U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2011

or

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

For the transition period from ________ to _________

Commission File Number 000-50055

SOMERSET HILLS BANCORP

(Exact name of registrant as specified in its charter)

New Jersey (State of other jurisdiction of incorporation or organization)	22-3768777 (I. R. S. Employer Identification No.)
155 Morristown Road, Bernardsville, NJ (Address of principal executive offices)	07924 (Zip Code)

(908) 221-0100
(Registrants’ telephone number including area code)

Securities registered under Section 12(b) of the Exchange Act:

Title of each class	Name of each exchange on which registered
Common Stock, no par value	Nasdaq

Securities registered under Section 12(g) of the Exchange Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes £ No S

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes £ No S

Check whether the registrant (1) has filed all 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 S No £

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

Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by referenced 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, or a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (check one) : Large accelerated filer £ Accelerated filer £ Non-accelerated filer £ Smaller reporting company S

(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 S

As of June 30, 2011, the aggregate market value of voting and non-voting equity held by non-affiliates was $40.1 million.

As of March 9th, 2012 there were 5,336,043 shares of common stock, no par value per share outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

	10-K Item	Document Incorporated
Item 10.	Directors and Executive Officers of the Registrant	Proxy Statement for 2012 Annual Meeting of Shareholders to be filed no later than April 30, 2012.
Item 11.	Executive Compensation	Proxy Statement for 2012 Annual Meeting of Shareholders to be filed no later than April 30, 2012.
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	Proxy Statement for 2012 Annual Meeting of Shareholders to be filed no later than April 30, 2012.
Item 13.	Certain Relationships and Related Transactions	Proxy Statement for 2012 Annual Meeting of Shareholders to be filed no later than April 30, 2012.
Item 14.	Principal Accountant Fees and Services	Proxy Statement for 2012 Annual Meeting of Shareholders to be filed no later than April 30, 2012.

PART I

ITEM 1. DESCRIPTION OF BUSINESS

General

Somerset Hills Bancorp (the “Company”) is a one-bank holding company incorporated under the laws of New Jersey in January 2000 to serve as the holding company for Somerset Hills Bank (the “Bank”). We were organized at the direction of the Board of Directors of the Bank. Effective January 1, 2001, Somerset Hills Bancorp acquired all of the capital stock of the Bank and became a bank holding company under the Bank Holding Company Act of 1956, as amended. Our only significant operation is our investment in the Bank. Our main office is located at 155 Morristown Road, Bernardsville, New Jersey and our telephone number is (908) 630-5029.

The Bank is a commercial bank formed under the laws of the State of New Jersey in 1997. The Bank operates from its main office at 155 Morristown Road, Bernardsville, New Jersey, and its five branch offices located in Long Valley, Madison, Mendham, Morristown and Summit, New Jersey. The Bank operates a licensed mortgage company subsidiary, Sullivan Financial Services, Inc. (“Sullivan”). Sullivan’s operations are located in Madison, New Jersey. The Company considers Sullivan to be a separate business segment.

The Bank’s deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation up to applicable limits. The operations of the Bank are subject to the supervision and regulation of the Federal Deposit Insurance Corporation and the New Jersey Department of Banking and Insurance. Our mortgage company’s operations are subject to regulation by the New Jersey Department of Banking and Insurance, the Departments of Banking in Florida, New York and Pennsylvania as well as the Department of Housing and Urban Development and the Veterans Administration.

We separate our business into two reporting segments: community banking and mortgage banking. For financial information on our business segments, see Note 12 to the accompanying Financial Statements.

Business of the Bank

The Bank conducts a traditional commercial banking business and offers services including personal and business checking accounts, time deposits, money market accounts and regular savings accounts. The Bank’s lending activities are oriented to the small-to-medium sized business, high net worth individuals, professional practices and consumer and retail customers living and working primarily in the Bank’s market area of Somerset, Morris and Union Counties, New Jersey. The Bank offers the commercial, consumer, and mortgage-lending products typically offered by community banks and, through its mortgage company subsidiary, a variety of residential mortgage products.

The deposit services offered by the Bank include small business and personal checking and savings accounts and certificates of deposit. The Bank’s signature retail deposit account is the Paramount Checking Account, an interest paying checking account offering features such as free checks, telephone banking, text banking, internet banking and bill payment, free safe deposit box and a refund of foreign ATM fees. Another deposit service the bank offers is the Escrow Ease product. Escrow Ease is specifically designed to meet the trust account needs of attorneys, realtors and title companies. The Escrow Ease Account offers the convenience of segregation of client funds, by sub account, within a single master trust account with detailed sub account reporting including the preparation of year-end tax documents. Sub accounts may be either interest or non-interest bearing and, for attorneys, can also be designated as IOLTA accounts. The Bank concentrates on customer relationships in building our customer deposit base and competes aggressively in the area of transaction accounts.

In addition, the Bank has established a wealth management subsidiary pursuant to which it offers insurance services, securities brokerage and investment advisory services on a non-proprietary basis under the terms of an agreement with Mass Mutual, its affiliated securities brokerage and its locally affiliated agents. The Bank has also established a title insurance agency joint venture which offers traditional title agency services in connection with commercial real estate transactions. The Bank is a 50 percent owner of the joint venture.

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Service Area

The service area of the Bank primarily consists of Somerset, Morris and Union Counties, New Jersey, although we make loans throughout New Jersey. The Bank operates through its main office in Bernardsville, New Jersey, and its branch offices located in Long Valley, Madison, Mendham, Morristown and Summit, New Jersey.

Our mortgage company subsidiary originates loans primarily in New Jersey, and to a lesser degree, New York, Pennsylvania and Florida. The mortgage company’s operations are located in Madison, New Jersey.

Competition

The Bank operates in a highly competitive environment competing for deposits and loans with commercial banks, thrifts and other financial institutions, many of which have greater financial resources than the Bank. Many large financial institutions compete for business in the service area of the Bank. In addition, in November 1999, the Gramm-Leach-Bliley Financial Modernization Act of 1999 was passed into law. The Act permits insurance companies and securities firms, among others, to acquire financial institutions and has increased competition within the financial services industry. Certain of our competitors have significantly higher lending limits than we do and provide services to their customers that we do not offer.

Management believes that the Bank is able to compete favorably with our competitors because we provide responsive personalized service through management’s knowledge and awareness of our market area, customers and businesses.

Employees

At December 31, 2011 and 2010, we employed 56 and 60 full-time employees and 5 and 14 part-time employees, respectively. None of these employees are covered by a collective bargaining agreement and we believe that our employee relations are good.

Supervision and Regulation

Bank holding companies and banks are extensively regulated under both federal and state law. These laws and regulations are intended to protect depositors, not shareholders. In addition, the operations of Sullivan are subject to various state and federal regulations designed to protect consumers, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in the applicable law or regulation may have a material effect on the business and prospects of the Company and the Bank.

BANK HOLDING COMPANY REGULATION

General

As a bank holding company registered under the Bank Holding Company Act, the Company is subject to the regulation and supervision applicable to bank holding companies by the Board of Governors of the Federal Reserve System. The Company is required to file with the Federal Reserve annual reports and other information regarding its business operations and those of its subsidiaries.

The Bank Holding Company Act requires, among other things, the prior approval of the Federal Reserve 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 company’s voting shares) or (iii) merge or consolidate with any other bank holding company. The Federal Reserve will not approve any acquisition, merger, or consolidation that would have a substantially anticompetitive 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 Federal Reserve 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, when reviewing acquisitions or mergers.

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The Bank Holding Company Act generally 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 Federal Reserve to be so closely related to banking or managing or controlling banks as to be properly incident thereto.

The Bank Holding Company Act was substantially amended through the Gramm-Leach Bliley Financial Modernization Act of 1999 (“Financial Modernization Act”). The Financial Modernization Act permits bank holding companies and banks, which meet certain capital, management and Community Reinvestment Act standards to engage in a broader range of non-banking activities. In addition, bank holding companies that elect to become financial holding companies may engage in certain banking and non-banking activities without prior Federal Reserve approval. Finally, the Financial Modernization Act imposes certain privacy requirements on all financial institutions and their treatment of consumer information. At this time, the Company has elected not to become a financial holding company, as it does not engage in any activities that are not permissible for banks.

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 provisions of the Bank Holding Company Act, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve also has the authority under the Bank Holding Company Act to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the Federal Reserve’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 Federal Reserve 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 profile 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. These requirements apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and to certain bank holding companies with less than $500 million in consolidated assets if they are engaged in substantial non-banking activities or meet certain other criteria. We do not meet these criteria, and so are not subject to a minimum consolidated capital requirement.

In addition to the risk-based capital guidelines, the Federal Reserve 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. This minimum leverage requirement only applies to bank holding companies on a consolidated basis if the risk based capital requirements discussed above apply. We do not have a minimum consolidated capital requirement at the holding company level at this time.

BANK REGULATION

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

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Insurance of Deposits

The Dodd-Frank Wall Street Reform and Consumer Protection act of 2010 (the “Dodd-Frank Act”) has caused significant changes in the FDIC’s insurance of deposit accounts. Among other things, the Dodd-Frank Act permanently increased the FDIC deposit insurance limit to $250 thousand per depositor. In addition, the Dodd- Frank Act includes provisions replacing, by statute, the FDIC’s program to provide unlimited deposit insurance coverage for noninterest bearing transactional accounts. All institutions, including the Bank, are required to participate in this program and are not required to pay an additional assessment for this additional coverage. Under the Dodd-Frank Act, this unlimited coverage for non-interest bearing transaction accounts will expire on January 1, 2013.

The FDIC had significantly increased deposit insurance assessment rates in the second quarter of 2009. As increased, the adjusted base assessment rated range from 12.0 to 77.5 basis points of deposits, a significant increase over premium rates for the past several years. The FDIC also levied a special assessment of 5 basis points on assets less Tier 1 Capital as of June 30, 2009, paid September 30, 2009 resulting in a charge to the Bank of approximately $141 thousand. The FDIC also required insured depository institutions to pre-pay deposit insurance premiums for the next two and one-half years in 2009.

On February 7, 2011 the FDIC announced the approval of a revised assessment system mandated by the Dodd-Frank Act. The Dodd-Frank Act requires that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on average total consolidated assets minus average tangible equity. The new rate schedule became effective during the second quarter of 2011 and reduced the Company’s costs for Federal deposit insurance.

Capital Adequacy Guidelines

The FDIC has promulgated risk-based capital guidelines, which are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. 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 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, qualifying preferred stock and certain permissible hybrid instruments, 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) non-qualifying preferred stock, (c) hybrid capital instruments, (d) perpetual debt, (e) mandatory convertible securities, and (f) qualifying subordinated debt and intermediate-term preferred stock up to 50% of Tier I capital. 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 Federal Reserve (determined on a case by case basis or as a matter of policy after formal rule-making).

Bank 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, and loans secured by deposits in the Bank which carry a 20% 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 financial obligations are given a 100% risk weighting. Transaction related contingencies such as bid bonds, standby letters of credit backing non-financial 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 FDIC has adopted a minimum Tier 1 capital (leverage) ratio. Under these guidelines, a bank must maintain a minimum level of Tier I capital to average total consolidated assets of

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at least 3% in the case of a bank that has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other banks are expected to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum.

Dividends

As long as the operations of the Bank remain our primary source of income, our ability to pay dividends will be affected by any legal or regulatory limitations on the Bank’s ability to pay dividends. The Bank may pay dividends as declared from time to time by the Board of Directors out of funds legally available, subject to certain restrictions. Under the New Jersey Banking Act of 1948, the Bank may not pay a cash dividend unless, following the payment, the Bank’s capital stock will be unimpaired and the Bank will have a surplus of no less than 50% of the Bank’s capital stock or, if not, the payment of the dividend will not reduce the surplus. In addition, the Bank would be prohibited from paying dividends in such amounts as would reduce the Bank’s capital below regulatory imposed minimums.

REGULATION OF SULLIVAN

As a subsidiary of the Bank, Sullivan is subject to regulation and examination by the New Jersey Department of Banking and Insurance and the FDIC. In addition, as a licensed lender, Sullivan is subject to the jurisdiction of the New Jersey Department of Banking and Insurance and, as an approved Department of Housing and Urban Development and Veterans Administration lender, Sullivan is subject to examination by the Department of Housing and Urban Development and the Veterans Administration. Sullivan is also subject to regulation by the Florida Office of Financial Services as well as the Department of Financial Services in New York and Pennsylvania Department of Banking.

LEGISLATIVE AND REGULATORY CHANGES

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law on July 21, 2010. Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Some uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry by increasing compliance costs and reducing some sources of revenue. The Dodd-Frank Act, among other things:

• Directs the Federal Reserve to issue rules which limit debit-card interchange fees;

• Provides for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets;

• Permanently increases the deposit insurance coverage to $250 thousand and allows depository institutions to pay interest on checking accounts;

• Creates a new consumer financial protection bureau that will have rulemaking authority for a wide range of consumer protection laws that would apply to all banks and would have broad powers to supervise and enforce consumer protection laws directly for large institutions;

• Provides for new disclosure and other requirements relating to executive compensation and corporate governance;

• Changes standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries;

• Provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and

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• Creates a financial stability oversight council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.

On July 30, 2002, the Sarbanes-Oxley Act, or “SOX” was enacted. SOX is not a banking law, but applies to all public companies, including Somerset Hills Bancorp. The stated goals of SOX are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX is the most far reaching U.S. securities legislation enacted in some time. SOX generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended.

SOX includes very specific additional disclosure requirements and new corporate governance rules and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specific issues by the SEC. SOX represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. SOX addresses, among other matters:

• audit committees;

• certification of financial statements by the chief executive officer and the chief financial officer;

• management’s assessment of a company’s internal controls over financial reporting, and a company’s auditor’s certification of such assessment;

• the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

• a prohibition on insider trading during pension plan black out periods;

• disclosure of off-balance sheet transactions;

• a prohibition on personal loans to officers and directors, unless subject to Federal Reserve Regulation O;

• expedited filing requirements for Form 4 statements of changes of beneficial ownership of securities required to be filed by officers, directors and 10% shareholders;

• disclosure of whether or not a company has adopted a code of ethics;

• “real time” filing of periodic reports;

• auditor independence; and

• various increased criminal penalties for violations of securities laws.

Complying with the requirements of SOX as implemented by the SEC has and will continue to increase our compliance costs and could make it more difficult to attract and retain board members.

On October 26, 2001, a new anti-terrorism bill, the International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001, was signed into law. This law restricts money laundering by terrorists in the United States and abroad. This act specifies new “know your customer” requirements that will obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with the act’s money laundering provisions in making decisions regarding approval of acquisitions and mergers. In addition, sanctions for violations of the act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1 million.

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ITEM 1A. RISK FACTORS

Risks affecting our business:

The recent nationwide recession has reduced real estate values in our trade area and may adversely affect our business by stressing the ability of our customers to repay their loans.

Our trade area, like the rest of the United States, is currently experiencing weak economic conditions. As a result, many companies have experienced reduced revenues and have laid off employees. These factors have stressed the ability of both commercial and consumer customers to repay their loans and may result in higher levels of non-accrual loans. In addition, real estate values have declined in our trade area. Since the majority of our loans are secured by real estate, declines in the market value of real estate impact the value of the collateral securing our loans, and could lead to greater losses in the event of defaults on loans secured by real estate.

Changes in interest rates can have an adverse effect on profitability.

Our earnings and cash flows are largely dependent upon net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition, and policies of various governmental and regulatory agencies and, in particular, the policies of the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, including our securities portfolio, and (iii) the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk). Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

Our earnings may not grow if we are unable to successfully attract core deposits and lending opportunities and exploit opportunities to generate fee-based income.

Historically, the growth of our loans and deposits has been the principal factor in our increase in net interest income. In the event that we are unable to execute our business strategy of continued growth in loans and deposits, our earnings could be adversely impacted. Our ability to continue to grow depends, in part, upon our ability to expand our market share, to successfully attract core deposits and identify loan and investment opportunities, as well as opportunities to generate fee-based income. Our ability to manage growth successfully will also depend on whether we can continue to efficiently fund asset growth and maintain asset quality and cost controls, as well as on factors beyond our control, such as economic conditions and interest rate trends.

Our business strategy could be adversely affected if we are not able to attract and retain skilled employees and manage our expenses.

Our ability to successfully implement business strategies, especially given the persistently poor economy and an increasingly onerous regulatory environment, will depend upon our ability to continue to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our staff employees.

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Our mortgage banking operations expose us to risks that are different from community banking.

The bank’s mortgage banking operations expose us to risks that are different from our retail banking operations. Our mortgage banking operations are dependent upon the level of demand for residential mortgages. During higher and rising interest rate environments, the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues than currently recognized and that may not exceed our fixed costs to run the business. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third- party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, the bank may be required to charge such shortfall to earnings.

Risks Related to the Banking Industry:

Changes in local economic conditions could adversely affect our loan portfolio.

Our success depends to a great extent upon the general economic conditions of the local markets that we serve. Unlike larger banks that are more geographically diversified, we provide banking and financial services primarily to customers in our central and northern New Jersey trade area, so any decline in the economy of this specific region could have an adverse impact on us.

Our loans, the ability of borrowers to repay these loans and the value of collateral securing these loans, are impacted by economic conditions. Our financial results, the credit quality of our existing loan portfolio, and the ability to generate new loans with acceptable yield and credit characteristics may be adversely affected by changes in prevailing economic conditions, including declines in real estate values, changes in interest rates, adverse employment conditions and the monetary and fiscal policies of the federal government. We cannot assure you that negative trends or developments will not have a significant adverse effect on us.

There is a risk that we may not be repaid in a timely manner, or at all, for loans we make.

The risk of non-payment (or deferred or delayed payment) of loans is inherent in banking. Such non-payment, or delayed or deferred payment of loans to the Company, if they occur, may have a material adverse effect on our earnings and overall financial condition. Additionally, in compliance with applicable banking laws and regulations, the Company maintains an allowance for loan losses created through charges against earnings. As of December 31, 2011, the Company’s allowance for loan losses was $3.0 million. The Company’s marketing focus on small to medium-size businesses may result in the assumption by the Company of certain lending risks that are different from or greater than those which would apply to loans made to larger companies. We seek to minimize our credit risk exposure through credit controls, which include evaluation of potential borrowers’ available collateral, liquidity and cash flow. However, there can be no assurance that such procedures will actually reduce loan losses.

Our allowance for loan losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. Our allowance for loan losses may not be adequate to cover actual losses, and future provisions for loan losses could materially and adversely affect the results of our operations. Risks within the loan portfolio are analyzed on a continuous basis by management; and, periodically, by an independent loan review function and by the Audit Committee. A risk system, consisting of multiple-grading categories for each loan class, is utilized as an analytical tool to assess risk and the appropriate level of loss reserves. Along with the risk system, management further evaluates risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrowers, past and expected loan loss experience and other factors management feels deserve recognition in establishing an adequate reserve. This risk assessment process is performed at least quarterly and as adjustments become necessary, they are realized in the periods in which they become known. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. State and federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses and may require an increase in our allowance for loan losses. Although we believe that our allowance for loan losses is adequate to cover probable and reasonably estimated losses, we cannot assure you that we will not further increase the allowance for loan

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losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings.

We are in competition with many other banks, including larger commercial banks which have greater resources than us.

The banking industry within our trade area is highly competitive. The Company’s principal market area is also served by branch offices of large commercial banks and thrift institutions. In addition, in 1999 the Gramm-Leach-Bliley Financial Modernization Act of 1999 was passed into law. The Modernization Act permits other financial entities, such as insurance companies and securities firms, to acquire or form financial institutions, thereby further increasing competition. A number of our competitors have substantially greater resources than we do to expend upon advertising and marketing, and their substantially greater capitalization enables them to make much larger loans. Our success depends a great deal upon our judgment that large and mid-size financial institutions do not adequately serve small businesses in our principal market area and upon our ability to compete favorably for such customers. In addition to competition from larger institutions, we also face competition for individuals and small businesses from recently-formed banks seeking to compete as “hometown” institutions. Most of these new institutions have focused their marketing efforts on the smaller end of the small business market we serve.

The banking business is subject to significant government regulations, which are designed for the protection of depositors and the public, but not our stockholders.

We are subject to extensive governmental supervision, regulation and control. These laws and regulations are subject to change, and may require substantial modifications to our operations or may cause us to incur substantial additional compliance costs. In addition, future legislation and government policy could adversely affect the commercial banking industry and our operations. Such governing laws can be anticipated to continue to be the subject of future modification. These laws and regulations are generally designed to protect depositors and the deposit insurance funds and to foster economic growth and not for the purpose of protecting stockholders. Our management cannot predict what effect any such future modifications will have on our operations.

For example, the recently adopted Dodd-Frank Act has and may result in substantial new compliance costs, and may restrict certain sources of revenue. The Dodd-Frank Act was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on our business, results of operations and financial condition. The Dodd-Frank Act, among other things:

• Directs the Federal Reserve to issue rules which limit debit-card interchange fees;

• Provides for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the deposit insurance fund from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets less capital;

• Permanently increases the deposit insurance coverage to $250 thousand and allows depository institutions to pay interest on checking accounts;

• Creates a new consumer financial protection bureau that has rulemaking authority for a wide range of consumer protection laws that would apply to all banks and would have broad powers to supervise and enforce consumer protection laws;

• Provides for new disclosure and other requirements relating to executive compensation and corporate governance;

• Changes standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries;

• Provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will

9

	apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and
•	Creates a financial stability oversight council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.

We can give no assurance that future changes in laws and regulations or changes in their interpretation will not adversely affect our business.

We cannot predict how changes in technology will impact our business.

The financial services market, including banking services, is increasingly affected by advances in technology, including developments in:

• telecommunications;

• data processing;

• automation;

• internet-based banking, including fraud and computer virus protection;

• consumer check capture;

• social media;

• telephone and mobile banking; and

• debit cards and so-called “smart cards.”

Our ability to compete successfully in the future will depend on whether we can anticipate and respond to technological changes. To develop these and other new technologies, we will likely have to make additional capital investments. Although we continually invest in new technology, we cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain competitive in the future.

The Company’s information systems may experience an interruption or breach in security.

The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer-relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company’s information systems could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny or expose the Company to civil litigation and possible financial liability; any of which could have a material adverse affect on the Company’s financial condition and results of operations. In addition, with the advent of new delivery channels in banking including, but not limited to, internet banking and mobile banking, the risk of financial fraud is increased.

ITEM 1B. UNRESOLVED STAFF COMMENTS

There are no unresolved staff comments.

ITEM 2. DESCRIPTION OF PROPERTY

The Bank owns its main office in Bernardsville, New Jersey and branch office in Long Valley, New Jersey, and leases its Madison, Mendham, Morristown and Summit, New Jersey branch offices.

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The following table sets forth certain information regarding the properties of the Bank:

Owned Properties
Location	Square Feet
Bernardsville	14,000
Long Valley	1,200

Leased Properties
Location	Square Feet		Monthly Rental			Expiration of Term
Madison		4,000		$	11,241		2016
Mendham		2,500			7,500		2015
Morristown		2,379			4,758		2013
Summit		4,016			9,625		2014

ITEM 3. LEGAL PROCEEDINGS

We 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 business of the Company and the Bank. Management does not believe that there is any pending or threatened proceeding against the Company or the Bank, which if determined adversely, would have a material effect on the business or financial position of the Company.

ITEM 4. MINE SAFETY DISCLOSURE

Not applicable

PART II

ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company’s common stock is currently traded on Nasdaq Global Market under the symbol “SOMH.”

The following table shows the high and low sale prices for the common stock as reported on the Nasdaq from January 1, 2010 through December 31, 2011.

	Sales Price(1)						Dividends Declared
	High			Low
2011
First Quarter.		$	10.18		$	8.50		$	0.06
Second Quarter			9.24			8.05			0.06
Third Quarter.			8.60			7.10			0.06
Fourth Quarter.			7.98			7.10			0.07
2010
First Quarter.		$	6.10		$	7.13		$	0.05
Second Quarter			9.42			7.62			0.05
Third Quarter.			8.80			7.75			0.05
Fourth Quarter.			9.20			8.00			0.06

(1) The prices quoted above have been adjusted, where applicable, to reflect the 5% stock dividend declared in April 2010 and paid in May 2010.

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As of December 31, 2011, there were 176 record holders of our common stock.

In February 2007, our Board of Directors adopted a stock repurchase program under which we may repurchase up to 250,000 shares of our common stock in open market or privately negotiated transactions. In October 2007 the Board increased this program by 250,000 shares and in October, 2011 the Board increased this program by another 250,000 shares. The following table shows the Company’s repurchases during the fourth quarter of 2011:

Period	Total Number of Shares Purchased		Average Price Paid per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1—October 31		—		$	—		—		325,822
November 1—November 30		6,024			7.65		6,024		319,798
December 1—December 31		10,514			7.77		10,514		309,284
Total		16,538			7.73		16,538		309,284

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA AND OTHER DATA

SELECTED CONSOLIDATED FINANCIAL DATA AND OTHER DATA
(in thousands, except per share data)

Set forth below is selected historical financial data of the Company. This information is derived in part from and should be read in conjunction with the consolidated financial statements and notes thereto presented elsewhere in this Annual Report on Form 10-K.

	Years Ended December 31,
	2011			2010			2009			2008			2007
Selected Operating Data:
Total interest income		$	13,640		$	13,473		$	13,854		$	14,988		$	17,867
Total interest expense			1,793			2,193			3,391			4,275			7,142
Net interest income			11,847			11,280			10,463			10,713			10,725
Provision for loan losses			220			125			950			515			1,031
Net interest income after provision for loan losses			11,627			11,155			9,513			10,198			9,694
Other income			2,002			2,214			2,931			1,747			2,386
Other expenses			9,627			9,640			10,109			9,780			11,159
Income before income taxes			4,002			3,729			2,335			2,165			921
Income tax expense			1,189			1,219			441			599			539
Net income			2,813			2,510			1,894			1,566			382
Dividends on preferred stock and accretion			-			-			350			-			-
Net income available to common stockholders		$	2,813		$	2,510		$	1,544		$	1,566		$	382
Basic earnings per share			$0.52			$0.46			$0.28			$0.29			$0.07
Diluted earnings per share			$0.52			$0.46			$0.28			$0.28			$0.07

Note: All per share data has been restated to reflect the 5% stock dividends declared in 2007, 2008 and 2010.

Selected Financial Data:	At December 31,
	2011				2010				2009				2008				2007
Total Assets		$	364,447			$	328,896			$	330,110			$	299,663			$	285,470
Net Loans			229,503				204,271				203,657				208,427				205,257
Total Deposits			314,714				276,541				279,125				249,760				244,673
Stockholders’ Equity			40,369				39,391				38,200				37,529				36,621
Selected Financial Ratios:
Return on Average Assets (ROA)			0.83	%			0.80	%			0.61	%			0.56	%			0.13	%
Return on Average Equity (ROE)			6.98	%			6.37	%			4.65	%			4.24	%			1.01	%
Tangible Common Equity to Total Assets at Year-End			11.08	%			11.98	%			11.57	%			12.52	%			12.83	%

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements in this document discuss future expectations, contain projections or results of operations or financial conditions or state other “forward-looking” information. Those statements are subject to known and unknown risk; uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. We based the forward-looking statements on various factors and using numerous assumptions. Important factors that may cause actual results to differ from those contemplated by forward-looking statements include those disclosed under Item 1A – Risk Factors as well as the following factors:

• the success or failure of our efforts to implement our business strategy;

• the effect of changing economic conditions and, in particular, changes in interest rates;

• changes in government regulations, tax rates and similar matters;

• our ability to attract and retain quality employees; and

• other risks which may be described in our future filings with the SEC.

We do not promise to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2011 contains a summary of the Company’s significant accounting policies. Management believes the Company’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 of the Company.

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

OVERVIEW AND STRATEGY

The Company serves as a holding company for the Bank, which is its primary asset and only operating subsidiary. The Bank conducts a traditional banking business, making commercial loans, consumer loans, and residential and commercial real estate loans. In addition, the Bank offers various non-deposit products through non- proprietary

14

relationships with third party vendors. The Bank relies primarily upon deposits as the funding source for its assets. The Bank offers traditional deposit products. In addition, as an alternative to traditional certificate of deposit accounts, the Bank offers its Paramount Checking Account, a retail interest paying checking account which also provides a suite of additional services, such as free checks, free telephone banking and free bill payment, free safe deposit box and refunds for foreign ATM fees. Although the rate the Bank pays on the Paramount Checking Account may be higher than the rate offered on interest paying checking accounts by many of the Bank’s competitors, management believes the account has helped to reduce the Bank’s overall cost of funds and has been an integral part of the Bank’s core account acquisition strategy. Core accounts consist of noninterest-bearing deposits-demand, NOW, money market and savings accounts. Paramount Checking Account balances are generally higher than other account balances, and the account helps the Bank develop an overall relationship with its customers, which frequently leads to cross-selling opportunities, which the Bank actively pursues through direct mailings and other special promotions. Another component to the Bank’s core account acquisition strategy is the generation of deposit accounts which result from new commercial loan customers who move their deposit relationship to the Bank and the continued expansion of the Bank’s Escrow Ease product. Escrow Ease is specially designed to meet the trust account needs of attorneys, realtors and title companies. At December 31, 2011, the core account balances represented 87.0% of total deposit balances.

Through its Sullivan Financial Services subsidiary (“Sullivan”), the Bank also engages in mortgage banking operations, originating loans primarily for resale into the secondary market and, to a lesser extent, for the Bank’s loan portfolio. We treat the operations of Sullivan as a separate reporting segment apart from our community banking business. See Note 12 to the accompanying Audited Financial Statements for financial information on our business segments.

The Company’s results of operations depend primarily on its net interest income, which is the difference between the interest earned on its interest-earning assets and the interest paid on funds borrowed to support those assets, primarily deposits. Net interest margin is the difference between the weighted average rate received on interest-earning assets and the weighted average rate paid on interest-bearing liabilities, and is also affected by the average level of interest-earning assets as compared with that of interest-bearing liabilities. Net income is also affected by the amount of non-interest income and non-interest expenses.

RESULTS OF OPERATIONS - 2011 versus 2010

Net Income

Net income for 2011 was $2.813 million, up $303,000, or 12.1%, from $2.510 million in 2010. Diluted earnings per share was $0.52 for 2011, a 13.0% increase from $0.46 in 2010. The significant improvement in both net income and earnings per share for 2011 versus 2010 was due primarily to higher net interest income, lower staff-related costs, and lower occupancy expenses partially offset by lower gains on sale of residential mortgages. Also impacting 2011 were two significant items: a $267,000 tax-free BOLI death benefit and a $426,000 pretax ($256,000 after taxes) charge on the early extinguishment of certain of the Bank’s Federal Home Loan Bank borrowings.

Net Interest Income

Net interest income on a fully taxable equivalent basis for 2011 totaled $12.044 million, an increase of $547,000, or 4.8%, from $11.497 million earned in 2010. The increase in net interest income in 2011 was primarily attributable to an 8.3% increase in average interest-earning assets, to $318.9 million in 2011 from $294.3 million in 2010, and was partially offset by a 14 basis point decline, to 3.84% in 2011 from 3.98% in 2010, in the net interest margin. The increase in average interest-earning assets was largely due to a growth in average loans, primarily funded by growth in core deposits. Average loans grew by 8.4% to $223.9 million in 2011 from $206.6 million in 2010, while average core deposits (defined as all deposits other than time deposits) grew by 12.3% to $246.5 million in 2011 from $219.5 million in 2010. The excess of growth in core deposits over growth in loans increased the Bank’s average cash and due from banks balances by $6.8 million. The decrease in net interest margin in 2011 versus 2010 was due to the aforementioned increase in cash and due from banks, which was predominantly invested at low overnight rates, as well as the re-pricing characteristics of our loans and investment securities, which re-priced downward at a faster pace than our deposits.

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Average Balance Sheets

The following table sets forth certain information relating to the Company’s average assets and liabilities for the years ended December 31, 2011, 2010, and 2009, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Securities available for sale are reflected in the following table at amortized cost. Non-accrual loans are included in the average loan balance.

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	For the years ended December 31, (dollars in thousands)
	2011										2010										2009
	Average Balance				Interest			Average Yield/Cost			Average Balance				Interest			Average Yield/Cost			Average Balance				Interest			Average Yield/Cost
ASSETS
Interest Earning Assets:
Interest earning deposits		$	45,602			$	135		0.30	%		$	38,789			$	119		0.31	%		$	33,106			$	89		0.27	%
Loans receivable			223,937				11,776		5.26				206,639				11,357		5.50				208,840				11,501		5.51
Investment securities			46,421				1,780		3.83				44,550				1,980		4.44				44,441				2,228		5.01
Loans held for sale			1,989				103		5.22				3,429				187		5.46				4,056				219		5.40
Restricted stock			902				43		4.79				938				47		5.05				900				45		5.05
Federal funds sold			-				-		-				-				-		-				442				2		0.35
Total interest earning assets			318,851				13,837		4.34	%			294,345				13,690		4.65	%			291,785				14,084		4.83	%
Non-interest earning assets			23,699										23,126										21,784
Allowance for loan losses			(2,968	)									(3,160	)									(2,779	)
TOTAL ASSETS		$	339,582									$	314,311									$	310,790
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest Bearing Liabilities:
Interest bearing demand deposits		$	145,012			$	535		0.37	%		$	131,368			$	786		0.60	%		$	118,130			$	1,074		0.91	%
Savings accounts			7,851				14		0.19				6,940				19		0.27				6,082				20		0.33
Money market accounts			20,486				60		0.29				20,900				91		0.44				22,113				118		0.53
Certificates of deposit			41,494				841		2.03				43,069				926		2.15				57,681				1,808		3.13
FHLB advances			10,082				343		3.40				11,003				371		3.37				11,000				371		3.37
Other borrowings			3				-		0.73				3				-		0.73				3				-		0.51
Federal funds purchased			8				-		0.92				-				-		-				11				-		1.00
Total interest bearing liabilities			224,936				1,793		0.80	%			213,283				2,193		1.03	%			215,020				3,391		1.58	%
Non-interest bearing deposits			73,184										60,330										53,811
Other liabilities			1,154										1,325										1,277
Total liabilities			299,274										274,938										270,108
Stockholders’ Equity			40,308										39,373										40,682
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	339,582									$	314,311									$	310,790
Net Interest Income						$	12,044									$	11,497									$	10,693
Net Interest Rate Spread(1)									3.54	%									3.62	%									3.25	%
Net Interest Margin(2)									3.84	%									3.98	%									3.74	%
Ratio of Average Interest-Earning Assets to Average Interest-Bearing Liabilities			141.75	%									138.01	%									135.70	%

(1)	Net Interest Rate Spread equals Total interest earning assets yield less Total interest bearing liabilities cost.
(2)	Net Interest Margin equals Net Interest Income divided by Total average interest earning assets.

The data contained in the table has been adjusted to a tax equivalent basis, based on the Company’s federal statutory rate of 34 percent. Management believes that this presentation provides comparability of net interest income and net interest margin arising from both taxable and tax-exempt sources and is consistent with industry practice and SEC rules.

17

Rate/Volume Analysis

The following table presents, by category, the major factors that contributed to the changes in net interest income. Changes due to both volume and rate have been allocated in proportion to the relationship of the dollar amount change in each.

	Year Ended December 31, 2011 versus 2010												Year Ended December 31, 2010 versus 2009
	(in thousands)
	Increase (Decrease) due to change in Average												Increase (Decrease) due to change in Average
	Volume				Rate				Net				Volume				Rate				Net
Interest Income:
Cash and due from banks		$	21			$	(5	)		$	16			$	15			$	15			$	30
Loans			951				(532	)			419				(121	)			(23	)			(144	)
Securities			83				(283	)			(200	)			5				(254	)			(249	)
Loans held for sale			(79	)			(5	)			(84	)			(34	)			2				(32	)
Restricted stock			(2	)			(2	)			(4	)			2				-				2
Federal funds sold			-				-				-				(2	)			-				(2	)
Total interest income		$	974			$	(827	)		$	147			$	(135	)		$	(260	)		$	(395	)
Interest Expense:
Interest bearing deposits		$	82			$	(333	)		$	(251	)		$	120			$	(409	)		$	(289	)
Savings accounts			2				(7	)			(5	)			3				(4	)			(1	)
Money market accounts			(2	)			(29	)			(31	)			(6	)			(20	)			(26	)
Certificates of deposit			(34	)			(51	)			(85	)			(457	)			(425	)			(882	)
FHLB advances			(31	)			3				(28	)			-				-				-
Federal funds purchased			-				-				-				-				-				-
Total interest expense			17				(417	)			(400	)			(340	)			(858	)			(1,198	)
Net interest income		$	957			$	(410	)		$	547			$	205			$	598			$	803

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Provision for Loan Losses

For the year ended December 31, 2011, the Company’s provision for loan losses was $220 thousand, an increase of $95 thousand from $125 thousand for the year ended December 31, 2010. The increase in provision for loan losses in 2011 versus 2010 was largely due to growth in the loan portfolio in 2011. This was in contrast to 2010 when the Bank’s originations of new loans were essentially offset by maturities and pay-downs. The Company’s asset quality metrics, such as nonaccrual loan, charge-off, and delinquency ratios remain sound relative to its competitive peer groups, and the relatively low level of loan loss provisioning during both 2011 and 2010 reflects very few new problem credits. Nevertheless, management continues to believe that there remains heightened risks in certain segments of the loan portfolio. Management regularly reviews the adequacy of its allowance and may provide for additional provisions in future periods due to increased general weakness in the economy or in our geographic trade area, deterioration or impairment of specific credits, or as management may deem necessary.

Non-Interest Income

The largest component of our non-interest income is gains on sales of mortgage loans originated by Sullivan, our mortgage company subsidiary (see “Segment Reporting”). The Company also earns non-interest revenue from additional sources such as bank-owned life insurance (“BOLI”), wealth management, fees on deposit accounts, ATM usage, wire transfer, lock box services, and safe deposit boxes.

Non-interest income was $2.002 million for the full-year 2011, down $212 thousand from $2.214 million earned during 2010. The decrease was primarily due to a $495 thousand decline in gains on sales of residential mortgage loans, due to reduced origination volume at Sullivan Financial Services, Inc., a wholly-owned mortgage banking subsidiary of the Bank. Sullivan’s loans originated for sale fell to $70.4 million in 2011 from $129.4 million in 2010, reflecting continued weakness in home sales and reduced refinance activity. Partially offsetting this decline were a $257 thousand increase in BOLI income, due principally to the above-mentioned death benefit, $9 thousand of gains on sales of investment securities and higher debit card, lock box, and wealth management revenue.

Non-Interest Expense

Management continued its focus on operating efficiency throughout 2011. Non-interest expense for 2011, which included a $426 thousand loss on debt extinguishment, was essentially flat at $9.627 million versus $9.640 million in 2010. Excluding the loss on debt extinguishment 2011 non-interest expense decreased by $439 thousand, or 4.6%, from 2010. The components of the decrease included: salaries and employee benefits, which were lower by $136 thousand, largely due to lower staff count; occupancy expense, which was lower by $162 thousand primarily due to consolidation of back office space and lower deprecation of fixed assets; advertising and business promotions, which declined by $60 thousand; and other operating expenses, which declined by $76 thousand, largely due to lower FDIC insurance premium expense due to a change in the assessment calculation method which benefited most community banks in the nation.

Income Taxes

The Company recorded provisions for income taxes of $1.2 million for both the full-year 2011 and 2010. The effective tax rates were 29.7% for 2011 and 32.7% for 2010. The decrease in the effective tax rate was due to the previously-mentioned tax free BOLI death benefit received in 2011.

FINANCIAL CONDITION

Total assets as of December 31, 2011 were $364.4 million, an increase of $35.5 million, or 10.8%, from $328.9 million at December 31, 2010. Loans receivable increased by $25.3 million to $232.5 million at year-end 2011, investments available for sale increased by $7.6 million, while total cash and cash equivalents increased by $2.4 million. The increase in total assets was predominantly funded by growth in core deposits (defined as all deposits other than time deposits), which increased by $39.0 million to $273.8 million as of year-end 2011, and was partially offset by a $3.5 million decline in Federal Home Loan Bank advances. Loan growth picked up in 2011 versus 2010 reflecting stabilizing economic conditions in the Bank’s primary market, as well as Management’s successful efforts to originate loans to credit worthy borrowers. Loan growth was strong in 2011, but was still outpaced by deposit growth

19

resulting in continued high levels of cash and cash equivalents. Cash and cash equivalents were $60.0 million and $57.6 million at year-end 2011 and 2010, respectively. At year-end 2011, the Bank’s loan pipeline was strong and Management expects continued strong loan growth into the first half of 2012.

Loan Portfolio

The Bank’s lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail customers living and working in the Bank’s market area of Somerset, Morris and Union Counties, New Jersey. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of customer service, competitive rate structures and selective marketing have enabled it to gain market entry. Bank mergers and lending restrictions at larger banks competing with the Bank have also contributed to the Bank’s success in attracting borrowers.

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, inventory and equipment and liens on commercial and residential real estate. Construction, land and land development loans include loans secured by first liens on commercial or residential properties to finance the construction or renovation of such properties. Commercial mortgages include loans secured by first liens on completed commercial properties to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Consumer loans consist primarily of home equity loans secured by 1st or 2nd liens.

During 2011, the loan portfolio was positively impacted by an increase in commercial real estate loan demand, as well as refinancing strategies employed by many of the Bank’s borrowers. With regard to new loan originations, the Bank has made a strategic decision to hold in its loan portfolio a portion of residential mortgages that meet our credit quality standards that were closed by Sullivan Financial, the Bank’s mortgage banking subsidiary.

20

The following table sets forth the classification of our loans by major category as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively:

	December 31,
	2011						2010						2009						2008						2007
	Amount			Percent of Total Loans			Amount			Percent of Total Loans			Amount			Percent of Total Loans			Amount			Percent of Total Loans			Amount			Percent of Total Loans
Commercial		$	32,206		13.9	%		$	31,556		15.2	%		$	40,102		19.4	%		$	57,600		27.3	%		$	60,264		28.9	%
Construction, land and land development			7,505		3.2				7,489		3.6				7,540		3.7				6,945		3.3				7,502		3.6
Commercial mortgages			113,148		48.7				98,183		47.4				100,118		48.4				84,578		40.1				81,849		39.3
Residential mortgages			37,360		16.1				26,907		13.0				11,656		5.6				12,718		6.0				9,652		4.6
Consumer			42,074		18.1				42,864		20.8				47,237		22.9				49,274		23.3				49,109		23.6
Gross Loans			232,293		100.0	%			206,999		100.0	%			206,653		100.0	%			211,115		100.0	%			208,376		100.0	%
Net deferred costs (fees)			192						147						115						131						82
Total loans			232,485						207,146						206,768						211,246						208,458
Less: Allowance for loan losses			2,982						2,875						3,111						2,819						3,201
Net loans		$	229,503					$	204,271					$	203,657					$	208,427					$	205,257

21

The following table sets forth fixed and adjustable rate loans in the loan portfolio as of December 31, 2011 in terms of contractual maturity (in thousands):

	Within One Year			1 to 5 Years			After 5 Years			Total
Loans with Fixed Rate		$	23,576		$	8,875		$	74,354		$	106,805
Loans with Adjustable Rate			33,091			66,744			25,653			125,488

Asset Quality

The Company’s principal assets are its loans. Inherent in the lending function is the risk of the borrower’s inability to repay a loan under its existing terms. The Company attempts to minimize overall credit risk through loan diversification and its loan approval procedures. Due diligence begins at the time a borrower and the Company begin to discuss the origination of a loan. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source and timing of the repayment of the loan, and other factors are analyzed before a loan is submitted for approval. Loans made are also subject to periodic audit and review.

Non-performing assets include non-accrual loans, loans delinquent 90 days or more and still accruing and other real estate owned (“OREO”). Generally, a loan is placed on non-accrual status when principal or interest is past due for a period of 90 days or more, unless the asset is both well secured and in the process of collection. When a loan is classified as non-accrual, interest accruals discontinue and all past due interest, including interest applicable to prior periods, is reversed and charged against current income. OREO refers to real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure. The OREO property is recorded at the lower of cost or estimated fair value at the time of acquisition. Estimated fair value generally represents the estimated sale price based on current market conditions, less estimated costs to sell the property. Holding costs and declines in estimated fair value result in charges to expense after acquisition.

In limited situations the Company will modify or restructure a borrower’s existing loan terms and conditions. A restructured loan is considered a troubled debt restructuring (“TDRs”) when the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower in modifying or renewing a loan that the institution would not otherwise consider. As of December 31, 2011, the Company had one TDR totaling $344 thousand, which is currently performing under its restructured terms.

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The following table sets forth information concerning the Company’s non-performing assets and TDRs as of the dates indicated:

	December 31,
	2011			2010			2009			2008			2007
	(in thousands)
Non-accrual loans		$	146		$	254		$	256		$	1,365		$	3,036
Loans past due 90 days and still accruing			-			-			-			-			-
Total non-performing loans		$	146		$	254		$	256		$	1,365		$	3,036
OREO			-			-			-			-			-
Total non-performing assets		$	146		$	254		$	256		$	1,365		$	3,036
Troubled debt restructured loans		$	344		$	738		$	394		$	-		$	-
Non-performing loans to total loans			0.06%			0.12%			0.12%			0.65%			1.46%
Non-performing assets to total assets			0.04%			0.08%			0.08%			0.46%			1.06%
Allowance for loan losses as a percentage of non-performing loans			2,042%			1,132%			1,215%			207%			105%

Other than as disclosed in the table above and impaired loans (as disclosed in Note 3 to the Company’s Consolidated Financial Statements), there were no loans where information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans in the table above.

As of December 31, 2011 and 2010, there were no concentrations of loans exceeding 10% of the Company’s total loans. The Company’s loans are primarily to businesses and individuals located in northern and central New Jersey.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level considered adequate to provide for probable incurred loan losses. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. The Company’s officers analyze risks within the loan portfolio on a continuous basis, through an external independent loan review function, and by the Company’s Audit Committee. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the Company’s allowance for loan losses.

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The following is a summary of the reconciliation of the allowance for loan losses for the periods indicated:

	2011				2010				2009				2008				2007
	(in thousands)
Balance, beginning of year		$	2,875			$	3,111			$	2,819			$	3,201			$	2,170
Charge-offs
Commercial and industrial			(125	)			(389	)			(656	)			(898	)			-
Real Estate			-				-				-				-				-
Consumer			(2	)			(6	)			(7	)			(3	)			(1	)
Total Charge-offs			(127	)			(395	)			(663	)			(901	)			(1	)
Recoveries
Commercial and Industrial			14				34				-				-				-
Real Estate			-				-				-				-				-
Consumer			-				-				5				4				1
Total Recoveries			14				34				5				4				1
Provision charged to expense			220				125				950				515				1,031
Balance, end of year		$	2,982			$	2,875			$	3,111			$	2,819			$	3,201
Ratio of net charge-offs to average loans outstanding			0.05%				0.17%				0.32%				0.43%				-%
Balance of allowance as a percentage of total loans at end of year			1.28%				1.39%				1.50%				1.33%				1.54%

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The following table sets forth, for each of the Company’s major lending areas, the amount and percentage of the Company’s allowance for loan losses attributable to such category, and the percentage of total loans represented by such category, as of the periods indicated:

	Allocation of the Allowance for Loan Losses by Category For the years ended December 31, (dollars in thousands)
	2011									2010									2009									2008									2007
	Amount			% of ALL			% of total loans			Amount			% of ALL			% of total loans			Amount			% of ALL			% of total loans			Amount			% of ALL			% of total loans			Amount			% of ALL			% of total loans
Balance applicable to:
Commercial and commercial real estate		$	2,186		73.3	%		65.8	%		$	2,109		73.4	%		66.2	%		$	2,503		80.4	%		71.5	%		$	2,240		79.5	%		70.7	%		$	2,658		83.0	%		71.8	%
Residential real estate			215		7.2			16.1				205		7.1			13.0				65		2.1			5.6				64		2.3			6.0				48		1.5			4.6
Consumer, installment and home equity loans			531		17.8			18.1				506		17.6			20.8				537		17.3			22.9				489		17.3			23.3				485		15.2			23.6
Sub-total		$	2,932		98.3			100.0			$	2,820		98.1			100.0			$	3,105		99.8			100.0			$	2,793		99.1			100.0			$	3,191		99.7			100.0
Unallocated reserves			50		1.7			-				55		1.9			-				6		0.2			-				26		0.9			-				10		0.3			-
TOTAL		$	2,982		100.0	%		100.0	%		$	2,875		100.0	%		100.0	%		$	3,111		100.0	%		100.0	%		$	2,819		100.0	%		100.0	%		$	3,201		100.0	%		100.0	%

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Investment Securities

The Company maintains an investment portfolio to fund increased loan demand or deposit withdrawals and other liquidity needs and to provide an additional source of interest income. The portfolio is composed of obligations of U.S. Government Agencies, obligations of U.S. States and Political Subdivisions and corporate debt securities, stock in the Federal Home Loan Bank, and equity securities of another financial institution. Corporate debt securities consist of trust preferred securities and corporate debt securities issued by various large-capitalization financial institutions.

Securities are classified as “held-to-maturity” (HTM), “available for sale” (AFS), or “trading” at time of purchase. Securities are classified as HTM based upon management’s intent and the Company’s ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts. Securities which are bought and held principally for resale in the near term are classified as trading securities, which are carried at market value. Realized gains and losses as well as gains and losses from marking the portfolio to market value are included in trading revenue. The Company has no trading securities. Securities not classified as HTM or trading securities are classified as AFS and are stated at fair value. Unrealized gains and losses on AFS securities are excluded from results of operations, and are reported as a component of accumulated other comprehensive (loss) income, net of taxes, which is included in stockholders’ equity. Securities classified as AFS include securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital, or other similar requirements.

Management determines the appropriate classification of securities, whether AFS or HTM, at the time of purchase. The carrying value of our available for sale investment securities portfolio increased by $7.6 million from year-end 2010 to $43.6 million at year-end 2011. This increase was primarily due to purchases of general obligation bonds and mortgage-backed securities issued by U.S. Government sponsored agencies. The carrying value of our held to maturity investment securities portfolio remained constant at $10.7 million over the course of 2011. The following table sets forth both the amortized cost and the estimated fair value of the Company’s investment securities portfolio as of the dates indicated.

	At December 31,
	(in thousands)
	2011						2010						2009
	Amortized Cost			Estimated Fair Value			Amortized Cost			Estimated Fair Value			Amortized Cost			Estimated Fair Value
Available for sale
U.S. Government sponsored agency securities		$	14,560		$	14,753		$	9,051		$	9,023		$	5,500		$	5,502
Mortgage backed securities			22,775			23,814			18,909			19,847			22,394			23,292
Collateralized mortgage obligations			2,677			2,734			5,583			5,677			5,284			5,421
Corporate debt securities			2,372			2,278			1,470			1,446			-			-
Total available for sale			42,384			43,579			35,013			35,993			33,178			34,215
Held to maturity
Obligations of US States and Political Subdivisions			9,228			9,640			9,227			9,209			10,748			10,787
Corporate debt securities			1,510			1,209			1,513			1,339			1,514			1,196
Total held to maturity			10,738			10,849			10,740			10,548			12,262			11,983
Total securities		$	53,122		$	54,428		$	45,753		$	46,541		$	45,440		$	46,198

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The following table sets forth as of December 31, 2011 and December 31, 2010, the maturity distribution of the Company’s debt investment portfolio:

	Maturity of Debt Investment Securities Securities Available for Sale ($ in thousands)
	December 31, 2011									December 31, 2010
	Amortized Cost			Estimated Fair Value			Weighted Average Yield			Amortized Cost			Estimated Fair Value			Weighted Average Yield
Within 1 year		$	1,032		$	1,034		0.52	%		$	-		$	-		-	%
1 to 5 years			8,628			8,661		1.43	%			4,744			4,781		1.52	%
Over 5 years			32,724			33,884		3.12	%			30,269			31,212		3.97	%
		$	42,384		$	43,579					$	35,013		$	35,993

	Maturity of Debt Investment Securities Securities Held to Maturity ($ in thousands)
	December 31, 2011									December 31, 2010
	Amortized Cost			Estimated Fair Value			Weighted Average Yield (1)			Amortized Cost			Estimated Fair Value			Weighted Average Yield (1)
Within 1 year		$	375		$	378		4.71	%		$	-		$	-		-	%
1 to 5 years			706			611		2.11	%			581			608		4.98	%
Over 5 year			9,657			9,860		5.95	%			10,159			9,940		5.67	%
		$	10,738		$	10,849					$	10,740		$	10,548

(1) Weighted average yield, where applicable, is reflected on a tax equivalent basis.

Deposits

Deposits are the Company’s primary source of funds. Average total deposits increased $25.4 million, or 9.7%, to $288.0 million in 2011 from $262.6 million in 2010. The increase in deposits in 2011 was largely due to growth in demand deposits (both interest- and noninterest-bearing), which increased by $26.5 million, or 13.8%, to $218.2 million in 2011 from $191.7 million in 2010. Partially offsetting the increase in demand deposits was a decline in time deposits, which declined by $1.6 million, or 3.7%, to $41.5 million in 2011 from $43.1 million in 2010. This shift in deposit composition helped the bank by reducing its overall cost of deposits.

The following table sets forth the average amount of various types of deposits for each of the periods indicated:

	Year Ended December 31, ($ in Thousands)
	2011						2010						2009
	Average Amount			Average Yield/Rate			Average Amount			Average Yield/Rate			Average Amount			Average Yield/Rate
Non-interest bearing demand		$	73,184		-			$	60,330		-			$	53,811		-
Interest bearing demand			145,012		0.37	%			131,368		0.60	%			118,130		0.91	%
Savings and money market			28,337		0.26	%			27,840		0.39	%			28,195		0.49	%
Time deposits			41,494		2.03	%			43,069		2.15	%			57,681		3.13	%
		$	288,027		0.50	%		$	262,607		0.69	%		$	257,817		1.17	%

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The Company does not typically rely on short-term deposits of $100,000 or more because of the liquidity risks posed by such deposits. The following table summarizes the maturity distribution of time deposits in denominations of $100,000 or more as of December 31, 2011 (in thousands).

Three months or less	$	2,795
Over three months through six months		2,986
Over six months through twelve months		4,202
Over twelve months		10,048
Total	$	20,031

Liquidity

The Company’s liquidity is a measure of its ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. The Company’s principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition.

At December 31, 2011, the amount of liquid assets remained at a level management deemed adequate to ensure that, on a short- and long-term basis, contractual liabilities, depositors’ withdrawal requirements, and other operational and customer credit needs could be satisfied. As of December 31, 2011, liquid assets (cash and due from banks, interest bearing deposits at other banks and unencumbered investment securities) were $98.5 million, which represented 27.0% of total assets and 31.3% of total deposits and borrowings.

The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of December 31, 2011, had the ability to borrow $76.7 million. The Bank also has a credit facility with the Federal Reserve Bank of New York for direct discount window borrowings that had, as of December 31, 2011, an approximate borrowing capacity based on pledged collateral of $10.4 million. In addition, the Bank has in place additional borrowing capacity of $18.5 million through correspondent banks. At December 31, 2011, the Bank had aggregate available and unused credit of $98.1 million, which represents the aforementioned facilities totaling $105.6 million net of $7.5 million in outstanding borrowings. At December 31, 2011 outstanding commitments for the Bank to extend credit were $86.4 million.

Off-Balance Sheet Arrangements

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

The following table shows the amounts and expected maturities of significant commitments, as of December 31, 2011. Further discussion of these commitments is included in Note 11 to the Consolidated Financial Statements.

	One Year or Less			One to Three Years			Three to Five Years			Over Five Years			Total
	(in thousands)
Standby letters of credit		$	1,724		$	-		$	-		$	-		$	1,724

Commitments under standby letters of credit, both financial and performance, do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.

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CONTRACTUAL OBLIGATIONS

The following table shows the contractual obligations of the Company by expected payment period, as of December 31, 2011. Further discussion of these commitments is included in Notes 10 and 11 to the Consolidated Financial Statements.

Contractual Obligation	Total			Less than one year			1-3 years			3-5 years			More than 5 years
	(in thousands)
Operating Lease Obligations		$	1,407		$	397		$	678		$	332		$	-
Federal Home Loan Bank Borrowings			7,500			-			-			-			7,500

Operating leases represent obligations entered into by the Company for the use of land, premises and equipment. The leases generally have escalation terms based upon certain defined indexes.

Interest Rate Sensitivity Analysis

The principal objective of the Company’s asset and liability management function is to evaluate the interest-rate risk included in certain balance sheet accounts; determine the level of risk appropriate given the Company’s business focus, operating environment, and capital and liquidity requirements; establish prudent asset concentration guidelines; and manage the risk consistent with Board approved guidelines. The Company seeks to reduce the vulnerability of its operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Committee (the “ALCO”). The ALCO generally reviews the Company’s liquidity, cash flow needs, maturities of investments, deposits and borrowings, and current market conditions and interest rates.

The Company currently utilizes net interest income simulation and economic value of portfolio equity (“EVPE”) models to measure the potential impact to the Company of future changes in interest rates. As of December 31, 2011 and 2010 the results of the models were within guidelines prescribed by the Company’s Board of Directors. If model results were to fall outside prescribed ranges, action would be required by the ALCO.

The net interest income simulation model attempts to measure the change in net interest income over the next one-year period assuming certain changes in the general level of interest rates. In our model, which was run as of December 31, 2011, we estimated that a gradual (often referred to as “ramped”) 200 basis-point increase in the general level of interest rates will increase our net interest income by 0.1%, while a ramped 200 basis-point decrease in interest rates will decrease net interest income by 1.7%. As of December 31, 2010, our model predicted that a 200 basis point ramped increase in general interest rates would increase net interest income by 0.9%, while a 200 basis point decrease would decrease net interest income by 1.6%.

An EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of up and down 200 basis points. The economic value of equity is likely to be different as interest rates change. The Company’s variance in EVPE as a percentage of assets as of December 31, 2011, was -1.25% with a rate shock of up 200 basis points, and -0.34% with a rate shock of down 200 basis points. At December 31, 2010, the variances were -1.09% assuming an up 200 basis points rate shock and +0.03% assuming a down 200 basis points rate shock.

Capital

A significant measure of the strength of a financial institution is its capital base. The Bank’s Federal regulators have classified and defined capital into the following components: (1) Tier I Capital, which includes tangible stockholders’ equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) Tier II Capital, which includes a portion of the allowance for probable loan losses, certain qualifying long-term debt, and preferred stock which does not qualify for Tier I Capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines which require certain capital as a percent of the Bank’s assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets).

A bank is required to maintain, at a minimum, Tier I Capital as a percentage of risk-adjusted assets of 4.0% and combined Tier I and Tier II Capital as a percentage of risk-adjusted assets of 8.0%.

29

In addition to the risk-based guidelines, the Bank’s regulators require that an institution which meets the regulator’s highest performance and operation standards maintain a minimum leverage ratio (Tier I Capital as a percentage of average tangible assets) of 4.0%. For those institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be evaluated through the ongoing regulatory examination process.

The following table summarizes the risk-based and leverage capital ratios for the Bank as well as the required minimum regulatory capital ratios:

	At December 31, 2011
	Actual Ratio			Minimum Requirement			Well Capitalized Requirement
Somerset Hills Bank:
Total risk-based capital ratio		15.03	%		8.00	%		10.00	%
Tier 1 risk-based capital ratio		13.91	%		4.00	%		6.00	%
Leverage ratio		10.16	%		4.00	%		5.00	%

	At December 31, 2010
	Actual Ratio			Minimum Requirement			Well Capitalized Requirement
Somerset Hills Bank:
Total risk-based capital ratio		15.48	%		8.00	%		10.00	%
Tier 1 risk-based capital ratio		14.28	%		4.00	%		6.00	%
Leverage ratio		10.44	%		4.00	%		5.00	%

The Company’s tangible common equity ratio was 11.08% as of December 31, 2011 and 11.98% as of December 31, 2010.

Borrowings

As an additional source of liquidity, we use advances from the Federal Home Loan Bank of New York. The Company had outstanding advances at December 31, 2011 as follows:

Maturity	Rate	Amount
November 29, 2017	3.41%		$	1,500,000
January 8, 2018	3.12%		$	2,000,000
January 8, 2018	3.61%		$	2,000,000
February 22, 2018	3.71%		$	2,000,000
			$	7,500,000

IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, nearly all of the assets and liabilities of the Company are monetary. Therefore, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

30

RECENT ACCOUNTING PRONOUNCEMENTS

For a discussion of the impact of recently issued accounting standards, please see Note 1 to the Company’s consolidated financial statements.

ITEM 8. FINANCIAL STATEMENTS

The information required by this item is included elsewhere in this Annual Report on Form 10-K. See p. 36.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

(b) Management’s report on internal control over financial reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting was designed by or under the supervision of the Company’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of the preparation of the Company’s financial statements for external and regulatory reporting purposes, in accordance with U.S. generally accepted accounting principles. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the COSO. Based on the assessment, management determined that, as of December 31, 2011, the Company’s internal control over financial reporting is effective.

The forgoing shall not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section. In addition, this information shall not be deemed to be incorporated by reference into any of the Registrant’s filings with the Securities and Exchange Commission, except as shall be expressly set forth by specific reference in any such filing.

/s/ Stewart E. McClure, Jr.	/s/ William S. Burns
Stewart E. McClure, Jr. President & CEO	William S. Burns Executive Vice President & Chief Financial Officer

(c) Changes in internal controls:

There were not any significant changes in internal controls 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.

ITEM 9B. OTHER INFORMATION

Not applicable

31

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE WITH SECTION 16(A)

Information required by this part is included in the definitive Proxy Statement for the Company’s 2012 Annual Meeting under the captions “ELECTION OF DIRECTORS” and “SECTION 16(A) BENEFICIAL OWNERSHIP REPORTS COMPLIANCE,” each of which is incorporated herein by reference. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2012.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning executive compensation is included in the definitive Proxy Statement for the Company’s 2012 Annual Meeting under the captions “EXECUTIVE COMPENSATION” and “DIRECTOR COMPENSATION”, which is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2012.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information concerning security ownership of certain beneficial owners and management is included in the definitive Proxy statement for the Company’s 2012 Annual Meeting under the caption “SECURITY OWNERSHIP OF MANAGEMENT”, which is incorporated herein by reference. It is expected that such Proxy statement will be filed with the Securities and Exchange Commission no later than April 30, 2012.

The following table sets forth information with respect to the Company’s equity compensation plans as of the end of the most recently completed fiscal year.

Equity Compensation Plan Information

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)		Weighted-average exercise price of outstanding options, warrants and rights (b)			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) (c)
Equity compensation plans approved by security holders		346,018		$	7.64		1,056
Equity compensation plans not approved by security holders		-			-		-
Total		346,018		$	7.64		1,056

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning certain relationships and related transactions is included in the definitive Proxy Statement for the Company’s 2012 Annual Meeting under the caption “INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS”, which is incorporated herein by reference. It is expected that such Proxy statement will be filed with the Securities and Exchange Commission no later than April 30, 2012.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information concerning principal accountant fees and services as well as related pre-approval policies under the caption “RATIFICATION OF INDEPENDENT AUDITORS” in the Proxy Statement for the Company’s 2012 Annual Meeting of Shareholders is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2012.

32

ITEM 15. EXHIBITS

(a) Exhibits

Exhibit number		Description of Exhibits
	3.1	Certificate of Incorporation of Somerset Hills Bancorp(1)
	3.2	Bylaws of Somerset Hills Bancorp(3)
	3.3	Certificate of Incorporation for Somerset Hills Bank(1)
	3.4	Bylaws of Somerset Hills Bank(1)
	4.1	Specimen Common Stock Certificate(1)
	10.1	2001 Combined Stock Option Plan(1)
	10.2	2007 Equity Incentive Plan(4)
	10.3	Supplemental Retirement Plan dated July 19, 2007 with Stewart E. McClure, Jr.(5)
	10.4	Form of Change in Control Agreement with Messrs. J. Nigro and W. Burns.(6)
	10.5	Employment Agreement of Stewart E. McClure, Jr. as amended(1) on May 15, 2003(6), September 26, 2007 and January 16, 2009(7)
	14	Code of Ethics(2)
	21	Subsidiaries of Somerset Hills Bancorp
	23	Consent of Crowe Horwath LLP
	31	Rule 13a-14(a)/15d-14(a) Certifications
	32	Section 1350 Certification
	101	The following materials from Somerset Hills Bancorp’s Annual Report on Form 10-K for the period ended December 31, 2012, formatted in eXtensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.
	101.INS**	XBRL Instance Document
	101.SCH**	XBRL Taxonomy Extension Schema
	101.CAL**	XBRL Taxonomy Extension Calculation Linkbase
	101.DEF**	XBRL Taxonomy Extension Definition Linkbase
	101.LAB**	XBRL Taxonomy Extension Label Linkbase
	101.PRE**	XBRL Taxonomy Extension Presentation Linkbase
	**	Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

(1)	Incorporated by reference from the Registrant’s Registration Statement on Form SB-2, as amended, File No. 333-99647, declared effective on November 12, 2002.
(2)	Incorporated by reference from Exhibit 14 from the Registrant’s Annual Report on Form10-KSB for the year ended December 31, 2003.
(3)	Incorporated by reference from Current Report on Form 8-k filed December 20, 2007.
(4)	Incorporated by reference from Exhibit 4 from the Registrant’s registration Statement on Form S-8 File No.333–143194 filed on May 23, 2007.
(5)	Incorporated by reference from Exhibits 10.1 and 10.2 of Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 and as amended as set forth in the Current Report on Form 8-K filed July 28, 2008.
(6)	Incorporated by reference from Exhibit 10.1 of Current Report on Form 8-K filed May 19, 2011.
(7)	Incorporated by reference from Exhibit 10.3 of Quarterly Report on form 10-Q for the quarter ended September 30, 2007 and Exhibit 10.4(1) and (2) to Annual Report on Form 10-K for the year ended December 31, 2010.

33

SOMERSET HILLS BANCORP AND SUBSIDIARY

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Independent Registered Public Accounting Firm		35
Consolidated Statements of Financial Condition as of December 31, 2011 and 2010		36
Consolidated Statements of Income for the Years ended December 31, 2011 and 2010		37
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2011 and 2010		38
Consolidated Statements of Cash Flows for the Years ended December 31, 2011 and 2010		39
Notes to Consolidated Financial Statements		40

34

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of
Somerset Hills Bancorp
Bernardsville, New Jersey

We have audited the accompanying consolidated statements of financial condition of Somerset Hills Bancorp and subsidiary as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit 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 audit 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 Somerset Hills Bancorp and subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

/s/ Crowe Horwath LLP

Livingston, New Jersey
March 20, 2012

35

SOMERSET HILLS BANCORP AND SUBSIDIARY

Consolidated Statements of Financial Condition
December 31, 2011 and 2010
(Dollars in Thousands)

	2011				2010
ASSETS
Cash and due from banks		$	4,588			$	5,480
Interest bearing deposits at other banks			55,411				52,086
Total cash and cash equivalents			59,999				57,566
Loans held for sale			2,928				2,230
Investment securities held to maturity (Estimated fair value of $10,849 in 2011 and $10,548 in 2010)			10,738				10,740
Investment securities available for sale			43,579				35,993
Loans receivable			232,485				207,146
Less: allowance for loan losses			(2,982	)			(2,875	)
Net loans receivable			229,503				204,271
Premises and equipment, net			4,996				5,285
Bank owned life insurance			8,000				8,053
Accrued interest receivable			1,168				1,111
Prepaid expenses			985				1,251
Other assets			2,551				2,396
Total assets		$	364,447			$	328,896
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits
Noninterest-bearing deposits-demand		$	80,532			$	68,521
Interest bearing deposits
NOW, money market and savings			193,276				166,304
Certificates of deposit, under $100,000			20,875				21,101
Certificates of deposit, $100,000 and over			20,031				20,615
Total deposits			314,714				276,541
Federal Home Loan Bank advances			7,500				11,000
Other liabilities			1,864				1,964
Total liabilities			324,078				289,505
Commitments and contingencies (notes 10 and 11)
STOCKHOLDERS’ EQUITY
Preferred stock-1,000,000 shares authorized; none issued			-				-
Common stock-authorized, 9,000,000 shares of no par value; issued and outstanding, 5,344,648 in 2011 and 5,421,924 in 2010			36,972				37,600
Retained earnings			2,608				1,145
Accumulated other comprehensive income			789				646
Total stockholders’ equity			40,369				39,391
Total liabilities and stockholders’ equity		$	364,447			$	328,896

See accompanying notes to consolidated financial statements.

36

SOMERSET HILLS BANCORP AND SUBSIDIARY

Consolidated Statements of Income
Years ended December 31, 2011 and 2010
(Dollars in thousands, except per share data)

	2011			2010
INTEREST INCOME
Loans, including fees		$	11,879		$	11,544
Investment securities			1,626			1,810
Interest bearing deposits with other banks			135			119
Total interest income			13,640			13,473
INTEREST EXPENSE
Deposits			1,450			1,822
Federal Home Loan Bank advances			343			371
Total interest expense			1,793			2,193
Net interest income			11,847			11,280
PROVISION FOR LOAN LOSSES			220			125
Net interest income after provision for loan losses			11,627			11,155
NON-INTEREST INCOME
Service fees on deposit accounts			286			299
Gains on sales of mortgage loans and fees, net			786			1,281
Bank owned life insurance			555			298
Gain on sales of investment securities, net			9			-
Other income			366			336
Total non-interest income			2,002			2,214
NON-INTEREST EXPENSE
Salaries and employee benefits			5,324			5,460
Occupancy expense			1,499			1,665
Advertising and business promotion			129			189
Stationery and supplies			128			133
Data processing			539			535
Loss on debt extinguishment			426			-
Other operating expenses			1,582			1,658
Total non-interest expense			9,627			9,640
Income before income taxes			4,002			3,729
PROVISION FOR INCOME TAXES			1,189			1,219
NET INCOME		$	2,813		$	2,510
Earnings per share:
Basic		$	0.52		$	0.46
Diluted		$	0.52		$	0.46
Weighted average shares outstanding-basic			5,409,947			5,445,049
Weighted average shares outstanding-diluted			5,459,476			5,496,910

See accompanying notes to consolidated financial statements.

37

SOMERSET HILLS BANCORP AND SUBSIDIARY

Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2011 and 2010
(Dollars in Thousands)

	Common Stock Number of Shares			Common Stock				Retained Earnings				Accumulated Other Comprehensive Income (loss), Net of tax				Comprehensive Income				Total
Balance January 1, 2010		5,179,773			$	37,334			$	182			$	684			$	-			$	38,200
Exercise of common stock options, net of tax benefit		19,878				117				-				-				-				117
Stock based compensation						35				-				-				-				35
Net income for the period						-				2,510				-				2,510				2,510
Stock dividend paid (5.00%)		259,918				429				(429	)			-				-				-
Cash dividend paid ($0.21 per share)						-				(1,118	)			-				-				(1,118	)
Common stock repurchased		(37,645	)			(315	)			-				-				-				(315	)
Other comprehensive income, net of taxes						-				-				(38	)			(38	)			(38	)
Total comprehensive income																		2,472
Balance December 31, 2010		5,421,924				37,600				1,145				646								39,391
Exercise of common stock options, net of tax benefit		34,371				210				-				-				-				210
Stock based compensation						44				-				-				-				44
Forfeiture of restricted shares		(979	)			-				-				-				-				-
Net income for the period						-				2,813				-				2,813				2,813
Cash dividend paid ($0.25 per share)						-				(1,350	)			-				-				(1,350	)
Common stock repurchased		(110,668	)			(882	)			-				-				-				(882	)
Other comprehensive income, net of taxes						-				-				143				143				143
Total comprehensive income																	$	2,956
Balance December 31, 2011		5,344,648			$	36,972			$	2,608			$	789							$	40,369

See accompanying notes to consolidated financial statements.

38

SOMERSET HILLS BANCORP AND SUBSIDIARY

Consolidated Statements of Cash Flows
Years ended December 31, 2011 and 2010
(Dollars in Thousands)

	2011				2010
OPERATING ACTIVITIES
Net income		$	2,813			$	2,510
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			604				582
Provision for loan losses			220				125
Gain on sale of investment securities, net			(9	)			-
Stock-based compensation			44				35
Mortgage loans originated for sale			(70,385	)			(129,445	)
Proceeds from mortgage loan sales			70,473				133,856
Gain on sale of mortgage loans and fees, net			(786	)			(1,281	)
(Increase) decrease in accrued interest receivable			(57	)			16
Proceeds from life insurance death benefit			267				-
Decrease (increase) in bank owned life insurance			(214	)			(297	)
Decrease in other assets			111				202
(Decrease) increase in other liabilities			(173	)			198
Net cash provided by operating activities			2,908				6,501
INVESTING ACTIVITIES
Maturity and payments of investment securities held to maturity			-				1,518
Purchases of investment securities available-for-sale			(23,401	)			(17,078	)
Maturity and payments of investment securities available-for-sale			13,905				15,133
Proceeds from sale of investment securities available-for-sale			1,934				-
Net increase in loans receivable			(25,452	)			(739	)
Purchases of premises and equipment			(112	)			(161	)
Net cash used in investing activities			(33,126	)			(1,327	)
FINANCING ACTIVITIES
Net proceeds from exercise of common stock and options, including tax benefit			210				117
Cash dividends paid common stock			(1,350	)			(1,118	)
Net increase in demand deposits and savings accounts			38,983				6,027
Net decrease in certificates of deposit			(810	)			(8,611	)
Repurchase of common stock			(882	)			(315	)
Repayment of Federal Home Loan Bank advances			(3,500	)			-
Net cash provided by (used in) financing activities			32,651				(3,900	)
Net increase in cash and cash equivalents			2,433				1,274
Cash and cash equivalents at beginning of period			57,566				56,292
Cash and cash equivalents at end of period		$	59,999			$	57,566
Supplemental information:
Cash paid during the year for:
Interest		$	1,823			$	2,282
Income taxes			1,427				1,250

See accompanying notes to consolidated financial statements.

39

SOMERSET HILLS BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2011 and 2010

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a) Basis of Financial Statement Presentation

The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (US GAAP). The financial statements include the accounts of the Company and its wholly-owned subsidiary, Somerset Hills Bank (the “Bank”) and its wholly-owned subsidiaries, Sullivan Financial Services, Inc. (“Sullivan”), Somerset Hills Wealth Management Services, LLC, Somerset Hills Investment Holdings, Inc. and SOMH Holdings, LLC. The Bank is also a 50% owner of Somerset Hills Title Group, LLC. All material intercompany balances and transactions have been eliminated in the financial statements.

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses during the reporting periods. Therefore, actual results could differ from those estimates.

The principal estimate that is particularly susceptible to significant change in the near term relates to the allowance for loan losses. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, and current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The Company has two reportable segments: community banking and mortgage banking.

b) Earnings Per Share

Basic earnings per share of common stock is calculated by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is calculated by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period plus the dilutive effect of potential common shares.

40

The following tables set forth the computations of basic and diluted earnings per share (dollars and share data in thousands):

	12 Months Ended December 31, 2011								12 Months Ended December 31, 2010
	Income (Numerator)			Shares (Denominator)		Per Share Amount			Income (Numerator)			Shares (Denominator)		Per Share Amount
Basic EPS:
Net income applicable to common stockholders		$	2,813		5,410		$	0.52		$	2,510		5,445		$	0.46
Effect of dilutive securities: Options			-		50						-		52
Diluted EPS:
Net income applicable to common stock holders and assumed conversions		$	2,813		5,460		$	0.52		$	2,510		5,497		$	0.46

The tables above exclude options with exercise prices that exceed the average market price of the Company’s common stock during the periods presented because such options would have an anti-dilutive effect on the diluted earnings per common share calculation. The number of anti-dilutive common stock options totaled 21,244 and 16,667 at December 31, 2011 and 2010, respectively.

c) Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Included in Cash and due from banks at December 31, 2011 and 2010 is $1,110,000 and $883,000, respectively, representing reserves required by banking regulations.

d) Investment Securities

Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

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.

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.

e) Stock-Based Compensation

At December 31, 2011, the Company had two stock-based plans, which are described more fully in Note 9. The Company recognizes compensation expense based on the fair value of awards under the plan at the date of the grant over the period the awards are earned.

The Company recognizes compensation expense related to stock options granted based on the fair value of such awards at the date of the grant over the period the awards are earned.

f) Loans and Allowance for Loan Losses

Loans — Loans Receivable, for all loan portfolio classes, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal, adjusted for any charge-

41

offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest on loans, for all loan portfolio classes, is accrued and credited to operations based upon the principal amounts outstanding.

Allowance for Loan Losses — The Company maintains an allowance for loan losses to absorb probable incurred losses in the loan portfolio based, for all loan portfolio classes, on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio.

The specific component incorporates the results of measuring impaired loans as required by the “Receivables” topic of the FASB Accounting Standards Codification. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered troubled debt restructurings and are also recognized as impaired. A loan is not deemed to be impaired if there is a short delay in receipt of payment. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the impairment measurement of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a partial charge-off is recorded against the allowance for loan losses.

The formula component is calculated using many factors including: (i) the Company’s historical charge-off and delinquency experience, (ii) the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and (iii) other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by loan type and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.

Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectability of the loan portfolio as of the evaluation date have changed. Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2011. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments at the time of their examinations.

Our primary market area is Morris, Somerset and Union Counties, New Jersey. Negative economic conditions in our market area could affect both depositors and borrowers, and thereby adversely affect our performance.

Nonaccrual Policy — The Company’s nonaccrual loan policy covers all loan portfolio classes. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. Loans are considered delinquent when they become 30 or more days past due. Loans are placed on non-accrual when principal or interest is delinquent for 90 days or more unless the loan is both well-secured and in the process of collection, or when management no longer expects payment in full of principal or interest. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. Loans can be returned to accruing status when they become current as to principal and interest, and when, in management’s opinion, they are estimated to be fully collectible.

42

Charge-off Policy — The Company’s charge-off policy covers all loan portfolio classes. Loans are generally charged-off at the earlier of when it is determined that collection efforts are no longer productive or when they have been identified as losses by management, internal loan review and/or bank examiners. Factors considered in determining whether collection efforts are no longer productive include any amounts currently being collected, the status of discussions or negotiations with the borrower, the principal and/or guarantors, the cost of continuing efforts to collect, the status of any foreclosure or other legal actions, the value of the collateral, and any other pertinent factors.

g) Loans Held for Sale

Residential mortgage loans funded by the Bank and held for sale in the secondary market are carried at the lower of aggregate cost or fair value. Fair value is generally determined by the value of purchase commitments. Aggregate net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Aggregate net unrealized gains, if any, are recorded in other assets and credited to income. Estimated net revenue related to commitments to fund residential mortgage loans that are expected to be sold are recorded as a receivable and credited to income. Residential mortgage loans held for sale are typically sold with servicing rights released.

h) 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 five to thirty-nine and one half years for buildings and improvements and three to 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. Significant renewals and improvements are capitalized. Maintenance and repairs are charged to operations as incurred.

i) Bank Owned Life Insurance

The Company has purchased life insurance policies on certain key executives. 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.

j) Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to temporary differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

k) Comprehensive Income

Comprehensive income includes net income and unrealized gains and losses on investment securities available for sale.

l) Foreclosed Assets

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. There were no foreclosed assets in 2011 and 2010.

m) 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 now are such matters that will have a material effect on the financial statements.

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n) Recent Accounting Pronouncements

Adoption of New Accounting Guidance

In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-20 Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU requires significantly more information about credit quality in a financial institution’s portfolio and the allowance for credit losses. The disclosure requirements are effective for interim and annual reporting periods ending on or after December 15, 2010. The impact of adoption was not material.

In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.” The provisions of ASU No. 2011-02 amend and clarify GAAP related to the accounting for debt restructurings. Specifically, ASU No. 2011-02 requires that, when evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. In evaluating whether a concession has been granted, a creditor must evaluate whether (i) a debtor has access to funds at a market rate for debt with similar risk characteristics as the restructured debt in order to determine if the restructuring would be considered to be at a below-market rate, indicating that the creditor has granted a concession, (ii) a temporary or permanent increase in the contractual interest rate as a result of a restructuring may be considered a concession because the new contractual interest rate on the restructured debt is still below the market interest rate for new debt with similar risk characteristics, and (iii) a restructuring that results in a delay in payment is either significant and is a concession or is insignificant and is not a concession. In evaluating whether a debtor is experiencing financial difficulties, a creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default. A creditor should evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without a modification of the debt. The provisions of ASU No. 2011-02 are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retroactively to the beginning of the annual period of adoption. The impact of adoption was not material.

NOTE 2 – INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities held to maturity and available for sale are as follows (in thousands):

Held to Maturity	Amortized Cost			Gross Unrecognized Gains			Gross Unrecognized Losses				Estimated Fair Value
2011
Obligations of US States and Political Subdivisions		$	9,228		$	412		$	-			$	9,640
Corporate debt securities			1,510			-			(301	)			1,209
Total held to maturity		$	10,738		$	412		$	(301	)		$	10,849

Held to Maturity	Amortized Cost			Gross Unrecognized Gains			Gross Unrecognized Losses				Estimated Fair Value
2010
Obligations of US States and Political Subdivisions		$	9,227		$	120		$	(138	)		$	9,209
Corporate debt securities			1,513			-			(174	)			1,339
Total held to maturity		$	10,740		$	120		$	(312	)		$	10,548

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Available for Sale	Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses				Estimated Fair Value
2011
Corporate debt securities		$	2,372		$	-		$	(94	)		$	2,278
U.S. Government sponsored agency securities			14,560			198			(5	)			14,753
Mortgage backed securities, residential			22,775			1,039			-				23,814
Collaterized mortgage obligations			2,677			57			-				2,734
Total available for sale		$	42,384		$	1,294		$	(99	)		$	43,579
2010
Corporate debt securities		$	1,470		$	5		$	(29	)		$	1,446
U.S. Government sponsored agency securities			9,051			15			(43	)			9,023
Mortgage backed securities, residential			18,909			940			(2	)			19,847
Collaterized mortgage obligations			5,583			94			-				5,677
Total available for sale		$	35,013		$	1,054		$	(74	)		$	35,993

The amortized cost and fair value of the Company’s investment securities held to maturity and available for sale at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).

Held to Maturity	Amortized Cost			Estimated Fair Value
Due in one year or less		$	375		$	378
Due in one to five years			706			611
Due in five years to ten years			2,015			2,140
Due after ten years			7,642			7,720
		$	10,738		$	10,849
Available for Sale
Due in one year or less		$	1,032		$	1,034
Due in one year to five years			7,928			7,942
Due in five years to ten years			4,446			4,531
Due after ten years			3,526			3,524
Mortgage Backed Securities and Collateralized Mortgage Obligations			25,452			26,548
		$	42,384		$	43,579

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Gross unrealized losses on securities and the estimated fair value of the related securities aggregated by securities category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2011 and 2010 are as follows:

2011	Less than 12 months						12 Months or longer						Total
Held to Maturity	Estimated Fair Value			Unrecognized Losses			Estimated Fair Value			Unrecognized Losses			Estimated Fair Value			Unrecognized Losses
Corporate debt securities		$	450		$	62		$	759		$	239		$	1,209		$	301
Total		$	450		$	62		$	759		$	239		$	1,209		$	301

2010	Less than 12 months						12 Months or longer						Total
Held to Maturity	Estimated Fair Value			Unrecognized Losses			Estimated Fair Value			Unrecognized Losses			Estimated Fair Value			Unrecognized Losses
Municipal securities		$	3,708		$	98		$	279		$	40		$	3,987		$	138
Corporate debt securities			503			11			836			163			1,339			174
Total		$	4,211		$	109		$	1,115		$	203		$	5,326		$	312

2011	Less than 12 months						12 Months or longer						Total
Available for Sale	Estimated Fair Value			Unrealized Losses			Estimated Fair Value			Unrealized Losses			Estimated Fair Value			Unrealized Losses
U.S. Government sponsored agency securities		$	3,010		$	5		$	-		$	-		$	3,010		$	5
Corporate debt securities			1,352			20			926			74			2,278			94
Total		$	4,362		$	25		$	926		$	74		$	5,288		$	99

2010	Less than 12 months						12 Months or longer						Total
Available for Sale	Estimated Fair Value			Unrealized Losses			Estimated Fair Value			Unrealized Losses			Estimated Fair Value			Unrealized Losses
U.S. Government sponsored agency securities		$	5,576		$	43		$	-		$	-		$	5,576		$	43
Mortgage backed securities, residential			1,004			2			-			-			1,004			2
Corporate debt securities			971			29			-			-			971			29
Total		$	7,551		$	74		$	-		$	-		$	7,551		$	74

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At December 31, 2011, there were $1.7 million in securities with gross unrecognized losses that have been in a continuous unrealized loss position for twelve or more months. Unrealized losses on these securities have not been recognized into income because the issuer(s) bonds are investment grade, management does not intend to sell and it is not likely that management will be required to sell the securities prior to their anticipated recovery. The decline in fair value is largely a result of the securities of these issuers falling out of favor in the broader bond market. The fair value is expected to recover as the bond(s) approach maturity.

For the year ended December 31, 2011 the gross proceeds on sales of securities was approximately $1.9 million. For the year ended December 31, 2011 the gross gain on sales of securities was approximately $20,000. There was $11,000 in gross losses on sales of securities for the year ended December 31, 2011. The tax benefit (provision) related to these net realized gains and losses was $3,000. There was no sale of securities for the year ended December 31, 2010.

Securities with an amortized cost of $974 thousand and $983 thousand were pledged to secure public funds on deposit at December 31, 2011 and 2010, respectively.

The Company is a member of the Federal Home Loan Bank of New York (FHLBNY) and Atlantic Central Bankers Bank. As a result, the Company is required to hold shares of capital stock of FHLBNY as well as Atlantic Central Bankers Bank, which are carried at cost, based upon a specified formula.

NOTE 3 – LOANS

Loans are summarized as follows (in thousands):

	December 31,
	2011				2010
Commercial		$	32,206			$	31,556
Commercial mortgage			113,148				98,183
Construction, land and land development			7,505				7,489
Consumer			42,074				42,864
Residential			37,360				26,907
Gross loans			232,293				206,999
Net deferred costs			192				147
Less: Allowance for loan losses			(2,982	)			(2,875	)
Total		$	229,503			$	204,271

The portfolio classes in the above table have unique risk characteristics with respect to credit quality:

• The repayment of commercial loans is generally dependent on the creditworthiness and cash flow of borrowers and, if applicable, guarantors, which may be negatively impacted by adverse economic conditions. While the majority of these loans are secured, collateral type, marketability, coverage, valuation and monitoring is not as uniform as in other portfolio classes and recovery from liquidation of such collateral may be subject to greater variability.

• Payment on commercial mortgages is driven principally by operating results of the managed properties or underlying businesses and secondarily by the sale or refinance of such properties. Both primary and secondary sources of repayment, and value of the properties in liquidation, may be affected to a greater extent by adverse conditions in the real estate market or the economy in general.

• Properties underlying construction, land and land development loans often do not generate sufficient cash flow to service debt and thus repayment is subject to the ability of the borrower and, if applicable, guarantors, to complete development or construction of the property and carry the project, often for extended periods of time. As a result, the performance of these loans is contingent upon future events whose probability at the time of origination is uncertain.

• The ability of borrowers to service debt in the residential and consumer loan portfolios is generally subject to personal income which may be impacted by general economic conditions, such as increased unemployment

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levels. These loans are predominantly collateralized by first and second liens on single family properties. If a borrower cannot maintain the loan, the Company’s ability to recover against the collateral in sufficient amount and in a timely manner may be significantly influenced by market, legal and regulatory conditions.

The following table presents information about impaired loans by loan portfolio class as of December 31, 2011 and 2010 (in thousands):

Impaired Loans

2011	Unpaid Principal Balance			Recorded Investment			Related Allowance
With no related allowance recorded:
Commercial		$	-		$	-		$	-
Commercial mortgage			765			768			-
Construction, land and land development			-			-			-
Consumer			146			146			-
Residential			-			-			-
With an allowance recorded:
Commercial			-			-			-
Commercial mortgage			344			344			11
Construction, land and land development			-			-			-
Consumer			-			-			-
Residential			-			-			-
Total:
Commercial			-			-			-
Commercial mortgage			1,109			1,112			11
Construction, land and land development			-			-			-
Consumer			146			146			-
Residential			-			-			-

2010	Unpaid Principal Balance			Recorded Investment			Related Allowance
With no related allowance recorded:
Commercial		$	-		$	-		$	-
Commercial mortgage			782			787			-
Construction, land and land development			-			-			-
Consumer			-			-			-
Residential			-			-			-
With an allowance recorded:
Commercial			217			217			5
Commercial mortgage			992			862			134
Construction, land and land development			-			-			-
Consumer			-			-			-
Residential			-			-			-
Total:
Commercial			217			217			5
Commercial mortgage			1,774			1,649			134
Construction, land and land development			-			-			-
Consumer			-			-			-
Residential			-			-			-

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	Twelve months ended December 31
	2011			2010
Average of individually impaired loans during period:
Commercial		$	71		$	775
Commercial mortgage			1,643			1,815
Construction, land and land development			-			457
Consumer			49			90
Residential			-			-
Interest income recognized during impairment:
Commercial		$	4		$	35
Commercial mortgage			89			116
Construction, land and land development			-			17
Consumer			1			-
Residential			-			-

There was no cash-basis interest income recognized on any loans for the twelve months ended December 31, 2011 and 2010, respectively.

The outstanding balances of non-accrual loans, loans past due 90 days and still accruing, other real estate owned, and troubled debt restructured loans as of year-end were as follows (in thousands):

	2011			2010
Nonaccrual loans		$	146		$	254
Loans past due 90 days and still accruing			-			-
Total non-performing loans			146			254
OREO			-			-
Total non-performing assets		$	146		$	254
Troubled debt restructured loans		$	344		$	738

The following table presents loans receivable on nonaccrual status by loan portfolio class as of December 31, 2011 and 2010, respectively (in thousands):

Nonaccrual loans	2011			2010
Commercial		$	-		$	-
Commercial mortgage			-			254
Construction, land and land development			-			-
Consumer			146			-
Residential			-			-
Total		$	146		$	254

The balance of troubled debt restructured loans at year-end 2011 is represented by one credit that is currently performing under its restructured terms and for which the Company has no commitment to lend additional funds. The balance of troubled debt restructured loans at year-end 2010 is represented by two credits performing under their restructured terms and for which the Company has no commitment to lend additional funds. There were no TDR’s during 2011 that did not perform in accordance with their modified terms.

During the twelve months ended December 31, 2011 there were no new loans modified as troubled debt restructurings.

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The following table presents past due and current loans by the loan portfolio class as of December 31, 2011 and 2010, respectively (in thousands):

	30-59 days past due			60-89 days past due			Greater than 90 Days past due			Total past due			Current			Total loans receivable			Loans past due 90 days and still accruing
2011
Commercial		$	-		$	259		$	-		$	259		$	31,947		$	32,206		$	-
Commercial mortgage			-			468			-			468			112,680			113,148			-
Construction, land and land development			-			-			-			-			7,505			7,505			-
Consumer			-			148			146			294			41,780			42,074			-
Residential			-			-			-			-			37,360			37,360			-
Total		$	-		$	875		$	146		$	1,021		$	231,272		$	232,293		$	-

	30-59 days past due			60-89 days past due			Greater than 90 Days past due			Total past due			Current			Total loans receivable			Loans past due 90 days and still accruing
2010
Commercial		$	2		$	-		$	-		$	2		$	31,554		$	31,556		$	-
Commercial mortgage			510			-			254			764			97,419			98,183			-
Construction, land and land development			-			-			-			-			7,489			7,489			-
Consumer			-			-			-			-			42,864			42,864			-
Residential			-			-			-			-			26,907			26,907			-
Total		$	512		$	-		$	254		$	766		$	206,233		$	206,999		$	-

The Company categorizes loans into risk categories based on relevant information about the quality and realizable value of collateral, if any, and the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed whenever a credit is extended, renewed or modified, or when an observable event occurs indicating a potential decline in credit quality, and no less than annually for large balance loans. The Company uses the following definitions for risk ratings:

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor, or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment and liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Normal payment from the borrower is in jeopardy, although loss of principal, while still possible, is not imminent.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable.

The following table presents the risk category of loans by class of loans based on the most recent analysis performed as of December 31, 2011 and 2010, respectively (in thousands):

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Credit risk profile by internally assigned grades	Pass			Special Mention			Substandard			Doubtful			Total
2011
Commercial		$	29,215		$	2,991		$	-		$	-		$	32,206
Commercial mortgage			110,500			1,539			1,109			-			113,148
Construction, land and land development			7,505			-			-			-			7,505
Consumer			41,780			148			146			-			42,074
Residential			36,555			805			-			-			37,360
Total		$	225,555		$	5,483		$	1,255		$	-		$	232,293

Credit risk profile by internally assigned grades	Pass			Special Mention			Substandard			Doubtful			Total
2010
Commercial		$	28,366		$	2,973		$	217		$	-		$	31,556
Commercial mortgage			95,192			1,217			1,774			-			98,183
Construction, land and land development			7,489			-			-			-			7,489
Consumer			42,592			272			-			-			42,864
Residential			26,102			805			-			-			26,907
Total		$	199,741		$	5,267		$	1,991		$	-		$	206,999

Changes in the allowance for loan losses were as follows (in thousands):

	December 31,
	2011				2010
Balance at beginning of year		$	2,875			$	3,111
Charge-offs			(127	)			(395	)
Recoveries			14				34
Provision charged to operations			220				125
Balance at end of year		$	2,982			$	2,875

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The following table represents the allocation of allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the impairment methodology at December 31, 2011 and 2010, respectively (in thousands):

(in thousands)	Commercial			Commercial Mortgage			Construction, Land and Land Development			Consumer			Residential			Unallocated			Total
2011
Allowance for Loan Losses:
Individually evaluated for impairment		$	-		$	11		$	-		$	-		$	-		$	-		$	11
Collectively evaluated for impairment			522			1,531			122			531			215			50			2,971
Total		$	522		$	1,542		$	122		$	531		$	215		$	50		$	2,982
Loans Receivable
Individually evaluated for impairment		$	-		$	1,109		$	-		$	146		$	-					$	1,255
Collectively evaluated for impairment			32,206			112,039			7,505			41,928			37,360						231,038
Total		$	32,206		$	113,148		$	7,505		$	42,074		$	37,360					$	232,293

(in thousands)	Commercial			Commercial Mortgage			Construction, Land and Land Development			Consumer			Residential			Unallocated			Total
2010
Allowance for Loan Losses:
Individually evaluated for impairment		$	5		$	134		$	-		$	-		$	-		$	-		$	139
Collectively evaluated for impairment			181			1,687			102			506			205			55			2,736
Total		$	186		$	1,821		$	102		$	506		$	205		$	55		$	2,875
Loans Receivable
Individually evaluated for impairment		$	217		$	1,774		$	-		$	-		$	-					$	1,991
Collectively evaluated for impairment			31,339			96,409			7,489			42,864			26,907						205,008
Total		$	31,556		$	98,183		$	7,489		$	42,864		$	26,907					$	206,999

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The following table presents the activity in the Company’s allowance for loan losses by class of loans based on the most recent analysis performed for the twelve months ended December 31, 2011 (in thousands):

Allowance for Loan Losses	Commercial			Commercial Mortgage				Construction, Land and Land Development			Consumer				Residential			Unallocated				Total
Balance December 31, 2010		$	186		$	1,821			$	102		$	506			$	205		$	55			$	2,875
Charge-offs			-			(125	)			-			(2	)			-			-				(127	)
Recoveries			14			-				-			-				-			-				14
Provision for loan losses			322			(154	)			20			27				10			(5	)			220
Balance, December 31, 2011		$	522		$	1,542			$	122		$	531			$	215		$	50			$	2,982

NOTE 4 – PREMISES AND EQUIPMENT

Premises and equipment are as follows (in thousands):

	December 31,
	2011				2010
Land		$	693			$	693
Buildings and improvement			5,294				5,282
Furniture, fixtures and equipment			2,244				2,227
Leasehold improvements			955				955
Computer equipment and software			939				938
			10,125				10,095
Less accumulated depreciation and amortization			(5,129	)			(4,810	)
Total premises and equipment, net		$	4,996			$	5,285

Depreciation charged to operations amounted to approximately $401 thousand and $468 thousand for the years ended December 31, 2011 and 2010, respectively.

NOTE 5 – CERTIFICATES OF DEPOSIT

At December 31, 2011, a summary of the maturity of certificates of deposit is as follows (in thousands):

2012	$	19,589
2013		9,297
2014		3,289
2015		7,058
2016		1,673
	$	40,906

Deposits held at the Company by related parties, which include executive officers, directors, and companies in which Board members have a significant ownership interest, approximated $23.4 million and $16.1 million at December 31, 2011 and 2010, respectively.

NOTE 6 – BORROWINGS

a) Federal Home Loan Bank Borrowing

As of December 31, 2011 and 2010, the Company had an approved borrowing capacity of approximately $76.7 million and $82.2 million, respectively, with the Federal Home Loan Bank of New York (FHLB), based on total assets and eligible collateral. Eligible collateral may include certain investment securities and qualifying mortgage loans. Borrowings under this arrangement have interest rates that range from 3.12% to 3.71% at December 31, 2011 with maturity dates of November 29, 2017 through February 22, 2018 and are callable at the option of the FHLB. At

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December 31, 2011 and 2010, $7.5 million and $11.0 million, respectively in borrowings were outstanding with the FHLB. There were $3.5 million of FHLB borrowings prepaid in 2011, and the Company realized a $426,000 pretax charge recorded as a loss on debt extinguishment. The company had outstanding advances at December 31, 2011 and 2010, respectively, as follows:

2011 Maturity	First Date Callable	Rate			Amount
November 29, 2017	November 29, 2010		3.41	%		$	1,500,000
January 8, 2018	January 8, 2011		3.12	%			2,000,000
January 8, 2018	January 8, 2013		3.61	%			2,000,000
February 22, 2018	February 22, 2013		3.71	%			2,000,000
Total						$	7,500,000

2010 Maturity	First Date Callable	Rate			Amount
November 29, 2017	November 29, 2009		3.21	%		$	1,500,000
November 29, 2017	November 29, 2010		3.41	%			1,500,000
January 8, 2018	January 8, 2009		2.87	%			2,000,000
January 8, 2018	January 8, 2011		3.12	%			2,000,000
January 8, 2018	January 8, 2013		3.61	%			2,000,000
February 22, 2018	February 22, 2013		3.71	%			2,000,000
Total						$	11,000,000

b) Credit Lines and Borrowings

The Company has three lines of credit with financial institutions aggregating $18.5 million at December 31, 2011. Borrowings under these agreements have interest rates that fluctuate based on market conditions. The Company also purchases Federal Funds on an overnight basis. The Company had no borrowings outstanding under these lines as of December 31, 2011 and 2010, respectively.

NOTE 7 – INCOME TAXES

Deferred income taxes are provided for the temporary difference between the financial reporting basis and the tax basis of the Company’s assets and liabilities.

The components of income taxes (benefit) are summarized as follows (in thousands):

	December 31,
	2011				2010
Current Tax Expense:
Federal		$	1,118			$	970
State			247				197
			1,365				1,167
Deferred Tax (Benefit):
Federal			(154	)			7
State			(23	)			45
			(176	)			52
		$	1,189			$	1,219

54

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

	December 31,
	2011				2010
Federal income tax		$	1,361			$	1,268
Add (deduct) effect of:
State income taxes net of federal income tax effect			136				159
Stock options			1				4
Meals and entertainment			15				25
Increase in cash surrender value life insurance			(189	)			(101	)
Tax-exempt income			(128	)			(138	)
Other			(7	)			2
		$	1,189			$	1,219

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 (in thousands):

	2011				2010
Deferred tax assets and (liabilities):
Allowance for loan losses		$	1,064			$	1,150
Mark to market – loans			37				21
Non accrual loan income			3				10
Depreciation			(107	)			(254	)
Deferred compensation			180				162
Unrealized Loss (Gain) – AFS			(406	)			(391	)
NOL carryover and other			38				-
Net deferred tax assets		$	809			$	698

The Company does not have a material amount of unrecognized tax benefits and does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

There was no valuation allowance for deferred taxes as of December 31, 2011 and 2010. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.

The Company is subject to U.S. Federal income tax as well as income tax of the State of New Jersey. The Company is no longer subject to examination by taxing authorities for years before 2008.

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. The Company recognizes interest and /or penalties related to income tax matters in income tax expense.

NOTE 8 – RELATED PARTY TRANSACTIONS

Loans to executive officers, directors, and their affiliates during 2011 were as follows (in thousands):

Beginning balance	$	1,126
New loans		583
Repayments		(447	)
Ending balance	$	1,262

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A director of the Company is a member of a law firm which represents the Company in various matters from time-to-time. The Company paid fees to this law firm, relating to general corporate matters, of approximately $11,000 and $21,000 during the years ended December 31, 2011 and 2010, respectively. This law firm had outstanding loan balances of $96,000 and $197,000 at December 31, 2011 and 2010, respectively in connection with one term loan made by the Bank in 2009. This law firm had approximately $20,978,000 and $15,291,000 of deposits held with the Company as of December 31, 2011 and 2010, respectively.

A director of the Company is an owner of a restaurant which the Company uses for entertainment purposes. The Company paid this restaurant approximately $2,000 in each of the years ended December 31, 2011 and 2010. The restaurant had outstanding loan balances of $231,000 and $304,000 at December 31, 2011 and 2010, respectively in connection with one line of credit loan made by the Bank in 2003 and converted to a term loan in 2011. This restaurant had approximately $13,000 and $12,000 of deposits held with the Company as of December 31, 2011 and 2010, respectively.

NOTE 9 – BENEFIT PLANS

Stock Options

The Company has two equity compensation plans outstanding for the members of the board of directors, executive officers, and certain employees of the Bank.

The Company’s 2001 Combined Stock Option Plan (2001 Combined Plan) provides for the granting of 295,490 shares of the Company’s common stock. The Company’s 2007 Equity Incentive Plan (2007 Plan) provides for the granting of 137,813 shares of the Company’s common stock. Both incentive stock options (ISOs) and non- qualified options (NQOs) may be granted under the plans. The 2007 Plan also permits grants of shares of restricted stock. Only employees of the Company may receive ISOs.

Options granted pursuant to the 2001 Combined Stock Option Plan must be exercisable at a price greater than or equal to the par value of the Common Stock, but in no event may the option price be lower than (i) in the case of an ISO, the fair market value of the shares subject to the ISO on the date of grant, (ii) in the case of an NQO issued to a Director as compensation for serving as a Director or as a member of the advisory boards of the Bank, the fair market value of the shares subject to the NQO on the date of grant, and (iii) in the case of an NQO issued to a grantee as employment compensation, eighty-five percent (85%) of the fair market value of the shares subject to the NQO on the date of grant. In addition, no ISO may be granted to an employee who owns common stock possessing more than ten percent (10%) of the total combined voting power of the Company’s common stock unless the price is at least 110% of the fair market value (on the date of grant) of the common stock. Options granted under the 2007 Plan must have an exercise price equal to at least 100% of the fair market value of the shares on the grant date.

A summary of the status of the Company’s stock option plans as of December 31, 2011, and the change during the year ended is represented below:

	Number of shares			Weighted average exercise price			Weighted average life		Aggregate intrinsic value (in thousands)
Outstanding at December 31, 2010		302,591			$	7.15		3.7 years		$	634
Granted		87,208				8.89
Exercised		(34,371	)			6.07
Forfeited		(9,410	)			9.15
Outstanding at December 31, 2011		346,018			$	7.64		4.9 years		$	235
Vested and expected to vest		346,018			$	7.64		4.9 years		$	235
Exercisable at end of the year		233,605			$	7.22		2.9 years		$	227

In 2011 stock options were granted on two separate dates. The fair values of stock options granted during 2011 were $1.96 and $1.21 on the dates of grant using the Black Scholes option-pricing model with the following assumptions for 2011: expected dividend yields of 2.44% and 3.06%, stock price volatility of 21.69% and 21.69%, risk-free interest rates of 2.84% and 1.70% and expected lives of 7 years. The fair value of stock options granted

56

during 2010 was $1.65 on the date of grant using the Black Scholes option-pricing model with the following assumptions for 2010: expected dividend yields of 2.53%, stock price volatility of 22.48%, risk-free interest rates of 3.12% and expected lives of 7 years.

At December 31, 2011 and 2010, the number of options exercisable was 233,605 and 258,037, respectively, and the weighted-average exercise price of those options was $7.22 and $7.09, respectively.

At December 31, 2011 and 2010, there were 1,056 and 93,714 additional shares available for grant under the Plans.

Information related to the stock option plan during each year follows (in thousands):

	2011			2010
Intrinsic value of options exercised		$	99		$	63
Cash received from options exercised			210			117
Tax benefit realized from option exercises			2			1
Weighted average fair value of options granted			1.60			1.57

As of December 31, 2011 there was $143 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Company’s plans. The cost is expected to be recognized over a weighted-average period of 3.8 years.

Share Awards

The 2007 Plan also provides for the issuance of shares to directors and officers. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date, based on the price on the Nasdaq Global Market exchange. Shares granted to date have a vesting period of 4 years. There were 3,780 shares issued in 2007.

A summary of changes in the Company’s nonvested shares for the year follows:

	Shares			Weighted-Average Grant-Date Fair Value
Nonvested at January 1, 2011		731			$	11.56
Granted		-				-
Vested		(593	)			11.56
Forfeited		(138	)			11.56
Nonvested at December 31, 2011		-			$	-

As of December 31, 2011 all share awards were vested and no additional costs are expected to be recognized. The total fair value of shares vested during the year ended December 31, 2011 was $5 thousand.

During 2007 the Company entered into a non-qualified Supplemental Executive Retirement Plan (“SERP”) with its Chief Executive Officer and it’s then current Chief Financial Officer. The benefit provided to them by the SERP is calculated at $48 thousand and $24 thousand, respectively, per year for fifteen years after retirement. The Company’s expense for the SERP was $70 thousand and $68 thousand for the period ending December 31, 2011 and 2010, respectively resulting in a deferred compensation liability of $451 thousand and $405 as of year-end 2011 and 2010. Due to the passing of the Chief Financial Officer in January 2009, the Company recognized $183 thousand of expense in the first quarter of 2009. Payment of the benefit accrued for the former Chief Financial Officer is being paid to his beneficiary evenly over 12 years.

The Company has a 401(k) profit sharing plan for eligible employees. The Company matches employee contributions equal to 50% of the amount of the salary reduction the employee elects to defer, up to a maximum of 5% of eligible compensation. The Company may also contribute a discretionary amount each year as determined by the Company. The Company’s contribution to the Plan was approximately $95 thousand and $102 thousand for the years ended December 31, 2011 and 2010, respectively.

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NOTE 10—COMMITMENTS

a) Lease Commitments

The Company leases certain office space and equipment under non-cancelable lease agreements, which have expiration dates through 2016. Lease and rental expense was approximately $447 thousand and $539 thousand for the years ended December 31, 2011 and 2010, respectively.

The following is a schedule of minimum commitments under operating leases at December 31, 2011 (in thousands):

2012	$	397
2013		364
2014		314
2015		231
2016		101
Thereafter		-
Total	$	1,407

b) Employment Agreements

The Company is a party to an employment agreement with its President and CEO. The agreement provides for one year terms which automatically renew unless either party provides notice at least six (6) months prior to the termination date of their intention not to renew. Pursuant to this agreement, our President and CEO will receive a base salary and certain increases as defined in the agreement.

c) Preferred Stock

The Company’s certificate of incorporation authorizes it to issue up to 1,000,000 shares of preferred stock, in one or more series, with such designations and such relative voting, dividend and liquidation, conversion and other rights, preferences and limitations as shall be resolved by the Board of Directors.

d) Litigation

The Company is involved in legal proceedings incurred in the normal course of business. In the opinion of management, none of these proceedings are expected to have a material affect on the financial position or results of operations of the Company.

NOTE 11 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

The Company 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 letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

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The Company had the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk. These instruments are almost entirely made up of variable rate loans (in thousands):

	December 31,
	2011			2010
Commitments to extend credit and unused lines of credit		$	92,807		$	85,685
Letters of credit—standby and performance			1,724			1,592
Total		$	94,531		$	87,277

Commitments to extend credit are agreements to lend to a customer so 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 are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include guarantees, marketable securities, residential or commercial real estate, accounts receivable, inventory or equipment. The Company had commitments to extend credit to related parties for approximately $1.4 million and $1.4 million at December 31, 2011 and 2010, respectively.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support contracts entered into by customers. Most guarantees extend for one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

NOTE 12 – REPORTABLE SEGMENTS

We separate our business into two reporting segments: community banking and mortgage banking.

The primary activities of the Company include acceptance of deposits from the general public, origination of mortgage loans secured by residential and commercial real estate, commercial and consumer loans, and investment in debt securities, mortgage-backed securities and other financial instruments (community banking). Sullivan Financial Services, Inc. provides mortgage-banking services to customers on behalf of investor companies (mortgage banking).

The Company follows U.S. generally accepted accounting principles as described in the summary of significant accounting policies. Consolidation adjustments reflect elimination of intersegment revenue and expenses and statement of financial condition.

The following table sets forth certain information about the reconciliation of reported net income for each of the reportable segments as of and for the year ended December 31, 2011 (in thousands).

	The Bank and Bancorp			Sullivan Financial Services, Inc.				Eliminating Entries				Consolidated
Interest income		$	13,571		$	111			$	(42	)		$	13,640
Interest expense			1,793			42				(42	)			1,793
Provision for loan losses			220			-				-				220
Non-interest income			1,336			786				(102	)			2,002
Non-interest expense(1)			10,069			867				(102	)			10,816
Net income		$	2,825		$	(12	)		$	-			$	2,813
Total assets		$	363,904		$	4,928			$	(4,385	)		$	364,447

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The following table sets forth certain information about the reconciliation of reported net income for each of the reportable segments as of and for the year ended December 31, 2010 (in thousands).

	The Bank and Bancorp			Sullivan Financial Services, Inc.			Eliminating Entries				Consolidated
Interest income		$	13,346		$	195		$	(68	)		$	13,473
Interest expense			2,193			68			(68	)			2,193
Provision for loan losses			125			-			-				125
Non-interest income			1,035			1,281			(102	)			2,214
Non-interest expense(1)			9,823			1,138			(102	)			10,859
Net Income		$	2,240		$	270		$	-			$	2,510
Total assets		$	327,927		$	4,287		$	(3,318	)		$	328,896

⁽¹⁾ Includes income taxes

NOTE 13 – REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. At year-end 2011 and 2010, 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 have changed the institution’s category.

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2011, management believes the Bank met all capital adequacy requirements to which it is subject.

The Bank’s actual capital amounts and ratios are presented in the tables (in thousands):

	Actual						For Capital Adequacy Purpose						For Classification As Well Capitalized
	Amount			Ratio			Amount			Ratio			Amount			Ratio
December 31, 2011:
Total capital (to risk-weighted assets)		$	39,962		15.03	%		$	21,266		≥8.00	%		$	26,581		≥10.00	%
Tier I capital (to risk-weighted assets)			36,980		13.91	%			10,633		≥4.00	%			15,949		≥6.00	%
Tier I capital (to average assets)			36,980		10.16	%			14,565		≥4.00	%			18,206		≥5.00	%
December 31, 2010:
Total capital (to risk-weighted assets)		$	37,004		15.48	%		$	19,122		≥8.00	%		$	23,904		≥10.00	%
Tier I capital (to risk-weighted assets)			34,129		14.28	%			9,561		≥4.00	%			14,342		≥6.00	%
Tier I capital (to average assets)			34,129		10.44	%			13,076		≥4.00	%			16,345		≥5.00	%

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As of December 31, 2011 and 2010, the Bank’s ratio of equity capital to total assets was 10.17% and 10.40%, respectively.

NOTE 14 – FAIR VALUE

FASB ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

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

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

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or 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 fair value of loans held for sale is based upon binding quotes from 3rd party investors (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

	Fair Value Measurements at December 31, 2011
	Quoted Prices in Active Markets for Identical Unobservable Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S Government sponsored Agency Securities		$	-		$	14,753		$	-
Mortgage Backed Securities, residential			-			23,814			-
Collaterized Mortgage Obligations			-			2,734			-
Corporate Debt Securities			-			2,278			-

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	Fair Value Measurements at December 31, 2010
	Quoted Prices in Active Markets for Identical Unobservable Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S Government sponsored Agency Securities		$	-		$	9,023		$	-
Mortgage Backed Securities, residential			-			19,847			-
Collaterized Mortgage Obligations			-			5,677			-
Corporate Debt Securities			-			1,446			-

Assets and Liabilities Measured on a Non-Recurring Basis

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

	Fair Value Measurements at December 31, 2010
	Quoted Prices in Active Markets for Identical Unobservable Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Commercial		$	-		$	-		$	145
Commercial mortgage			-			-			211

There were no impaired loans measured at fair value on a non-recurring basis at December 31, 2011.

The following represent impairment charges recognized during the period:

A loan is impaired when full payment under the loan terms is not expected. If a loan is impaired, a portion of the allowance for loan losses is allocated so that the loan is reported net of the allocated allowance. Collateral dependent impaired loans for which there is a specific reserve, which are measured for impairment using the fair value of the collateral, had a carrying amount of $471 thousand, including a valuation allowance of $114 thousand at December 31, 2010. At December 31, 2011 there were no collateral dependent impaired loans for which there is a specific reserve. Fair value is classified as Level 3 in the fair value hierarchy and is based on the lesser of appraised value, broker opinion or projected list price of the property less estimated expenses for the disposal of the property, which include taxes, commissions, first liens and legal fees.

For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Therefore, the Company uses significant estimations and present value calculations to prepare this disclosure.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instrument. The estimation methodologies used, the estimated fair values, and recorded book balances at December 31, 2011 and 2010 are outlined below. For cash and due from banks, and federal funds sold, the recorded book value of approximately $60.0 million and $57.6 million approximates fair value at December 31, 2011 and 2010, respectively.

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The carrying amount of loans held for sale is approximately $2.9 million and $2.2 million at December 31, 2011 and 2010, respectively, and approximates their fair value. No impairment charges were recognized on loans held for sale for the period ending 2011 and 2010.

The fair values of loans are estimated based on a discounted cash flow analysis using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.

	2011						2010
	Carrying amount			Estimated Fair value			Carrying amount			Estimated Fair value
	(in thousands)
Investment securities - held to maturity		$	10,738		$	10,849		$	10,740		$	10,548
Investment securities - available for sale			43,579			43,579			35,993			35,993
Loans, including deferred costs			232,485			235,344			207,146			208,199

The estimated fair values of demand deposits (i.e., interest and non-interest bearing checking accounts, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly time deposit maturities.

	2011						2010
	Carrying amount			Estimated Fair value			Carrying amount			Estimated Fair value
	(in thousands)
Time deposits		$	40,906		$	41,883		$	41,716		$	42,456

The fair values of fixed-rate Federal Home Loan Bank borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly Federal Home Loan borrowings maturities.

	2011						2010
	Carrying amount			Estimated Fair value			Carrying amount			Estimated Fair value
	(in thousands)
Federal Home Loan Bank Borrowings		$	7,500		$	8,682		$	11,000		$	12,707

The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated costs to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial.

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NOTE 15 – PARENT COMPANY ONLY

The following information on the parent only financial statements as of December 31, 2011 and 2010 and for the years ended December 31, 2011 and 2010 should be read in conjunction with the notes to the consolidated financial statements (in thousands).

Statements of Financial Condition

	2011			2010
Assets:
Cash and due from subsidiaries		$	2,226		$	4,314
Investment in subsidiaries			37,769			34,775
Other assets			374			302
Total assets		$	40,369		$	39,391
Liabilities:
Other liabilities		$	-		$	-
Stockholders’ equity:
Common stock			36,972			37,600
Accumulated other comprehensive income			789			646
Retained earnings			2,608			1,145
Total stockholders’ equity			40,369			39,391
Total liabilities and stockholders’ equity		$	40,369		$	39,391

The following information on the parent only operating statements and cash flows as of December 31, 2011 and 2010 and for the years then ended should be read in conjunction with the notes to the consolidated financial statements (in thousands).

Statements of Operations

	2011			2010
Equity in undistributed income of subsidiaries		$	2,851		$	2,570
Other expenses			38			60
Net income		$	2,813		$	2,510

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Statements of Cash Flows

	2011				2010
Cash flows from operating activities:
Net income		$	2,813			$	2,510
Equity in undistributed income of the subsidiaries			(2,851	)			(2,570	)
Increase in other assets			(72	)			(27	)
Stock-based compensation			44				35
Net cash used in operating activities			(66	)			(52	)
Cash flows from financing activities:
Proceeds from exercise of options			210				117
Common stock repurchase			(882	)			(315	)
Cash dividend paid common stock			(1,350	)			(1,118	)
Net cash used in financing activities			(2,022	)			(1,316	)
Net change in cash for the period			(2,088	)			(1,368	)
Net cash at beginning of year			4,314				5,682
Net cash at end of year		$	2,226			$	4,314

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NOTE 16 – QUARTERLY FINANCIAL DATA (unaudited)

Selected Consolidated Quarterly Financial Data

2011 Quarter Ended, (In thousands, except per share data)	March 31,			June 30,			September 30,			December 31,
Total interest income		$	3,325		$	3,376		$	3,484		$	3,454
Total interest expense			450			463			445			434
Net interest income			2,875			2,913			3,039			3,020
Provision for loan losses			75			30			95			20
Net interest income after provision for loan losses			2,800			2,883			2,944			3,000
Other income			396			368			734			503
Other expenses			2,353			2,278			2,744			2,251
Income before income taxes			843			973			934			1,252
Income tax expense			240			322			197			430
Net income		$	603		$	651		$	737		$	822
Earnings per share:
Basic		$	0.11		$	0.12		$	0.14		$	0.16
Diluted		$	0.11		$	0.12		$	0.13		$	0.16

2010 Quarter Ended, (In thousands, except per share data)	March 31,			June 30,			September 30,			December 31,
Total interest income		$	3,309		$	3,380		$	3,410		$	3,374
Total interest expense			641			548			526			478
Net interest income			2,668			2,832			2,884			2,896
Provision for loan losses			75			-			25			25
Net interest income after provision for loan losses			2,593			2,832			2,859			2,871
Other income			422			485			579			728
Other expenses			2,450			2,425			2,399			2,366
Income before income taxes			565			892			1,039			1,233
Income tax expense			155			291			350			423
Net income		$	410		$	601		$	689		$	810
Earnings per share:
Basic		$	0.08		$	0.11		$	0.13		$	0.15
Diluted		$	0.08		$	0.11		$	0.13		$	0.15

Note: Earnings per share have been adjusted to reflect the 5% stock dividend declared in April 2010 and paid in May 2010.

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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 in the Borough of Bernardsville, State of New Jersey, on March 20, 2012.

SOMERSET HILLS BANCORP
By: /s/ Stewart E. McClure, Jr.
Stewart E. McClure, Jr.
President, Chief Executive Officer
and Chief Operating Officer

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 indicated below on March 20, 2012.

/s/ Stewart E. McClure, Jr. Stewart E. McClure, Jr.	President, Chief Executive Officer and Chief Operating Officer
/s/ William S. Burns William S. Burns	Executive Vice President and Chief Financial Officer
/s/ Edward B. Deutsch Edward B. Deutsch	Chairman
/s/ William F. Keefe William F. Keefe	Director
/s/ Jefferson W. Kirby Jefferson W. Kirby	Director
/s/ Desmond V. Lloyd Desmond V. Lloyd	Director
/s/ Thomas J. Marino Thomas J. Marino	Director
/s/ Gerald B. O’Connor Gerald B. O’Connor	Director
/s/ M. Gerald Sedam, II M. Gerald Sedam, II	Director

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