary source of funds for the Company's lending and investment activities as well as for general business purposes; however, should the need arise, the Company may access the Federal Reserve Bank discount window to supplement its supply of lendable funds and to meet deposit withdrawal requirements.  The Company maintains the ability to borrow funds on an overnight basis under secured and unsecured lines of credit with correspondent banks.  In addition, the Company had advances totaling $16.0 million from the FHLB as of December 31, 2008, with $1.7 million maturing within 1 year, with a fixed rate range of 3.16% to 4.05%, $2.3 million maturing within two years, with a fixed rate of 3.43%, $2.3 million maturing within three years, with a fixed rate of 3.85%, $2.2 million maturing within four years, with a fixed rate of 4.11%, and $7.5 million maturing within five years, with a fixed rate of 4.25%, none of which can be prepaid without penalty.

 

On May 1, 2007, Sterling Banks Capital Trust I, a Delaware statutory business trust and a wholly-owned subsidiary of the Company (the “Trust”), issued $6.2 million of variable rate capital trust pass-through securities (“capital securities”) to investors.  The variable interest rate re-prices quarterly after five years at the three month LIBOR plus 1.70% and was 6.744% as of December 31, 2008.  The Trust purchased $6.2 million of variable rate junior subordinated deferrable interest debentures from the Company.  The debentures are the sole asset of the Trust.  The terms of the junior subordinated debentures are the same as the terms of the capital securities.  The Company has also fully and unconditionally guaranteed the obligations of the Trust under the capital securities.  The capital securities are redeemable by the Company on or after May 1, 2012 at par, or earlier if the deduction of related interest for federal income taxes is prohibited, classification as Tier I Capital is no longer allowed, or certain other contingencies arise.  The capital securities must be redeemed upon final maturity of the subordinated debentures on May 1, 2037.  Proceeds of approximately $4.5 million were contributed in 2007 to paid-in capital of the Bank.  The remaining $1.5 million was retained at the Company for future use.  If the Company determines that there is a need to preserve capital or improve liquidity, the ability exists to defer interest payments for a maximum of five years.

The following table sets forth information regarding the Company’s borrowed funds:

Competition

We experience substantial competition in attracting and retaining deposits and in making loans.  In attracting depositors and borrowers, we compete with commercial banks, savings banks, and savings and loan associations, as well as regional and national insurance companies, regulated small loan companies, local credit unions, regional and national issuers of money market funds and corporate and government borrowers.  The principal market presently served by us has approximately 80 offices of other financial institutions.  In New Jersey generally, and in our Burlington and Camden County market specifically, large commercial banks, as well as savings banks and savings and loan associations, hold a dominant market share.  By virtue of their larger capital and asset size, many such institutions have substantially greater lending limits and other resources than we have and, in certain cases, lower funding costs (the price a bank must pay for deposits and other borrowed monies used to make loans to customers).  In addition, many such institutions are empowered to offer a wider range of services, including international banking and trust services.

In addition to having established deposit bases and loan portfolios, these institutions, particularly the large regional commercial and savings banks, have the ability to finance extensive advertising campaigns and to allocate considerable resources to locations and products perceived as profitable.

Although we face competition for deposits from other financial institutions, management believes that we have been able to compete effectively for deposits because of our image as a community-oriented bank, providing a high level of personal service as well as an attractive array of deposit programs.  We have emphasized personalized banking services and the advantage of local decision-making in our banking business, and management believes that this emphasis has been well received by consumers and businesses in our market area.

 

Although we face competition for loans from mortgage banking companies, savings banks, savings and loan associations, other commercial banks, insurance companies, consumer loan companies, credit unions, and other institutional and private lenders, management believes that our image in the community as a local bank that provides a high level of personal service and direct access to senior management gives us a competitive advantage.  Factors that affect competition include the general availability of lendable funds and credit, general and local economic conditions, current interest rate levels and the quality of service.

Regulation

General .   Sterling Banks, Inc. is a bank holding company incorporated under the laws of the State of New Jersey on February 28, 2006 for the sole purpose of becoming the holding company of Sterling Bank.  At the 2006 Annual Meeting of Shareholders held on December 12, 2006, shareholders of the Bank approved a proposal to reorganize the Bank into the holding company form of organization in accordance with a Plan of Acquisition.  The Company recognized the assets and liabilities transferred at the carrying amounts in the accounts of the Bank as of March 16, 2007, the effective date of the reorganization.

Sterling Bank is a commercial bank, which commenced opera­tions on December 7, 1990.  The Bank is chartered by the New Jersey Department of Banking and Insurance and is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation.  The Bank maintains its principal office at 3100 Route 38 in Mount Laurel, New Jersey and has ten other full service branches.  The Bank’s primary deposit products are checking, savings and term certificate accounts, and its primary loan products are consumer, residential mortgage and commercial loans.

Insurance of Deposits .  Our deposits are normally insured up to a maximum of $100,000 per depositor under the Bank Insurance Fund of the FDIC.  Pursuant to the Emergency Economic Stabilization Act of 2008, the maximum deposit insurance amount per depositor has been increased from $100,000 to $250,000 until December 31, 2009.  The FDIC has established a risk-based assessment system for all insured depository institutions.  Under the risk-based assessment system in 2008, deposit insurance premium rates range from zero to 27 basis points, with our deposit insurance premium having been assessed at ten basis points of deposits.  On February 27, 2009, the FDIC adopted a final rule with respect to the risk-based assessment system, which will take effect on April 1, 2009.  Under the final rule, deposit insurance premium rates will range from seven to 77.5 basis points of deposits. Additionally, the FDIC recently adopted an interim rule that imposes a 20 basis point emergency special assessment on all insured depository institutions on June 30, 2009.  The special assessment will be collected September 30, 2009, at the same time that the risk-based assessments for the second quarter of 2009 are collected. The interim rule also permits the FDIC to impose an emergency special assessment of up to 10 basis points on all insured depository institutions whenever, after June 30, 2009, the FDIC estimates that the fund reserve ratio will fall to a level that the FDIC believes would adversely affect public confidence or to a level close to zero or negative at the end of a calendar quarter.

Community Investment and Consumer Protection Laws.   In connection with our lending activities, we are subject to a variety of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population.  Included among these are the federal Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act, Equal Credit Opportunity Act, Fair Credit Reporting Act and Community Reinvestment Act (“CRA”).

 

 

The CRA requires insured institutions to define the communities that they serve, identify the credit needs of those communities and adopt and implement a “CRA Statement” pursuant to which they offer credit products and take other actions that respond to the credit needs of the community.  The responsible federal banking regulator must conduct regular CRA examinations.  We are in compliance with applicable CRA requirements.

 

Capital Adequacy Guidelines.   The Federal Reserve Board has adopted risk based capital guidelines for member banks such as us.  To be considered “adequately capitalized,” the required minimum ratio of total capital to total risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8.0%.  At least half of the total risk based capital is required to be “Tier I capital,” consisting principally of common shareholders’ equity, non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill.  The remainder (“Tier II capital”) may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the allowance for loan losses.

In addition to the risk-based capital guidelines, the Federal Reserve Board has established minimum leverage ratio (Tier I capital to average total assets) guidelines for member banks.  These guidelines provide for a minimum leverage ratio of 3% for those member banks, which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other member banks are required to maintain a leverage ratio of at least 1 to 2% above the 3% stated minimum.  We are in compliance with these guidelines.

Prompt Corrective Action.   Under the Federal Deposit Insurance Act, the federal banking agencies possess broad powers to take “prompt corrective action” as deemed appropriate for an insured depository institution and its holding company.  The extent of these powers depends upon whether the institution in question is considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”  Generally, the smaller an institution’s capital base in relation to its total assets, the greater the scope and severity of the agencies’ powers.  Business activities may also be influenced by an institution’s capital classification.  At December 31, 2008, we exceeded the required ratios for classification as “well capitalized.”  For additional discussion of capital requirements, we refer you to Note 14, Regulatory Matters of the Notes to our Consolidated Financial Statements.

Restrictions on Dividends.   Because the Company has substantially no assets other than the stock of the Bank, cash dividend payments to our shareholders are primarily limited to the Bank’s ability to pay dividends to the Company.  Dividends by the Bank are subject to the New Jersey Banking Act of 1948 (the “Banking Act”), the Federal Reserve Act, and the Federal Deposit Insurance Act (the “FDIA”).  Under the Banking Act, no dividends may be paid if after such payment the Bank’s surplus (generally, additional paid-in capital plus retained earnings) would be less than 50% of the Bank’s capital stock. Under Federal Reserve Board regulations, without prior approval of the Federal Reserve Board, we cannot pay dividends that exceed our net income from the current year and the preceding two years and, in any event, cannot pay any dividends if we have an accumulated deficit.  Under the FDIA, no dividends may be paid by an insured bank if the bank is in arrears in the payment of any insurance assessment due to the FDIC.

As discussed below, state and federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by banks.  Adherence to such standards further limits our ability to pay dividends to our shareholders.

In 2008, we did not pay a cash dividend, and we have no plans to do so in 2009.  In 2007, we paid three cash dividends of $0.03 per share.  Our future dividend policy is subject to the discretion of our Board of Directors and will depend upon a number of factors, including future earnings, financial conditions, cash needs, general business conditions and applicable dividend limitations.  Further, the Company's ability to pay cash dividends to shareholders will depend largely on the Bank’s ability to pay dividends to the Company. We have distributed a 5% stock dividend, accounted for as a stock split, each year during the period from 1997 through 2002 and from 2004 through 2006.  In 2007, we distributed a 21 for 20 stock split, effected in the form of a 5% common stock dividend.  Currently, we have no plans to declare additional stock dividends or splits.

Holding Company Regulation .  The Company is subject to the provisions of the Bank Holding Company Act and to supervision by the FRB and by the New Jersey Department of Banking.  The Bank Holding Company Act requires the Company to secure the prior approval of the FRB before it owns or controls, directly or indirectly, more than 5% of the voting shares or substantially all of the assets of any institution, including another bank.

A bank holding company is also prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in, non-banking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.  In making this determination, the FRB considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects.

As a bank holding company, the Company is required to register as such with the FRB, and is required to file with the FRB an annual report and any additional information as the FRB may require pursuant to the Bank Holding Company Act.  The FRB may also conduct examinations of the Company and any or all of its subsidiaries.  Further, under the Bank Holding Company Act and the FRB’s Regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of credit or provision of any property or services.  The so-called anti-tie-in provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer provide additional credit or service to the Bank, to the Company or to any other subsidiary of the Company or on the condition that the customer not obtain other credit or service from a competitor of the Bank, to the Company or to any other subsidiary of the Company.

In 1999, legislation was enacted that allows bank holding companies to engage in a wider range of non-banking activities, including greater authority to engage in securities and insurance activities.  Under the Gramm-Leach-Bliley Act (“GLB Act”), a bank holding company that elects to become a financial holding company may engage in any activity that the FRB, in consultation with the Secretary of the Treasury, determines by regulation or order is (1) financial in nature, (2) incidental to any such financial activity, or (3) complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.  The GLB Act makes significant changes in the U.S. banking law, principally by repealing the restrictive provisions of the 1933 Glass-Steagall Act.  The GLB Act specifies certain activities that are deemed to be financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment, or economic advisory services; underwriting, dealing in or making a market in, securities; and any activity currently permitted for bank holding companies by the FRB under section 4(c)(8) of the Bank Holding Company Act.  The GLB Act does not authorize banks or their affiliates to engage in commercial activities that are not financial in nature.

 

A bank holding company may elect to be treated as a financial holding company only if all depository institution subsidiaries of the holding company are well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act.  The Company may elect to become a financial holding company but has not done so as of December 31, 2008.

USA PATRIOT Act.   The USA PATRIOT Act of 2001, which was renewed in 2006, establishes a wide variety of new and enhanced ways of combating terrorism, including amending the Bank Secrecy Act to provide the federal government with enhanced authority to identify, deter, and punish international money laundering and other crimes.  Among other things, the USA PATRIOT Act prohibits financial institutions from doing business with foreign “shell” banks and requires increased due diligence for private banking transactions and correspondent accounts for foreign banks.  In addition, financial institutions must follow new minimum verification of identity standards for all new accounts and will be permitted to share information with law enforcement authorities under circumstances that were not previously permitted.

Sarbanes-Oxley Act .  The Sarbanes-Oxley Act of 2002 required changes in some of our corporate governance, securities disclosure and compliance practices.  In particular, Section 404 of the Sarbanes-Oxley Act requires public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting.  Beginning with the Annual Report on Form 10-K for our 2009 fiscal year, the independent registered public accounting firm auditing the Company’s financial statements must attest to and report on the effectiveness of the Company’s internal control over financial reporting.  The costs associated with the implementation of this requirement, including documentation and testing, have not been estimated by us.  Moreover, if we are ever unable to conclude that we have effective internal control over financial reporting, or if our independent auditors are unable to provide us with an unqualified report as to the effectiveness of our internal control over financial reporting for any future year-ends as required by Section 404, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our securities.

 

Emergency Economic Stabilization Act of 2008 .  The Emergency Economic Stabilization Act of 2008 (the “EESA”), which established the U.S. Treasury Department’s Troubled Asset Relief Program (“TARP”), was enacted on October 3, 2008.  As part of TARP, the Treasury Department created the Capital Purchase Program (“CPP”), under which the Treasury Department will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies for the purpose of stabilizing and providing liquidity to the U.S. financial markets.  The Company did not choose to participate in the CPP.  On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs.

Temporary Liquidity Guarantee Program .  Pursuant to the EESA, the maximum deposit insurance amount per depositor has been increased from $100,000 to $250,000 until December 31, 2009.  Additionally, on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President of the United States, the Secretary of the Treasury signed the systemic risk exception to the FDIC Act, enabling the FDIC to establish its Temporary Liquidity Guarantee Program (“TLGP”). Under the transaction account guarantee program of the TLGP, the FDIC will fully guarantee, until the end of 2009, all non-interest-bearing transaction accounts, including NOW accounts with interest rates of 0.5 percent or less and IOLTAs (lawyer trust accounts).

 

The TLGP also guarantees all senior unsecured debt of insured depository institutions or their qualified holding companies issued between October 14, 2008 and June 30, 2009 with a stated maturity greater than 30 days. All eligible institutions were permitted to participate in both of the components of the TLGP without cost for the first 30 days of the program. Following the initial 30 day grace period, institutions were assessed at the rate of ten basis points for transaction account balances in excess of $250,000 for the transaction account guarantee program and at the rate of either 50, 75, or 100 basis points of the amount of debt issued, depending on the maturity date of the guaranteed debt, for the debt guarantee program. Institutions were required to opt-out of the TLGP if they did not wish to participate.  The Company did not choose to opt out of either the transaction account guarantee program or debt guarantee program components of the TGLP.

Future Regulation .  Various laws, regulations and governmental programs affecting financial institutions and the financial industry are from time to time introduced in Congress or otherwise promulgated by regulatory agencies.  Such measures may change the operating environment of the Company in substantial and unpredictable ways. With the recent enactments of the EESA and the ARRA, the nature and extent of future legislative, regulatory or other changes affecting financial institutions is very unpredictable at this time.

Employees.   As of December 31, 2008, we had 99 full-time and 27 part-time employees.  Our employees are not represented by a collective bargaining agent.  We believe the relationship with our employees to be good.

 

Item 1A.  Risk Factors.

Our business, operations and financial condition are subject to various risks.  In addition to the other information contained in this Form 10-K, you should carefully consider the risks, uncertainties and other factors described below because they could materially and adversely affect our business, financial condition, operating results, cash flow and prospects, and/or the market price of our common stock.  This section does not describe all risks that may be applicable to us, our business or our industry, and is included solely as a summary of certain material risk factors.

Risks Related to Our Business

If we experience excessive loan losses relative to our allowance, our earnings will be adversely affected.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan.  Given the current economic situation and particularly the adverse impact on the market for real estate, which constitutes nearly all the collateral for approximately 70% of our loans, we cannot be sure we are adequately secured. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality.  Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable.

If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.

As of December 31, 2008, our allowance for loan losses was approximately $8.5 million, which represented 2.78% of outstanding loans.  At such date, we had 22 loans on nonaccrual status.  Although management believes that our allowance for loan losses is adequate, there can be no assurance that the allowance will prove sufficient to cover future loan losses.  Further, although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our non-performing or performing loans.  Additions to our allowance for loan losses would result in a decrease in our net income and capital, and could have a material adverse effect on our financial condition and results of operations.

We realize income primarily from the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and changes in interest rates may adversely affect our profitability and assets.

Changes in prevailing interest rates may hurt our business.  We derive our income mainly from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities.  In general, the larger the spread, the more we earn.  When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate.  This can cause decreases in our spread and can adversely affect our income.

Interest rates affect how much money we can lend.  For example, when interest rates rise, the cost of borrowing increases and loan originations tend to decrease.  In addition, changes in interest rates can affect the average life of loans and investment securities.  A reduction in interest rates generally results in increased prepayments of loans and mortgage-backed securities, as borrowers refinance their debt in order to reduce their borrowing cost.  This causes reinvestment risk, because we generally are not able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities.

Changes in market interest rates could also reduce the value of our financial assets.  If we are unsuccessful in managing the effects of changes in interest rates, our financial condition and results of operations could suffer.

We may be required to pay significantly higher Federal Deposit Insurance Corporation (FDIC) premiums in the future.

Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The FDIC expects a higher rate of insured institution failures in the next few years compared to recent years; thus, the reserve ratio may continue to decline.  In addition, EESA temporarily increased the limit on FDIC coverage to $250,000 through December 31, 2009.  These developments will cause the premiums assessed to us by the FDIC to increase.

On December 16, 2008, the FDIC Board of Directors determined deposit insurance assessment rates for the first quarter of 2009 at 12 to 14 basis points per $100 of deposits.  Beginning April 1, 2009, the rates will increase to 12 to 16 basis points per $100 of deposits.  Additionally, on February 27, 2009, the FDIC announced an interim rule imposing a 20 basis point special emergency assessment on June 30, 2009, payable September 30, 2009. The interim rule also allows the FDIC to impose a special emergency assessment after June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in FDIC insurance. These higher FDIC assessment rates and special assessments could have an adverse impact on our results of operations.

 

Our ability to be profitable will depend upon our ability to grow, which will be limited by our need to maintain required capital levels.

We believe that we have in place the management and systems, including data processing systems, internal controls and a strong credit culture, to support continued growth.  However, our continued growth and profitability depend on the ability of our officers and key employees to manage such growth effectively, to attract and retain skilled employees and to maintain adequate internal controls and a strong credit culture.  Accordingly, there can be no assurance that we will be successful in managing our expansion, and the failure to do so would adversely affect our financial condition and results of operations.

Our business is geographically concentrated and is subject to regional economic factors that could have an adverse impact on our business.

Substantially all of our business is with customers in our market area of southern New Jersey.  Most of our customers are consumers and small and medium-sized businesses which are dependent upon the regional economy.  Adverse changes in economic and business conditions in our markets have adversely affected some of our borrowers, their ability to repay their loans and to borrow additional funds, and consequently our financial condition and performance.

Additionally, we often secure our loans with real estate collateral, most of which is located in southern New Jersey.  A decline in local economic conditions could adversely affect the values of such real estate.  Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

Most of our loans are commercial loans, which have a higher degree of risk than other types of loans.

Commercial loans are often larger and may involve greater risks than other types of lending.  Because payments on   such loans are often dependent on the successful operation of the property or business involved, repayment of such loans may be more sensitive than other types of loans to adverse conditions in the real estate market or the economy.  Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself and the general economic environment.  If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired.

We have incurred and expect to continue to incur significant expenses in connection with our branch expansion.

We have historically experienced growth through expansion of our existing branches as well as through the establishment of new branches.  A natural consequence of our growth during the branch expansion program has been a significant increase in noninterest expenses.  These costs are associated with marketing, increased staffing, branch construction and equipment needs sufficient to create the infrastructure necessary for branch operations.  Unless and until a new branch generates sufficient income to offset these additional costs, a new branch will reduce our earnings.

Most of our loans are secured, in whole or in part, with real estate collateral which may be subject to declines in value.

In addition to the financial strength and cash flow characteristics of the borrower in each case, we often secure our loans with real estate collateral.  As of December 31, 2008, approximately 70% of our loans had real estate as a primary, secondary or tertiary component of collateral.  Real estate values and real estate markets are generally affected by, among other things, changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower.  As real estate prices in our markets decline, the value of the real estate collateral securing our loans will be further reduced.  If we are required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.

Our legal lending limits are relatively low and restrict our ability to compete for larger customers.

At December 31, 2008, our lending limit per borrower was approximately $6.1 million, or approximately 15% of our capital.  Accordingly, the size of loans that we can offer to potential borrowers is less than the size of loans that many of our competitors with larger capitalization are able to offer.  We may engage in loan participations with other banks for loans in excess of our legal lending limits.  However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and our customers.

The loss of our executive officers and certain other key personnel could hurt our business.

Our success depends, to a great extent, upon the services of Robert H. King, our President and Chief Executive Officer; John Herninko, our Executive Vice President and Senior Loan Officer; R. Scott Horner, our Executive Vice President and Chief Financial Officer; Dale F. Braun, Jr., our Senior Vice President and Controller; Kimberly A. Johnson, Senior Vice President and Senior Administrative Officer; and Theresa S. Valentino Congdon, our Senior Vice President and Senior Retail Officer.  From time to time, we also need to recruit personnel to fill vacant positions for experienced lending and credit administration officers.  Competition for qualified personnel in the banking industry is intense, and there can be no assurance that we will continue to be successful in attracting, recruiting and retaining the necessary skilled managerial, marketing and technical personnel for the successful operation of our existing lending, operations, accounting and administrative functions or to support the expansion of the functions necessary for our future growth.  Our inability to hire or retain key personnel could have a material adverse effect on our results of operations.

Risks Related to Our Common Stock

There is a limited trading market for our common stock, which may adversely impact the ability to sell shares and the price received for shares.

Our common stock has limited trading activity, and although our common stock is listed on the Nasdaq Capital Market, there can be no assurance that trading in our common stock will develop at any time in the foreseeable future.  This means that there may be limited liquidity for our common stock, which may make it difficult to buy or sell our common stock, may negatively affect the price of our common stock and may cause volatility in the price of our common stock.  See Item 5, “Market for Common Equity and Related Stockholder Matters,” below.

 

There is a possibility that our common stock may be delisted and as a result, become more volatile and less liquid.

Due to the recent trading price range of our common stock, it is possible that without a sustained increase in the trading price range of our common stock, the shares will be delisted by NASDAQ.  If that were to occur, our common shares might continue to trade on the “over-the-counter” (OTC) market although there can be no assurances that will occur.  OTC transactions involve risks in addition to those associated with transactions on a stock exchange.  Many OTC stocks trade less frequently and in smaller volumes than stocks listed on an exchange.  Accordingly, OTC-traded shares are less liquid and are likely to be more volatile than exchange-traded stocks.

We have ceased paying cash dividends on a quarterly basis on our common stock and there is no assurance that we will resume doing so.

We have a limited history of paying cash dividends on our common stock.  We paid our first cash dividend to our shareholders in February 2004.  Although we subsequently paid cash dividends on a quarterly basis, the Company has not paid a cash dividend since the third quarter of 2007 and there is no assurance that the Company will resume paying cash dividends in the future.  Future payment of cash dividends, if any, will be at the discretion of the Board of Directors and will be dependent upon a number of factors including financial condition, cash needs, general business conditions and applicable legal limitations, including meeting regulatory capital requirements.  See Item 5, “Market for Common Equity and Related Stockholder Matters,” below.

 

Our management and significant shareholders control a substantial percentage of our stock and therefore have the ability to exercise substantial influence over our affairs.

As of March 13, 2009, our directors and executive officers beneficially owned approximately 913,000 shares, or approximately 15%, of our common stock, including options with the vested right to purchase approximately 241,000 shares, in the aggregate, of our common stock at exercise prices ranging from $6.27 to $10.90 per share.  In addition, approximately 7% of our common stock is controlled by a non-management shareholder.  Also, approximately 5% of our common stock is control by an institutional investor.  Because of the large percentage of stock held by our directors and executive officers and other significant shareholders, these persons could influence the outcome of any matter submitted to a vote of our shareholders.

We may issue additional shares of common stock, which may dilute the ownership and voting power of our shareholders and the book value of our common stock.

We are currently authorized to issue up to 15,000,000 shares of common stock.  Of that amount, approximately 5,843,362 shares were issued and outstanding as of March 13, 2009.  On March 16, 2007, we completed the Plan of Merger with Farnsworth Bancorp, Inc., for which the Holding Company issued approximately 768,438 shares of common stock.  Our Board of Directors has authority, without action or vote of the shareholders (except to the extent required under applicable rules of the Nasdaq Capital Market), to issue all or part of the authorized but unissued shares.  A total of 602,586 shares of common stock have been reserved for issuance under options outstanding on March 13, 2009.  As of March 13, 2009, options to purchase a total of 309,481 shares were exercisable and had exercise prices ranging from $6.27 to $10.90.  Any such issuance will dilute the percentage ownership interest of shareholders and may further dilute the book value of our common stock.

Our common stock is not insured and you could lose the value of your entire investment.

An investment in shares of our common stock is not a deposit and is not insured against loss by the government.

Risks Related to Our Industry

The capital and credit markets have experienced unprecedented levels of volatility.

During 2008, the capital and credit markets experienced extended volatility and disruption.  In the third and fourth quarters of 2008, the volatility and disruption reached unprecedented levels.  In response to the financial conditions affecting the banking system and financial markets and the potential threats to the solvency of investment banks and other financial institutions, the U.S. government has taken unprecedented actions.  These actions include the government assisted acquisition of Bear Stearns by JPMorgan Chase, the federal conservatorship of Fannie Mae and Freddie Mac, and the plan of the Treasury Department to inject capital and to purchase mortgage loans and mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets or particular financial institutions. Investors should not assume that these governmental actions will necessarily benefit the financial markets in general, or the Company in particular.  Investors should not assume that the government will continue to intervene in the financial markets at all.  Investors should be aware that governmental intervention (or the lack thereof) could materially and adversely affect the Company’s business, financial condition and results of operations.

We operate in a competitive market which could constrain our future growth and profitability.

We operate in a competitive environment, competing for deposits and loans with commercial banks, savings associations and other financial entities.  Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives.  Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries.  Many of the financial intermediaries operating in our market area offer certain services, such as trust investment and international banking services, which we do not offer.  Moreover, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers.  See Item 1, “Description of Business – Competition,” above.

 

Legislative and regulatory actions taken now or in the future to address the current liquidity and credit crisis in the financial industry may significantly affect our financial condition, results of operation, liquidity or stock price

The Emergency Economic Stabilization Act of 2008 (the “EESA”), which established the U.S. Treasury Department’s Troubled Asset Relief Program (“TARP”), was enacted on October 3, 2008.  As part of TARP, the Treasury Department created the Capital Purchase Program (“CPP”), under which the Treasury Department will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies for the purpose of stabilizing and providing liquidity to the U.S. financial markets.  On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “ARRA”) was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs.  There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets.  The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Company’s financial condition, results of operation, liquidity or stock price.

In addition, there have been numerous actions undertaken in connection with or following EESA and ARRA by the Federal Reserve Board, Congress, the Treasury Department, the FDIC, the SEC and others in efforts to address the current liquidity and credit crisis in the financial industry that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; a mandatory “stress test” requirement for banking institutions with assets in excess of $100 billion to analyze capital sufficiency and risk exposure; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.  The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system.  However, the EESA, the ARRA and any current or future legislative or regulatory initiatives may not have their desired effect, or may have an adverse effect when applied to the Company.

We are required to comply with extensive and complex governmental regulation which can adversely affect our business.

Our operations are and will be affected by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities.  We are subject to supervision and periodic examination by the Federal Reserve Board, or FRB, the Federal Deposit Insurance Corporation, or FDIC, and the New Jersey Department of Banking and Insurance.  Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services.  We are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized.  It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any such changes may have on our future business and earnings prospects.  Further, the cost of compliance with regulatory requirements may adversely affect our ability to operate profitability.

 

In addition, the monetary policies of the FRB have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future.  Among the instruments of monetary policy used by the FRB to implement its objectives are changes in the discount rate charged on bank borrowings and changes in the reserve requirements on bank deposits.  It is not possible to predict what changes, if any, will be made to the monetary policies of the FRB or to existing federal and state legislation or the effect that such changes may have on our future business and earnings prospects.

 

During the past several years, significant legislative attention has been focused on the regulation and deregulation of the financial services industry.  Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, have been permitted to engage in activities which compete directly with traditional bank business.

 

As a public company, our business is subject to numerous reporting requirements that are currently evolving and could substantially increase our operating expenses and divert management’s attention from the operation of our business.

 

Compliance with the requirements of the Sarbanes-Oxley Act of 2002 and the rules and listing standards promulgated by the SEC and Nasdaq may significantly increase our legal and financial and accounting costs in the future, once full compliance is required.  In addition, full compliance with the requirements may take a significant amount of management’s and the Board of Directors’ time and resources.  Likewise, these developments may make it more difficult for us to attract and retain qualified members of our board of directors, particularly independent directors, or qualified executive officers.

As directed by Section 404 of the Sarbanes-Oxley Act, the SEC adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting.  Under the SEC’s current rules, we began to comply with this requirement with our 2007 annual report.  Beginning with our 2009 fiscal year, the independent registered public accounting firm auditing the Company’s financial statements must attest to and report on the effectiveness of the Company’s internal control over financial reporting.  The costs associated with the implementation of this requirement, including documentation and testing, have not been estimated by us.  If we are ever unable to conclude that we have effective internal control over financial reporting or, if our independent auditors are unable to provide us with an unqualified report as to the effectiveness of our internal control over financial reporting for any future year-ends as required by Section 404, we may incur additional costs to rectify the deficiency and investors could lose confidence in the reliability of our financial statements, either of which could result in a decrease in the value of our securities.

Item 1B.  Unresolved Staff Comments.

Not Applicable.

Item 2.  Properties.

The Company currently operates 10 bank branches, including the main branch; 5 are owned and 5 are leased.  Our principal office in Mount Laurel, New Jersey, consisting of 10,500 square feet, is leased.  The lease expires on December 31, 2015 with renewal options available through December 31, 2035.   A second branch office is leased in Medford, New Jersey consisting of 3,000 square feet.  The Medford lease expires on May 31, 2025 with renewal options available through May 31, 2035.  A third branch office is leased in Voorhees, New Jersey consisting of 3,000 square feet.  The Voorhees lease expires on November 30, 2020 with renewal options available through November 30, 2045.  A fourth branch office is leased in Marlton, New Jersey consisting of 2,200 square feet.  The Marlton lease expires on November 30, 2012 with renewal options available through November 30, 2022.  A fifth branch office is leased in Delran, New Jersey consisting of 3,000 square feet.  The Delran lease expires on June 30, 2027 with renewal options available through June 30, 2047.  In addition, we own branch offices located in Cherry Hill, Vincentown, Maple Shade, Bordentown and Florence, New Jersey containing 3,000, 6,400, 3,300, 7,900 and 1,000 square feet, respectively.

We also lease an administrative office in Mount Laurel, New Jersey consisting of 8,100 square feet.  This lease will expire on July 31, 2011.

Management considers the physical condition of all offices and branches to be good and adequate for the conduct of the Company’s business.

Item 3. Legal Proceedings.

The Company, from time to time, is a party to routine litigation that arises in the normal course of business.  Management does not believe the resolution of this litigation, if any, would have a material adverse effect on the Company’s financial condition or results of operations.  However, the ultimate outcome of any such matter, as with litigation generally, is inherently uncertain and it is possible that some of these matters may be resolved adversely to the Company.

Item 4.  Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of the shareholders of the Company during the fourth quarter of the fiscal year ended December 31, 2008.

PART II

 

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

Our common stock is listed on the Nasdaq Capital Market.  The number of shareholders of record of our common stock, as of December 31, 2008, was 522.

For information with respect to Equity Compensation Plans see Item 12 (“Securities Authorized for Issuance under Equity Compensation Plans”).

The table below presents the high and low sales prices reported for our common stock as reported by the NASDAQ Capital Market for the periods indicated.  Sale prices have been adjusted for stock splits and dividends.

Dividends

The holders of our common stock are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available therefor.  Our ability to pay cash dividends is limited by applicable state and federal law.  See "Item 1. Description of Business – Regulation – Restriction on Dividends".

 

In 2008, we did not pay a cash dividend, and we have no plans to do so in 2009.  In 2007, we paid three cash dividends of $0.03 per share.  The Company has not paid a cash dividend since the third quarter of 2007 and there is no assurance that the Company will resume paying cash dividends in the future.

Future payments of dividends, if any, is subject to the discretion of our Board of Directors and will depend upon a number of factors, including future earnings, financial conditions, cash needs, general business conditions and applicable legal limitations, including meeting regulatory capital requirements.  Further, the Company's ability to pay cash dividends to shareholders will depend largely on the Bank’s ability to pay dividends to the Company.

We have distributed a 5% stock dividend, accounted for as a stock split, each year during the period from 1997 through 2002 and from 2004 through 2006.  In 2007, we distributed a 21 for 20 stock split, effected in the form of a 5% common stock dividend.

Item 6.  Selected Financial Data.

Not Applicable for Smaller Reporting Companies.

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

The information contained in the section captioned “Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations” is included as an exhibit to this Annual Report.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.

Not Applicable for Smaller Reporting Companies.

 

Item 8.  Financial Statements and Supplementary Data.

The Company's financial statements listed under Item 15 are included as an exhibit to this Annual Report.

Item 9.  Changes in and Disagreements with Accountants On Accounting and Financial Disclosure.

Not applicable.

Item 9A(T).  Controls and Procedures.

Disclosure Controls and Procedures

The Company, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective, because of the material weakness described below, to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.  Because of the inherent limitations in all control systems, any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Furthermore, our controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control, and misstatements due to error or fraud may occur and not be detected on a timely basis.

Management’s Annual Report on Internal Control over Financial Reporting .

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.  The Company’s internal control over financial reporting is designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements and the reliability of financial reporting.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.  Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008.  In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework .  Based on our assessment, we believe that, as of December 31, 2008, the Company’s internal control over financial reporting is not effective based on those criteria because management identified a material weakness related to the internal controls over the process supporting the determination of the adequacy of the allowance for loan losses. Specifically, the Company did not initially provide sufficient general reserves under SFAS No. 5 in reaction to the rapidly deteriorating economic conditions affecting the credit quality of segments of the loan portfolio and did not timely identify loans that had become impaired under SFAS No.114.  This resulted in material adjustments to the allowance for loan losses within the 2008 annual consolidated financial statements, following the Company’s fourth quarter and year-end earnings release, which necessitated a delay in filing of the Company’s Form 10-K.  Management determined that these control deficiencies constitute a material weakness in the Company’s internal control over financial reporting.  In order to ensure that adequacy and accuracy in these determinations are consistently present, a procedure of external review of the details of management’s assessments will be completed on a timely basis each quarter in order to meet the deadlines for all future reporting.  This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting in the quarter ended December 31, 2008 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information.

Not applicable.

PART III

The Company will file a definitive proxy statement for its 2009 Annual Meeting of Shareholders pursuant to Regulation 14A (the “Proxy Statement”) within 120 days after the end of the fiscal year covered by this annual report on Form 10-K (i.e., by April 30, 2009); accordingly, certain information that is required under Part III of this Annual Report on Form 10-K is omitted from this report and will be included in the Proxy Statement, and is incorporated herein by reference to the Proxy Statement.

The information contained under the sections captioned “Section 16(a) Beneficial Ownership Reporting Compliance” and “Election of Directors” in the Company’s Proxy Statement is incorporated herein by reference.

Code of Ethics.   The Company has adopted a Code of Ethics for the Company’s chief executive officer and principal financial and accounting officers.  Printed copies of the Code of Ethics are available without charge to any shareholder upon written request addressed to R. Scott Horner, Secretary, Sterling Banks, Inc., 3100 Route 38, Mount Laurel, New Jersey 08054.  Any amendments to the Code of Ethics, or any waivers of the Code of Ethics, will be disclosed promptly on a Current Report on Form 8-K filed with the Securities and Exchange Commission.

Item 11.  Executive Compensation.

The information contained in the section captioned “Director and Executive Officer Compensation” in the Proxy Statement is incorporated herein by reference.

 

Item 12.

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

Information required by this item is incorporated herein by reference to the first chart in the section captioned “Security Ownership of Directors and Executive Officers and Certain Beneficial Owners” in the Proxy Statement.

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

The information is incorporated herein by reference to the sections captioned “Certain Transactions” and “Election of Directors” in the Proxy Statement.

Item 14.  Principal Accountant Fees and Services.

The information is incorporated herein by reference to the section captioned “Independent Auditors” in the Proxy Statement.

PART IV

Item 15.  Exhibits and Financial Statement Schedules.

(a)(1)     Financial Statements .  The consolidated statements of financial condition of Sterling Banks, Inc. as of December 31, 2008 and 2007 and the related consolidated statements of operations, shareholders’ equity and cash flows for the years ended December 31, 2008 and 2007 together with the related notes, are filed as a part of this Annual Report.

(a)(2)    Financial Statement Schedules .  Schedules have been omitted as they are not applicable.

(a)(3)     Exhibits .  The exhibits required by Item 601 of Regulation S-K are listed below:

	2.1	Plan of Acquisition, dated April 26, 2006 by and between Sterling Bank and Sterling Banks, Inc. (a)
	2.2	Agreement and Plan of Merger, dated June 23, 2006, by and among Sterling Banks, Inc., Sterling Bank, and Farnsworth Bancorp, Inc. (b)
	3.1	Certificate of Incorporation of Sterling Banks, Inc. (c)
	3.2	Amended and Restated Bylaws of Sterling Banks, Inc. (d)
	10.1	1994 Employee Stock Option Plan (e), (g)
	10.2	1998 Employee Stock Option Plan (e), (g)
	10.3	2003 Employee Stock Option Plan (e), (g)
	10.4	Sterling Banks, Inc. 2008 Employee Stock Option Plan (i)
	10.5	Sterling Banks, Inc. 2008 Director Stock Option Plan (j)
	10.6	Change in Control Severance Agreement dated December 26, 2007 between the Company, the Bank and R. Scott Horner (g), (h)
	10.7	Change in Control Severance Agreement dated December 26, 2007 between the Company, the Bank and John Herninko (g), (h)
	10.8	Employment agreement dated January 26, 2006 between the Bank and Robert H. King (f), (g)
	10.9	Amendment to Employment Agreement dated December 26, 2007 between the Bank and Robert H. King (g)
	10.10	Lease dated as of April 3, 1990, as amended, for headquarters facility in Mount Laurel, New Jersey (e)
	23.1	Consent of McGladrey & Pullen, LLP, Independent Registered Public Accounting Firm
	31.1	CEO Certification required under Section 302 of Sarbanes – Oxley Act of 2002
	31.2	CFO Certification required under Section 302 of Sarbanes – Oxley Act of 2002
	32.1	CEO Certification required under Section 906 of Sarbanes – Oxley Act of 2002
	32.2	CFO Certification required under Section 906 of Sarbanes – Oxley Act of 2002

SIGNATURES

 

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	STERLING BANKS, INC.
	By:	/s/ Robert H. King
		Robert H. King
		President and Chief Executive Officer

Date: April 15, 2009

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on April 15, 2009.