Management's Discussion and Analysis of Financial Condition and Results of
Operations
This section presents management's discussion and analysis of the results
of operations and financial condition of Interchange Financial Services
Corporation on a consolidated basis (the "Company"). The discussion and analysis
should be read in conjunction with the Company's consolidated financial
statements and notes thereto on pages 32 through 52 and the summary consolidated
data included elsewhere in this report.
Overview
The Company is a community bank operating in Bergen County, NJ, one of the
most affluent counties in the country, and provides diversified financial
services to both consumer and business customers. Our primary source of earnings
is net interest income which represents the difference between the interest the
Company earns on its assets, principally loans and leases (herein referred to
collectively as loans) and investment securities, and interest it pays on its
deposits and borrowings. When expressed as a percentage of average interest
earning assets, it is referred to as net interest margin ("margin"). We augment
our primary revenue source through other non-interest income sources that
include service charges on deposits, bank owned life insurance income ("BOLI"),
commissions on mutual funds and annuities and gains on sales of loans. In
addition, the Company from time to time may recognize income on gains on sales
of securities, however, we do not consider this a primary source of income as we
do not have a securities trading portfolio.
Over the past several years we have sought to focus our emphasis on
developing and expanding our business customer relationships and operations. As
part of this effort we continued to expand our commercial lending group and
product offerings, which included establishing a Small Business Administration
loan department and a Rapid Response loan program focused on small businesses.
In addition, we enhanced our presence in Eastern Bergen County when we completed
our acquisition of Bridge View Bancorp ("Bridge View") on April 30, 2003. As of
that date Bridge View had approximately $291 million of total consolidated
assets, $184 million of loans and $259 million of deposits, resulting in an
increase of approximately 30% in the Company's total assets. The aggregate
purchase price paid to Bridge View shareholders was approximately $85.7 million
and consisted of approximately 2.9 million shares of the Company's common stock
with an approximate market value of $52.2 million based upon the average closing
price three days prior to and after the acquisition date and $33.5 million in
cash. The transaction was accounted for as a purchase and the cost in excess of
net assets acquired of approximately $58.7 million was allocated to identified
intangibles of approximately $4.3 million and goodwill of approximately $54.4
million. We believe that the acquisition of Bridge View also provides us with
the ability to leverage their customer base with our product offerings and
acquire new customers as a result of an increase in our branch network. The
increase in customers in terms of new customers to the merged entity or
providing additional services to existing customers, we believe will drive
volume in both deposits and assets and provide us with net interest income and
non-interest income growth.
The economic and competitive landscape provided significant challenges
during a historically low interest rate environment. Margin compression occurred
across the industry as interest rates hit a 45 year low in June of 2003. During
the fourth quarter margin compression appears to have subsided as many
institutions reported stabilization in their margins. The Company also
experienced margin compression during 2003, however we continued to outperform
our peer group from a margin perspective. It is anticipated that with changes in
our asset mix as well as a slow down in prepayments in our loan and securities
portfolios any additional margin compression will be minimized and over the
longer term our margin should improve.
Demand for commercial loans was soft across the industry as uncertainty in
the economy restrained business expansion and loan demand. In addition, as
demand softened competition increased for commercial loans which resulted in
competitors offering longer term fixed rate loans which did not appear to
provide an adequate risk reward profile. Although we were also impacted by the
soft loan market and competition, we were able to increase our overall
commercial loan portfolio.
Earnings Summary
Earnings per diluted common share for the year ended December 31, 2003
increased $0.06 to $1.36 as compared to $1.30 during the preceding year, an
increase of 4.6%. Earnings per basic common share for the year ended December
31, 2003 increased $0.08 to $1.39 as compared to $1.31 during the preceding
year, an increase of 6.1%. Net income for the year 2003 increased $3.5 million,
or 27.1%, to $16.4 million when compared to 2002. For 2003, the Company's return
on average assets ("ROA") was 1.35% as compared to 1.43% in 2002. The Company's
return on average equity ("ROE") was 13.54% in 2003 as compared to 17.35% for
the previous year. The change in ROA was a result of net interest margin
compression due to prepayments in the loan and securities portfolio's along with
core deposit growth outpacing deployment of those funds into higher yielding
loans and maintaining an average life on the investment portfolio of
approximately 2.5 years. ROE declined mainly due to an increase in equity as a
result of the acquisition of Bridge View. Based on its earnings performance, the
Company increased the quarterly dividend paid on common stock to an annualized
rate of $0.50 for 2004 as compared to $0.44 in 2003.
Net interest income, on a tax equivalent basis, increased to $46.4 million
from $39.0 million an increase of $7.4 million, or 18.9%, which resulted from
growth in interest earning assets and deposits offsetting a decline in margin.
The taxable equivalent adjustment of $533 thousand represented an increase of
approximately $157 thousand as compared to $376 thousand for the prior year. The
Company believes that utilizing a taxable equivalent adjustment basis for net
interest income provides a more meaningful basis for comparing the Company's
results year over year and versus the industry. See Financial Highlights
footnotes. Overall earnings improved despite the pressure exerted on our margin.
Contributing to our earnings growth was an increase in our non-interest income.
Non-interest income increased $4.1 million, or 63%, for 2003 as compared
to 2002. Of the increase approximately $3.0 million, or 73%, resulted from the
Company's organic growth. The improvement in non-interest income was largely due
to increases in "other" non-interest income, BOLI income and service charges on
deposits. Non-interest expense for 2003 increased $6.2 million, or 24.6%, as
compared to 2002. The increase was due largely to the additional operating costs
resulting from the Bridge View merger and normal increases related to salaries
and benefits along with occupancy expense.
Earnings per diluted common share for the year ended December 31, 2002
increased $0.23 to $1.30 as compared to $1.07 during the preceding year, an
increase of 21.5%. Earnings per basic common share for the year ended December
31, 2002 increased $0.23 to $1.31 as compared to $1.08 during the preceding
year, an increase of 21.3%.
13
Net income for the year 2002 increased $2.3 million, or 22.2%, to $12.9 million
when compared to 2001. For 2002, the Company's ROA increased to 1.43% from 1.31%
in 2001. The Company's ROE increased to 17.35% in 2002 from 16.06% for the
previous year.
The earnings performance for 2002 was driven by a $5.1 million, or 14.9%,
increase in net interest income, on a taxable equivalent basis, which resulted
from growth in interest earning assets and deposits and an improved margin. The
margin improved largely due to a decrease in the Company's funding costs which,
based on the composition of the Company's total deposits, was favorably affected
by a decline in market interest rates. The earnings improved despite the
increased levels of consumer loan prepayments, which occurred as a result of
declining market interest rates. In addition, non-interest income grew 16.8% and
contributed to the growth in revenue. The growth in revenue was partly offset by
a 9.6% increase in non-interest expenses that is mostly attributable to normal
growth and expansion.
Non-interest income increased $936 thousand, or 16.8%, for 2002 as compared
to 2001 due principally to growth from the sale of mutual funds and annuities,
security gains and an increase in BOLI income. non-interest expense increased
$2.2 million, or 9.6%, for 2002 as compared to 2001. Approximately $910 thousand
of the growth is directly related to the growth and operation of the Company's
leasing subsidiary and a new branch office that opened during 2002. These
expansion programs are aimed at enhancing the Company's franchise value in its
trade area.
Table 1
- -------------------------------------------------------------------------------------------------------------
Summary of Operating Results
- -------------------------------------------------------------------------------------------------------------
2003 2002 2001
-------------------- ------------- -------------------
Net income (in thousands) $16,366 $ $2,877 $ 10,540
Basic earnings per common share 1.39 1.31 1.08
Diluted earnings per common share 1.36 1.30 1.07
Return on average total assets 1.35% 1.43% 1.31%
Return on average total equity 13.54% 17.35% 16.06%
Dividend payout ratio* 30.37% 33.56% 33.37%
Average total stockholders' equity to
average total assets 9.95 % 8.27% 8.13%
* Cash dividends declared on common shares to net income.
Results of Operations
Net Interest Income
Net interest income represents the Company's primary source of income.
Table 2 sets forth a summary of average interest-earning assets and
interest-bearing liabilities for the years ended December 31, 2003, 2002 and
2001, together with the interest earned and paid on each major type of asset and
liability account during such periods. The average rates on the earning assets
and the average cost of interest-bearing liabilities during such periods are
also summarized. Table 3, which presents changes in interest income and interest
expense by each major asset and liability category for 2003 and 2002,
illustrates the impact of average volume growth (estimated according to prior
year rates) and rate changes (estimated on the basis of prior year volumes).
Changes not due solely to changes in either volume or rates have been allocated
based on the relationship of changes in volume and changes in rates.
Figures are adjusted to a taxable equivalent basis to recognize the income
from tax-exempt assets as if the interest was taxable, thereby allowing a
uniform comparison to be made between yields on assets.
14
Table 2
- ------------------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ------------------------------------------------------------------------------------------------------------------------------------
For the years ended December 31,
(dollars in thousands)
2003 2002 2001
------------------------------------ --------------------------- ----------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------------------------------ --------------------------- ----------------------------
Assets
Interest earning assets
Loans (1) $ 729,581 $49,142 6.74 % $ 611,659 $45,496 7.44 % $579,034 $46,319 8.00%
Taxable securities (2) 304,418 10,034 3.30 200,257 10,312 5.15 160,202 10,138 6.33
Tax-exempt securities (2)(3) 27,737 1,287 4.64 14,545 822 5.65 11,844 712 6.01
Interest earning deposits 5,810 61 1.05 - - - - - -
Federal funds sold 25,827 276 1.07 15,730 246 1.56 13,138 557 4.24
------------- ---------------------- ----------- -------- ------ ---------- -----------------
Total interest-earning assets 1,093,373 60,800 5.56 % 842,191 56,876 6.75 % 764,218 57,726 7.55%
---------- ---- -------- ---------
Non-interest earning assets
Cash and due from banks 34,316 20,635 20,216
Allowance for loan and lease losses (8,762) (6,572) (6,368)
Other assets 96,646 41,303 29,265
------------- ----------- ----------
Total assets $ 1,215,573 $897,557 $ 807,331
============= =========== ==========
Liabilities and stockholders' equity
Interest-bearing liabilities
Demand deposits $ 395,408 4,700 1.19 % $304,908 5,744 1.88 % $246,037 6,871 2.79%
Savings deposits 199,127 1,408 0.71 136,527 1,952 1.43 128,987 2,801 2.17
Time deposits 273,382 7,053 2.58 224,931 8,661 3.85 222,493 12,398 5.57
Short-term borrowings 17,875 285 1.59 19,119 694 3.63 25,545 1,374 5.38
Long-term borrowings 10,000 428 4.28 9,945 427 4.29 - - -
------------- --------------------- ----------- -------- ------ ---------- -----------------
Total interest-bearing liabilities 895,792 13,874 1.55 % 695,430 17,478 2.51 % 623,062 23,444 3.76%
Non-interest bearing liabilities
Demand deposits 183,451 115,714 110,576
Other liabilities 15,434 12,176 8,078
------------- ----------- ----------
Total liabilities (4) 1,094,677 823,320 741,716
Stockholders' equity 120,896 74,237 65,615
------------- ----------- ----------
Total liabilities and stockholders'
equity $1,215,573 $897,557 $ 807,331
============= =========== ==========
Net interest income (tax-equivalent basis) 46,926 4.01 % 39,398 4.24 % 34,282 3.79%
Tax-equivalent basis adjustment (533) (376) (324)
----------- -------- --------
Net interest income $46,393 $39,022 $33,958
=========== ======== ========
Net interest income as a percent of
interest-earning assets (tax-equivalent basis) (5) 4.29 % 4.68 % 4.49%
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan
portfolio.
(2) The average balances are based on historical cost and do not reflect unrealized gains or losses.
(3) Computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%.
(4) All deposits are in domestic bank offices.
(5) Net interest margin.
</FN>
15
Table 3
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of Volume and Rate Changes on Net Interest Income
- ------------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Year ended December 31, Year ended December 31,
2003 compared with 2002 2002 compared with 2001
increase (decrease) increase (decrease)
due to change in: due to change in:
------------------------------------------------------ ------------------------------------------
Net Net
Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------------------------------------------------------ -------------------------------------------
Interest income
Loans $8,771 $ (5,125) $ 3,646 $ 3,357 $ (4,180) $(823)
Taxable securities 5,364 (5,642) (278) 2,535 (2,361) 174
Tax-exempt securities 746 (281) 465 162 (52) 110
Interest bearing deposits 61 - 61 - - -
Federal funds sold 158 (128) 30 142 (453) (311)
------ --------- -------- ------- ------- -----
Total interest income 15,100 (11,176) 3,924 6,196 (7,046) (850)
------ --------- -------- ------- ------- -----
Interest expense
Demand deposits 4,290 (5,334) (1,044) 3,130 (4,257) (1,127)
Savings deposits 5,333 (5,876) (543) 175 (1,024) (849)
Time deposits 3,023 (4,631) (1,608) 137 (3,874) (3,737)
Short-term borrowings (43) (366) (409) (297) (383) (680)
Long-term borrowings - 1 1 427 - 427
------ ------- -------- ------ ------- -------
Total interest expense 12,603 (16,206) (3,603) 3,572 (9,538) (5,966)
------ -------- -------- ------ ------- -------
Change in net interest income $ 2,497 $ 5,030 $ 7,527 $ 2,624 $ 2,492 $5,116
======= ======== ======== ======= ======= =======
<FN>
- ----------------------------------------
Non-performing loans are included in interest earning assets.
</FN>
Net interest income, on a taxable equivalent basis, amounted to $46.9
million in 2003, an increase of $7.5 million, or 19.1%, from $39.4 million in
2002. The increase in net interest income was largely due to growth in average
interest-earning assets of $251.2 million. The interest earning asset growth was
funded by a $269.3 million growth in average deposits. The growth in interest
earning assets and deposits were primarily attributed to the Bridge View
acquisition. The change in the margin of 39 basis points to 4.29% for 2003 as
compared to the same period in 2002, partially offset the growth in interest
earning assets. The change in the margin was attributable to a shift in our
asset mix due to the historically low interest rates occurring in 2003, causing
prepayments in our loan and securities portfolios and strong deposit growth. The
funds from the prepayments and deposit growth being reinvested mainly into lower
yielding investment securities along with loan modifications resulted in margin
compression.
Interest income, on a taxable equivalent basis, totaled $60.8 million for
2003, an increase of $3.9 million, or 6.9%, as compared to 2002. For the years
ended December 31, 2003 and 2002, the tax equivalent basis adjustments were $533
thousand and $376 thousand, respectively. The increase in interest income is
attributed to a growth in interest earning assets. The growth in interest
earning assets was largely due to increases in average loans and investments of
$117.9 million and $117.4 million, respectively. The Bridge View acquisition was
the primary contributor to the increase in interest earning assets and loans for
2003. The increase in interest income was partly offset by a 119 basis point
decline in interest earning asset yields for 2003 as compared to 2002. The
decline in interest earning asset yields was largely attributed to a decrease in
market interest rates and change in asset mix.
Interest expense totaled $13.9 million in 2003, a decrease of $3.6
million, or 20.6%, as compared to 2002. The decrease was principally due to a
decline in the average rates paid on interest-bearing liabilities of 96 basis
points to 1.55% in 2003 as compared to 2.51% in 2002, which was mostly due to a
decline in short-term market interest. Average rates paid on interest-bearing
demand and time deposits decreased 69 basis points and 127 basis points,
respectively, for 2003 as compared to 2002. The benefit derived from a decline
in average rates more than offset the increase in interest expense associated
with the growth of average interest-bearing liabilities of $200.4 million for
2003 as compared to the prior year. The growth in average interest-bearing
liabilities was due mostly to the Bridge View acquisition and occurred primarily
in interest-bearing demand, savings and time deposits, which increased $90.5
million, $62.6 million and $48.5 million, respectively.
Net interest income, on a taxable equivalent basis, amounted to $39.4
million in 2002, an increase of $5.1 million, or 14.9%, from $34.3 million in
2001. The increase in net interest income was largely due to growth in average
interest-earning assets of $78.0 million and a 19 basis point improvement in the
margin. The interest earning asset growth was principally funded by a $74.0
million growth in average deposits, which occurred largely in interest-bearing
demand deposits. The improvement in the margin of 19 basis points to 4.68% for
2002 as compared to 4.49% for 2001 was due mostly to a decrease in the Company's
funding cost. Two factors were largely responsible for the decrease in funding
cost: first, the composition ("mix") of the Company's retail deposits
experienced a positive shift towards lower cost demand and savings deposits;
second, short-term market interest rates (used to price deposit products)
declined. Each of these factors served to reduce the Company's funding cost.
Interest income, on a taxable equivalent basis, totaled $56.9 million in
2002, a decrease of $850 thousand, or 1.5%, from $57.7 million in 2001. The
decrease in interest income was driven by lower average rates on interest
earning assets, mostly loans, as a result of a decline in market interest rates.
The average yield on interest earning assets decreased 80 basis points to 6.75%
for 2002 as compared to 7.55% in 2001. Growth in average interest earning assets
served to offset some of the effects of the lower average rates. The increase in
average interest earning assets was largely due to growth in securities and
loans of $42.8 million, or 24.9%, and $32.6 million, or 5.6%, respectively. The
growth
16
in average loans was principally in commercial loans, which increased by $43.0
million, or 15.6%, to $317.7 million in 2002, as compared to $274.6 million in
2001. In addition, equipment financing leases generated by the Bank's leasing
subsidiary, Interchange Capital Company L.L.C. ("ICC") grew, on average, $5.7
million, or 25.3%, for 2002. The average balance of consumer loans (comprised
mostly of 1 to 4 family first mortgages and home equity loans) totaled $265.6
million in 2002, compared to $281.7 million in 2001, a decrease of $16.1
million, or 5.7%. The decline in the consumer loan portfolio was principally
driven by higher levels of loan prepayments as a result of the low interest rate
environment.
Interest expense totaled $17.5 million in 2002, a decrease of $6.0
million, or 25.5%, as compared to 2001. The decrease was principally due to a
decline in the average rates paid on interest-bearing liabilities of 125 basis
point to 2.51% in 2002 as compared to 3.76% in 2001. The decrease in average
rates was mostly due to a decline in short-term market interest rates, which had
a favorable impact on average rates paid on interest-bearing demand and time
deposits. Average rates paid on interest-bearing demand and time deposits
decreased 91 basis points and 172 basis points, respectively, for 2002 as
compared to 2001. The benefit derived from a decline in average rates helped
offset the increase in interest expense associated with the growth of average
interest-bearing liabilities of $72.4 million for 2002 as compared to the prior
year. The growth in average interest-bearing liabilities was due mostly to an
increase in interest-bearing demand deposits of $58.9 million, or 23.9%, for
2002 as compared to 2001. In addition, savings deposits increased $7.5 million,
or 5.9%, for 2002 as compared to 2001.
Non-interest Income
Non-interest income consists of all income other than interest and dividend
income and is principally derived from: service charges on deposits; loan fees;
commissions on sales of annuities and mutual funds; rental fees for safe deposit
space; BOLI income and net gains on sale of securities and loans. The Company
recognizes the importance of supplementing net interest income with other
sources of income and maintains a management committee that explores new
opportunities to generate non-interest income.
Non-interest income increased $4.1 million, or 63%, for 2003 as compared to
2002. Of the increase approximately $3.0 million, or 77%, resulted from the
Company's organic growth. The improvement in non-interest income was largely due
to increases in "other" non-interest income, BOLI income and service charges on
deposits of $1.2 million, $1.1 million and $904 thousand, respectively. The
increase in other income was primarily a result of prepayment penalties on
commercial loans, while the increase in BOLI income was due to a claim on
insurance policies, which amounted to $921 thousand. The growth in service
charges on deposits and "other" non-interest income were largely due to the
acquisition of Bridge View. Contributing to the improvement in non-interest
income were net gains from the sale of loans and commissions on sales of mutual
funds and annuities. The gain on sales of loans were from two programs the
Company commenced in 2003; the Mortgage Partnership Financing program with the
Federal Home Loan Bank of New York, whereby the Company sells its new originated
conforming 20 and 30 year residential mortgages, and originating Small Business
Administration loans and selling these into the secondary market.
During 2003, the Company recognized net gains on the sale of securities of
$793 thousand as compared to $564 thousand for the same period in 2002. The net
gains for 2003 were a result of a combination of net realized gains from
security sales of $1.2 million and gross losses of $415 thousand primarily from
an acceleration of premium amortization on certain collateralized mortgage
obligations. The acceleration of premium amortization was largely driven by the
historically high mortgage prepayment speeds due to the low interest rate
environment.
Non-interest income for 2002 was $6.5 million, an increase of $936
thousand, or 16.8%, from $5.6 million in 2001. The growth was due mostly to a
$312 thousand increase in net gain on sale of securities and an increase of $517
thousand in income related to the cash surrender value of BOLI contracts.
Contributing to the growth in non-interest income was an increase in fee income
derived from the sale of mutual funds, which increased $330 thousand. The growth
in non-interest income for 2002 was reduced by a decline in net gains on the
sale of loans and leases of $150 thousand.
Table 4
______________________________________________________________________________________________
Non-interest Income
________________________________________________________________________________________________
for the years ended December 31,
(dollars in thousands)
2003 2002 2001
_______ _______ ________
Service fees on deposit accounts $ 3,485 $ 2,581 $ 2,459
Net gain on sale of securities 793 564 252
Net gain on sale of loans and leases 769 400 550
Bank owned life insurance 2,019 895 378
Commissions on sales of annuities and mutual funds 883 603 273
All other 2,696 1,471 1,666
________ _______ _______
Total $ 10,645 $ 6,514 $ 5,578
======== ======= =======
17
Non-interest Expense
Non-interest expense for 2003 increased $6.2 million, or 24.6%, to $31.2
million as compared to 2002. The increase was due largely to the additional
operating costs resulting from the merger with Bridge View. Also contributing to
the increase were normal increases related to salaries and benefits along with
occupancy expense. In addition, the Company incurred direct integration expenses
of approximately $357 thousand associated with the Bridge View merger, which
included expenses associated with data processing, customer notifications and
advertising, and salaries.
The largest component of non-interest expense, salaries and benefits,
increased $3.3 million, or 24.3%, for 2003 of which approximately $1.7 million
of the increase was related to the Bridge View acquisition. Salaries and
benefits, excluding amounts related to Bridge View, increased 11.9% due mostly
to increased head count as a result of the Company's expansion, salary increases
and higher benefit expenses. Bridge View also accounted for $986 thousand and
$291 thousand of the increases in occupancy and amortization of the intangibles,
respectively. Other non-interest expense increased $1.1 million, largely due to
an increase of $294 thousand in data processing costs and $226 thousand in
printing and postage costs while all other expenses increased $585 thousand.
Non-interest expense for 2002 increased $2.2 million, or 9.6%, to $25.1
million as compared to 2001. Approximately $910 thousand of the increase was
attributable to the expansion of the Bank's operations, principally the full
year expense for a new office opened in the first quarter in 2002 and the growth
of ICC. The growth in ICC was principally due to the assumption of Monarch
Capital Corporation ("MCC") operations during the first quarter of 2002, which
resulted from the Company's acquisition of certain assets and the assumption of
certain liabilities of MCC. Excluding the costs related to the expansion,
non-interest expense for 2002 increased $1.3 million, or 5.6%.
The largest component of non-interest expense, salaries and benefits,
increased $1.3 million, or 10.7%, for 2002 of which approximately $500 thousand
of the increase was directly related to the expansion programs described above.
Salaries and benefits, excluding amounts related to the expansion programs,
increased 6.6% due mostly to normal promotions, salary increases and higher
benefit expenses. In addition, other expense increased $708 thousand, largely
due to an increase of $218 thousand in professional fees, an increase of $71
thousand in data processing costs and an increase of $419 thousand in all other
expenses.
Table 5
________________________________________________________________________________
Non-interest Expense
________________________________________________________________________________
for the years ended December 31,
(dollars in thousands)
2003 2002 2001
=========== ========= ===========
Salaries and benefits $16,994 $ 13,673 $ 12,353
Occupancy 4,577 3,438 3,275
Furniture and equipment 1,327 1,124 1,157
Advertising and promotion 1,412 1,295 1,251
Amortization of intangible assets 360 69 81
Other expenses
Professional fees 1,568 1,458 1,240
Data Processing 933 639 568
All other 4,068 3,367 2,948
----- ----- -----
Total $31,239 $ 25,063 $ 22,873
============ ========== ===========
Income Taxes
In 2003, income taxes amounted to $7.6 million as compared to $6.1 million
and $5.0 million for 2002 and 2001, respectively. The effective tax rate in 2003
was 31.8% as compared to 32.1% and 32.4% for 2002 and 2001, respectively.
Detailed information on income taxes is shown in Notes 1 and 17 to the
Consolidated Financial Statements.
________________________________________________________________________________
Financial Condition
Loan Portfolio
At December 31, 2003, total loans amounted to $796.6 million, an increase
of $181.0 million, or 29.4%, compared to $615.6 million at December 31, 2002.
The growth was predominately a result of the Bridge View acquisition and
occurred primarily in commercial real estate mortgage loans and commercial and
financial loans, which increased $107.5 million and $45.0 million, respectively.
Commercial real estate mortgage loans are typically secured by first priority
mortgage liens on owner occupied commercial properties. The commercial loan
growth was largely within the subsidiary Bank's delineated community, which is
in Bergen County, New Jersey.
While a significant portion of the Company's loans are collateralized by
real estate located in northern New Jersey, the Company does not have any
concentration of loans in any single industry classified under the North
American Industry Classification System, which exceeds 10% of its total loans
and unfunded commitments.
18
Table 6
- -----------------------------------------------------------------------------------------------------
Loan Portfolio
- -----------------------------------------------------------------------------------------------------
at December 31,
2003 2002 2001 2000 1999
========== ========== ========= ========= =========
Amounts of loans by type (in thousands)
Real estate-mortgage
1-4 family residential
First liens $ 100,286 $ 100,302 $ 113,703 $ 110,369 $ 110,269
Junior liens 4,138 6,241 8,384 11,195 9,829
Home equity 136,477 125,037 130,658 142,610 144,747
Commercial 330,040 222,628 198,319 181,722 166,354
Construction 31,077 11,359 5,265 3,755 4,008
------------ ---------- ---------- ---------- ---------
602,018 465,567 456,329 449,651 435,207
------------ ---------- ---------- ---------- ---------
Commercial loans
Commercial and financial 149,462 104,542 85,801 76,702 63,684
Lease financing 28,440 26,356 15,850 23,804 1,813
------------ ---------- ---------- ---------- ---------
177,902 130,898 101,651 100,506 65,497
------------ ---------- ---------- ---------- ---------
Consumer loans
Lease financing 12,416 15,969 18,822 4,919 7,569
Installment 4,245 3,207 4,521 5,803 3,703
------------ ---------- ---------- ---------- ---------
16,661 19,177 23,343 10,722 11,272
------------ ---------- ---------- ---------- ---------
Total $ 796,581 $ 615,641 $ 581,323 $ 560,879 $ 511,976
============ ========== ========== ========== =========
Percent of loans by type
Real estate-mortgage
1-4 family residential
First liens 12.6 % 16.3 % 19.6 % 19.7 % 21.5 %
Junior liens 0.5 1.0 1.4 2.0 1.9
Home equity 17.1 20.3 22.5 25.4 28.3
Commercial 41.4 36.2 34.1 32.4 32.5
Construction 3.9 1.8 0.9 0.7 0.8
------------ ---------- ---------- ---------- ---------
75.5 75.6 78.5 80.2 85.0
------------ ---------- ---------- ---------- ---------
Commercial loans
Commercial and financial 18.8 17.0 14.8 13.7 12.4
Lease financing 3.6 4.3 2.7 4.2 0.4
------------ ---------- ---------- ---------- ---------
22.4 21.3 17.5 17.9 12.8
------------ ---------- ---------- ---------- ---------
Consumer loans
Lease financing 1.6 2.6 3.2 0.9 1.5
Installment 0.5 0.5 0.8 1.0 0.7
------------ ---------- ---------- ---------- ----------
2.1 3.1 4.0 1.9 2.2
------------ ---------- ---------- ---------- ----------
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
============ ========== ========== ========== ==========
The following table sets forth the maturity distribution of the
Company's loan portfolio as of December 31, 2003. The table excludes real estate
loans (other than construction loans), and consumer loans: (in thousands)
Due after
Due in one year Due after
one year through five
or less five years years Total
------------ ---------- ---------- ---------
Commercial and financial $57,470 $53,774 $38,218 $149,462
Lease financing 1,203 26,867 370 28,440
Real estate-construction 24,418 6,659 - 31,077
----------- ---------- ---------- -----------
Total $83,091 $87,300 $38,588 $208,979
=========== ========== ========== ==========
The following table sets forth the interest rate characteristics of loans
due after one year as of December 31, 2003: (in thousands)
Due after
one year Due after
through five
five years years
------------ ----------
Fixed interest rate $ 62,043 $ 17,308
Variable interest rate 25,257 21,280
------------ ----------
Total $ 87,300 $ 38,588
============ ==========
19
Loan Quality
The lending activities of the Company follow the lending policy established
by the Company's Board of Directors. Loans must meet the tests of a prudent
loan, which include criteria regarding the character, capacity and capital of
the borrower, collateral provided for the loan and prevailing economic
conditions. Generally, the Company obtains an independent appraisal of real
property, within regulatory guidelines, when it is considered the primary
collateral for a loan.
The Company maintains an independent loan review function. The
responsibility of this function rests with the loan review officer who oversees
the evaluation of credit risk for substantially all large commercial loans and
leases as well as a sample of smaller commercial loans and leases. The loan
review officer also monitors the integrity of the Company's credit risk rating
system. This review process is intended to identify adverse developments in
individual credits, regardless of whether such credits are also included on the
"watchlist" discussed below and whether or not the loans are delinquent. In
addition, the loan review officer reviews commercial leases and consumer loans
considered homogeneous in nature, to identify and evaluate the credit risks of
these portfolios. The loan review officer reports directly to the Senior Vice
President and Chief Financial Officer of the Company and provides quarterly
reports to the Company's Board of Directors.
Management maintains a "watchlist" system under which credit officers are
required to provide early warning of possible deterioration in the credit
quality of loans. These loans may not currently be delinquent, but may present
indications of financial weakness, such as deteriorating financial ratios of the
borrowers, or other concerns. Identification of such financial weaknesses at an
early stage allows early implementation of responsive credit strategies. The
"watchlist" report is presented to executive management monthly and to the Board
of Directors on a quarterly basis.
Allowance for Loan and Lease Losses and Related Provision
Credit risk represents the possibility that a borrower, counterparty or
insurer may not perform in accordance with contractual terms. Credit risk is
inherent in the financial services business and results from extending credit to
customers, purchasing securities and entering into financial derivative
transactions. The Company seeks to manage credit risk through, among other
techniques, diversification, limiting credit exposure to any single industry or
customer, requiring collateral, and selling participations to third parties.
The allowance for loan and lease losses ("ALLL") is established through
periodic charges to income. Loan losses are charged against the ALLL when
management believes that the future collection of principal is unlikely.
Subsequent recoveries, if any, are credited to the ALLL. If management considers
the ALLL inadequate to cover inherent losses on existing loans, based on, but
not limited to, increases in the size of the loan portfolio, increases in
charge-offs or changes in the risk characteristics of the loan portfolio, then a
provision is made to increase the ALLL.
The Company performs periodic, systematic reviews of its portfolios to
identify inherent losses and assess the overall probability of collection. These
reviews result in the identification and quantification of loss factors, which
are used in determining the amount of the ALLL. In addition, the Company
periodically evaluates prevailing economic and business conditions,
concentration and changes in the size and characteristics of the portfolio and
other pertinent factors. Portions of the ALLL are allocated to cover the
probable losses inherent in each loan and lease category based on the results of
this detailed review process.
Commercial loans and leases, which are not considered as part of a
homogenous pool, are individually assigned a credit risk rating. Commercial
loans, which have been internally classified above a certain credit risk rating,
are periodically analyzed to determine the need for a specific loan loss
allocation. For commercial loans and leases, not specifically reviewed, loss
allocations are computed utilizing probable loss factors derived from actual
delinquency and loss experience. The combination of these analyses is the basis
for the determination of the commercial loan and lease portions of the ALLL.
Consumer loans, which include residential mortgages, home equity
loans/lines, direct/indirect loans, and consumer finance, are generally
evaluated for credit risk as a group based upon product type. The determination
of the ALLL for consumer loans are based upon a combination of historical losses
and delinquencies Credit risk for small business loans and leases are analyzed
in a similar manner utilizing a migration analysis, based upon delinquencies and
historical losses. The results of the analyses are reviewed, discussed and
approved by the Company's Board of Directors.
On a quarterly basis an analysis of the ALLL and specific allocations of
the reserve are performed. As a result, adjustments to reserve allocations for
specific segments of the loan and lease portfolio may be made. At December 31,
2003, the Company's allocated ALLL amounted to 87% of the total ALLL. The
process used by the Company to determine the appropriate overall reserve for
credit losses is based on this analysis, taking into consideration management's
judgment. This reserving methodology is reviewed on a periodic basis and
modified as appropriate. Based on this analysis, including the aforementioned
assumptions, management believes that the reserve for credit losses is adequate
as of December 31, 2003.
An integral component of the Company's risk management process is
allocating the ALLL based upon risk characteristics, demonstrated losses, loan
segmentations, and other factors. The unallocated component of the ALLL
represents management's view that, given the complexities of the loan portfolio,
there are probable losses that have been incurred but not yet specifically
identified.
This unallocated reserve may change periodically after evaluating factors
impacting assumptions utilized in the allocated reserve calculation. While the
ALLL is management's best estimate of the inherent loan losses incurred as of
the balance sheet date, the process of determining the adequacy of the ALLL is
judgmental and subject to changes in external conditions. Accordingly, there can
be no assurance that existing levels of the ALLL will ultimately prove adequate
to cover actual loan losses.
Loan loss provisions for 2003 amounted to $1.8 million, an increase of
$315 thousand from the prior year. In 2002, the loan loss provision amounted to
$1.5 million, an increase of $425 thousand from 2001. The increase in the loan
loss provision for 2003 was attributable to an increase in commercial loans and
higher levels of non-performing loans. Loans are charged-off against the ALLL,
when management believes that the future collection of principal is unlikely. In
2003, non-performing loans increased $2.6 million to $8.6 million as compared to
$6.0 million in 2002. Loans charged-off, net of recoveries increased $448
thousand to $1.3 million as compared to $862 thousand in 2002. The charge-offs
occurred principally in the ICC commercial lease portfolio which accounted for
$1.1 million or 79% of all loans charged-off. Over the last three years ICC's
leasing portfolio accounted for approximately $2.7 million or 79% of all
charge-offs. The charge-offs occurred mostly in the two commercial lease
portfolios that were purchased from brokers (indirect) during 2001. ICC's
indirect commercial lease portfolio, which has experienced most of the
charge-offs appears to have stabilized. ICC did not purchase any indirect lease
portfolios in 2002 or 2003. ICC's credit policy was amended to exclude the
purchase of indirect lease portfolios, on a flow basis or in the aggregate, from
indirect sources and the Bank's Board of
20
Directors must approve any exceptions to policy. Management has been working to
reduce the delinquencies in the lease portfolio and obtaining possession of the
foreclosed equipment, which will be re-marketed by the vendors to new customers.
In addition, management believes that at December 31, 2003 the allocated
allowance to the commercial lease portfolio is sufficient to cover possible
losses.
Table 7
- -------------------------------------------------------------------------------------------------
Loan Loss Experience
- -------------------------------------------------------------------------------------------------
for the years ended December 31,
(dollars in thousands)
2003 2002 2001 2000 1999
----------- --------- -------- --------- -------------
Average loans outstanding $729,581 $611,659 $579,034 $536,971 $494,022
=========== ========= ========= ========= =============
Allowance at beginning of year $7,207 $6,569 $6,154 $5,476 $5,645
----------- --------- --------- --------- -------------
Loans charged-off:
Real estate 162 17 11 186 120
Commercial and financial 25 - - - 1,234
Commercial lease financing 1,072 875 949 8 -
Consumer loans 97 34 4 25 59
----------- --------- --------- --------- -------------
Total 1,356 926 964 219 1,413
----------- --------- --------- --------- -------------
Recoveries of loans previously charged-off:
Real estate 35 29 22 99 10
Commercial and financial - - 264 27 14
Commercial lease financing 8 16 8 - -
Consumer loans 3 19 10 21 20
----------- --------- --------- --------- -------------
Total 46 64 304 147 44
----------- --------- --------- --------- -------------
Net loans charged-off 1,310 862 660 72 1,369
----------- --------- --------- --------- -------------
Additions due to merger 1,929 - -- - -
Provision for loan and lease losses 1,815 1,500 1,075 750 1,200
----------- --------- --------- --------- -------------
Allowance at end of year $9,641 $7,207 $6,569 $6,154 $5,476
=========== ========= ========= ========= =============
Allowance to total loans 1.21 % 1.17 % 1.13 % 1.10 % 1.07 %
Allowance to nonaccrual loans 112.50 % 120.86 % 304.12 % 441.15 % 491.12 %
Allowance to nonaccrual loans and
loans past due 90 days or more 112.50 % 120.86 % 304.12 % 441.15 % 491.12 %
Ratio of net charge-offs to average loans 0.18 % 0.14 % 0.11 % 0.01 % 0.28 %
At December 31, 2003, the ratio of the ALLL to total loans was 1.21% as
compared to 1.17% at the end of the prior year. The ALLL represented 112.5% of
nonaccrual loans and loans past due 90 days or more at December 31, 2003, down
from 120.9% at the end of 2002. This ratio was impacted by a $2.6 million
increase in nonaccrual loans in 2003 as compared to the end of the year in 2002
offset by a $1.9 million increase in the ALLL in 2003 to reflect Bridge View's
ALLL at the time of acquisition. Refer to the section titled "non-performing
Assets" and Table 9 for more detail on loan delinquencies and non-performing
assets.
The Company has the same collateral policy for loans whether they are
funded immediately or based on a commitment. A commitment to extend credit is a
legally binding agreement to lend funds to a customer usually at a stated
interest rate and for a specified purpose. Such commitments have fixed
expiration dates and generally require a fee. The extension of a commitment
gives rise to credit risk. The actual liquidity requirements or credit risk that
the Company will experience will be lower than the contractual amount of
commitments to extend credit because a significant portion of those commitments
are expected to expire without being drawn upon. Certain commitments are subject
to loan agreements containing covenants regarding the financial performance of
the customer that must be met before the Company is required to fund the
commitment. The Company uses the same credit policies in making commitments to
extend credit as it does in funding loans.
In addition, the Company manages the potential credit risk in commitments
to extend credit by limiting the total amount of arrangements, both by
individual customer and in the aggregate; by monitoring the size and maturity of
the structure of these portfolios; and by applying the same credit standards
maintained for all of its related credit activities. The credit risk associated
with these off balance sheet commitments is recorded as a liability in the
Company's balance sheet and management's determination of the reserve for these
amounts are $140 thousand.
21
Table 8
- -----------------------------------------------------------------------------------------------------------------------------
Allocation of Allowance for Loan and Lease Losses
- -----------------------------------------------------------------------------------------------------------------------------
at December 31,
(dollars in thousands)
2003 2002 2001 2000 1999
__________________ ___________________ __________________ __________________ _____________________
% of % of % of % of % of
Loans Loans Loans Loans Loans
to Total to Total to Total to Total to Total
Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1) Amount Loans(1)
------- -------- ------- --------- ------- -------- -------- ------- --------- ---------
Real estate $6,743 75.5% $3,724 75.6% $4,028 78.5% $2,713 80.2% $2,191 85.0%
Commercial and financial 479 18.8 1,435 17.0 1,389 14.8 931 13.6 634 12.5
Commercial lease financing 968 3.6 720 4.3 542 2.7 435 5.1 81 1.8
Consumer loans 186 2.1 132 3.1 5 4.0 35 1.1 82 0.7
Unallocated 1,265 - 1,196 - 605 - 2,040 - 2,488 -
--------- --------- ------- ------- ------- ------- ------- ------- --------- -------
$9,641 100.0% $7,207 100.0% $6,569 100.0% $6,154 100.0% $ 5,476 100.0%
========= ========= ======= ======= ======= ======= ======= ======= ========== =======
<FN>
(1) This column reflects each respective class of loans as a percent of total
loans.
The above allocation is intended for analytical purposes and may not be
indicative of the categories in which future loan losses may occur.
</FN>
Non-performing Assets
Non-performing assets consist of nonaccrual loans, restructured loans and
foreclosed assets (comprised of foreclosed real estate and repossessed assets.
Loans are placed on nonaccrual status when, in the opinion of management, the
future collection of interest or principal according to contractual terms may be
doubtful or when principal or interest payments are in arrears 90 days or more.
Foreclosed real estate, representing real estate collateral acquired by legal
foreclosure procedures, is valued using independent appraisals, and the
Company's policy is to obtain revised appraisals annually. The Company intends
to dispose of each property at or near its current valuation. However, there can
be no assurance that disposals will be made as soon as anticipated or at
expected values.
Table 9 below presents the detail of non-performing assets and the
aggregate of loans whose principal and/or interest has not been paid according
to contractual terms. At December 31, 2003, non-performing assets increased $2.7
million, or 43.3%, as compared to the end of the prior year. The increase in
non-performing assets was due mainly to one relationship representing $1.7
million of the increase in nonaccrual loans. Based upon the best currently
available information it is believed that this relationship will be worked out
during 2004 and the Company is not likely to experience a loss. Non-performing
assets increased $3.3 million, or 119.1%, in 2002 as compared to 2001. Based on
the current information available, except for the loans included in the table,
management believes that there were no material probable problem loans or
leases, either individually or in the aggregate, at December 31, 2003.
Table 9
_____________________________________________________________________________________________________________________
Loan Delinquencies and Nonperforming Assets
_____________________________________________________________________________________________________________________
at December 31,
(dollars in thousands)
2003 2002 2001 2000 1999
Loans delinquent and accruing interest ----------- ----------- --------- ---------- ----------
Loans past due 30-89 days $1,265 $2,121 $1,938 $2,058 $190
Loans past due 90 days or more - - - - -
----------- ----------- ---------- ---------- ----------
Total loans delinquent and accruing interest $1,265 $2,121 $1,938 $2,058 $190
=========== =========== ========== ========== ===========
Nonaccrual loans $8,570 $5,963 $2,160 $1,395 $1,115
Foreclosed assets 230 176 492 250 250
Restructured loans - - 150 - 222
----------- ----------- ---------- ---------- -----------
Total nonperforming assets $8,800 $6,139 $2,802 $1,645 $1,587
=========== =========== ========== ========== ===========
Total nonperforming assets and loans $8,800 $6,139 $2,802 $1,645 $1,587
past due 90 days or more =========== =========== ========== ========== ===========
Nonaccrual loans to total loans 1.08 % 0.97 % 0.37 % 0.25 % 0.22 %
Nonperforming assets to total loans and
foreclosed assets 1.10 % 1.00 % 0.48 % 0.29 % 0.31 %
Nonperforming assets to total assets 0.63 % 0.66 % 0.34 % 0.21 % 0.22 %
Nonaccrual loans and loans past due 90 days
or more to total loans 1.08 % 0.97 % 0.37 % 0.25 % 0.22 %
22
Securities Held-to-Maturity and Securities Available-for-Sale
The Company identifies as "securities available-for-sale" securities
used as part of its asset/ liability management strategy, or securities that may
be sold in response to, among other things, changes in interest rates and
prepayment risk. Debt securities purchased with the intent and ability to hold
until maturity are classified as "held-to-maturity". See Notes 1 and 4 of Notes
to Consolidated Financial Statements for additional information concerning
securities.
Table 10 presents a summary of the contractual maturities and weighted
average yields (adjusted to a taxable equivalent basis using the corporate
federal tax rate of 34%) of "securities held-to-maturity" and "securities
available-for-sale". Historical cost was used to calculate the weighted-average
yields.
Table 10
- ---------------------------------------------------------------------------------------------------------------------
Securities
- ---------------------------------------------------------------------------------------------------------------------
at December 31, 2003
(dollars in thousands)
After 1 After 5 Weighted
Within But Within But Within After Average
1 Year 5 Years 10 Years 10 Years Total Yield (1)
------------ --------- ---------- --------- ---------- --------
Securities held-to-maturity at amortized cost
Mortgage-backed securities $ 4,563 $ 3,456 $ 745 $ 1,086 $ 9,850 4.98 %
Obligations of states & political subdivisions 1,178 3,178 3,966 935 9,257 6.77
------------ --------- ---------- --------- ---------- --------
5,741 6,634 4,711 2,021 19,107 5.85
------------ --------- ---------- --------- ---------- --------
Securities available-for-sale at estimated fair value
Mortgage-backed securities 43,017 55,579 6,604 8,987 114,187 3.74
Obligations of U.S. agencies 16,062 249,161 7,937 - 273,160 2.73
Obligations of states & political subdivisions 12,296 7,479 5,499 9,764 35,038 4.29
Obligations of the US Treasury 6,035 - - - 6,035 2.94
------------ --------- ---------- --------- ---------- --------
77,410 312,219 20,040 18,751 428,420 3.13
Equity securities - - - - 4,533 4.64 %
------------ --------- ---------- --------- ---------- ---------
Total $ 83,151 $ 318,853 $ 24,751 $ 20,772 $ 452,060
============ ========= ========== ========= ==========
Weighted average yield (1) 2.66 % 3.04 % 4.89 % 6.72 % 3.26 %
<FN>
(1) Computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%.
</FN>
The following table sets forth the carrying value of the Company's held-to-maturity and available-for-sale securities portfolios
for the years ended December 31: (dollars in thousands)
2003 2002 2001
----------------------- --------------------- --------------------
Amount % Amount % Amount %
------------ --------- ---------- --------- ---------- --------
Securities held-to-maturity at amortized cost
Mortgage-backed securities $ 9,850 51.6 % $ 16,437 58.3 % $ 22,201 57.1 %
Obligations of U.S. agencies - - 1,991 7.1 5,977 15.4
Obligations of states & political subdivisions 9,257 48.4 9,664 34.3 9,855 25.3
Other debt securities - - 100 0.3 839 2.2
------------ --------- ---------- --------- ---------- --------
$ 19,107 100.0 % $ 28,192 100.0 % $ 38,872 100.0 %
============ ========= ========== ========= ========== ========
Securities available-for-sale at estimated fair value
Mortgage-backed securities $ 114,187 26.4 % $ 102,605 45.7 % $ 98,517 63.5 %
Obligations of U.S. agencies 273,160 63.1 95,559 42.6 40,064 25.9
Obligations of states & political subdivisions 35,038 8.1 22,219 9.9 10,455 6.7
Obligations of U.S. Treasury 6,035 1.4 - - 2,017 1.3
Equity securities 4,533 1.0 3,937 1.8 3,977 2.6
------------ --------- ---------- --------- ---------- --------
$ 432,953 2.4 % $ 224,320 100.0 % $ 155,030 100.0 %
============ ========= ========== ========= ========== ========
23
The Company's total investment portfolio increased by $199.5 million, or
79%, to $452.1 million at December 31, 2003 as compared to the prior year. The
increase in the investment portfolio was primarily through deposit growth,
prepayment on loans and the Bridge View acquisition. Total gross unrealized
gains and total gross unrealized losses for the investment portfolio amounted to
$6.5 million and $990 thousand, respectively, at December 31, 2003.
At December 31, 2003, available-for-sale ("AFS") securities amounted to
$433.0 million, or 95.8%, of total securities, compared to $224.3 million, or
88.8%, of total securities at year-end 2002. The Company's AFS portfolio
increased by $208.6 million, or 93.0%, at December 31, 2003 as compared to the
prior year. The composition of investment securities shifted from
mortgage-backed securities to obligations of U.S. Agencies mostly due to market
conditions and the Company's asset/liability management strategy. Substantially
all of the mortgage-backed securities held by the Company are issued or backed
by U.S. federal agencies.
At December 31, 2003, the Company held no securities of a single issuer
(except U.S. federal agencies) with a book value that exceeds 10% of
Consolidated Stockholders' Equity.
The Company's held-to-maturity portfolio decreased by $9.1 million, or
32.2%, to $19.1 million at December 31, 2003 as compared to the prior year. The
decrease was mostly due to declines in mortgage-backed securities and
obligations of U.S. agencies, which were largely the result of amortization and
maturities.
Deposits
Deposits, which include non-interest-bearing demand deposits,
interest-bearing demand deposits, savings and time deposits, are an essential
and cost-effective funding source for the Company. The Company attributes its
long-term success in growing deposits to the emphasis it places on building core
customer relationships. The Company offers a variety of deposit products
designed to meet the financial needs of the customers based on identifiable
"life stages". Deposits increased $341.1 million, or 41.8%, to $1.2 billion at
December 31, 2003 as compared to the prior year mainly from the acquisition of
Bridge View and internal growth. For 2003, the Company's overall yield on
deposits decreased by 94 basis points to 1.52% due mostly to a decline in market
interest rates and change in deposit mix.
The growth in the deposit base occurred mostly in interest-bearing
demand deposits and non-interest bearing demand deposits. Interest-bearing
demand deposits, which comprised the largest segment of the Company's total
deposits, amounted to $446.8 million at December 31, 2003, an increase of $122.8
million, or 37.9%, from year-end 2002. The Company's yield on interest-bearing
demand deposits decreased by 69 basis points to 1.19% for 2003 as compared to
2002. Non-interest bearing demand deposits increased $105.2 million, or 88.7%,
to $223.7 million at December 31, 2003 as compared to the prior year.
Non-interest bearing demand deposits represented 19.3% of total deposits at
December 31, 2003 and 14.5% at December 31, 2002. The growth in non-interest
bearing demand deposits positively impacted the overall yield on deposit
liabilities at December 31, 2003 as compared to year-end 2002.
Contributing to the growth in deposits was a $44.5 million, or 18.8%,
increase in time deposits at December 31, 2003 as compared to year-end 2002.
Time deposits represented 24.4% of total deposits at December 31, 2003 and 29.1%
at December 31, 2002. The Company's yield on total time deposits decreased by
127 basis points to 2.58% for 2003 as compared to 2002.
Table 11
- -------------------------------------------------------------------------------------------------
Deposit Summary
- -------------------------------------------------------------------------------------------------
at December 31,
(dollars in thousands)
2003 2002 2001
------------------------- ----------------- ------------------
Non-interest bearing demand $ 223,745 19.3 % $ 118,578 14.5 % $ 109,416 15.1 %
Interest bearing demand 446,786 38.6 323,998 39.7 282,173 38.8
Money market 120,136 10.4 55,372 6.8 47,569 6.5
Savings 84,162 7.3 80,300 9.8 72,092 9.9
Time deposits less than $100,000 265,356 22.9 210,727 25.9 194,754 26.9
Time deposits greater than $100,000 16,613 1.5 26,697 3.3 20,479 2.8
-------------- ---------- ---------- ------ ---------- -----
$ 1,156,798 100.0 % $ 815,672 100.0 % $ 726,483 100.0 %
============== ========== ========== ====== ========== =====
The following table shows the time remaining to maturity of time certificates of
deposit of $100,000 or more as of December 31, 2003:
(in thousands)
Three months or less ......................................... $ 7,914
Over three months through six months ......................... 3,699
Over six months through twelve months ........................ 3,066
Over twelve months ........................................... 1,934
-------
$16,613
=======
24
Market Risk
Market risk is generally described as the sensitivity of income to adverse
changes in interest rates, foreign currency exchange rates, commodity prices,
and other relevant market rates or prices. Market rate sensitive instruments
include: financial instruments such as investments, loans, mortgage-backed
securities, deposits, borrowings and other debt obligations; derivative
financial instruments, such as futures, forwards, swaps and options; and
derivative commodity instruments, such as commodity futures, forwards, swaps and
options that are permitted to be settled in cash or another financial
instrument.
The Company does not have any material exposure to foreign currency
exchange rate risk or commodity price risk. The Company did not enter into any
market rate sensitive instruments for trading purposes nor did it engage in any
trading or hedging transactions utilizing derivative financial instruments
during 2003. The Company's real estate loan portfolio, concentrated primarily in
northern New Jersey, is subject to risks associated with the local and regional
economies. The Company's primary source of market risk exposure arises from
changes in market interest rates ("interest rate risk").
Interest Rate Risk
Interest rate risk is generally described as the exposure to potentially
adverse changes in current and future net interest income resulting from:
fluctuations in interest rates; product spreads; and imbalances in the repricing
opportunities of interest-rate-sensitive assets and liabilities. Therefore,
managing the Company's interest rate sensitivity is a primary objective of the
Company's senior management. The Company's Asset/Liability Committee ("ALCO") is
responsible for managing the exposure to changes in market interest rates. ALCO
attempts to maintain stable net interest margins by periodically evaluating the
relationship between interest-rate-sensitive assets and liabilities. The
evaluation, which is performed at least quarterly and presented to the Board,
simulates the impact on net interest margin from current and prospective changes
in market interest rates.
The Company manages interest rate risk exposure with the utilization of
financial modeling and simulation techniques. These methods assist the Company
in determining the effects of market rate changes on net interest income and
future economic value of equity. The objective of the Company is to maximize net
interest income within acceptable levels of risk established by policy. The
techniques utilized for managing exposure to market rate changes involve a
variety of interest rate, pricing and volume assumptions. These assumptions
include projections on growth, prepayment and withdrawal levels as well as other
embedded options inherently found in financial instruments. The Company reviews
and validates these assumptions at least annually or more frequently if economic
or other conditions change. At December 31, 2003, the Company simulated the
effects on net interest income given an instantaneous and parallel shift in the
yield curve of up to a 200 basis point rising interest rate environment and a
100 basis point declining interest rate environment. Based on the simulation, it
was estimated that net interest income, over a twelve-month horizon, would not
decrease by more than 4.5%. The Company's interest rate risk management policies
provide that net interest income should not decrease by more than 15% or 10% if
interest rates increase from current rates given an instantaneous and parallel
shift in the yield curve of a 200 basis point rise in rates or 100 basis point
decline in rates, respectively. Policy exceptions, if any are reported to the
Board of Directors. At December 31, 2003, the Company was within policy limits
established for changes in net interest income and future economic value of
equity.
The following table sets forth the sensitivity results for the last two years.
Net Interest Income Sensitivity Simulation
Percentage Change in
Estimated Net Interest
Income over a
twelve month horizon
----------------------
2003 2002
--------- --------
+200 basis points -3.8 % -4.4 %
+100 basis points -0.6 % 0.2 %
-100 basis points -4.5 % -2.9 %
-200 basis points * *
<FN>
* Not simulated due to the historically low interest rate environment.
</FN>
The simulation described above does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape;
prepayments on loans and securities; deposit decay rates; pricing decisions on
loans and deposits; reinvestment/replacement of asset and liability cashflows;
and others. While assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
Further, as market conditions vary from those assumed in the simulation,
actual results will also differ due to: prepayment/refinancing levels deviating
from those assumed; the varying impact of interest rate changes on caps or
floors on adjustable rate assets; the potential effect of changing debt service
levels on customers with adjustable rate loans; depositor early withdrawals and
product preference changes; and other internal/external variables. Furthermore,
the simulation does not reflect actions that ALCO might take in response to
anticipated changes in interest rates or competitive conditions in the market
place.
In addition to the above-mentioned techniques, the Company utilizes
sensitivity gap analysis as an interest rate risk measurement. Sensitivity gap
is determined by analyzing the difference between the amount of interest-earning
assets maturing or repricing within a specific time period and the amount of
interest bearing liabilities maturing or repricing within that same period of
time. Sensitivity gap analysis provides an indication of the extent to which the
Company's net interest income may be affected by future changes in market
interest rates. The cumulative gap position expressed as a percentage of total
assets provides one relative measure of the Company's interest rate exposure.
The cumulative gap between the Company's interest-rate-sensitive assets
and its interest-rate-sensitive liabilities repricing within a one-year period
was a negative 12.8% at December 31, 2003. Since the cumulative gap was
negative, the Company has a "negative gap" position, which theoretically will
cause its assets to reprice more slowly than its deposit liabilities. In a
declining interest rate environment, interest costs may be expected to fall
faster than the interest received on earning assets, thus increasing the net
interest spread. If interest rates increase, a negative gap means that the
interest received on earning assets may be expected to increase more slowly than
the interest paid on the Company's liabilities therefore decreasing the net
interest spread.
25
Certain shortcomings are inherent in the method of gap analysis presented
in Table 12. Although certain assets and liabilities may have similar maturities
or periods of repricing, they may react in different degrees to changes in
market interest rates. The rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates, while rates on other types of
assets and liabilities may lag behind changes in market rates. In the event of
a change in interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in calculating the table. The ability of
borrowers to service debt may decrease in the event of an interest rate
increase. Management considers these factors when reviewing its sensitivity gap
position and establishing its ongoing asset/liability strategy.
Table 12
- -----------------------------------------------------------------------------------------------------------------------------
Interest Rate Sensitivity Analysis
- -----------------------------------------------------------------------------------------------------------------------------
at December 31, 2003
(dollars in thousands)
Non-
3 6 6 Mos. to 1 to 3 3 to 5 Over interest
Subject to rate change within Months Months 1 Year Years Years 5 Years Sensitive Total
--------- --------- ---------- --------- --------- ---------- --------- ---------
Assets
Net loans $245,648 $ 43,457 $ 81,528 $220,368 $ 151,899 $ 47,155 $ (3,115) $ 786,940
Investment securities 61,703 36,740 37,186 244,966 43,617 23,522 4,326 452,060
Cash and amounts due from banks 12 - - - - - 31,423 31,435
Other noninterest earning assets - - 21,343 - - - 94,094 115,437
--------- --------- ---------- --------- --------- ---------- --------- --------
Total assets 307,363 80,197 140,057 465,334 195,516 70,677 126,728 1,385,872
--------- --------- ---------- --------- --------- ---------- --------- =========
Liabilities and stockholders' equity
Demand deposits 72,084 72,084 144,168 190,711 93,666 97,818 - 670,531
Money market accounts 31,696 9,259 18,517 13,277 6,137 5,276 - 84,162
Savings deposits 10,512 10,512 21,024 54,000 16,657 7,431 - 120,136
Fixed maturity certificates of
deposits 90,856 69,813 94,400 24,315 2,585 - - 281,969
Securities sold under
agreements to repurchase 8,379 4,380 760 946 520 633 - 15,618
Short-term borrowings 46,491 - - - - - - 46,491
Long-term borrowings - - - - 10,000 - - 10,000
Other liabilities - - - - - - 13,772 13,772
Stockholders' equity - - - - - - 143,193 143,193
--------- --------- ---------- --------- --------- ---------- --------- --------
Total liabilities and
stockholders' equity 260,018 166,048 278,869 283,249 129,565 111,158 156,965 $1,385,872
--------- --------- ---------- --------- --------- ---------- --------- =========
Gap $ 47,345 $ (85,851) $ (138,812) $ 182,085 $ 65,951 $ (40,481) $ (30,237)
========= ========= ========== ========= ========= ========== =========
Gap to total assets 3.42 % (6.19)% (10.02)% 13.14 % 4.76 % (2.92)%
Cumulative Gap $ 47,345 $(38,506) $ (177,318) $ 4,767 $ 70,718 $ 30,237
========= ========= ========== ========= ========= =========
Cumulative Gap to total assets 3.42 % (2.78)% (12.79)% 0.34 % 5.10 % 2.18 %
26
Operational Risk
The Company is exposed to a variety of operational risks that can affect
each of its business activities, particularly those involving processing and
servicing of loans. Operational risk is defined as the risk of loss resulting
from inadequate or failed internal processes, people or systems from external
events. The risk of loss also includes losses that may arise from potential
legal actions that could result from operational deficiencies or noncompliance
with contracts, laws or regulations. The Company monitors and evaluates
operational risk on an ongoing basis through systems of internal control, formal
corporate-wide policies and procedures, and an internal audit function.
Liquidity
A fundamental component of the Company's business strategy is to manage
liquidity to ensure the availability of sufficient resources to meet all
financial obligations and to finance prospective business opportunities.
Liquidity management is critical to the stability of the Company. The liquidity
position of the Company over any given period of time is a product of its
operating, financing and investing activities. The extent of such activities is
often shaped by such external factors as competition for deposits and loan
demand.
Traditionally, financing for the Company's loans and investments is derived
primarily from deposits, along with interest and principal payments on loans and
investments. At December 31, 2003, total deposits amounted to $1.2 billion, an
increase of $341.1 million, or 41.8%, over the prior comparable year. At
December 31, 2003, advances from the FHLB, overnight borrowings and securities
sold under agreements to repurchase totaled $72.1 million and represented 5.2%
of total assets as compared to $27.4 million and 2.9% of total assets at
December 31, 2002.
Loan production continued to be the Company's principal investing activity.
Net loans at December 31, 2003 amounted to $786.9 million, an increase of $178.5
million, or 29.3%, compared to the same period in 2002.
The Company's most liquid assets are cash and due from banks and federal
funds sold. At December 31, 2003, the total of such assets amounted to $31.4
million, or 2.3%, of total assets, compared to $33.9 million, or 3.6%, of total
assets at year-end 2002. The decrease in liquid assets, principally federal
funds sold, was driven by the growth in the securities and loan portfolios.
Another significant liquidity source is the Company's available-for-sale
securities. At December 31, 2003, available-for-sale securities amounted to
$433.0 million, or 95.8%, of total securities, compared to $224.3 million, or
88.8%, of total securities at year-end 2002.
In addition to the aforementioned sources of liquidity, the Company has
available various other sources of liquidity, including federal funds purchased
from other banks and the Federal Reserve discount window. The Bank also has a
$98.3 million line of credit available through its membership in the FHLB of
which $46.5 million at December 31, 2003 was utilized. The Company maintains a
policy of paying regular cash dividends and anticipates continuing that policy.
The Company could, if necessary, modify the amount or frequency, of dividends as
an additional source of liquidity. There are imposed dividend restrictions on
the Bank. See Note 18 of Notes to Consolidated Financial Statement for
additional information.
Management believes that the Company's sources of funds are sufficient to
meet its present funding requirements.
The following table sets forth contractual obligations and various commitments
representing required and potential cash flows as of December 31, 2003.
Table 13
- ------------------------------------------------------------------------------------------
Contractual Obligations and Commitments
- ------------------------------------------------------------------------------------------
at December 31, 2003
(dollars in thousands)
Contractual Obligations
Payment due by Period
--------------------------------------------
----------- ----------- ----------- ---------- -------------
Total
Less than One to Four to After Amounts
one year three years five years five years Committed
----------- ----------- ----------- ---------- -------------
Minimum annual rental under
non-cancelable operating leases $ 2,409 $ 4,389 $ 3,480 $ 7,669 $ 17,947
Remaining contractual maturities
of time deposits 255,069 24,315 2,585 - 281,969
Securities sold under agreement
to repurchase and short-term
borrowings 62,109 - - - 62,109
Long-term borrowings - - 10,000 - 10,000
------------ ----------- ----------- ---------- -------------
Total contractual cash
obligations $ 319,587 $ 28,704 $ 16,065 $ 7,669 $ 372,025
============ =========== =========== ========== =============
Other Commitments
Amount of Commitment Expiration By Period
----------------------------------------------------
Total
Less than One to Four to After Amounts
one year three years five years five years Committed
----------- ----------- ----------- ---------- -------------
Loan commitments $ 60,311 $ 4,222 - $152,761 $ 217,294
Standby letters of credit 3,534 - - - 3,534
------------ ----------- ----------- ---------- -------------
Total other commitments $ 63,845 $ 4,222 - $152,761 $ 220,828
============ =========== =========== ========== =============
27
Capital Adequacy
Stockholders' equity totaled $143.2 million, or 10.3%, of total assets at
December 31, 2003, compared to $80.7 million, or 8.6%, of total assets at
December 31, 2002. The $62.5 million growth was largely attributable to the
acquisition of Bridge View and net income which contributed $52.2 million and
$16.4 million, respectively, of the growth. These increases were offset in part
by cash dividends of $5.0 million during 2003.
Guidelines issued by the Federal Reserve Board and the Federal Deposit
Insurance Corporation ("FDIC") establish capital adequacy guidelines for bank
holding companies and state-chartered banks. The guidelines establish a
risk-based capital framework consisting of (1) a definition of capital and (2) a
system for assigning risk weights. Capital consists of Tier 1 capital, which
includes common stockholders' equity less certain intangibles, and a
supplementary component called Tier 2 capital, which includes a portion of the
allowance for loan and lease losses. Effective October 1, 1998, the Federal
Reserve Board and the FDIC adopted an amendment to their risk-based capital
guidelines that permits insured depository institutions to include in their Tier
2 capital up to 45% of the pre-tax net unrealized gains on certain
available-for-sale equity securities. All assets and off-balance sheet items are
assigned to one of four weighted risk categories ranging from 0% to 100%. Higher
levels of capital are required for the categories perceived as representing
greater risks. An institution's risk-based capital ratio is determined by
dividing its qualifying capital by its risk-weighted assets. The guidelines make
regulatory capital requirements more sensitive to differences in risk profiles
among banking institutions, take off-balance sheet items into account in
assessing capital adequacy and minimize the disincentive to holding liquid,
low-risk assets. Banking organizations are generally expected to operate with
capital positions well above the minimum rates. Institutions with higher levels
of risk, or which experience or anticipate significant growth, are also expected
to operate well above minimum capital standards. At December 31, 2003, the
Company's and the Bank's Tier 1 risk-based capital ratio was 9.34 % and 9.24%,
respectively, well in excess of minimum capital standards.
These guidelines focus principally on broad categories of credit risk,
although the framework for assigning assets and off-balance sheet items to risk
categories does incorporate elements of transfer risk. The risk-based capital
ratio does not, however, incorporate other factors that may affect a company's
financial condition, such as overall interest rate exposure, liquidity, funding
and market risks, the quality and level of earnings, investment or loan
concentrations, the quality of loans and investments, the effectiveness of loan
and investment policies and management's ability to monitor and control
financial and operating risks.
In addition to the risk-based guidelines discussed above, the Federal
Reserve Board and the FDIC require that a bank holding company and bank which
meet the regulators' highest performance and operation standards and which are
not contemplating or experiencing significant growth maintain a minimum leverage
ratio (Tier 1 capital as a percent of quarterly average adjusted assets) of 3%.
For those financial institutions with higher levels of risk or that are
experiencing or anticipating significant growth, the minimum leverage ratio will
be increased. At December 31, 2003, the Company's and the Bank's leverage ratio
was 6.24% and 6.22%, respectively.
Stock Repurchase Program
On April 26, 2001, the Board of Directors of Interchange authorized a
program to repurchase up to 450,000 shares of Interchange's outstanding common
stock on the open market or in privately negotiated transactions. No shares were
repurchased during 2003 and as of December 31, 2003, the Company had purchased
170,193 shares at a total cost of approximately $2.2 million under the
authorized program. The repurchased shares are held as treasury stock and will
be principally used for the exercise of stock options, restricted stock awards
under the Stock Plan and other general corporate purposes.
Effects of Inflation and Changing Prices
The financial statements and related financial data presented herein have
been prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without considering changes
in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than do general levels of inflation. Interest rates do not
necessarily move in the same magnitude as the prices of goods and services.
Off Balance Sheet Arrangements
As noted in Note 1 of the Consolidated Financial Statements on page 36,
the Company's policy is to consolidate majority-owned subsidiaries that it
controls. The Company does not dispose of troubled loans or problem assets by
means of unconsolidated special purpose entities, use off-balance sheet entities
to fund its business operations nor capitalize any off-balance sheet entity with
the Company's stock. In the ordinary course of business, the Company originates
and sells commercial leases and other financial assets, such as mortgage loans,
to the secondary market. Exposure to loan commitments and letters of credit can
be found in Table 13 under Liquidity.
Critical Accounting Policies and Judgments
The Company's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 1 Accounting Policies in the Notes to Consolidated Financial
Statements. Certain of these policies require numerous estimates and strategic
or economic assumptions that may prove inaccurate or subject to variations and
may significantly affect the Company's reported results and financial position
for the period or in future periods. The use of estimates, assumptions, and
judgments are necessary when financial assets and liabilities are required to be
recorded at, or adjusted to reflect, fair value. Assets and liabilities carried
at fair value inherently result in more financial statement volatility. Fair
values and the information used to record valuation adjustments for certain
assets and liabilities are based on either quoted market prices or are provided
by other independent third party sources, when available. When such information
is not available, management estimates valuation adjustments primarily by using
internal cash flow and other financial modeling techniques. Changes in
underlying factors, assumptions, or estimates in any of these areas could have a
material impact on the Company's future financial condition and results of
operations.
Allowance For Loan and Lease Losses
The allowance for loan and lease losses ("ALLL") is established through
periodic charges to income. Loan losses are charged against the ALLL when
management believes that the future collection of principal is unlikely.
Subsequent recoveries, if any, are credited to the ALLL. The Company considers
the ALLL of $9.6 million is adequate to cover specifically identifiable loan
losses, as well as estimated losses inherent in our portfolio for which certain
loss are probable but not specificially identifiable.
28
Management's determination of the adequacy of the allowances is based on
periodic evaluations of the loan portfolio and other relevant factors. The
evaluations are inherently subjective as it requires material estimates
including such factors as potential loss factors, changes in trend of
non-performing loans, current state of local and national economy, value of
collaterial, changes in the composition and volume of the loan portfolio, review
of specific problem loans and management's assessment of the inherent risk and
overall quality of the loan portfolio. All of these factors may be susceptible
to significant change. Also, the allocation of the allowance for credit losses
to specific loan pools is based on historical loss trends and management's
judgment concerning those trends.
The primary risks inherent in the loan portfolio are possible increases in
interest rates, a decline in the economy, and a possible decline in real estate
market values. Any one or a combination of these events may adversely affect our
loan portfolio resulting in increased delinquencies, loan losses, and future
levels of provisions. To the extent actual outcomes differ from management
estimates, additional provision for credit losses may be required that would
adversely impact earnings in future periods.
For further discussion see the "Loan Quality" and "Allowance for Loan and
Lease Losses" sections on pages 20-22, along with Note 1 "Nature of Business and
Summary of Significant Accounting Policies"; Note 6 "Allowance for Loan and
Lease Losses"; and Note 19 "Commitments And Contingent Liabilities" of the
Consolidated Financial Statements.
Business Combinations: Business combinations are accounted using the purchase
method of accounting, the net assets and liabilities of the companies acquired
are recorded at their estimated fair value at the date of acquisition and
include the results of operations of the acquired business from the date of
acquisition. The excess of the purchase price over the estimated fair value of
the net assets including identified intangible assets acquired is recognized as
goodwill.
Goodwill and Intangibles: With the adoption of Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), on January 1, 2002, goodwill is no longer amortized to expense,
but rather is tested for impairment periodically. Other intangible assets are
amortized to expense using straight-line methods over their respective estimated
useful lives. At least annually, and on an interim basis when conditions
require, management reviews goodwill and other intangible assets and evaluates
events or changes in circumstances that may indicate impairment in the carrying
amount of such assets. If the sum of the expected undiscounted future cash
flows, excluding interest charges, is less than the carrying amount of the
asset, an impairment loss is recognized. An impairment is measured on a
discounted future cash flow basis and a charge is recognized in the period that
the asset has been deemed to be impaired. The majority of the Corporation's
goodwill relates to its acquisition of Bridge View Bancorp on April 30, 2003.
The value of this goodwill is dependent upon the Corporation's ability to
provide quality, cost effective services in the face of competition from other
market leaders on a national and local level. As such, goodwill value is
supported ultimately by earnings which is driven by the volume of business
transacted. A decline in earnings as a result of a lack of growth or the
Company's inability to deliver cost effective services over sustained periods
can lead to impairment of goodwill which could result in a charge and adversely
impact earnings in future periods. Total goodwill was $55.9 million at December
31, 2003. See Note 1 "Accounting Policies" and Note 8 "Goodwill And Other
Intangible Assets" for additional information.
Pensions Plans: The Bank maintains a qualified defined benefit pension plan (the
"Pension Plan"), which covers all eligible employees and an unfunded
supplemental pension plan which provides retirement income to all eligible
employees who would have been paid amounts in excess of the amounts provided by
the Pension Plan but for limitations under the qualified Pension Plan. In
addition, the Company has an unfunded retirement plan for all directors of the
Bank who are not employees of the Company or any subsidiary or affiliate.
Our expected long-term rate of return on plan assets is 8.0% and was based
on our expectations of the long-term return on the balanced mutual fund that we
invest our plan assets which has had a return for the life of the fund of 8.33%.
A 1.0% decrease in the long-term rate of return on plan assets would have
increased the net periodic pension cost of the Pension Plan by approximately $16
thousand.
The discount rate that we utilize of 6.25% for determining future pension
obligations is based on a review of long-term bonds that receive one of the two
highest ratings given by a recognized rating agency. A 1.0% decrease in the
discount rate would have increased the net periodic pension cost by
approximately $183 thousand.
Recently Issued Accounting Pronouncements
In January 2003, the FASB issued Statement of Financial Accounting
Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation -
Transition and Disclosure." SFAS No. 148 amends FASB Statement No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation," to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS No. 148 is effective for fiscal years beginning
after December 15, 2002. The Company adopted the disclosure provisions of SFAS
No. 148 on January 1, 2003. The Company does not expect to change to using the
fair value based method of accounting for stock-based employee compensation; and
therefore, the adoption of SFAS No. 148 impacts only the disclosures, not the
financial results, of the Company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
ARB 51." FIN 46 addresses consolidation by business enterprises of variable
interest entities (`VIE'). FIN 46 requires a VIE to be consolidated by a company
if that company is subject to a majority of the risk of loss from the VIE's
activities or entitled to receive a majority of the entity's residual returns,
or both. The provisions are effective for any new entities that are originated
subsequent to January 31, 2003. On December 24, 2003, the FASB issued a revision
to FIN 46 ("FIN 46-R"). The Company has adopted FIN 46-R as the method used for
evaluating whether or not VIEs must be consolidated as of December 26, 2003. The
adoption of FIN 46 and 46-R did not have an impact on the consolidated financial
statements.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). This Statement is effective for contracts entered into
or modified after June 30, 2003, except for contracts that relate to SFAS 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 and for hedging relationships designated after June 30,
29
2003. The adoption of SFAS 149 did not have a material impact on the financial
position or results of operations of the Company.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 "Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity" ("SFAS 150"), which establishes how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS 150 did not have a material impact on the financial position or
results of operations of the Company because the Company does not have any
financial instruments that have characteristics of both liabilities and equity.
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003), Employers' Disclosures about Pensions and
Other Postretirement Benefits ("SFAS 132"). The revised SFAS 132 retains the
disclosure requirements in the original statement and requires additional
disclosures about pension plan assets, benefit obligations, benefit costs and
other relevant information. The Company has included the new disclosures that
are required for financial statements of annual periods ending after December
15, 2003.
Forward Looking Statements
In addition to discussing historical information, certain statements
included in or incorporated into this report relating to the financial
condition, results of operations and business of the Company which are not
historical facts may be deemed "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. When used herein, the
words "anticipate," "believe," "estimate," "expect," "will" and other similar
expressions (including when preceded or followed by the word "not") are
generally intended to identify such forward-looking statements. Such statements
are intended to be covered by the safe harbor provisions for forward-looking
statements contained in such Act, and we are including this statement for
purposes of invoking these safe harbor provisions. Such forward-looking
statements include, but are not limited to, statements about the operations of
the Company, the adequacy of the Company's allowance for losses associated with
the loan and lease portfolio, the quality of the loan and lease portfolio, the
prospects of continued loan and deposit growth, and improved credit quality. The
forward-looking statements in this report involve certain estimates or
assumptions, known and unknown risks and uncertainties, many of which are beyond
the control of the Company, and reflect what we currently anticipate will happen
in each case. What actually happens could differ materially from what we
currently anticipate will happen due to a variety of factors, including, among
others, (i) increased competitive pressures among financial services companies;
(ii) changes in the interest rate environment, reducing interest margins or
increasing interest rate risk; (iii) deterioration in general economic
conditions, internationally, nationally, or in the State of New Jersey; (iv) the
occurrence of acts of terrorism, such as the events of September 11, 2001, or
acts of war; (v) legislation or regulatory requirements or changes adversely
affecting the business of the Company; (vi) losses in the Company's leasing
subsidiary exceeding management's expectations; (vii) expected revenue synergies
from the Company's acquisition of Bridge View may not be fully realized or
realized within the expected time frame; (viii) revenues following the Company's
acquisition of Bridge View may be lower than expected; (ix) deposit attrition,
operating costs, customer loss and business disruption following the Company's
acquisition of Bridge View, including, without limitation, difficulties in
maintaining relationships with employees, may be greater than expected and (x)
other risks detailed in reports filed by the Company with the Securities and
Exchange Commission. Readers should not place undue expectations on any
forward-looking statements. We are not promising to make any public announcement
when we consider forward-looking statements in this document to be no longer
accurate, whether as a result of new information, what actually happens in the
future or for any other reason.
Table 14
- --------------------------------------------------------------------------------
Quarterly Common Stock Price Range
- --------------------------------------------------------------------------------
for the years ended December 31,
The Company's common stock is quoted on the Nasdaq National Market System
under the symbol "IFCJ." There are imposed dividend restrictions on the Bank.
See Note 18 of Notes to Consolidated Financial Statement for additional
information.
High Low Cash
Sales Sales Dividends
Price Price Declared
------------ ------------ ------------
2002
First quarter . . . . . $ 16.23 $ 12.47 $ 0.10
Second quarter . . . . . 19.27 16.23 0.10
Third quarter . . . . . 18.67 15.70 0.10
Fourth quarter . . . . . 19.10 15.95 0.14
2003
First quarter . . . . . $ 18.03 $ 16.10 $ 0.11
Second quarter . . . . . 22.50 17.20 0.11
Third quarter . . . . . 22.52 19.34 0.11
Fourth quarter . . . . . 26.68 20.45 0.11
The number of stockholders of record as of February 27, 2003 was 1,386.
<FN>
All per share data was restated to reflect a 3-for-2 stock split declared on May
23, 2002 and paid on July 12, 2002.
</FN>
30
Independent Auditor's Report
Board of Directors and Stockholders
Interchange Financial Services Corporation
Saddle Brook, New Jersey
We have audited the accompanying consolidated balance sheets of Interchange
Financial Services Corporation and subsidiaries (the "Company") as of December
31, 2003 and 2002 and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in
all material respects, the financial position of Interchange Financial Services
Corporation and subsidiaries as of December 31, 2003 and 2002 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York
February 20, 2004
31
Interchange Financial Services Corporation
- ----------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------
December 31,
(dollars in thousands)
December 31, December 31,
2003 2002
---------------- ---------
Assets
Cash and due from banks $ 31,423 $ 23,266
Interest earning deposits 12 -
Federal funds sold - 10,650
---------------- ---------
Total cash and cash equivalents 31,435 33,916
---------------- ---------
Securities held to maturity at amortized cost (estimated fair value of
$20,223 and $29,590 for 2003 and 2002, respectively) 19,107 28,192
---------------- ---------
Securities available for sale at estimated fair value (amortized cost
of $428,597 and $217,924 for 2003 and 2002, respectively) 432,953 224,320
---------------- ---------
Loans and leases (net of unearned income and deferred fees of $6,057 and
$8,657 for 2003 and 2002 respectively. 796,581 615,641
Less: Allowance for loan and lease losses 9,641 7,207
---------------- ---------
786,940 608,434
---------------- ---------
Bank owned life insurance 21,853 21,274
Premises and equipment, net 20,343 10,512
Foreclosed assets and other repossessed assets 230 176
Goodwill 55,924 1,447
Intangible assets 4,165 231
Accrued interest receivable and other assets 12,922 7,830
---------------- ---------
Total assets $1,385,872 $936,332
================ =========
Liabilities
Deposits
Non-interest bearing $223,745 $118,578
Interest bearing 933,053 697,094
---------------- ---------
Total deposits 1,156,798 815,672
---------------- ---------
Securities sold under agreements to repurchase 15,618 17,390
Short-term borrowings 46,491 -
Long-term borrowings 10,000 10,000
Accrued interest payable and other liabilities 13,772 12,590
---------------- ---------
Total liabilities 1,242,679 855,652
---------------- ---------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, without par value; 22,500,000 shares authorized; 12,810,193
and 9,815,207 shares isssued and outstanding for 2003 and
2002, respectively 5,397 5,397
Capital surplus 73,231 21,097
Retained earnings 74,710 63,314
Accumulated other comprehensive income 2,434 3,596
---------------- --------
155,772 93,404
Less: Treasury stock 12,579 12,724
---------------- --------
Total stockholders' equity 143,193 80,680
---------------- ---------
Total liabilities and stockholders' equity $1,385,872 $936,332
================ =========
<FN>
- --------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
</FN>
32
Interchange Financial Services Corporation
- -------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
- -------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
(in thousands, except per share data)
2003 2002 2001
-------------- ----------- ------------
Interest income
Interest on loans and leases $48,982 $45,343 $ 46,175
Interest on federal funds sold 276 246 557
Interest on interest bearing deposits 61 - -
Interest and dividends on securities
Taxable interest income 9,847 10,123 9,890
Interest income exempt from federal income taxes 914 599 532
Dividends 187 189 248
-------------- ----------- ------------
Total interest income 60,267 56,500 57,402
-------------- ----------- ------------
Interest expense
Interest on deposits 13,161 16,357 22,070
Interest on securities sold under agreements to repurchase 267 291 526
Interest on short-term borrowings 18 403 848
Interest on long-term borrowings 428 427 -
-------------- ----------- ------------
Total interest expense 13,874 17,478 23,444
-------------- ----------- ------------
Net interest income 46,393 39,022 33,958
Provision for loan and lease losses 1,815 1,500 1,075
-------------- ----------- ------------
Net interest income after provision for loan and lease losses 44,578 37,522 32,883
-------------- ----------- ------------
Non-interest income
Service fees on deposit accounts 3,485 2,581 2,459
Net gain on sale of securities 793 564 252
Net gain on sale of loans and leases 769 400 550
Bank owned life insurance 2,019 895 378
Commisions on sale of annuities and mutual funds 883 603 273
Other 2,696 1,471 1,666
-------------- ----------- ------------
Total non-interest income 10,645 6,514 5,578
-------------- ----------- ------------
Non-interest expense
Salaries and benefits 16,994 13,673 12,353
Occupancy 4,577 3,438 3,275
Furniture and equipment 1,327 1,124 1,157
Advertising and promotion 1,412 1,295 1,251
Amortization of intangible assets 360 69 81
Other 6,569 5,464 4,756
-------------- ----------- ------------
Total non-interest expense 31,239 25,063 22,873
-------------- ----------- ------------
Income before income taxes 23,984 18,973 15,588
Income taxes 7,618 6,096 5,048
-------------- ----------- ------------
Net income $ 16,366 $ 12,877 $ 10,540
============== =========== ============
Basic earnings per common share $1.39 $1.31 $1.08
============== =========== ============
Diluted earnings per common share $1.36 $1.30 $1.07
============== =========== ============
<FN>
- ------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements
All per share data was restated to reflect a 3-for-2 stock split declared on May
23, 2002 and paid on July 12, 2002.
</FN>
33
Interchange Financial Services Corporation
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the Twelve Months Ended December 31
(dollars in thousands, except per share data)
Accumulated
Other
Comprehensive Retained Comprehensive Common Capital Treasury
Income Earnings Income Stock Surplus Stock Total
------------- -------- -------------- ------- -------- --------- ---------
Balance at January 1, 2001 $47,735 $526 $5,397 $21,077 $(12,751) $61,984
Comprehensive income
Net Income $10,540 10,540 10,540
Other comprehensive income, net of taxes
Unrealized gains on AFS debt
securities 602
Add: realized losses on
disposition of securities 28
------------
Other comprehensive income, net
of taxes 630 630 630
------------
Comprehensive income $11,170
============
Dividends on common stock (3,517) (3,517)
Issued 22,320 shares of common stock in connection
with Executive Compensation
Plan (14) 255 241
Exercised 13,226 option shares (70) 152 82
Purchased 140,643 shares of common stock (1,727) (1,727)
-------- ------------ ------- --------- ------- ---------
Balance at December 31, 2001 54,758 1,156 5,397 20,993 (14,071) 68,233
Comprehensive income
Net Income $ 12,877 12,877 12,877
Other comprehensive income, net of taxes
Unrealized gains on AFS debt
securities 3,037
Less: realized gains on
disposition of securities (597)
Unrealized gains on equity
securities -
----------
Other comprehensive income, net
of taxes 2,440 2,440 2,440
----------
Comprehensive income $ 15,317
==========
Dividends on common stock (4,321) (4,321)
Issued 21,069 shares of common stock in connection
with Executive Compensation
Plan 66 244 310
Exercised 25,158 option shares (93) 291 198
Issued 107,877 shares of common stock in connection with
the acquisition of certain assets and assumption of
certain liabilities of Monarch Capital Corporation 131 1,244 1,375
Purchased 29,550 shares of common stock (432) (432)
--------- -------- ------- --------- -------- -------
Balance at December 31, 2002 63,314 3,596 5,397 21,097 (12,724) 80,680
Comprehensive income
Net Income $16,366 16,366 16,366
Other comprehensive income, net of taxes
Unrealized net gains on AFS
debt securities (474)
Less: net gains on disposition
of securities (820)
Unrealized gains on equity
securities 137
Minimum pension liability (5)
-----------
Other comprehensive income, net
of taxes (1,162) (1,162) (1,162)
----------
Comprehensive income $ 15,204
==========
Dividends on common stock (4,970) (4,970)
Issued 20,883 shares of common stock in connection
with Executive Compensation
Plan 109 245 354
Exercised 59,695 option shares (155) 593 438
Issued 2,949,719 shares of common stock in connection with
the acquisition of Bridge View Bancorp 52,180 52,180
Reacquired 35,959 shares in lieu of non-performing asset (693) (693)
-------- ------- ------- -------- -------- ---------
Balance at December 31, 2003 $74,710 $2,434 $5,397 $73,231 $(12,579) $143,193
======== ======= ======= ======== ======== =========
<FN>
- --------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
All share data was restated to reflect a 3-for-2 stock split declared on May 23, 2002 and paid on July 12, 2002.
</FN>
34
Interchange Financial Services Corporation
- -------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------------
For the Years Ended December 31,
(in thousands)
2003 2002 2001
------------ ----------- -----------
Cash flows from operating activities
Net income $ 16,366 $ 12,877 $ 10,540
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 1,752 1,446 1,486
Amortization of securities premiums 4,643 2,039 1,044
Accretion of securities discounts (315) (305) (326)
Amortization of premiums in connection with acquisition 1,033 69 81
Provision for loan and lease losses 1,815 1,500 1,075
Increase in cash surrender value of Bank Owned Life Insurance (579) (895) (378)
Net gain on sale of securities (1,208) (564) (252)
Origination of loans held for sale (18,089) - -
Sale of loans held for sale 18,679 - -
Acceleration of premium amortization on certain collateralized
mortgage obligations 415 - -
Net gain on sale of loans and leases (769) (400) (550)
Net loss on sale of fixed assets 10 - -
Net gain on sale of foreclosed real estate and repossessed assets (7) (40) -
Decrease (increase) in operating assets
Accrued interest receivable (1,225) (330) 443
Accounts receivable- leases sold - 4,921 -
Deferred taxes 1,672 - (185)
Other (4,080) (383) (5,337)
(Decrease) increase in operating liabilities
Accrued interest payable (322) (308) (478)
Other (115) 1,467 4,010
------------ ----------- -----------
Cash provided by operating activities 19,676 21,094 11,173
------------ ----------- -----------
Cash flows from investing activities
(Payments for) proceeds from
Net originations of loans and leases (904) (26,826) (15,303)
Purchase of loans and leases (53) (14,967) (18,760)
Sale of loans and leases 3,176 6,603 13,267
Purchase of securities available for sale (341,335) (131,069) (99,767)
Maturities of securities available for sale 122,581 43,219 46,339
Sale of securities available for sale 44,361 21,867 19,348
Maturities of HTM securities 8,900 8,481 18,699
Sale of securities held to maturity - 2,023 2,003
Purchase of HTM securities - - (18,548)
Sale of foreclosed real estate and other repossessed assets 141 766 -
Purchase of fixed assets (1,242) (1,646) (1,652)
Premium in connection with acquisition (90) (1,748) -
Net cash proceeds from acquisition of Bridge View Bancorp 19,439 - -
Purchase of Bank Owned Life Insurance - (5,000) (15,000)
Sale of fixed assets - - 1,260
------------------------------------
Cash used in investing activities (145,026) (98,297) (68,114)
------------------------------------
Cash flows from financing activities
Proceeds from (payments for)
Deposits in excess of withdrawals 82,332 89,189 57,623
Securities sold under agreements to repurchase and other borrowings 147,734 64,693 55,592
Retirement of securities sold under agreement to repurchase and
other borrowings (103,014) (62,104) (62,292)
Minimum pension liability, net of taxes (5) - -
Dividends (4,970) (4,321) (3,517)
Common stock issued 354 1,685 241
Treasury stock - (432) (1,727)
Exercise of option shares 438 198 82
------------ ----------- -----------
Cash provided by financing activities 122,869 88,908 46,002
------------ ----------- -----------
(Decrease) increase in cash and cash equivalents (2,481) 11,705 (10,939)
Cash and cash equivalents, beginning of year 33,916 22,211 33,150
------------ ----------- -----------
Cash and cash equivalents, end of year $ 31,435 $ 33,916 $ 22,211
============ =========== ===========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 14,052 $ 17,786 $ 23,922
Income taxes 9,003 6,701 1,409
Supplemental disclosure of non-cash investing and financing activities:
Loans transferred to foreclosed real estate and other repossessed assets 188 410 242
Stock issued for net assets purchased - 1,375 -
Stock issued related to Bridge View acquisition 52,180 - -
<FN>
____________________________________________________________________________________________________________________________________
See notes to consolidated financial statements.
</FN>
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Summary of Significant Accounting Policies
The following is a description of the business of Interchange
Financial Services Corporation ("Interchange") and subsidiaries (collectively,
the "Company") and its significant accounting and reporting policies used in the
preparation of the consolidated financial statements:
Nature of Business
Interchange, a New Jersey business corporation, is a registered bank
holding company under the Bank Holding Company Act of 1956, as amended, whose
principal subsidiary is Interchange Bank (the "Bank"), a New Jersey state bank
and member of the Federal Reserve System. The Bank is principally engaged in the
business of attracting commercial and retail deposits and investing those funds
into commercial business and commercial mortgage loans as well as residential
mortgage and consumer loans. When available funding exceeds loan demand, the
Bank generally invests in debt securities. As a community bank operating in the
northeast region of New Jersey (primarily Bergen County), the Bank is engaged in
providing its customers a broad range of financial products and services, such
as equipment leasing, mutual funds and annuities, brokerage services,
conventional insurance, internet banking and title insurance.
Summary of Significant Accounting Policies
Principles of consolidation: The accompanying consolidated financial statements
include the accounts of the Company, including its direct and indirect
wholly-owned subsidiaries and its indirect subsidiary, Clover Leaf Management
Realty Corporation, which is 99.0% owned by the Bank. The consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). Significant intercompany
accounts and transactions have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform with the financial statement
presentation of 2003.
Use of estimates: The preparation of the consolidated financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amount of revenues and expenses during the reporting
period. Such estimates include the allowance for loan and lease losses, the fair
value of financial instruments, goodwill, intangibles, and retirement benefits.
Actual results could differ from those estimates.
Cash and cash equivalents: For the purposes of presentation in the consolidated
statements of cash flows, cash and cash equivalents include cash on hand,
amounts due from banks, interest bearing deposits and federal funds sold, with
original maturities of three months or less.
Securities held-to-maturity and securities available-for-sale: Debt securities
purchased with the intent and ability to hold until maturity are classified as
securities held-to-maturity ("HTM") and are carried at cost, adjusted for the
amortization of premiums and accretion of discounts. Management determines
whether the security will be classified as HTM at the time of purchase.
All other securities, including equity securities, are classified as
securities available-for-sale ("AFS"). Securities classified as AFS may be sold
prior to maturity in response to, but not limited to, changes in interest rates,
changes in prepayment risk or for asset/liability management strategies. These
securities are carried at fair value and any unrealized gains and losses are
reported, net of taxes, in accumulated other comprehensive income (loss)
included in the consolidated statement of stockholders' equity. The estimated
fair value for securities are based on quoted market prices, where available. If
quoted market prices are not available, estimated fair values are based on
quoted market prices of comparable instruments. Gains and losses from the sale
of these securities are determined using the specific identification method and
are reported in non-interest income. The Company does not acquire securities for
the purpose of engaging in trading activities.
Interest and dividends are accrued and credited to income as earned.
Purchase premiums and discounts are recognized in interest income using the
effective interest method over the term of the securities.
On a quarterly basis the investment portfolio is evaluated to determine if
there are any securities with losses that are other than temporary. An other
than temporary impairment charge on a security is recorded if it is determined
that we are unable to recover all amounts due under the contractual obligations
of the debt or if there is a permenant diminution of value of equity securities.
Loans and Leases: Loans and leases (herein referred to collectively as loans)
are carried at the principal amounts outstanding, net of unearned discount and
deferred loan origination fees and costs. Interest income is accrued and
recognized as income when earned. Origination fees and certain direct loan
origination costs are deferred and amortized to interest income over the
estimated life of the loan as an adjustment to the yield. Mortgage loans held
for sale are carried at lower of aggregate cost or market value. Gains and
losses on loans sold are included in non-interest income. There were no loans
held for sale at December 31, 2003 and 2002.
Direct finance leases have terms ranging from three to seven years. Under
direct finance lease accounting, the balance sheet includes the gross minimum
lease payments receivable, unguaranteed estimated residual values of the leased
equipment, and capitalized indirect costs, reduced by unearned lease income.
Income from syndicated leases are included in non-interest income.
The equipment lease residual values represent the expected proceeds from
the sale of leased equipment at the end of the term of the lease and are
determined on the basis of analyses prepared by the Bank's equipment leasing
subsidiary, Interchange Capital Company L.L.C. ("ICC"), based upon professional
appraisals, historical experience and industry data. Management reviews the
estimated residual values on a periodic basis, and impairments in value, if any,
are recognized as an immediate charge to income.
Loans are placed on nonaccrual status when principal or interest payments
are in arrears 90 days or more and/or in the opinion of management the future
collection of interest or principal according to contractual terms may be
doubtful. Amounts previously accrued are evaluated for collectibility and if
necessary previously recognized income is reversed. Interest income on
nonaccrual loans is recognized on a cash basis, to the extent there is no doubt
of the future collection of principal. Loans are returned to accrual status when
the obligation is brought current and has performed in accordance with the
contractual terms for a reasonable period of time and, in management's
judgement, collection of the contractual principal and interest is no longer
doubtful.
Loans are considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect all amounts due
according to contractual terms of the loan agreement. The
36
collection of all amounts due according to contractual terms means that
both the contractual interest and principal payments of a loan will be collected
as scheduled in the loan agreement. All nonaccrual commercial and commercial
mortgage loans as well as non-homogeneous one-to-four family residential
mortgage loans and consumer loans are considered impaired.
The impairment of a commercial loan is measured based on the present value
of expected future cash flows discounted at the loan's effective interest rate
or, as a practical expedient, at the loan's observable market price or the fair
value of the underlying collateral. The fair value of collateral, reduced by
costs to sell on a discounted basis, is utilized if a loan is collateral
dependent or foreclosure is probable. One-to-four family residential mortgage
loans and consumer loans with small balances are pooled together as homogeneous
loans and, accordingly, are not covered by Statement of Financial Accounting
Standards ("SFAS") No. 114 "Accounting by Creditors for Impairment of a Loan."
A loan is categorized as a troubled debt restructure if a significant
concession to contractual terms is granted to the borrower due to deterioration
in the financial condition of the borrower. Generally, a nonaccrual loan that is
restructured remains on nonaccrual until the obligation is brought current and
has performed for a period of time to demonstrate that the borrower can meet the
restructured terms. If the borrower's ability to meet the revised payment
schedule is uncertain, the loan remains classified as a nonaccrual loan.
Allowance for loan and lease losses: The allowance for loan and lease losses
("ALLL") is established through periodic charges to income. Loan losses are
charged against the ALLL when management believes that the future collection of
principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL.
Management's determination of the adequacy of the allowances is based on
periodic evaluations of the loan portfolio and other relevant factors. The
evaluations are inherently subjective as it requires material estimates
including such factors as potential loss factors, changes in trend of
non-performing loans, current state of local and national economy, value of
collateral, changes in the composition and volume of the loan portfolio, review
of specific problem loans and management's assessment of the inherent risk and
overall quality of the loan portfolio. All of these factors may be susceptible
to significant change. Also, the allocation of the allowance for credit losses
to specific loan pools is based on historical loss trends and management's
judgment concerning those trends.
The primary risks inherent in the loan portfolio are possible increases in
interest rates, a decline in the economy, and a possible decline in real estate
market values. Any one or a combination of these events may adversely affect our
loan portfolio resulting in increased delinquencies, loan losses, and future
levels of provisions. To the extent actual outcomes differ from management
estimates, additional provision for credit losses may be required that would
adversely impact earnings in future periods.
In addition to the allowance for credit losses, the Company maintains an
allowance for unfunded loan commitments and letters of credit. This amount,
reported as a liability on the Consolidated Balance Sheet, is determined using
estimates of the probability of losses related to those credit exposures.
Premises and equipment: Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Depreciation and amortization are
computed using the straightline method. Premises and equipment are depreciated
over the estimated useful lives of the assets.Leasehold improvements are
amortized over the term of the lease, if shorter. Estimated lives are 30 to 40
years for premises and 3 to 20 years for furniture and equipment. Maintenance
and repairs are charged to expenses as incurred, while renewals and major
improvements are capitalized.
Foreclosed assets: Foreclosed assets consist of real estate and other
repossessed assets and are carried at the lower of cost or estimated fair value,
less estimated selling costs, at time of foreclosure or repossession. When an
asset is acquired, the excess of the carrying amount over fair value, if any, is
charged to the ALLL. Subsequent valuations are performed periodically and the
carrying value is adjusted by a charge to foreclosed asset expense to reflect
any subsequent declines in the estimated fair value. As a result, further
declines in the asset values may result in increased foreclosed asset expense.
Routine holding costs are charged to foreclosed asset expense as incurred.
Business Combinations: In business combinations accounted for using the purchase
method of accounting, the assets and liabilities of the companies acquired are
recorded at their estimated fair value at the date of acquisition and include
the results of operations of the acquired business from the date of acquisition.
The excess of the purchase price over the estimated fair value of the net assets
acquired is recognized as goodwill.
Goodwill and Intangibles: With the adoption of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), on January 1, 2002, goodwill is no longer amortized to expense, but
rather is tested for impairment periodically. Other intangible assets are
amortized to expense using straight-line methods over their respective estimated
useful lives. At least annually, and on an interim basis when conditions
require, management reviews goodwill and other intangible assets and evaluates
events or changes in circumstances that may indicate impairment in the carrying
amount of such assets. If the sum of the expected undiscounted future cash
flows, excluding interest charges, is less than the carrying amount of the
asset, an impairment loss is recognized. An impairment is measured on a
discounted future cash flow basis and a charge is recognized in the period that
the asset has been deemed to be impaired. At the date of adoption, there was no
unamortized goodwill.
Income taxes: Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply in the period(s) in which the deferred tax asset or liability
is expected to be settled or realized. The effect on deferred taxes of a change
in tax rates is recognized in income in the period in which the change occurs.
Deferred tax assets are reduced, through a valuation allowance, if necessary, by
the amount of such benefits that are not expected to be realized based on
current available evidence.
Earnings per common share: Basic earnings per common share represents
income available to common stockholders divided by the weighted-average number
of common shares outstanding during the period. Diluted earnings per common
share reflects additional common shares that would have been outstanding if
dilutive potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common shares that
may be issued by the Company relate solely to outstanding stock options, and are
determined using the treasury stock method.
Segment Reporting: SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information" ("SFAS No. 131"), requires disclosures for each
reportable operating segment. As a community-oriented
37
financial institution, substantially all of the Company's operations entail the
delivery of loan and deposit products and various other financial services to
customers in its primary market area, which is Bergen County, New Jersey. The
Company's community-banking operation constitutes the Company's only operating
segment for financial reporting purposes under SFAS No. 131.
Treasury Stock: The Company records common stock purchased for treasury at cost.
At the date of subsequent reissuance, the treasury stock account is reduced by
the average cost of such stock.
Stock-Based Compensation: At December 31, 2003, the Company has stock-based
employee compensation plans, which are described more fully in Note 12 Stock
Option and Incentive Plan. The Company accounts for these plans under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. No stock-based employee compensation
expense has been reflected in net income for stock options as all rights and
options to purchase the Company's stock granted under these plans had an
exercise price equal to the market value of the underlying stock on the date of
grant. A table, which illustrates the income from continuing operations and
earnings per share as if the Company had applied the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," as
amended, to stock-based employee compensation plans, is described more fully in
Note 13 "Stock Option and Incentive Plan".
Recently issued accounting pronouncements: In January 2003, the FASB
issued Statement of Financial Accounting Standards No. 148 ("SFAS 148"),
"Accounting for Stock-Based Compensation Transition and Disclosure." SFAS No.
148 amends FASB Statement No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements of the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. SFAS No. 148
is effective for fiscal years beginning after December 15, 2002. The Company
adopted the disclosure provisions of SFAS No. 148 on January 1, 2003. The
Company does not expect to change to using the fair value based method of
accounting for stock-based employee compensation; and therefore, the adoption of
SFAS No. 148 impacts only the disclosures, not the financial results, of the
Company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
ARB 51." FIN 46 addresses consolidation by business enterprises of variable
interest entities (`VIE'). FIN 46 requires a VIE to be consolidated by a company
if that company is subject to a majority of the risk of loss from the VIE's
activities or entitled to receive a majority of the entity's residual returns,
or both. The provisions are effective for any new entities that are originated
subsequent to January 31, 2003. On December 24, 2003, the FASB issued a revision
to FIN 46 ("FIN 46R"). The Company has adopted FIN 46R as the method used for
evaluating whether or not VIEs must be consolidated as of December 26, 2003. The
adoption of FIN 46 and 46R did not have an impact on the consolidated financial
statements.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). This Statement is effective for contracts entered into
or modified after June 30, 2003, except for contracts that relate to SFAS 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 and for hedging relationships designated after June 30,
2003. The adoption of SFAS 149 did not have a material impact on the financial
position or results of operations of the Company.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150 "Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity" ("SFAS 150"), which establishes how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS 150 did not have a material impact on the financial position or
results of operations of the Company because the Company does not have any
financial instruments that have characteristics of both liabilities and equity.
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003), Employers' Disclosures about Pensions and
Other Postretirement Benefits ("SFAS 132"). The revised SFAS 132 retains the
disclosure requirements in the original statement and requires additional
disclosures about pension plan assets, benefit obligations, benefit costs and
other relevant information. The Company has included the new disclosures that
are required for financial statements of annual periods ending after December
15, 2003.
Note 2. Acquisitions
On April 30, 2003, the Company completed it's acquisition of Bridge View
Bancorp ("Bridge View"), a Bergen County based bank holding company with eleven
locations. As of that date Bridge View had approximately $291 million of total
assets, $184 million of loans and $259 million of deposits. The aggregate
purchase price paid to Bridge View shareholders was approximately $85.7 million
and consisted of approximately 2.9 million shares of the Company's common stock
with an approximate market value of $52.2 million based upon the average closing
price three days prior to and after the acquisition date and $33.5 million in
cash. The transaction was accounted for as a purchase and the cost in excess of
net assets acquired of approximately $58.7 million was allocated to net
identified intangibles of approximately $4.3 million and goodwill of
approximately $54.4 million.
The following is a reconciliation of the purchase price paid by
Interchange for Bridge View:
Cash and due from banks $ 49,555
Federal funds sold 7,000
Investments 39,907
Loans 183,845
Premises and equipment 10,222
Intangible assets 4,295
Accounts receivable and other assets 839
Non-interest bearing deposits (85,353)
Interest bearing deposits (173,627)
Accounts payable and other liabilities (5,338)
---------------
Fair value net assets acquired 31,345
Purchase price 85,731
---------------
Goodwill $ 54,386
===============
38
The following unaudited pro forma condensed consolidated statements of
income for the years ended December 31, 2003 and 2002 give effect to the merger
as if the merger had been consummated on either January 1, 2003 or 2002.
The unaudited pro forma information is not necessarily indicative of the
results of operations in the future or the results of operations, which would
have been realized had the merger been consummated during the periods or as of
the dates for which the unaudited pro forma information is presented.
Interchange Financial Services Corporation and Subsidiaries
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
Year Ended
December 31,
------------------------------
2003 2002
(Unaudited) (Unaudited)
Pro Forma Pro Forma
-------------- ---------------
Interest income $ 64,585 $ 69,255
Interest expense 14,491 18,975
-------------- ---------------
Net interest income 50,094 50,280
Provision for loan and lease losses 1,830 2,070
-------------- ---------------
Net interest income after provision for loan and lease losses 48,264 48,210
Non-interest income 11,429 9,036
Non-interest expense
Salaries and benefits 18,489 18,075
Occupancy and FF&E 6,521 6,377
Other expenses 9,054 9,867
-------------- ---------------
34,064 34,319
Net income before taxes 25,629 22,927
Income Taxes 8,254 7,699
-------------- ---------------
Net income $ 17,375 $ 15,228
============== ===============
Earnings per common share:
Basic 1.36 1.19
Diluted 1.34 1.18
On January 16, 2002, the Company acquired certain assets and assumed
certain liabilities of Monarch Capital Corporation ("Monarch"). In this asset
purchase transaction, the Company acquired certain loans and leases valued at
approximately $12.8 million. In addition, the Company assumed certain
liabilities (borrowings) of Monarch, valued at approximately $12.7 million,
which had been used to fund the loans and leases. The total purchase price was
$1.6 million which was paid in cash and 71,918 in shares of Company stock with
an approximate market value of $917 thousand subject to certain adjustments. The
cost in excess of net assets acquired resulted in goodwill of approximately $1.5
million.
Note 3. Restrictions on Cash and Due from Banks
The Bank is required to maintain a reserve balance with the Federal Reserve
Bank of New York based upon the level of its deposit liability. The average
amount of this reserve balance for 2003 and 2002 was approximately $1.7 million
and $775 thousand, respectively.
39
Note 4. Securities Held-to-Maturity and Securities Available-for-Sale
Securities held-to-maturity and securities available-for-sale consist of the following: (in thousands)
-------------------------------------------------------
December 31, 2003
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ----------- ------------ --------------
Securities held-to-maturity
Mortgage-backed securities $ 9,850 $ 330 $ 1 $ 10,179
Obligations of states & political subdivisions 9,257 787 - 10,044
------------- ----------- ------------ --------------
$ 19,107 $ 1,117 $ 1 $ 20,223
============= =========== ============ ==============
Securities available-for-sale
Obligations of U.S. Treasury $ 6,032 $ 5 $ 2 $ 6,035
Mortgage-backed securities 112,981 1,363 157 114,187
Obligations of U.S. agencies 271,339 2,583 762 273,160
Obligations of states & political subdivisions 33,849 1,257 68 35,038
Equity securities 4,396 137 - 4,533
------------- ----------- ------------ --------------
428,597 5,345 989 432,953
------------- ----------- ------------ --------------
Total securities $ 447,704 $ 6,462 $ 990 $ 453,176
============= =========== ============ ==============
-------------------------------------------------------
December 31, 2002
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ----------- ------------ --------------
Securities held-to-maturity
Mortgage-backed securities $ 16,437 $ 667 $ - $ 17,104
Obligations of U.S. agencies 1,991 68 - 2,059
Obligations of states & political subdivisions 9,664 663 - 10,327
Other debt securities 100 - - 100
------------- ----------- ------------ --------------
28,192 $1,398 - 29,590
------------- ----------- ------------ --------------
Securities available-for-sale
Mortgage-backed securities 101,028 1,778 201 102,605
Obligations of U.S. agencies 91,577 3,982 - 95,559
Obligations of states & political subdivisions 21,382 889 52 22,219
Equity securities 3,937 - - 3,937
------------- ----------- ------------ --------------
217,924 6,649 253 224,320
------------- ----------- ------------ --------------
Total securities $ 246,116 $ 8,047 $ 253 $ 253,910
============= =========== ============ ==============
Securities Securities
Held-to-Maturity Available-for-Sale
-------------------------- ------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ----------- ------------
Within 1 year $ 5,741 $ 5,951 $ 77,204 $ 77,410
After 1 but within 5 years 6,634 6,945 309,449 312,219
After 5 but within 10 years 4,711 5,174 19,813 20,040
After 10 years 2,021 2,153 17,735 18,751
Equity securities - - 4,396 4,533
------------ ----------- ----------- ------------
Total $ 19,107 $ 20,223 $ 428,597 $ 432,953
============ =========== =========== ============
40
Proceeds from the sale of securities available-for-sale amounted to $44.4
million, $21.9 million and $19.3 million for the years ended December 31, 2003,
2002 and 2001, respectively, which resulted in gross realized gains of $1.3
million, $573 thousand and $141 thousand for those periods, respectively. Gross
realized losses from the sale of securities available-for-sale amounted to $71
thousand, $33 thousand and $19 thousand in 2003, 2002 and 2001, respectively.
These amounts are included in net gain on sale of securities in the Consolidated
Statements of Income.
Proceeds from the sale or call of securities held to maturity amounted to
$275 thousand for the year ended December 31, 2003 and $2.0 million for each of
the years ended December 31, 2002 and 2001, respectively. These security
transactions resulted in no gains for 2003 and realized gains of $24 thousand
and $130 thousand for 2002 and 2001, respectively. The securities were either
scheduled to mature within 3 months or were called before maturity.
During 2003, the Company recognized an other than temporary impairment
charge of $415 thousand from the acceleration of premium amortization on certain
collateralized mortgage obligations. The acceleration of premium amortization
was largely driven by the historically high mortgage prepayment speeds due to
the low interest rate environment. These amounts are included in net gain on
sale of securities in the Consolidated Statements of Income.
The investment portfolio is evaluated at least quarterly to determine if
there are any securities with losses that are other than temporary. One criteria
in assessing for an other than temporary impairment charge is if a security has
an unrealized loss that exceeds one year. At December 31, 2003, the Company had
$6.2 million of securities with unrealized losses of $13 thousand that were in
excess of one year. It is expected that the Company will recover all amounts due
under the contractual obligations of those securities and as such, no other than
temporary impairment charge was necessary.
Securities with carrying amounts of $46.1 million and $58.6 million at
December 31, 2003 and 2002, respectively, were pledged for public deposits,
Federal Home Loan Bank advances, securities sold under repurchase agreements and
other purposes required by law.
Note 5. Loans
The composition of the loan portfolio is summarized as follows:
(in thousands)
-------------------------------
December 31,
-------------------------------
2003 2002
-------------- -------------
Real Estate
Residential .................... $ 240,901 $ 231,580
Commercial ..................... 330,040 222,628
Construction ................... 31,077 11,359
Commercial
Commercial and financial ....... 149,462 104,542
Lease financing ................ 28,440 26,356
Consumer
Lease financing ................ 12,416 15,969
Installment .................... 4,245 3,207
--------- ---------
796,581 615,641
Allowance for loan and lease losses (9,641) (7,207)
--------- ---------
$ 786,940 $ 608,434
========= =========
Loans are net of unearned income and deferred fees of $6.1 million and $8.7
million at December 31, 2003 and 2002 respectively.
Non-performing loans include loans which are accounted for on a nonaccrual basis
and troubled debt restructurings.
Non-performing loans are as follows: (in thousands)
---------------------------
December 31,
---------------------------
2003 2002
---------- --------
Nonaccrual loans
Residential real estate $ 1,364 $ 495
Commercial real estate 1,603 1,780
Commercial and financial 2,858 1,300
Commercial lease financing 2,365 2,357
Consumer 380 31
---------- --------
$ 8,570 $ 5,963
---------- --------
Troubled debt restructurings
Commercial and financial - -
---------- --------
Total non-performing loans $8,570 $5,963
========== ========
At December 31, 2003, 2002 and 2001, there were no loans or leases on
which interest is accruing and included in income, but which were contractually
past due 90 days or more as to principal or interest payments. Interest income
that would have been recorded during the year on nonaccrual loans outstanding at
year-end in accordance with original terms amounted to $773 thousand, $576
thousand and $231 thousand for the years ended December 31, 2003, 2002 and 2001,
respectively. Interest income included in net income during the year on loans
currently classified as nonaccrual loans outstanding at year-end amounted to
$353 thousand, $321 thousand and $143 thousand for the years ended December 31,
2003, 2002 and 2001, respectively.
While a significant portion of the Company's loans are collateralized by
real estate located in northern New Jersey, the Company does not have any
concentration of loans in any single industry classified under the North
American Industry Classification System, which exceeds 10% of its total loans
and unfunded commitments.
Certain officers and directors of the Company and their affiliated
companies are customers of and are engaged in transactions with the Company in
the ordinary course of business on substantially the same terms as those
prevailing with other non-affiliated borrowers and suppliers.
The following table summarizes activity with respect to these loans: (in
thousands)
---------------------------
Years Ended December 31,
---------------------------
2003 2002
---------- --------
Balance at beginning of year $ 5,135 $ 6,133
Additions - -
Reductions (1,043) (998)
---------- --------
Balance at end of year $ 4,092 $ 5,135
========== ========
41
Note 6. Allowance for Loan and Lease Losses
The Company's recorded investment in impaired loans is as follows:(in thousands)
--------------------------------------------------------------
December 31,
--------------------------------------------------------------
2003 2002
----------------------------- -----------------------------
Investment Related Investment Related
in Allowance in Allowance
Impaired for Loan Impaired for Loan
Loans Losses Loans Losses
------------- ----------- ------------- ------------
Impaired loans
With a related allowance for loan losses
Commercial and financial ........................ $2,864 $ 463 $1,104 $ 128
Commercial real estate .......................... 1,603 40 1,780 45
Residential real estate ......................... 816 122 -- --
Without a related allowance for loan losses .................. -- -- -- --
------ ------ ------ ------
$5,283 $ 625 $2,884 $ 173
====== ====== ====== ======
<FN>
- ------------------------------------------------------------------------------
The impairment of the above loans was measured based on the fair value of
collateral.
</FN>
The following table sets forth certain information about impaired
loans: (in thousands)
------------------------
Years Ended December 31,
------------------------
2003 2002
------- -------
Average recorded investment $ 4,711 $ 3,166
======= =======
Interest income recognized during
time period that loans were
impaired, using cash-basis
method of accounting $ 198 $ 160
======= =======
Changes in the allowance for loan and lease losses are summarized as follows:
(in thousands)
---------------------------------
Year Ended December 31,
---------------------------------
2003 2002 2001
----------- -------- --------
Balance at beginning of year .................. $ 7,207 $ 6,569 $ 6,154
Additions (deductions)
Provision charged to operations .......... 1,815 1,500 1,075
Bridge View acquired allowance ........... 1,929 -- --
Recoveries on loans previously charged off 46 64 304
Loans charged off ........................ (1,356) (926) (964)
------- ------- -------
Balance at end of year ........................ $ 9,641 $ 7,207 $ 6,569
======= ======== ========
Note 7. Premises and Equipment, net
Premises and equipment are summarized as follows: (in thousands)
--------------------------------
December 31,
--------------------------------
2003 2002
----------------- --------------
Land $ 6,028 $1,698
Buildings 6,880 2,195
Furniture, fixtures and equipment 8,939 7,785
Leasehold improvements 11,124 10,016
----------------- --------------
32,971 21,694
Less: accumulated depreciation and amortization 12,628 11,182
----------------- --------------
$ 20,343 $10,512
================= ==============
Note 8. Goodwill and Other Intangibles
At December 31, 2003 gross intangible assets amounted to $4.6 million and
accumulated amortization amounted to $430 thousand. At December 31, 2002, gross
intangible assets amounted to $300 thousand and accumulated amortization
amounted to $69 thousand. Amortization of intangible assets as a result of
acquisitions, which is included in non-interest expense, amounted to $360
thousand, and $69 thousand for the year ended December 31, 2003 and 2002,
respectively. During the second quarter, the Company recorded a core deposit
intangible of $4.3 million in connection with the Bridge View merger. The core
deposit intangible has an estimated life of 10 years and the Company amortized
$286 thousand for the year ended December 31, 2003. The core deposit intangible
will be periodically reviewed for impairment. In addition, the Company recorded
goodwill of $54.4 million in connection with the Bridge View merger, which is
not deductible for tax purposes. The goodwill will be tested for impairment at
least annually in accordance with the provisions of SFAS No. 142.
At December 31, 2003, the scheduled amortization of the core deposit
intangible is as follows: (in thousands)
2004 $ 430
2005 430
2006 430
2007 430
2008 and thereafter 2,289
------------
Total $ 4,009
============
42
Note 9. Deposits
Deposits are summarized as follows: (in thousands)
------------------------------------
December 31,
------------------------------------
2003 2002
------------------ ---------------
Non-interest bearing demand deposits $ 223,745 $ 118,578
Interest bearing demand deposits 446,786 323,998
Money market deposits 84,162 55,372
Savings deposits 120,136 80,300
Time deposits 281,969 237,424
------------------ ---------------
$1,156,798 $ 815,672
================== ===============
At December 31, 2003 and 2002, the carrying amounts of certificates of
deposit that individually exceed $100,000 amounted to $16.6 million and $26.7
million, respectively. Interest expense relating to certificates of deposit that
individually exceed $100,000 was approximately $850 thousand, $1.0 million and
$1.5 million in 2003, 2002 and 2001 respectively.
At December 31, 2003, the scheduled maturities of time deposits are as
follows: (in thousands)
2004 $ 255,069
2005 20,916
2006 3,399
2007 1,252
2008 1,333
---------------
Total $ 281,969
===============
Note 10. Securities Sold Under Agreements to Repurchase and Short-term
Borrowings
Securities sold under repurchase agreements and short-term borrowings are
summarized as follows: (in thousands)
--------------------------
December 31,
--------------------------
2003 2002
--------------------------
Securities sold under agreements to repurchase $15,618 $17,390
Federal Home Loan Bank overnight advances 46,491 -
-------------- -----------
$62,109 $17,390
============== ===========
Average balance outstanding $17,875 $ 19,119
Average interest rate 1.59% 3.63%
Maximum amount borrowed $48,110 $ 30,607
Securities sold under agreements to repurchase mature within one year. In
addition, the bank has an additional $51.8 million available under its agreement
with Federal Home Loan Bank("FHLB") of New York.
Note 11. Long-term Borrowings
Long term borrowings consist of one FHLB advance of $10 million. The
borrowing has a fixed rate of 4.22%, matures in January 2007 and is
collateralized by U.S. Treasury and U.S. agency securities. The FHLB has an
option to call the advance on a quarterly basis if the 3 month LIBOR resets
above 7.50%.
Note 12. Benefit Plans
In 1993, the Bank established a non-contributory defined benefit pension
plan covering all eligible employees (the "Pension Plan"). The funding policy is
to contribute an amount that is at least the minimum required by law. The plan
assets are invested through an unaffiliated trust company in a fixed income and
equity (balanced) fund. The investment strategy of the fund is to hold 60% to
70% in stocks and the rest in fixed income securities. The fund performance is
reviewed periodically by an administrative committee comprised of the Bank's
President, Chief Financial Officer and Human Resources Director. Retirement
income is based on years of service under the Pension Plan and, subject to
certain limits, on final average compensation. Effective January 1, 1994, the
Bank established a supplemental plan covering all eligible employees (the
"Supplemental Plan") that provides for retirement income that would have been
paid but for the limitation under the qualified Pension Plan.
Effective August 1, 1994, the Company established a retirement plan for all
directors of the Bank who are not employees of Interchange or of any subsidiary
or affiliate of Interchange (the "Directors' Plan"). As a part of this
Directors' Plan, the Company contributes annually to a life insurance policy or
annuity contract for each director with 5 years or more of service, as follows:
Years of Service Amount Contributed
6 $5,000
7 6,000
8 7,000
9 8,000
10 9,000
11 or more 10,000
The Company owns the life insurance policies or annuity contracts.
Retirement income to a director who has completed five years of service through
ten years of service will be based on the cash value of the life insurance
policy or annuity contract. After ten years of service, the retirement income
will be based on the greater of the cash value of the life insurance policy or
annuity contract or an amount determined by multiplying the Bank's standard
annual retainer fees at the director's retirement date by the director's years
of service.
Pursuant to the Directors' Plan, as amended from time to time, a director
who has been on the board at least five years is entitled to receive upon
retirement an amount equal to the standard annual retainer (currently $10,000)
being paid to directors multiplied by the director's years of service on the
board, multiplied by the director's vested percentage. Vesting occurs in 20%
increments commencing in year six and ending in year ten at which time a
director becomes fully vested.
Notwithstanding the foregoing, the benefits payable to a participant who
was a participant on January 1, 2002 shall not be less than the greater of (i)
or (ii) below: (i) the benefits such participant had accrued as of such date
under the terms and provision of the Directors' Plan in effect prior to the
January 1, 2002 amendment, or (ii) the cash value of any life insurance policy
that was purchased and owned by the Company or one of its subsidiaries prior to
the plan amendment. The benefit may be paid in a lump sum or paid out in five
annual installment payments at the election of the participant.
43
Net pension cost of each plan consists of the following: (in thousand)
Pension Plan Supplemental Plan Directors' Plan
------------ ----------------- ---------------
2003 2002 2001 2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ---- ---- ---- ----
Service cost $ 490 $ 331 $ 249 $ 29 $ 25 $ 19 $ 85 $ 72 $ 49
Interest cost 181 150 116 21 19 14 114 98 94
Expected return on plan assets (124) (120) (100) - - - - - -
Amortization of prior service cost 2 2 - 2 3 8 - - -
Recognized net actuarial gain 1 - (18) - - (7) - - -
----- ----- ----- ---- ---- ---- ---- ----- -----
Net periodic benefit cost $ 550 $ 363 $ 247 $ 52 $ 47 $ 34 $199 $ 170 $ 143
===== ===== ===== ==== ==== ==== ==== ===== =====
The following table sets forth the funded status, as of December 31, the measurement date, of each plan and amounts
recognized in the Company's Consolidated Balance Sheets and the major assumptions used to determine these amounts:
(dollars in thousands)
Pension Plan Supplemental Plan Directors' Plan
------------ ----------------- ---------------
2003 2002 2003 2002 2003 2002
---- ---- ---- ---- ---- ----
Change in pension obligation
Pension obligation at beginning of year $ 2,962 $ 2,000 $ 352 $ 288 $ 1,555 $ 1,411
Service cost 490 331 29 25 85 72
Interest cost 181 150 21 19 114 98
Acquisition of Bridge View Plan - - - - 376 -
Actuarial (gain) loss 23 513 (21) 20 (29) (26)
Benefits paid (30) (32) - - - -
----- ----- ------ ----- ----- -----
Pension obligation at end of year 3,626 2,962 381 352 2,101 1,555
----- ----- ------ ----- ----- -----
Change in plan assets
Fair value of plan assets at beginning of year 1,397 1,401 - - - -
Actual gain (loss) on plan assets 320 (107) - - - -
Employer contribution 293 135 - - - -
Benefits paid (30) (32) - - - -
----- ----- ----- ----- ----- -----
Fair value of plan assets at end of year 1,980 1,397 - - - -
----- ----- ----- ----- ----- -----
Funded Status (1,646) (1,565) (381) (352) (2,100) (1,555)
Unrecognized net actuarial (gain) loss 289 463 32 53 (120) (91)
Unrecognized prior service cost 28 30 16 19 - -
----- ----- ------- ------ ------- -------
Accrued pension cost $(1,329) $(1,072) $ (333) $ (280) $(2,220) $(1,646)
======= ======== ====== ====== ======= ========
Weighted-average assumptions (1)
Discount rate for net periodic benefit cost 6.50 % 7.25 % 6.50 % 7.25 % 6.50 % 7.25 %
Discount rate for benefit obligations 6.25 6.50 6.25 6.50 6.25 6.50
Expected return on plan assets 8.00 8.00 8.00 8.00 8.00 8.00
Rate of compensation increase 5.00 5.00 N/A N/A N/A N/A
<FN>
(1) Weighted average assumptions were applied at the beginning of the period.
</FN>
Other Balance Sheet Amounts
The following amounts are included in the Consolidated Balance Sheets for
December 31,: (in thousands)
2003 2002
--------- --------
Accrued benefit cost $ (3,882) $ (2,998)
Intangible assets 16 -
Accumulated other comprehensive income 10 -
--------- --------
Net amount recognized $ (3,856) $ (2,998)
======== ========
The accumulated benefit obligation for all defined benefit pension plans was
$4.9 million and $3.7 million at December 31, 2003 and 2002, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets: (in thousands)
2003 2002
------- --------
Projected benefit obligation $ 6,108 $ 4,869
Accumulated benefit obligation $ 4,899 $ 3,730
Fair value of plan assets $ 1,980 $ 1,397
44
In 1976, the Bank established a Capital Investment Plan (the "Investment
Plan") which permits employees to make basic contributions up to 4% of base
compensation. In 1998, the Investment Plan was amended to permit employees to
make basic contributions up to 6% of base compensation. Additional contributions
up to 10% of compensation may be made when coupled with basic contributions.
Under the Investment Plan, the Bank provides a matching contribution equal to
50% of the basic contribution of each participant. The Investment Plan offers
employees a choice of 9 investment funds ranging from conservative to
aggressive. Both employee and Bank matching contributions are invested in these
funds according to the employees' elections. The investment choices are
administered by an unaffiliated trust company. The fund options are reviewed
periodically by an administrative committee comprised of the Bank's President,
Chief Financial Officer and Human Resources Director. In addition, the Bank
makes a fixed contribution on behalf of each participant equal to 1% of such
participant's base compensation, which is in the form of Interchange common
stock. The Bank's contribution to the Investment Plan amounted to $347 thousand,
$281 thousand and $236 thousand in 2003, 2002 and 2001, respectively.
NOTE 13. Stock Option and Incentive Plan
In 1989, the Company adopted a stock option plan, retitled the Stock Option
and Incentive Plan of 1997 (the "Stock Plan"), that covers certain key
employees. Under this plan, as amended, options to purchase a maximum of
1,384,313 shares of Interchange common stock may be granted at fair market value
at the date of grant. Options granted expire if not exercised within ten years
of date of grant and are exercisable according to a vesting schedule, starting
one year from the date of grant. Pursuant to the Stock Plan, incentive stock
options or non-qualified stock options may be granted to employees.
In 2000, the Company adopted a stock option plan, titled "Outside
Director's Incentive Compensation Plan" (the "Director's Stock Plan") that
covers those members of the Board of Directors of the Company who have not
served as a full-time employee of the Company or any of its subsidiaries during
the prior twelve-month period. Under this plan, options to purchase a maximum of
150,000 shares of Interchange common stock may be granted at fair market value
at the date of grant. Options granted expire if not exercised within ten years
of date of grant and are exercisable according to a vesting schedule, starting
one year from the date of grant. Only non-qualified stock options are granted
under the Director's Stock Plan.
The status of options granted under the Stock Plan and Director's Stock
Plan as of December 31, and changes during each of the three years then ended is
summarized below:
2003 2002 2001
-------------------- ------------------ ----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Incentive Stock Options Options Price Options Price Options Price
- -------------------------- ---------- --------- -------- -------- ------- --------
Outstanding at January 1 449,016 $ 11.75 343,992 $ 10.36 277,094 $ 10.06
Granted 172,500 17.00 133,875 14.70 94,500 10.79
Exercised (65,296) 8.84 (20,660) 7.34 (13,226) 6.17
Forfeited - - (8,191) 12.62 (14,376) 11.24
--------- --------- -------- -------- ------- --------
Outstanding at December 31 556,220 $ 13.72 449,016 $ 11.75 343,992 $ 10.36
========= ========= ======== ======== ======= ========
Options exercisable at December 31 266,970 $ 11.61 332,141 $ 11.06 184,733 $ 9.88
========= ========= ======== ======== ======= ========
Weighted-average fair value of options
granted during the year ended
December 31 (per option) $ 4.11 $ 4.00 $ 2.85
2003 2002 2001
-------------------- ------------------ ----------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Non-Qualified Stock Options Options Price Options Price Options Price
- --------------------------- ---------- --------- -------- -------- ------- --------
Outstanding at January 1 45,000 $ 13.54 33,000 $ 10.70 16,500 $ 9.33
Granted 18,000 17.70 16,500 18.33 16,500 12.07
Exercised (4,500) 10.94 (4,500) 10.24 - -
Forfeited - - - - - -
--------- --------- -------- -------- ------- --------
Outstanding at December 31 58,500 $ 15.02 45,000 $ 13.54 33,000 $ 10.70
========= ========= ======== ======== ======= ========
Options exercisable at December 31 24,000 $ 12.18 12,000 $ 10.24 5,495 $ 9.33
========= ======= ======== ======== ======= ========
Weighted-average fair value of options
granted during the year ended
December 31 (per option) $ 4.61 $ 5.04 $ 2.67
<FN>
All per share data and averages shares were restated to reflect a 3 for 2 stock split declared on
May 23, 2002 and paid on July 12, 2002.
</FN>
45
The following table summarizes information about options outstanding under the Plan at December 31, 2003:
Options Outstanding Options Exercisable
- ---------------------------------------------------------------------- ------------------------
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ------------------------------ ------------- ------------- ----------- ------------ -----------
Incentive Stock Options
$ 5 - $10 7,944 2.28 $ 5.57 7,944 $ 5.57
$10 - $15 375,776 6.66 12.39 259,026 11.79
$15 - $20 172,500 9.09 17.00 - -
------------- ------------
556,220 266,970
============= ============
Non-Qualified Stock Options
$5- $10 10,500 6.33 9.33 10,500 9.33
$10 - $15 14,000 7.38 12.07 8,500 12.07
$15 - $20 34,000 8.85 18.00 5,000 18.33
------------- ------------
58,500 24,000
------------- ------------
Total 614,720 290,970
============= ============
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2003, 2002 and 2001, respectively: dividend yield
of 2.14%, 2.37%, 2.66%; expected volatility of 24.69%, 25.12% and 22.02%;
risk-free interest rate of 3.39%, 4.65% and 5.03%; and expected lives of 7
years. The effects of applying these assumptions in determining the pro-forma
net income may not be representative of the effects on pro-forma net income for
future years.
If compensation cost for the Stock Plan and Director's Stock Plan awards
had been measured based on the fair value of the stock options awarded at the
grant dates, net income and diluted earnings per common share would have been
reduced to the pro-forma amounts below for the years ended December 31: (in
thousands, except per share data)
2003 2002 2001
---------- -------- --------
Net Income
As reported $16,366 $12,877 $10,540
Less: Total stock-based compensation
expense determined under the fair value
method for all rewards, net of related
tax effects 408 120 89
---------- -------- --------
Pro-forma $15,958 $12,757 $10,451
========== ======== ========
Diluted earnings per common share
As reported $1.36 $1.30 $1.07
Less: Total stock-based compensation
expense determined under the fair value
method for all rewards, net of related
tax effects 0.03 0.02 -
---------- -------- --------
$1.33 $1.28 $1.07
========== ======== ========
All per share data and average shares were restated to reflect a 3 for 2 stock
split declared on May 23, 2002 and paid on July 12,2002.
Stock-based compensation
Pursuant to the Stock Plan, key employees may be awarded restricted shares
of Interchange common stock subject to certain vesting and restrictions. The
awards are recorded at fair market value and amortized into salary expense over
the vesting period. The following table sets forth the changes in restricted
stock awards outstanding for the years ended December 31, 2003, 2002 and 2001.
Restricted Stock Awards 2003 2002 2001
------------- ------------- -----------
Outstanding at beginning of year 39,124 38,250 34,805
Granted 20,883 21,070 22,320
Vested (19,477) (20,196) (18,875)
Forfeited - - -
------------- ------------- -----------
Outstanding at end of year 40,530 39,124 38,250
============= ============= ===========
The amount of compensation cost related to restricted stock awards included
in salary epense in 2003, 2002 and 2001 amounted to $237 thousand, $196 thousand
and $185 thousand, respectively.
46
Note 14. Stockholders' Equity and Regulatory Capital
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. 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, the Company and the Bank must meet specific capital levels
that involve quantitative measures of their assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Company's and the Bank's capital amounts and the Bank's classification, under
the regulatory framework for prompt corrective action, are also subject to
qualitative judgments by the regulators about components, risk weighting, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets.
Management believes that as of December 31, 2003 the Company and the Bank met
all capital adequacy requirements to which they are subject.
As of December 31, 2003, the most recent notification from the Federal
Reserve categorized the Bank as "well capitalized" under the regulatory
framework for prompt corrective action. To be categorized as "well capitalized,"
the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
To Be "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------------- ----------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ------------ ------------- ------- ----------- ---------
As of December 31, 2003:
Total Capital (to Risk Weighted Assets):
The Company $91,694 10.46 % $70,146 8.00 % N/A N/A
The Bank 91,358 10.35 % 70,637 8.00 % 88,296 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 81,913 9.34 % 35,073 4.00 % N/A N/A
The Bank 81,576 9.24 % 35,319 4.00 % 52,978 6.00 %
Tier 1 Capital (to Average Assets):
The Company 81,913 6.24 % 39,367 3.00 % N/A N/A
The Bank 81,576 6.22 % 39,318 3.00 % 65,530 5.00 %
As of December 31, 2002:
Total Capital (to Risk Weighted Assets):
The Company $82,658 13.33 % $49,619 8.00 % N/A N/A
The Bank 80,813 13.00 % 49,714 8.00 % $62,143 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 75,451 12.16 % 24,809 4.00 % N/A N/A
The Bank 73,606 11.84 % 24,857 4.00 % 37,286 6.00 %
Tier 1 Capital (to Average Assets):
The Company 75,451 8.12 % 27,864 3.00 % N/A N/A
The Bank 73,606 7.92 % 27,868 3.00 % 46,446 5.00 %
Shares of common stock
On April 26, 2001, the Board of Directors of Interchange authorized a
program to repurchase up to 450,000 shares of Interchange's outstanding common
stock on the open market or in privately negotiated transactions. No shares were
repurchased during 2003 and as of December 31, 2003, the Company had purchased
170,193 shares at a total cost of approximately $2.2 million under the
authorized program. The repurchased shares are held as treasury stock and will
be principally used for the exercise of stock options, restricted stock awards
under the Stock Plan and other general corporate purposes.
The following table summarizes the activity in common shares:
(in thousands)
Shares Issued Shares in Treasury
------------- ------------
Balance at December 31, 2001 9,691 1,221
Purchase of treasury stock (30) 30
Issuance of stock from treasury 154 (154)
------------- ------------
Balance at December 31, 2002 9,815 1,097
Reacquired shares in lieu of
non-performing assets (36) 36
Issuance of stock from treasury 81 (81)
Issuance of stock for Bridge View
Bancorp acquisition 2,950 -
------------- ------------
Balance at December 31, 2003 12,810 1,052
============= ============
All per share data and average shares were restated to reflect a 3-for-2 stock
split declared on May 23, 2002 and paid on July 12, 2002.
47
Note 15. Earnings Per Common Share
The reconciliation of the numerators and denominators of the basic and
diluted earnings per common share computations for the years ended December 31
are as follows: (in thousands, except per share data)
2003 2002 2001
-------------------------------- -------------------------- ---------------------------
Weighted Per Weighted Per Weighted Per
Average Share Average Share Average Share
Income Shares Amount Income Shares Amount Income Shares Amount
----------- ---------- --------- -------------------------- --------- -------- --------
Basic Earnings per Common Share
Net income available to common
shareholders $16,366 11,816 $1.39 $12,877 9,809 $1.31 $10,540 9,779 $1.08
========= ======== ========
Effect of Dilutive Shares
Weighted average shares if converted 175 124 45
---------- --------- --------
Diluted Earnings per Common Share
Net income available to common
shareholders $16,366 11,991 $1.36 $12,877 9,933 $1.30 $10,540 9,824 $1.07
=========== ========== ========= ========================== ========= ======== ========
All per share data and average shares were restated to reflect a 3-for-2 stock
split declared on May 23, 2002 and paid on July 12, 2002.
Note 16. Other Non-interest Expense
Expenses included in other non-interest expense which exceed one percent
of the aggregate of total interest income and non-interest income for the years
ended December 31, are as follows: (in thousands)
2003 2002 2001
---- ---- ----
Professional fees ......... $1,568 $1,458 $1,240
Data Processing ........... 933 639 568
All other.................. 4,068 3,367 2,948
------ ------ ------
$6,569 $5,464 $4,756
====== ====== ======
Note 17. Income Taxes
Income tax expense for the years ended December 31, is summarized as
follows: (in thousands)
2003 2002 2001
---------- --------- --------
Federal: current $5,711 $6,586 $4,908
deferred 1,461 (732) (96)
State: current 34 242 236
deferred 412 - -
---------- --------- --------
$7,618 $6,096 $5,048
========== ========= ========
The effects of temporary differences that give rise to significant portions
of the Company's deferred tax assets and liabilities as of December 31, are as
follows: (in thousands)
2003 2002
--------- --------
Deferred tax assets
Excess of book over tax allowance
for loan and lease losses $ 4,242 $2,468
Excess of book over tax depreciation 21 280
Excess of book over tax provision
for benefit plan expense 1,773 1,038
Core deposit premium 261 195
Other 551 448
--------- --------
Total deferred tax assets 6,848 4,429
--------- --------
Deferred tax liabilities
Unrealized gains - securities available
for sale 1,779 2,175
Dividend on REIT 2,456 247
Excess of tax over book for leasing
originations 858 -
Premium related to Bridge View
acquisition 2,238 -
Other 363 372
--------- --------
Total deferred tax liabilities 7,694 2,794
--------- --------
Net deferred tax (liability) asset $ (846) $1,635
========= ========
The provision for income taxes differs from the expected statutory provision as
follows:
----------------------------------
December 31,
----------------------------------
2003 2002 2001
---------- --------- -------
Expected provision at statutory rate 35% 35 % 35 %
Difference resulting from:
State income tax, net of federal benefit 2 1 1
Interest income exempt from federal taxes (2) (2) (2)
Bank owned life insurance (3) (2) (1)
Other - - (1)
------- -------- -------
32% 32 % 32 %
======= ======== =======
48
Note 18. Restrictions of Subsidiary Bank Dividends
Under New Jersey law, the Bank may declare a dividend only if, after
payment thereof, its capital would be unimpaired and its remaining surplus would
equal 50 percent of its capital. At December 31, 2003, undistributed net assets
of the Bank were $141.6 million of which $78.8 million was available for the
payment of dividends. In addition, payment of dividends is limited by the
requirement to meet the capital guidelines issued by the Board of Governors of
the Federal Reserve System.
Note 19. Commitments and Contingent Liabilities
The Company has contingent liabilities and outstanding commitments that
include agreements to extend credit which arise in the normal course of business
and which are not shown in the accompanying financial statements.
Loan commitments are made to accommodate the financial needs of the
Company's customers. Standby letters of credit commit the Company to make
payments on behalf of customers when certain specified future events occur. They
are issued primarily to support performance bonds. Both arrangements have credit
risks essentially the same as that involved in extending loans to customers and
are subject to the normal credit policies of the Company. At December 31, 2003
the Company had a reserve of $140 thousand recorded as a liability for potential
losses associated with off balance sheet arrangements.
A summary of commitments to extend credit at December 31, are summarized as
follows: (in thousands)
2003 2002
----------- ----------
Home equity loans $ 89,249 $ 64,346
Other loans 128,045 90,156
Standby letters of credit 3,534 1,127
----------- ----------
$220,828 $155,629
=========== ==========
The following table illustrates the Company's accounting for, and
disclosure of, the issuance of certain types of guarantees as required under FIN
45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others".
Maximum potential Carrying
amount of future amount of
Nature of the guarantee payments the liability
- ----------------------------------------------------------------------------
Standby letters of credit $3,534 $ -
Standby letters of credit are typically underwritten for terms of less than
one year and are fully collateralized by either cash or indirectly secured by a
line of credit, which is collateralized by real estate, receivables or other
liquid collateral.
The minimum annual rental under noncancelable operating leases for premises
and equipment, exclusive of payments for maintenance, insurance and taxes, is
summarized as follows: (in thousands)
2004 $ 2,409
2005 2,350
2006 2,039
2007 1,871
2008 1,609
thereafter 7,669
------------
Total minimum lease payments $ 17,947
============
Rent expense for all leases amounted to approximately $2.3 million, $1.7
million and $1.5 million in 2003, 2002, and 2001, respectively. The Company
leases its operations facilities from an affiliated company of a director. The
lease expires in October 2007 and provides that the annual minimum rent of
approximately $84 thousand. Rent expense paid was approximately $62 thousand and
$51 thousand in 2003 and 2002, respectively.
Two directors of the Company provided legal services through affiliated
firms. Fees paid for these services amounted to approximately $356 thousand,
$296 thousand, and $309 thousand in 2003, 2002, and 2001, respectively. In
addition, a director provided certain real estate appraisal services through an
affiliated firm. Fees paid for these services amounted to approximately $8
thousand in 2003. The Company also obtained insurance from an affiliated agency
of a director. Total costs associated with the policies purchased through the
agency were approximately $17 thousand in 2003.
The Company believes that all of the services obtained from directors are
at arms length. In addition, Board approval is required to obtain services from
an affiliated party.
The Company is also a party to routine litigation involving various aspects
of its business, none of which, in the opinion of management and its legal
counsel, is expected to have a material adverse impact on the consolidated
financial condition, results of operations or liquidity of the Company.
49
Note 20. Fair Value of Financial Instruments
Fair value estimates of the Company's financial instruments are made at a
particular point in time, based on relevant market information and information
about the financial instrument. Fair values are most commonly derived from
quoted market prices. In the event market prices are not available, fair value
is determined using the present value of anticipated future cash flows. This
method is sensitive to the various assumptions and estimates used and the
resulting fair value estimates may be significantly affected by minor variations
in those assumptions or estimates. In that regard, it is likely the Company in
immediate settlement of the financial instruments would realize amounts
different from the fair value estimates.
The following table sets forth the carrying amounts and estimated fair values of
the Company's financial instruments: (in thousands)
-------------------------------------------------------------------
December 31,
-------------------------------------------------------------------
2003 2002
------------------------------------ ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------- ----------------- -------------- -------------
Financial assets:
Cash and cash equivalents $ 31,435 $ 31,435 $ 33,916 $ 33,916
Securities held to maturity 19,107 20,223 28,192 29,590
Securities available for sale 432,953 432,953 224,320 224,320
Loans, net 786,940 794,042 608,434 618,028
----------------- ----------------- -------------- -------------
$ 1,270,435 $ 1,278,653 $ 894,862 $ 905,854
================= ================= ============== =============
Financial liabilities:
Deposits $1,156,798 $ 1,157,635 $ 815,672 $ 817,661
Short-term borrowings 62,109 62,109 17,390 17,390
Long-term borrowings 10,000 10,149 10,000 10,438
----------------- ----------------- -------------- -------------
$1,228,907 $ 1,229,893 $ 843,062 $ 845,489
================= ================= ============== =============
The methods and significant assumptions used to determine the estimated
fair values of the Company's financial instruments are as follows:
Cash and cash equivalents: Cash and cash equivalents include cash on hand,
amounts due from banks, interest bearing deposits and federal funds sold. The
estimated fair values of these financial instruments approximate their carrying
values since they mature overnight or are due on demand.
Securities held to maturity and securities available for sale: Estimated
fair values are based principally on quoted market prices, where available, or
dealer quotes. In the event quoted market prices are not available, fair values
are estimated using market prices of similar securities.
Loans: The loan portfolio is segregated into various categories for
purposes of estimating fair value. The fair value of certain loans that reprice
frequently and have no significant change in credit risk is assumed to equal
their carrying values. The fair value of other types of loans is estimated by
discounting the future cash flows using interest rates that are currently being
offered for loans with similar terms to borrowers with similar credit quality.
The fair value of non-performing loans is estimated using methods employed by
management in evaluating the adequacy of the ALLL.
Deposits: The estimated fair values of deposits with no stated maturity,
such as demand deposits, savings, NOW and money market accounts are, by
definition, equal to the amount payable on demand at the reporting date. The
fair values of fixed-rate certificates of deposit are based on discounting the
remaining contractual cash flows using interest rates currently being offered on
certificates of deposit with similar attributes and remaining maturities.
Short-term borrowings: The fair value of short-term borrowings is assumed
to equal the carrying value in the financial statements, as these instruments
are short-term.
Long-term borrowings: Fair value estimates of long-term borrowings are
based on discounting the remaining contractual cash flows using rates, which are
comparable to rates currently being offered for borrowings with similar
remaining maturities.
Off-balance-sheet financial instruments: The fair values of commitments to
extend credit and unadvanced lines of credit approximate the fees currently
charged to enter into similar transactions, considering the remaining terms of
the commitments and the credit-worthiness of the potential borrowers. At
December 31, 2003 and 2002, the estimated fair values of these off-balance-sheet
financial instruments were immaterial.
50
Note 21. Parent Company Only Information (in thousands)
------------------------
December 31,
------------------------
Condensed balance sheets 2003 2002
------------- ----------
Assets
Cash $ 1,104 $ 1,630
Securities available for sale 484 -
Investment in subsidiaries
Bank 145,889 78,834
Other 142 142
Dividends receivable - 1,588
Other assets 8 -
------------- ----------
Total assets $ 147,627 $ 82,194
============= ==========
Liabilities
Dividends payable - $ 1,372
Other liabilities $ 4,434 142
------------- ----------
4,434 1,514
------------- ----------
Stockholders' equity
Common stock 5,396 5,397
Capital Surplus 73,232 21,097
Retained earnings 74,710 63,314
Accumulated other comprehensive income 2,434 3,596
------------- ----------
155,772 93,404
Less: Treasury stock 12,579 12,724
------------- ----------
Total stockholders' equity 143,193 80,680
------------- ----------
Total liabilities and stockholders' equity $ 147,627 $ 82,194
============= ==========
---------------------------------
Years Ended December 31,
---------------------------------
Condensed statements of income 2003 2002 2001
------------- -------------------
Dividends from subsidiary bank $ 20,320 $ 3,107 $ 6,467
Net gain on sale of securities - - $ 20
Other income - 1 21
------------- -------------------
Total revenues 20,320 3,108 6,508
------------- -------------------
Operating expenses 225 176 270
------------- -------------------
Income before equity in undistributed earnings
of subsidiaries 20,095 2,932 6,238
Equity in undistributed earnings of subsidiaries (3,729) 9,945 4,302
------------- -------------------
Net income $ 16,366 $ 12,877 $ 10,540
============= ===================
- --------------------------------------------------------------------------------
---------------------------------
Years Ended December 31,
---------------------------------
Condensed statements of cash flows 2003 2002 2001
------------- -------------------
Cash flows from operating activities:
Net income $16,366 $ 12,877 $ 10,540
Adjustments to reconcile net income
to net cash provided by operating activities
Net gain on sale of securities - - (20)
Decrease (increase) in other assets 1,588 485 (1,277)
Decrease (increase) in dividends payable (1,372) 501 56
Dncrease (increase) in other liabilities (198) (138) 138
Equity in undistributed income of subsidiaries 3,729 (9,945) (4,302)
------------- -------------------
Net cash provided by operating activities $20,113 3,779 5,135
------------- -------------------
Cash flows from investing activities:
Sale of securities available for sale - - 40
------------- -------------------
Net cash provided by investing activities - - 40
------------- -------------------
Cash flows from financing activities:
Cash dividends paid (4,970) (4,321) (3,517)
Treasury stock (693) (432) (1,727)
Common stock issued 354 1,685 241
Exercise of option shares 438 198 82
Net cash proceeds from acquisition of
Bridge View Bancorp (15,768) - -
------------- -------------------
Net cash used in financing activities (20,639) (2,870) (4,921)
------------- -------------------
Net decrease/(increase) in cash (526) 909 254
Cash at beginning of year 1,630 721 467
------------- -------------------
Cash at end of year $ 1,104 $ 1,630 $ 721
============= ===================
Supplemental disclosure of non-cash investing and financing activities:
Stock issued for net assets purchased - $ 1,375 -
Stock issued related to Bridge View acquisition $52,180 - -
51
Note 22. Quarterly Financial Data (unaudited) (in thousands, except per
share data)
- ----------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
2003 Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------------------------------------------------------------
Interest income $ 13,450 $ 15,202 $ 15,965 $ 15,651
Interest expense 3,598 3,602 3,371 3,303
Net Interest income 9,852 11,600 12,594 12,348
Provision for loan losses 265 530 485 535
Net gain on sale of securities - 19 501 273
Non-interest income, excluding net gain on sale of securities 1,844 2,625 2,834 2,549
Non-interest expenses 6,527 7,696 8,758 8,259
Income before income taxes 4,904 6,018 6,686 6,376
Net income 3,356 4,187 4,511 4,312
Basic earnings per common share $ 0.34 $ 0.35 $ 0.35 $ 0.34
Diluted earnings per common share $ 0.34 $ 0.35 $ 0.35 $ 0.33
- ----------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
2002 Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------------------------------------------------------------
Interest income $ 13,744 $ 14,200 $ 14,370 $ 14,185
Interest expense 4,676 4,574 4,309 3,918
Net Interest income 9,068 9,626 10,061 10,267
Provision for loan losses 225 255 405 615
Net gain on sale of securities 187 94 214 69
Non-interest income, excluding net gain on sale of securities 1,374 1,383 1,560 1,632
Non-interest expenses 6,132 6,292 6,326 6,312
Income before income taxes 4,273 4,556 5,104 5,040
Net income 2,940 3,065 3,457 3,416
Basic earnings per common share $ 0.30 $ 0.31 $ 0.35 $ 0.35
Diluted earnings per common share $ 0.30 $ 0.31 $ 0.35 $ 0.34
<FN>
All per share data has been restated to reflect a 3-for-2 stock split declared
on May 23, 2002 and paid on July 12, 2002.
</FN>
52