UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM____ TO ____
Commission File number 1-10518
INTERCHANGE FINANCIAL SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
New Jersey 22-2553159
- ------------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Park 80 West/Plaza Two, Saddle Brook, NJ 07663
- -------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(201) 703-2265
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
None
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such report) and (2) has been subject to such filing
requirements for the past 90 days. Yes__X__ No____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes__X__ No____
The number of outstanding shares of the Registrant's common stock, no
par value per share, as of July 29, 2005, was 19,160,765 shares.
INTERCHANGE FINANCIAL SERVICES CORPORATION
INDEX
PART I FINANCIAL INFORMATION
Page No.
Item 1 Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2005 and December 31, 2004..............................1
Unaudited Condensed Consolidated Statements of Income for the
three and six-month periods ended June 30, 2005 and 2004.........2
Unaudited Condensed Consolidated Statements of Changes in
Stockholders' Equity for the six months ended
June 30, 2005 and 2004...........................................3
Unaudited Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2005 and 2004......................4
Notes to Unaudited Condensed Consolidated Financial Statements...5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................16
Item 3 Quantitative and Qualitative Disclosures About Market Risk......31
Item 4 Controls and Procedures.........................................35
PART II OTHER INFORMATION
Item 1 Legal Proceedings...............................................36
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds.....36
Item 3 Defaults upon Senior Securities.................................36
Item 4 Submission of Matters to a Vote of Security Holders.............36
Item 5 Other Information...............................................37
Item 6 Exhibits........................................................37
Signatures....................................................38
PART I - FINANCIAL INFORMATION
<Table>
<Caption>
Item 1: FINANCIAL STATEMENTS
Interchange Financial Services Corporation
- --------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------
(dollars in thousands, except share data)
(unaudited) June 30, December 31,
2005 2004
-------------- -----------
Assets
Cash and due from banks $ 35,951 $ 33,108
Interest bearing demand deposits 2 2
-------------- -----------
Total cash and cash equivalents 35,953 33,110
-------------- -----------
Securities held-to-maturity at amortized cost (estimated fair value
of $35,519 and $15,276 for June 30, 2005 and December 31, 2004,
respectively) 34,763 14,530
-------------- -----------
Securities available-for-sale at estimated fair value (amortized
cost of $329,039 and $375,241 for June 30, 2005 and
December 31, 2004 respectively) 326,454 374,199
-------------- -----------
Loans and leases (net of unearned income and deferred fees of $5,829
and $5,514 for June 30, 2005 and December 31, 2004, respectively) 1,019,987 934,181
Less: Allowance for loan and lease losses 9,945 9,797
-------------- -----------
Net loans and leases 1,010,042 924,384
-------------- -----------
Bank owned life insurance 26,395 25,847
Premises and equipment, net 17,343 17,713
Foreclosed assets and other repossessed assets 154 156
Goodwill 55,952 55,952
Intangible assets 3,408 3,660
Accrued interest receivable and other assets 17,308 14,590
-------------- -----------
Total assets $1,527,772 $1,464,141
============== ===========
Liabilities
Deposits
Non-interest bearing $267,225 $235,036
Interest bearing 990,929 1,011,102
-------------- -----------
Total deposits 1,258,154 1,246,138
-------------- -----------
Securities sold under agreements to repurchase 4,683 4,401
Short-term borrowings 43,450 24,600
Long-term borrowings 35,000 30,000
Subordinated debentures 20,620 -
Accrued interest payable and other liabilities 10,675 8,847
-------------- -----------
Total liabilities 1,372,582 1,313,986
-------------- -----------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, without par value; 33,750,000 shares authorized;
19,157,688 and 19,119,814 shares issued and outstanding for
June 30, 2005 and December 31, 2004, respectively 5,397 5,397
Capital surplus 73,519 73,320
Retained earnings 92,025 86,542
Accumulated other comprehensive loss, net of taxes of $1,025 and
$408 for June 30, 2005 and December 31, 2004, respectively (1,560) (633)
-------------- -----------
169,381 164,626
Less: Treasury stock 14,191 14,471
-------------- -----------
Total stockholders' equity 155,190 150,155
-------------- -----------
Total liabilities and stockholders' equity $1,527,772 $1,464,141
============== ===========
- --------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
All share data was restated to reflect a 3-for-2 stock split declared on January 18, 2005 and paid on February 18, 2005.
</Table>
-1-
<Table>
<Caption>
Interchange Financial Services Corporation
- -----------------------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
(unaudited) Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2005 2004 2005 2004
-------------- -------------- ---------------- -------------
Interest income
Interest on loans and leases $ 15,853 $ 13,125 $ 30,810 $ 25,832
Interest on federal funds sold 1 31 1 37
Interest and dividends on securities
Taxable interest income 2,457 2,561 5,122 5,211
Interest income exempt from federal income taxes 464 279 787 548
Dividends 77 2 137 41
-------------- -------------- ---------------- -------------
Total interest income 18,852 15,998 36,857 31,669
-------------- -------------- ---------------- -------------
Interest expense
Interest on deposits 4,595 2,760 8,517 5,587
Interest on securities sold under agreements to repurchase 33 36 56 78
Interest on short-term borrowings 350 41 530 111
Interest on long-term borrowings 389 225 705 423
-------------- -------------- ---------------- -------------
Total interest expense 5,367 3,062 9,808 6,199
-------------- -------------- ---------------- -------------
Net interest income 13,485 12,936 27,049 25,470
Provision for loan and lease losses 225 300 400 675
-------------- -------------- ---------------- -------------
Net interest income after provision for loan and lease losses 13,260 12,636 26,649 24,795
-------------- -------------- ---------------- -------------
Non-interest income
Service fees on deposit accounts 889 935 1,772 1,777
Net gain on sale of securities 250 305 317 819
Net gain on sale of loans and leases 223 57 379 133
Bank owned life insurance 285 226 549 487
Commissions on sale of annuities and mutual funds 148 256 330 468
Other 681 913 1,323 1,523
-------------- -------------- ---------------- -------------
Total non-interest income 2,476 2,692 4,670 5,207
-------------- -------------- ---------------- -------------
Non-interest expense
Salaries and benefits 4,954 4,664 9,909 9,512
Occupancy 1,343 1,287 2,806 2,652
Furniture and equipment 316 326 631 660
Advertising and promotion 423 470 818 863
Amortization of intangible assets 126 126 252 252
Other 2,018 1,925 3,918 3,776
-------------- -------------- ---------------- -------------
Total non-interest expense 9,180 8,798 18,334 17,715
-------------- -------------- ---------------- -------------
Income before income taxes 6,556 6,530 12,985 12,287
Income taxes 2,041 2,175 4,050 3,946
-------------- -------------- ---------------- -------------
Net income $ 4,515 $ 4,355 $ 8,935 $ 8,341
============== ============== ================ =============
Basic earnings per common share $0.24 $0.23 $0.47 $0.44
===== ===== ===== =====
Diluted earnings per common share $0.23 $0.22 $0.46 $0.43
===== ===== ===== =====
- -----------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
All per share data was restated to reflect a 3-for-2 stock split declared on January 18, 2005 and paid on February 18, 2005.
</Table>
-2-
<Table>
<Caption>
Interchange Financial Services Corporation
- ----------------------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Six Months Ended June 30
- ----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
(unaudited)
Accumulated
Other
Comprehensive Retained Comprehensive Common Capital Treasury
Income Earnings Income (Loss) Stock Surplus Stock Total
------------ --------- ------------ --------- ---------- ---------- -----------
Balance at January 1, 2004 $74,710 $ 2,434 $5,397 $ 73,231 $(12,579) $ 143,193
Comprehensive income
Net Income $ 8,341 8,341 8,341
Other comprehensive income, net of taxes
Unrealized net gains on AFS debt securities (2,624)
Less: net gains on disposition of
securities (652)
-----------
Other comprehensive income, net of taxes (3,276) (3,276) (3,276)
-----------
Comprehensive income $ 5,065
===========
Dividends on common stock (3,194) (3,194)
Issued 11,690 shares of common stock in connection
with Executive Compensation Plan 103 102 205
Exercised 10,811 option shares (10) 112 102
Purchased 127,179 shares of common stock (2,154) (2,154)
--------- ------------ --------- ---------- ---------- -----------
Balance at June 30, 2004 79,857 (842) 5,397 73,324 (14,519) 143,217
Comprehensive income
Net Income $ 9,873 9,873 9,873
Other comprehensive losses, net of taxes
Unrealized losses on AFS debt securities 612
Less: net gains on disposition of
securities (408)
Minimum pension liability adjustment 5
-----------
Other comprehensive losses, net of taxes (209) 209 209
-----------
Comprehensive income $ 10,082
===========
Dividends on common stock (3,188) (3,188)
Exercised 11,254 option shares (4) 48 44
--------- ------------ --------- ---------- ---------- -----------
Balance at December 31, 2004 86,542 (633) 5,397 73,320 (14,471) 150,155
Comprehensive income
Net Income $ 8,935 8,935 8,935
Other comprehensive losses, net of taxes
Unrealized losses on AFS debt securities (808)
Less: net gains on disposition of
securities (119)
-----------
Other comprehensive losses, net of taxes (927) (927) (927)
-----------
Comprehensive income $ 8,008
===========
Dividends on common stock (3,445) (3,445)
Issued 18,772 shares of common stock in connection
with Executive Compensation Plan 173 162 335
Exercised 24,335 option shares 26 194 220
Purchased 4,532 shares of common stock (76) (76)
Payout of fractional shares resulting from the
three-for-two stock split declared
January 18, 2005 and paid on February 18, 2005 (7) (7)
--------- ------------ --------- ---------- ---------- -----------
Balance at June 30, 2005 $92,025 $ (1,560) $5,397 $ 73,519 (14,191) $ 155,190
========= ============ ========= ========== ========== ===========
- ----------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
All share data was restated to reflect a 3-for-2 stock split declared on January 18, 2005 and paid on February 18, 2005.
</Table>
-3-
<Table>
<Caption>
INTERCHANGE FINANCIAL SERVICES CORPORATION
- ------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30,
- ------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
2005 2004
------------- -----------
Cash flows from operating activities
Net income $ 8,935 $ 8,341
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 1,004 976
Amortization of securities premiums 2,080 2,973
Accretion of securities discounts (126) (122)
Amortization of loan premiums 46 23
Amortization of premiums in connection with acquisition 371 656
Provision for loan and lease losses 400 675
Increase in cash surrender value of Bank Owned Life Insurance (548) (487)
Net gain on sale of securities (317) (819)
Origination of loans held for sale (7,582) (1,437)
Sale of loans held for sale 7,056 1,532
Net gain on sale of loans and leases (379) (130)
Net loss/(gain) on sale of foreclosed assets and repossessed assets 13 (14)
Decrease (increase) in operating assets
Accrued interest receivable (247) 864
Other Assets (1,981) (1,115)
Increase (decrease) in operating liabilities
Accrued interest payable 145 (74)
Other 1,683 1,092
------------- -----------
Cash provided by operating activities 10,553 12,934
------------- -----------
Cash flows from investing activities
(Payments for) proceeds from
Net originations of loans and leases (81,876) (51,898)
Purchase of loans and leases (4,678) (36,449)
Sale of loans and leases 1,215 744
Purchase of securities available-for-sale (49,538) (38,840)
Maturities of securities available-for-sale 17,155 46,525
Sale of securities available-for-sale 77,127 58,235
Maturities of securities held-to-maturity 1,209 5,205
Sale of securities held-to-maturity 270 -
Purchase of securities held-to-maturity (21,891) (6,820)
Sale of foreclosed assets and other repossessed assets - 77
Purchase of fixed assets (503) (546)
------------- -----------
Cash used in investing activities (61,510) (23,767)
------------- -----------
Cash flows from financing activities
Proceeds from (payments for)
Net change in deposits 12,021 30,052
Securities sold under agreements to repurchase and other borrowings 557,077 223,418
Retirement of securities sold under agreement to repurchase and
other borrowings (532,945) (236,682)
Issuance of long term subordinated debentures 20,620 -
Dividends (3,445) (3,194)
Common stock issued 335 205
Payout of fractional shares resulting from 3-for-2 stock split (7) -
Treasury stock (76) (2,154)
Exercise of option shares 220 102
------------- -----------
Cash provided by financing activities 53,800 11,747
------------- -----------
Increase in cash and cash equivalents 2,843 914
Cash and cash equivalents, beginning of period 33,110 31,435
------------- -----------
Cash and cash equivalents, end of period $ 35,953 $ 32,349
============= ===========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 9,497 $6,275
Income taxes 5,144 4,100
Supplemental disclosure of non-cash investing and financing activities:
Loans transferred to foreclosed assets and other repossessed assets 11 34
- --------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
</Table>
-4-
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX-MONTH PERIODS ENDED JUNE 30, 2005
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Interchange Financial Services Corporation and certain
of its wholly owned subsidiaries (on a consolidated basis, the "Company")
including its principal operating subsidiary, Interchange Bank (the "Bank") and
Clover Leaf Mortgage Company, and have been prepared in conformity with
accounting principles generally accepted in the United States of America
("GAAP") and in accordance with the rules and regulations of the Securities and
Exchange Commission. The Company has two wholly owned trusts which are not
consolidated, see Note 12 "Subordinated Debentures" for a more detailed
discussion of these subsidiaries. Pursuant to such rules and regulations,
certain information or footnotes necessary for a complete presentation of
financial condition, results of operations and cash flows in conformity with
GAAP have been condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and schedules thereto included in the annual report on Form 10-K of
the Company for the year ended December 31, 2004.
The condensed consolidated financial data for the three and six months
ended June 30, 2005 and 2004, are unaudited but reflect adjustments consisting
of only normal recurring adjustments which are, in the opinion of management,
considered necessary for a fair presentation of the financial condition and
results of operations for the interim periods. The results of operations for
interim periods are not necessarily indicative of results to be expected for any
other period or the full year.
Use of estimates: The preparation of 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 condensed consolidated financial statements
and the reported amount of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The most significant estimates
pertain to the allowance for loan and lease losses, the fair value of financial
instruments, goodwill, intangibles, taxes and retirement benefits.
New Accounting Pronouncements: In December 2003, the American Institute of
Certified Public Accountants issued Statement of Position 03-3, "Accounting for
Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3
addresses accounting for differences between contractual cash flows and cash
flows expected to be collected from an initial investment in loans or debt
securities acquired in a transfer if those differences relate, at least in part,
to a deterioration of credit quality. SOP 03-3 prohibits companies from carrying
over valuation allowances in the initial accounting for such loans and limits
the yield that may be accreted to the excess of undiscounted expected cash flows
over the initial investment in the loan. Decreases in expected cash flows are
recognized as impairment and increases are
-5-
recognized prospectively through an adjustment of the loan yield. SOP 03-3 is
effective for loans and debt securities acquired on or after January 1, 2005.
Our adoption of this guidance did not have a significant effect on our condensed
consolidated financial statements.
On March 3, 2005, the Financial Accounting Standards ("FASB") Staff issued
FASB Staff Position ("FSP") FIN 46(R)-5, "Implicit Variable Interests under FASB
Interpretation No. 46" (FIN 46R-- Revised December 2003), "Consolidation of
Variable Interest Entities" ("VIE"). This FSP requires a reporting enterprise to
consider the impact of implicit variable interests in determining whether the
reporting enterprise may absorb variability of the VIE or potential VIE. This
staff position was effective in the second quarter of 2005 and its adoption did
not have a material impact on our condensed consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections- a replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS
No. 154 replaces APB Opinion No. 20, "Accounting Changes," and FASB Statement
No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
changes the accounting and reporting requirements for a change in accounting
principle. SFAS No. 154 applies to all voluntary changes in an accounting
principle, as well as to changes required by a new accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. SFAS No. 154 is effective for accounting changes and error
corrections made in fiscal years beginning after December 15, 2005 and requires
retrospective application to prior periods' financial statements for most
voluntary changes in an accounting principle, unless it is impracticable to do
so. The Company does not anticipate any material impact to its financial
condition or results of operations as a result of the adoption of SFAS No. 154.
At the June 29, 2005 FASB Board meeting, the Board agreed to issue FSP FAS
115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" which will replace the guidance previously set forth in
EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments". This FSP effectively eliminates the accounting guidance
provided in EITF 03-1 in favor of existing impairment recognition guidance under
SFAS 115, Staff Accounting Bulletin ("SAB") 59, Accounting Principles Board
("APB") Opinion No. 18, and EITF Topic D-44. The effective date of the FSP is
for periods beginning after September 15, 2005, but is not expected to have a
material impact on our condensed consolidated financial statements.
Stock Based Compensation: The Company accounts for stock option plans under the
recognition and measurement principles of "Accounting for Stock Issued to
Employees" (APB No. 25) and related interpretations. No stock-based employee
compensation costs are reflected in net income, as all options granted under
those plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. In December 2004, the FASB issued Statement
of Financial Accounting Standard ("SFAS") No. 123 (revised 2004), "Share-Based
Payment," ("SFAS No. 123(R)"). SFAS No. 123(R) addresses the accounting for
share-based payment transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair
-6-
value of the enterprise's equity instruments or that may be settled by the
issuance of such equity instruments. SFAS No. 123(R) requires an entity to
recognize the grant-date fair value of stock options and other equity-based
compensation issued to employees within the income statement using a
fair-value-based method, eliminating the intrinsic value method of accounting
previously permissible under APB No. 25 and related interpretations.
On April 15, 2005, the Securities and Exchange Commission ("SEC") issued a
ruling amending the date for compliance with SFAS No. 123(R). Registrants will
be required to adopt FAS 123(R) beginning with the first interim or annual
reporting period of the registrant's first fiscal year beginning on or after
June 15, 2005. For the Company, this ruling will require adoption of SFAS No.
123(R) by no later than January 1, 2006. The Company is in the process of
evaluating and determining which of the alternative methodologies under SFAS No.
123(R) will be utilized.
Prior to the required adoption of SFAS No. 123(R), the Company has elected
to account for its stock-based incentive plans and awards under APB No. 25, and
has adopted the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure."
The following table illustrates the effect on net income and diluted
earnings per common share if the Company had applied the fair value recognition
provisions of SFAS No. 123, to stock-based compensation for the three and six
months ended June 30, 2005 and 2004: (in thousands, except share data)
(unaudited)
<Table>
<Caption>
For the three months ended For the six months ended
June 30, June 30,
----------------------------- --------------------------
2005 2004 2005 2004
------------- ------------- ----------- ------------
Net Income
As reported $4,515 $4,355 $8,935 $8,341
Less: Total stock-based
compensation expense determined
under the fair value method for all
rewards, net of related tax effects 259 216 525 403
------------- ------------- ------------ ------------
Pro-forma $4,256 $4,139 $8,410 $7,938
============= ============= ============ ============
Earnings per share:
Basic:
As reported 0.24 0.23 0.47 0.44
Pro forma 0.22 0.22 0.44 0.41
Diluted:
As reported 0.23 0.22 0.46 0.43
Pro forma 0.22 0.21 0.43 0.41
</Table>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model. The following weighted-average
assumptions were used for option grants issued during the six months ended June
30, 2005 and 2004, respectively: dividend yield of 2.00% and 2.01%; expected
-7-
volatility of 23.07% and 23.05%; risk-free interest rate of 3.87% and 3.86%; and
expected lives of approximately 7 years.
2. Earnings Per Common Share
Basic earnings per common share represent income available to common
stockholders divided by the weighted-average number of common shares outstanding
during the period. Diluted earnings per common share reflect 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. At June 30, 2005 and 2004 the weighted average diluted
shares outstanding for the three months were approximately 19.6 million and 19.5
million, respectively. For the each of the six month periods ended June 30, 2005
and 2004 the weighted average diluted shares outstanding were approximately 19.6
million.
3. Commitments and Contingent Liabilities
Legal Proceedings
The Company is a party to routine litigation involving various aspects of
its business, none of which, in the opinion of management, is expected to have a
material adverse impact on the condensed consolidated financial condition,
results of operations or liquidity of the Company.
Commitments to Extend Credit
At June 30, 2005, the Company had commitments of approximately $280.5
million to extend credit, of which approximately $2.6 million represents standby
letters of credit.
4. Goodwill and Other Intangibles
Goodwill is not amortized to expense, but rather is tested for impairment
periodically. Goodwill is tested for impairment at least annually in accordance
with the provisions of SFAS No. 142.
Other intangible assets are amortized to expense using straight-line
methods over their respective estimated useful lives. At least annually,
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. Impairment, if any, is measured on a discounted
future cash flow basis. Net intangible assets are as follows: (in
thousands)(unaudited)
-8-
---------------- -----------------
June 30, December 31,
2005 2004
---------------- -----------------
Intangilbe assets $ 4,595 $ 4,595
Accumulated amortization (1,187) (935)
---------------- -----------------
Net intangible assets $ 3,408 $ 3,660
================ =================
Intangible assets are a result of acquisitions and are primarily related to
core deposit intangibles ("CDI") which have an estimated life of 10 years. For
each of the three and six month periods ended June 30, 2005 and 2004 the CDI
amortized was $107 thousand and $214 thousand, respectively. The CDI will be
periodically reviewed for impairment.
At June 30, 2005 the scheduled amortization of the intangible assets is as
follows (in thousands) (unaudited):
2006 $ 436
2007 430
2008 430
2009 430
2010 430
Thereafter 999
-------------
Total $ 3,155
=============
5. 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 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.
6. Cash Dividend
On July 19, 2005, the Company declared a cash dividend of $0.09 per share
payable on August 19, 2005, to holders of record as of August 1, 2005.
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7. Securities Held-to-Maturity and Securities Available-for-Sale
Securities held-to-maturity ("HTM") and securities available-for-sale
("AFS") consist of the following: (in thousands) (unaudited)
<Table>
<Caption>
--------------------------------------------------------
June 30, 2005
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ----------- ------------ --------------
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 3,907 $ 57 $ 1 $ 3,963
Obligations of states & political subdivisions 30,856 700 - 31,556
------------- ----------- ------------ --------------
$ 34,763 $ 757 $ 1 $ 35,519
============= =========== ============ ==============
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 120,567 $ 237 $ 937 $ 119,867
Other debt 172,026 3 2,383 169,646
Obligations of states & political subdivisions 31,641 509 14 32,136
Equity securities 4,805 - - 4,805
------------- ----------- ------------ --------------
329,039 749 3,334 326,454
------------- ----------- ------------ --------------
Total securities $ 363,802 $ 1,506 $ 3,335 $ 361,973
============= =========== ============ ==============
--------------------------------------------------------
December 31, 2004
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ----------- ------------ --------------
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 5,583 $ 128 $ - $ 5,711
Obligations of states & political subdivisions 8,947 618 - 9,565
------------- ----------- ------------ --------------
$ 14,530 $ 746 $ - $ 15,276
============= =========== ============ ==============
Securities available-for-sale
Obligations of U.S. Treasury $ 5,981 $ 1 $ - $ 5,982
Government-Sponsored Enterprises:
Mortgage-backed securities 121,198 793 599 121,392
Other debt 211,856 344 2,352 209,848
Obligations of states & political subdivisions 31,948 815 44 32,719
Equity securities 4,258 - - 4,258
------------- ----------- ------------ --------------
375,241 1,953 2,995 374,199
------------- ----------- ------------ --------------
Total securities $ 389,771 $ 2,699 $ 2,995 $ 389,475
============= =========== ============ ==============
</Table>
At June 30, 2005, the contractual maturities of securities HTM and
securities AFS are as follows: (in thousands) (unaudited)
<Table>
<Caption>
Securities Securities
Held-to-Maturity Available-for-Sale
---------------------------- -------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
------------- ------------- ----------- ------------
Within 1 year $ 15,006 $ 15,055 $ 98,619 $ 97,912
After 1 but within 5 years 3,789 3,952 212,780 210,493
After 5 but within 10 years 11,462 11,919 3,031 3,137
After 10 years 4,506 4,593 9,804 10,107
Equity securities - - 4,805 4,805
------------- ------------- ----------- ------------
Total $ 34,763 $ 35,519 $ 329,039 $ 326,454
============= ============= =========== ============
</Table>
-10-
Proceeds from the sale of securities AFS amounted to $77.1 million and
$58.2 million for the six months ended June 30, 2005 and 2004, respectively,
which resulted in gross realized gains of $670 thousand and $913 thousand for
those periods, respectively. Gross realized losses from the sale of securities
AFS amounted to $361 thousand and $94 thousand for the six months ended June 30,
2005 and 2004, respectively. Proceeds from the sale of securities HTM amounted
to $270 thousand for the six months ended June 30, 2005, which resulted in
realized gains of $8 thousand. The securities had significantly paid down to
less than 85% of the original purchased balance through normal principal
amortization and prepayments. There were no sales of securities HTM for the six
months ended June 30, 2004. These amounts are included in net gain on sale of
securities in the unaudited condensed consolidated statements of income.
On a quarterly basis, the Company makes an assessment to determine whether
there have been any events or economic circumstances to indicate that a security
on which there is an unrealized loss is impaired on an other-than-temporary
basis. The Company considers many factors including the severity and duration of
the impairment; the intent and ability of the Company to hold the security for a
period of time sufficient for a recovery in value; recent events specific to the
issuer or industry; and for debt securities, external credit ratings and recent
downgrades. Securities on which there is an unrealized loss that is deemed to be
other-than-temporary are written down to fair value with the write-down recorded
as a realized loss in securities gains (losses). Based upon the Company's
evaluation of the securities portfolios no other than temporary impairment
charge was necessary at June 30, 2005 and 2004.
The following table summarizes all securities that have an unrealized loss
and the duration of the unrealized loss at June 30, 2005: (in thousands)
(unaudited)
<Table>
<Caption>
----------------------- ------------------------- ------------------------
12 months or less 12 months or longer Totals
----------------------- ------------------------- ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ----------- ----------- ------------ ----------- ------------
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 48,790 $ 465 $ 44,552 $ 472 $ 93,342 $ 937
Other debt - - 168,603 2,383 168,603 2,383
Obligations of states & political subdivisions 485 1 1,648 13 2,133 14
----------- ----------- ----------- ------------ ----------- ------------
$ 49,275 $ 466 $ 214,803 $ 2,868 $ 264,078 $ 3,334
=========== =========== =========== ============ =========== ============
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 108 $ 1 $ 34 $ - $ 142 $ 1
=========== =========== =========== ============ =========== ============
</Table>
The following table summarizes all securities that have an unrealized loss
and the duration of the unrealized loss at December 31, 2004: (in thousands)
-11-
<Table>
<Caption>
------------------------ -------------------- ----------------------
12 months or less 12 months or longer Totals
------------------------ -------------------- ----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ----------- -------- ---------- --------- ---------
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 54,616 $ 555 $ 13,966 $ 44 $ 68,582 $ 599
Other Debt 91,582 840 104,493 1,512 196,075 2,352
Obligations of states & political subdivisions 479 7 3,138 37 3,617 44
----------- --------- --------- --------- --------- ----------
$ 146,677 $ 1,402 $ 121,591 $ 1,593 $ 268,274 $ 2,995
=========== ========= ========= ========= ========= ==========
</Table>
Securities with carrying amounts of $125.8 million and $62.2 million at
June 30, 2005 and December 31, 2004, respectively, were pledged for public
deposits, Federal Home Loan Bank advances, securities sold under repurchase
agreements and other purposes required by law.
8. Loans
The composition of the loan portfolio is summarized as follows: (in
thousands)
----------- ------------
June 30, December 31,
2005 2004
----------- ------------
(unaudited)
Real estate
Residential $ 296,040 $ 292,406
Commercial 418,413 375,985
Construction 73,536 51,162
Commercial
Commercial and financial 204,476 186,386
Lease financing 22,877 23,535
Consumer
Lease financing 198 680
Installment 4,447 4,027
---------- --------
1,019,987 934,181
Allowance for loan and lease (9,945) (9,797)
---------- --------
Net loans and leases $1,010,042 $ 924,384
========== =========
Loans are net of unearned income and deferred fees of $5.8 million and $5.5
million for the periods ended June 30, 2005 and December 31, 2004,
respectively.
Nonperforming Loans
Nonperforming loans include loans that are accounted for on a nonaccrual
basis. Nonperforming loans are as follows: (in thousands)
-12-
--------- -----------
June 30, December 31,
2005 2004
--------- -----------
(unaudited)
Nonaccrual loans
Residential real estate $ 700 $ 1,660
Commercial real estate 1,648 2,320
Commercial and financial 2,152 2,981
Commercial lease financing 1,546 1,836
Consumer 230 336
--------- --------
$ 6,276 $ 9,133
========= ========
9. Allowance for Loan and Lease Losses
The Company's recorded investment in impaired loans is as follows: (in
thousands) (unaudited)
<Table>
<Caption>
------------------- ----------------------
June 30, December 31,
------------------- ----------------------
2005 2004
------------------- ----------------------
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 $ 2,960 $ 421 $ 2,981 $ 420
Commercial real estate 1,655 26 2,320 98
Residential real estate 978 112 822 123
Without a related allowance for loan loses - - - -
-------- -------- --------- --------
$ 5,593 $ 559 $ 6,123 $ 641
======== ======== ========= ========
- -------------------------------------------------------------------------
The impairment of the above loans was measured based on the fair value of collateral.
</Table>
Changes in the allowance for loan and lease losses are summarized as follows:
(in thousands) (unaudited)
<Table>
<Caption>
--------------------------------------
Three months ended Six months ended
June 30, June 30,
------------------ -------------------
2005 2004 2005 2004
------- -------- -------- ----------
Balance at beginning of period $9,876 $9,635 $9,797 $9,641
Additions (deductions)
Provision charged to operation 225 300 400 675
Recoveries on loans previously charged off 5 24 83 60
Loans charged off (161) (171) (335) (588)
-------- -------- -------- --------
Balance at end of period $9,945 $9,788 $9,945 $9,788
======== ======== ======== ========
</Table>
-13-
10. Other Non-interest Expense
Expenses included in other non-interest expense are as follows: (in
thousands) (unaudited)
------------------ --------------------
Three months ended Six months ended
June 30, June 30,
------------------ --------------------
2005 2004 2005 2004
------- -------- -------- ----------
Professional fees $ 232 $ 361 $ 778 $ 677
Legal fees 256 240 441 450
Directors' fees, travel and retirement 205 194 422 410
Data processing 264 283 529 564
All other 1,061 847 1,748 1,675
--------- --------- --------- ---------
Total $ 2,018 $ 1,925 $ 3,918 $ 3,776
========= ========= ========= =========
11. Long-term Borrowings
Long-term borrowings consist of the following FHLB advances: (in thousands)
Maturity June 30, December 31,
Date Rate 2005 2004
- --------------------- ---------- -------------- --------------
(unaudited)
January 2006 2.09 % - $ 10,000
January 2007 (a) 4.22 $ 10,000 10,000
January 2007 2.69 10,000 10,000
January 2010 (b) 3.66 15,000 -
---------- -------------- --------------
3.52 % $ 35,000 $ 30,000
========== ============== ==============
(a) The FHLB has an option to call this advance on a quarterly basis if
the 3-month LIBOR resets above 7.50%.
(b) The FHLB has an option to call this advance in January 2008.
12. Subordinated Debentures
During June 2005, Interchange Statutory Trust I and Interchange Statutory
Trust II (together the "Trusts") each issued $10 million of pooled trust
preferred securities. In conjunction with the issuance of the trust preferred
securities the Company issued subordinated debentures to the Trusts totaling
$20.6 million. The rates of interest paid on the securities issued by the Trusts
and the Company have been fixed for 5 years, at an average rate of 6.10%, after
which time the rates will float at the 3-month LIBOR plus 1.71%. The Company has
the right to call the notes after 5 years on any of the interest payment dates.
The final maturity date on the pool trust preferred securities and debentures is
2035.
The Company does not meet the criteria as primary beneficiary for the
Trusts in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 46 (FIN 46) and FIN No. 46(R), "Consolidation of Variable
Interest Entities." As a result, these trusts are not consolidated. The Trusts
have no independent operations. The obligations of the Trusts are fully and
unconditionally guaranteed by the
-14-
Company. The debentures are unsecured and rank subordinate and junior in right
of payment to all indebtedness, liabilities and obligations of the Company.
Interest on the debentures is cumulative and payable in arrears. Proceeds from
any redemption of debentures would cause a mandatory redemption of pooled trust
preferred securities having an aggregate liquidation amount equal to the
principal amount of debentures redeemed.
13. Benefit Plans
In 1993, the Bank established a non-contributory defined benefit pension
plan covering all eligible employees (the "Pension Plan"). In 1994, the Bank
established a supplemental plan covering all eligible employees (the
"Supplemental Plan") that provides for income that would have been paid out but
for the limitation under the qualified Pension Plan. Also in 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").
The following table shows the aggregated components of net periodic benefit
costs for the periods noted: (in thousands) (unaudited)
<Table>
<Caption>
----------------------- ----------------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2005 2004 2005 2004
----------- ---------- ---------- ----------
Service cost $ 198 $ 166 $ 396 $ 333
Interest cost 102 95 204 190
Expected return on plan assets (56) (39) (112) (79)
Amortization of prior service cost 1 1 2 2
Amortization of net (gain) loss 1 - 2 -
----------- ---------- ---------- ----------
Net periodic benefit cost $ 246 $ 223 $ 492 $ 446
=========== ========== ========== ==========
</Table>
During 2005, the Bank anticipates contributing approximately $43 thousand
to the Pension Plan of which $9 thousand has already been contributed.
-15-
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion is an analysis of the condensed consolidated
financial condition and results of operations of the Company for the three and
six month periods ended June 30, 2005 and 2004, and should be read in
conjunction with the condensed consolidated financial statements and notes
thereto included in Item 1 hereof. In addition, you should read this section in
conjunction with Management's Discussion and Analysis and Results of Operations
included in the Company's 2004 Annual Report on Form 10-K.
Forward Looking Information
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" 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) adverse changes in Government-Sponsored Enterprises (the "GSE") status or
financial condition impacting the GSE's guarantees or ability to pay or issue
debt; (iii) changes in the interest rate yield curve such as flat, inverted or
steep yield curves, or interest rate environment which impact interest margins
and may impact prepayments on the mortgage-backed securities portfolio; (iv)
changes in consumer spending, borrowing and saving habits; (v) technological
changes, (vi) deterioration in general economic conditions, internationally,
nationally, or in the State of New Jersey; (vii) disruptions caused by
terrorism, such as the events of September 11, 2001, or military actions in the
Middle East or other areas; (viii) legislation or regulatory requirements or
changes adversely affecting the business of the Company; and (ix) 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
-16-
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.
Company
The Company is a bank holding company headquartered in Bergen County, New
Jersey. The Company's principal operating subsidiary is Interchange Bank, a New
Jersey-chartered commercial bank. In addition to the Bank, the Company has three
other wholly owned direct subsidiaries: Clover Leaf Mortgage Company, a New
Jersey corporation, which is not currently engaged in any business activity; and
Interchange Statutory Trust I and Interchange Statutory Trust II, which were
formed for the sole purpose of issuing trust preferred securities. The Company
does not qualify as the primary beneficiary for our wholly-owned trusts in
accordance with Financial Accounting Standards Board (FASB) Interpretation No.
46 (FIN 46) and FIN No. 46(R), "Consolidation of Variable Interest Entities." As
a result, these trusts are not consolidated. The Bank has five direct
subsidiaries: Clover Leaf Investment Corporation, an investment company
operating pursuant to New Jersey law; Clover Leaf Insurance Agency, Inc., a New
Jersey corporation engaged in the sale of tax-deferred annuities and insurance;
Clover Leaf Management Realty Corporation, a Real Estate Investment Trust
("REIT"), which manages certain real estate assets of the Company; Bridge View
Investment Company, an investment company operating pursuant to New Jersey law;
and Interchange Capital Company, L.L.C. ("ICC"), a New Jersey limited liability
company which engages in equipment lease financing. All of the Bank's
subsidiaries are 100% owned by the Bank, except for the REIT, which is 99% owned
by the Bank. Bridge View Investment Company has one wholly owned subsidiary,
Bridge View Delaware, Inc. ("BVDI"). BVDI is an investment company operating
pursuant to Delaware law.
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 our 2004 Annual Report on Form 10-K, Note 1 "Nature of Business and
Summary of Significant Accounting Policies," to our consolidated financial
statements and in Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MDA"): "Critical Accounting Policies and Judgments."
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
-17-
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.
If the ALLL is considered inadequate to absorb future loan 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 the provision for loan and lease losses is increased.
The Company considers the ALLL of $9.9 million adequate to cover estimated
losses inherent in the loan portfolio, loan commitments and standby and other
letters of credit that may become uncollectible based on management's
evaluations of the size and current risk characteristics of the loan and lease
portfolio as of the balance sheet date. The evaluations consider such factors as
changes in the composition and volume of the loan portfolio, the impact of
changing economic conditions on the credit worthiness of the borrowers, review
of specific problem loans and management's assessment of the inherent risk and
overall quality of the loan portfolio. For further discussion see the "Loan
Quality" and "Allowance for Loan and Lease Losses" sections of the MDA, along
with Note 1 "Nature of Business and Summary of Significant Accounting Policies";
Note 6 "Allowance for Loan and Lease Losses"; and Note 12 "Commitments and
Contingent Liabilities" to the Consolidated Financial Statements in our 2004
Annual Report on Form 10-K.
Business Combinations: Business combinations are accounted for using the
purchase method of accounting, which requires that the assets and liabilities of
the companies acquired are recorded at their estimated fair value at the date of
acquisition and included in the results of operations of the Company 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 Other Intangible Assets: Goodwill is not 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.
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 HTM and are carried at cost, adjusted for
-18-
the amortization of premiums and accretion of discounts. All other securities,
including equity securities, are classified as securities 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.
On a quarterly basis, the Company makes an assessment to determine whether
there have been any events or economic circumstances to indicate that a security
on which there is an unrealized loss is impaired on an other-than-temporary
basis. The Company considers many factors including the severity and duration of
the impairment; the intent and ability of the Company to hold the security for a
period of time sufficient for a recovery in value; recent events specific to the
issuer or industry; and for debt securities, external credit ratings and recent
downgrades. Securities on which there is an unrealized loss that is deemed to be
other-than-temporary are written down to fair value with the write-down recorded
as a realized loss in securities gains (losses).
Pension Plan: 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.
-19-
THREE MONTHS ENDED JUNE 30, 2005 AND 2004
RESULTS OF OPERATIONS
Summary
For the second quarter of 2005, the Company reported earnings per diluted
common share of $0.23, as compared to $0.22 for the same period in 2004, an
increase of approximately 4.5%. Net income for the three months ended June 30,
2005 was approximately $4.5 million, an increase of $160 thousand, or 3.7%, over
the same period last year. The increase in earnings resulted primarily from an
increase in our interest earning assets during the quarter of approximately $109
million, offset by a decline in our net interest margin, on a tax-equivalent
basis, of 15 basis points.
The Company's return on average assets decreased to 1.20% as compared to
1.25% for the three months ended June 30, 2005 and 2004, respectively. In
addition, the Company's return on average stockholders' equity decreased to
11.83% for the second quarter 2005 versus 12.08% for the second quarter in 2004.
The changes in return on average assets and equity were primarily the result of
the decline in the net interest margin.
Net Interest Income
Net interest income is the most significant source of the Company's
operating income. A portion of the Company's total interest income is derived
from investments that are exempt from federal taxation. The amount of pretax
income realized from those investments, due to the tax exemption, is less than
the amount of pretax income realizable from comparable investments subject to
federal taxation. For purposes of the following discussion, interest income
exempt from federal taxation has been restated to a fully tax-equivalent basis
using a corporate federal tax rate of 34% for the quarters ended June 30, 2005
and 2004. This was accomplished by adjusting this income upward to make it
equivalent to the level of taxable income required to earn the same amount after
taxes.
Net interest income on a tax-equivalent basis increased $644 thousand, or
4.9%, to $13.8 million for the quarter ended June 30, 2005 as compared to the
same quarter in 2004. The tax equivalent basis adjustments for the quarters
ended June 30, 2005 and 2004 were $257 thousand and $162 thousand, respectively.
The increase in net interest income was due mostly to an 8.7% growth in interest
earning assets. This interest earning asset growth was funded primarily by
deposit liabilities, which grew $62.0 million, or 5.3% on average, for the
second quarter of 2005 as compared to the same quarter in 2004. The margin for
the second quarter of 2005 was 4.05%, a decrease of 15 basis points as compared
to the same quarter in 2004.
Interest income, on a tax-equivalent basis, totaled $19.1 million for the
second quarter of 2005, an increase of $2.9 million, or 8.7%, as compared to the
same quarter in 2004. The increase was mostly attributed to the growth in
interest earning assets and the shift in asset mix as average loans grew $145.8
million, while investments declined by $24.0 million.
-20-
Interest expense totaled $5.4 million for the second quarter of 2005, an
increase of $2.3 million, as compared to the same period in 2004. The increase
in interest expense was a byproduct of the increase in market interest rates,
particularly short-term rates, during the second half of 2004 and the first half
of 2005. The increase in short-term interest rates increased the average rate
paid on deposit liabilities by 67 basis points to 1.84% for the quarter ended
June 30, 2005 as compared to the same period in 2004. Interest bearing deposits
grew on average $49.6 million, or 5.2%, for the second quarter of 2005 as
compared to the same period in 2004.
During June 2005 the Company issued $20.6 million of subordinated
debentures to unconsolidated trust subsidiaries. The average rate paid on the
subordinated debentures is 6.10% and is fixed for 5 years, after which time the
rate paid on the subordinated debentures will be the 3-month LIBOR plus 1.71%.
The subordinated debentures can be called at any of the interest payment dates
following the fifth anniversary of their issuance. The final maturity on the
subordinated debentures is June 2035. The issuance of the subordinated
debentures did not have a material impact on interest expense during the
quarter.
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- --------------------------------------------------------------------------------------------------------------------------
for the quarter ended June 30,
(dollars in thousands) 2005 2004
------------------------------------- -------------------------------
(unaudited) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ------------- --------- ----------- ---------- -------
Assets
Interest earning assets:
Loans (1) $991,543 $15,877 6.40 % $845,747 $13,160 6.22 %
Taxable securities (4) 314,142 2,534 3.23 363,281 2,563 2.82
Tax-exempt securities (2) (4) 52,069 697 5.35 26,930 406 6.03
Interest earning deposits 2 - - 6 - -
Federal funds sold 96 1 4.17 12,848 31 0.97
------------ ------------- --------- ----------- ---------- -------
Total interest-earning assets 1,357,852 19,109 5.63 1,248,812 16,160 5.18
------------- ----------
Non-interest earning assets:
Cash and due from banks 37,098 36,326
Allowance for loan and lease losses (9,993) (9,818)
Other assets 115,239 118,411
------------ -----------
Total assets $1,500,196 $1,393,731
============ ===========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $996,455 4,595 1.84 $946,834 2,760 1.17
Borrowings and subordinated debentures 95,446 772 3.24 54,862 302 2.20
------------ ------------- --------- ----------- ---------- -------
Total interest-bearing liabilities 1,091,901 5,367 1.97 1,001,696 3,062 1.22
------------- ----------
Non-interest bearing liabilities
Demand deposits 245,157 232,734
Other liabilities 10,447 15,129
------------ -----------
Total liabilities (3) 1,347,505 1,249,559
Stockholders' equity 152,691 144,172
------------ -----------
Total liabilities and stockholders' equity $1,500,196 $1,393,731
============ ===========
Net interest income (tax-equivalent basis) 13,742 3.66 13,098 3.96
Tax-equivalent basis adjustment (257) (162)
------------- ----------
Net interest income $13,485 $12,936
============= ==========
Net interest income as a percent of interest-earning assets
(tax-equivalent basis) 4.05 % 4.20 %
- ------------------------------------------------------------------------------------------------------------------------------
(1) Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan
portfolio. When applicable, tax exempt loans are computed on a fully taxable equivalent basis using the corporate federal
tax rate of 34%.
(2) Computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%.
(3) All deposits are in domestic bank offices.
(4) The average balances are based on historical cost and do not reflect unrealized gains or losses.
</Table>
-21-
Provision for Loan and Lease Losses
The provision for loan and lease losses represents management's estimate of
the amount necessary to bring the ALLL to a level that management considers
adequate to reflect the risk of estimated losses inherent in the Company's loan
and lease portfolio as of the balance sheet date. A more detailed discussion of
the evaluation of the ALLL can be found in the section titled "Critical
Accounting Policies and Judgments: Allowance for Loan and Lease Losses" above.
In the second quarter of 2005 and 2004, the Company's provision for loan and
lease losses was $225 thousand and $300 thousand, respectively. The decline in
the provision for loan and lease losses was primarily a result of an improvement
in our non-performing assets.
Non-interest Income
For the quarter ended June 30, 2005, non-interest income totaled $2.5
million, a decrease of $216 thousand, or 8.0%, as compared to the same period in
2004. The change was largely due to a decline in "other" non-interest income,
commissions on sale of annuities and mutual funds and net gains on sale of
securities of $232 thousand, $108 thousand and $55 thousand, respectively. This
was partly offset by growth in gain on sale of loans and leases of $166
thousand. The increase in gain on sale of loans arose out of an increase in
sales of Small Business Administration originated loans.
Non-interest Expense
For the quarter ended June 30, 2005, non-interest expense was $9.2 million,
an increase of $382 thousand, or 4.3 %. Contributing to the increase was an
increase in salaries and benefits of $290 thousand and "other" non-interest
expense of $93 thousand, as compared to the same period in 2004.
Income Taxes
Income tax expense as a percentage of pre-tax income was 31.1% for the
three months ended June 30, 2005 as compared to 33.3% for the same period of
2004. The decline in income tax expense was partly a result of an increase in
income from investment securities exempt from federal income taxes.
-22-
SIX MONTHS ENDED JUNE 30, 2005 AND JUNE 30, 2004
RESULTS OF OPERATIONS
Summary
Net income for the six months ended June 30, 2005 was approximately $8.9
million, an increase of $594 thousand, or 7.1%, over the same period last year.
The increase in earnings resulted from an increase primarily in the average
balance of loans outstanding of $143.0 million. The improvement in earnings was
partly offset by a 6 basis point decline in the net interest margin. For the
first six months of 2005, the Company reported earnings per diluted common share
of $0.46 as compared to $0.43 for the same period in 2004.
For the six months ended June 30, 2005 and 2004, the Company's Return on
Average Assets ("ROA") was 1.20%. Return on Average Equity ("ROE") for the six
months ended Juen 30, 2005 was 11.77% an increase from 11.61% when compared to
the same period last year.
Net Interest Income
Net interest income on a tax-equivalent basis increased $1.7 million, or
6.5%, to $27.5 million for the six months ended June 30, 2005 as compared to the
same period in 2004. The tax equivalent basis adjustments for the six months
ended June 30, 2005 and 2004 were $419 thousand and $322 thousand, respectively.
The increase in net interest income was due mostly to an 8.1% growth in interest
earning assets. This interest earning asset growth was funded primarily by
deposit liabilities, which grew 6.0% on average for the six months of 2005 as
compared to the same period in 2004. The aforementioned improvement in net
interest income was partly offset by a 6 basis point decline in the net interest
margin for the six months ended June 30, 2005 as compared to the same period in
2004. The margin was primarily affected by a 52 basis point increase in the cost
of interest bearing deposits and borrowings.
Interest income, on a tax-equivalent basis, totaled $37.3 million for the
six months ended June 30, 2005, an increase of $5.3 million, or 16.5%, as
compared to the same period in 2004. The increase was mostly attributed to a
$100.8 million, or 8.1%, growth in interest earning assets. The growth in
interest earning assets was the result of increases in average loans of $143.0
million, while investments declined by $34.6 million.
Interest expense, which totaled $9.8 million for the six months ended June
30, 2005, increased $3.6 million, or 58.2%, as compared to the same period in
2004. The increase in interest expense was a byproduct of the increase in market
interest rates, particularly short-term rates during the second half of 2004 and
first half of 2005. The increase in short-term interest rates increased the
average rate paid on interest bearing liabilities by 58 basis points to 1.82%
for the six months ended June 30, 2005 as compared to the same period in 2004.
Interest bearing deposits grew on average $56.6 million, or 6.0%, for the second
quarter of 2005 as compared to the same period in 2004. Augmenting our deposit
growth and supporting our increase in interest earning assets was an increase of
$23.7 million in average borrowings during the first six months of 2005 as
compared to the same period in 2004. During June 2005,
-23-
the Company issued $20.6 million of subordinated debentures to unconsolidated
trust subsidiaries. The average rate paid on the subordinated debentures is
6.10% and is fixed for 5 years, after which time the rate will float at 3-month
LIBOR plus 1.71%. The subordinated debentures can be called at any of the
interest payment dates following the fifth anniversary of their issuance. The
final maturity on the subordinated debentures is June 2035. The issuance of the
subordinated debentures did not have a material impact on interest expense
during the period.
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ------------------------------------------------------------------------------------------------------------------------------
for the six months ended June 30,
(dollars in thousands) 2005 2004
---------------------------------------- -----------------------------------
(unaudited) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ------------- --------- ----------- ---------- -----------
Assets
Interest earning assets
Loans (1) $969,104 $30,862 6.37 % $826,067 $25,908 6.27 %
Taxable securities (4) 330,151 5,259 3.19 383,388 5,252 2.74
Tax-exempt securities (2) (4) 43,563 1,154 5.30 24,964 794 6.36
Interest earning deposits 2 - - 9 - -
Federal funds sold 79 1 2.53 7,677 37 0.96
------------ ------------- --------- ----------- ---------- -------
Total interest-earning assets 1,342,899 37,276 5.55 1,242,105 31,991 5.15
------------- ----------
Non-interest earning assets
Cash and due from banks 35,992 35,937
Allowance for loan and lease losses (9,934) (9,727)
Other assets 115,337 118,672
------------ -----------
Total assets $1,484,294 1,386,987
============ ===========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $996,796 8,517 1.71 $940,178 5,588 1.19
Borrowings and subordinated debentures 83,808 1,291 3.08 60,112 611 2.03
------------ ------------- --------- ----------- ---------- -------
Total interest-bearing liabilities 1,080,604 9,808 1.82 $1,000,290 6,199 1.24
------------- ----------
Non-interest bearing liabilities
Demand deposits 241,871 228,417
Other liabilities 9,943 14,575
------------ -----------
Total liabilities (3) 1,332,418 1,243,282
Stockholders' equity 151,876 143,705
------------ -----------
Total liabilities and stockholders' equity $1,484,294 1,386,987
============ ===========
Net interest income (tax-equivalent basis) 27,468 3.73 25,792 3.91
Tax-equivalent basis adjustment (419) (322)
------------- ----------
Net interest income $27,049 25,470
============= ==========
Net interest income as a percent of interest-earning assets
(tax-equivalent basis) 4.09 % 4.15 %
- ------------------------------------------------------------------------------------------------------------------------------
(1) Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan
portfolio. When applicable, tax exempt loans are computed on a fully taxable equivalent basis using the corporate federal
tax rate of 34%.
(2) Computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%.
(3) All deposits are in domestic bank offices.
(4) The average balances are based on historical cost and do not reflect unrealized gains or losses.
</Table>
Provision for Loan and Lease Losses
The provision for loan and lease losses represents management's estimate of
the amount necessary to bring the allowance for loan and lease losses ("ALLL")
to a level that management considers adequate to reflect the risk of estimated
losses inherent in the Company's loan portfolio as of the balance sheet date. A
more detailed discussion of the evaluation of the ALLL can be found in the
section titled "Critical Accounting Policies and Judgments: Allowance for Loan
and Lease Losses" above. In the first six months of 2005 and 2004, the Company's
provision for loan and lease losses was $400 thousand and $675 thousand,
respectively.
Non-interest Income
Non-interest income totaled $4.7 million for the six months ended June 30,
2005, a decrease of $537 thousand, or 10.3%, as compared to the same period in
2004. The decline in non-interest income
-24-
was mostly due to decreases in net gains on the sale of securities, "other"
non-interest income and commissions on sale of annuities and mutual funds of
$502 thousand, $200 thousand and $138 thousand, respectively. The decline in
non-interest income was partly offset by an increase in net gain on sale of
loans and leases and Bank Owned Life Insurance ("BOLI") income of $246 thousand
and $138 thousand, respectively.
Non-interest Expense
For the six months ended June 30, 2005, non-interest expense was $18.3
million, an increase of $619 thousand, or 3.5%, when compared to the same period
in 2004. Contributing to the increase was an increase in salaries and benefits,
and occupancy expenses of $397 thousand and $154 thousand, respectively, as
compared to the same period in 2004.
Income Taxes
Income tax expense as a percentage of pre-tax income was 31.2% for the six
months ended June 30, 2005 as compared to 32.1% for the same period of 2004.
-25-
FINANCIAL CONDITION
Cash and Cash Equivalents
At June 30, 2005, cash and cash equivalents was $35.9 million as compared
to $33.1 million at December 31, 2004.
Securities Portfolio
Under Statement of Financial Accounting Standards No. 115 "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS 115"), each security
is classified as either trading, AFS, or HTM. The Company has no securities held
in a trading account. The securities AFS are recorded at their estimated fair
value. The after-tax difference between amortized cost and estimated fair value
of securities AFS is recorded as "accumulated other comprehensive income" in the
equity section of the balance sheet. The tax impact of such adjustment is
recorded as an adjustment to the amount of the deferred tax liability. The
securities HTM are carried at cost adjusted for the amortization of premiums and
accretion of discounts, which are recognized as an adjustment to income. Under
SFAS No. 115, securities HTM, with some exceptions, may only be sold within
three months of maturity.
The Company's U.S. Government-Sponsored Enterprises securities at June 30,
2005 and 2004 are not guaranteed by the U.S. Government; however, they are
credit rated AAA or Aaa by nationally recognized statistical rating
organizations. Substantially all obligations of states and political
subdivisions are credit rated AAA or Aaa due to insurance, which guarantees the
obligations against default, by private insurance companies. At June 30, 2005
and 2004, approximately $26.8 million and $6.4 million, respectively, of
issuances are bond or tax anticipation notes from local municipalities, which
are not rated.
The Company uses its securities portfolio to ensure liquidity for cash flow
requirements, to manage interest rate risk, provide a source of income, ensure
collateral is available for pledging requirements and manage asset quality
diversification. At June 30, 2005, investment securities totaled $361.2 million
and represented 23.6% of total assets, as compared to $388.7 million and 26.5%,
respectively, at December 31, 2004. Securities AFS comprised 90.4% of the total
securities portfolio at June 30, 2005 as compared to 96.3% at December 31, 2004.
At June 30, 2005, the Company had a net unrealized loss of $1.8 million as
compared to a net unrealized loss of $296 thousand at December 31, 2004. The
decrease was attributed to an increase in market interest rates during that
period.
Proceeds from the sale of securities AFS amounted to $77.1 million and
$58.2 million for the six months ended June 30, 2005 and 2004, which resulted in
gross realized gains of $670 thousand and $913 thousand for those periods,
respectively. Gross realized losses from the sale of securities AFS amounted to
$361 thousand and $94 thousand for the six months ended June 30, 2005 and 2004,
respectively. Proceeds from the sale of securities HTM amounted to $270 thousand
for the six months ended June 30, 2005, which resulted in realized gains of $8
thousand. The securities had significantly paid down to less than 85% of the
original purchased balance through normal principal amortization and
prepayments. There
-26-
were no sales of securities HTM for the six months ended June 30, 2004. These
amounts are included in net gain on sale of securities in the unaudited
condensed consolidated statements of income.
Loans
Total loans amounted to $1.0 billion at June 30, 2005, an increase of $85.8
million from $934.2 million at December 31, 2004. The growth was attributable to
increases in commercial mortgage loans, commercial and financial loans, and
construction loans of $42.4 million, $18.1 million, and $22.4 million,
respectively.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans, restructured loans,
foreclosed real estate and other repossessed assets. The Company's nonperforming
assets at June 30, 2005 amounted to $6.4 million as compared to $9.3 million at
December 31, 2004. The ratio of nonperforming assets to total loans and
foreclosed real estate and other repossessed assets decreased to 0.63% at June
30, 2005 from 0.99% at December 31, 2004.
The following table lists nonaccrual loans and foreclosed real estate and
other repossessed assets at June 30, 2005, and December 31, 2004: (in thousands)
--------- ------------
June 30, December 31,
2005 2004
--------- -----------
(unaudited)
Nonaccrual loans $ 6,276 $ 9,133
Foreclosed assets and other repossessed assets 154 156
--------- ---------
Total nonperforming assets $ 6,430 $ 9,289
========= =========
Allowance for Loan and Lease Losses
The ALLL is generally established through periodic charges to income
through the provision for loan and lease losses. During the six months ended
June 30, 2005, the ALLL increased $148 thousand to $9.9 million. Loan losses are
charged against the ALLL when management believes that the probable future
collection of principal is unlikely. Subsequent recoveries, if any, are credited
to the ALLL. If the ALLL is considered inadequate to absorb future loan 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 the provision for loan and lease losses is
increased.
The Company considers the ALLL of $9.9 million adequate to cover estimated
losses inherent in the loan portfolio that may become uncollectible based on
management's periodic evaluations of the loan portfolio and other relevant
factors. The evaluations are inherently subjective as they require material
estimates including such factors as potential loss factors, changes in trend of
non-performing loans, current
-27-
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 following table presents the provisions for loan and lease losses,
loans charged off and recoveries on loans previously charged off, the amount of
the allowance, the average loans outstanding and certain pertinent ratios for
the three and six months ended June 30, 2005 and 2004: (dollars in thousands)
(unaudited)
<Table>
<Caption>
------------------------- -----------------------
Three months ended Six months ended
June 30, June 30,
------------------------- -----------------------
2005 2004 2005 2004
------------- ---------- ----------- ----------
Average loans outstanding $ 991,543 $845,747 $ 969,104 $826,067
============= ========== =========== ==========
Allowance at beginning of period $9,876 $9,635 $9,797 $9,641
------------- ---------- ----------- ----------
Loans charged-off:
Real estate - 9 - 76
Commercial and financial - 2 89 57
Commercial lease financing 151 134 233 411
Consumer loans 10 26 13 44
------------- ---------- ----------- ----------
Total 161 171 335 588
------------- ---------- ----------- ----------
Recoveries of loans previously charged-off:
Real estate - 4 72 4
Commercial and financial 1 6 1 6
Commercial lease financing - 12 - 48
Consumer loans 4 2 10 2
------------- ---------- ----------- ----------
Total 5 24 83 60
------------- ---------- ----------- ----------
Provision for loan and lease losses 225 300 400 675
------------- ---------- ----------- ----------
Allowance at end of period $9,945 $9,788 $9,945 $9,788
============= ========== =========== ==========
Allowance to loans (end of period) 0.98 % 1.11 % 0.98 % 1.11 %
Ratio of net charge-offs to average loans
(annualized) 0.06 % 0.07 % 0.05 % 0.13 %
</Table>
Deposits
Deposits, which include non-interest bearing demand deposits, time deposits
and other interest-bearing deposits, are an essential and cost-effective funding
source for the Company. Other interest-bearing deposits, which include
interest-bearing demand, money market and savings accounts, comprise the largest
segment of the Company's total deposits. The Company emphasizes building core
customer relationships by offering a variety of products designed to meet the
financial needs of its customers based on their identifiable "life stages".
At June 30, 2005 total deposits grew $12.0 million, or 2.0% annualized, to
$1.26 billion from December 31, 2004 and experienced a favorable shift in
deposit mix. The increase was largely in non-
-28-
interest bearing demand deposits, which increased $32.2 million, or 13.7%, to
$267.2 million at June 30, 2005 from December 31, 2004. The aforementioned
increase was offset by declines in time deposits and other interest-bearing
deposits of $16.9 million and $3.3 million, respectively.
At June 30, 2005, non-interest bearing deposits amounted to $267.2 million
and improved to 21.2% of total deposits compared to 18.9% of total deposits at
December 31, 2004. Other interest-bearing deposits amounted to $670.5 million at
June 30, 2005 and slightly declined to 53.3% of total deposits compared to 54.1%
of total deposits at December 31, 2004. Time deposits amounted to $320.4
million, or 25.5%, of total deposits at June 30, 2005, as compared to $337.3
million, or 27.1% of total deposits at December 31, 2004.
The following table reflects the composition of deposit liabilities:
(dollars in thousands)
June 30, December 31,
2005 2004
---------------- ------------
(unaudited)
Non-interest bearing demand $ 267,225 $ 235,036
Interest bearing demand 455,729 472,807
Money market 102,273 87,595
Savings 112,504 113,352
Time deposits < $100,000 284,307 286,471
Time deposits > $100,000 36,125 50,877
---------------- ------------
$ 1,258,163 $ 1,246,138
================ ============
Subordinated Debentures
During June of 2005 Interchange Statutory Trust I and Interchange Statutory
Trust II (together the "Trusts") each issued $10 million of pooled trust
preferred securities. In conjunction with the issuance of the trust preferred
securities, the Company issued subordinated debentures to the Trusts totaling
$20.6 million. The rates of interest paid on the securities issued by the Trusts
and the Company have been fixed for 5 years, at an average rate of 6.10%, after
which time the rates will float at 3-month LIBOR plus 1.71%. The Company has the
right to call the notes after 5 years on any of the interest payment dates.
The Trusts are wholly owned unconsolidated subsidiaries of the Company and
have no independent operations. The obligations of the Trusts are fully and
unconditionally guaranteed by the Company. The debentures are unsecured and rank
subordinate and junior in right of payment to all indebtedness, liabilities and
obligations of the Company. Interest on the debentures is cumulative and payable
in arrears. Proceeds from any redemption of debentures would cause a mandatory
redemption of pooled trust preferred securities issued by the Trusts having an
aggregate liquidation amount equal to the principal amount of debentures
redeemed.
-29-
The trust preferred securities were issued as part of our overall capital
management plan and in support of our continued loan growth. The effect of the
issuance on net interest income was not material during either the three or six
months ending June 30, 2005.
-30-
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 the first six months of 2005. 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")
manages our 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 of directors, attempts
to determine 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 June 30, 2005, 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 200
basis point declining interest rate environment. Based on that simulation, it
was estimated that net interest income, over a twelve-month horizon, would not
decrease by more than 4.4%. At June 30, 2005, the Company was
-31-
within policy limits established by the board of directors for changes in net
interest income and future economic value of equity. The following table
illustrates 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 200 basis point declining interest rate environment:
(unaudited)
-------------------------------------------
Percentage Change in Estimated Net Interest
Income over a twelve month horizon
-------------------------------------------
June 30
2005 2004
---------- ----------
+200 basis points -3.3 % -5.6 %
+100 basis points -1.4 -1.7
- -100 basis points -1.6 -4.8
- -200 basis points -4.4 *
* Not simulated due to the historically low interest rate environment.
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.
Capital Adequacy
The Company is subject to capital adequacy requirements imposed by the
Board of Governors of the Federal Reserve System (the "Federal Reserve"); and
the Bank is subject to similar capital adequacy requirements imposed by the
Federal Deposit Insurance Corporation (the "FDIC"). The Federal Reserve and the
FDIC have adopted risk-based capital requirements for assessing bank holding
company and bank capital adequacy. These standards define capital and establish
minimum capital requirements in relation to assets and off-balance sheet
exposure, adjusted for credit risk. The risk-based capital standards currently
-32-
in effect are designed to make regulatory capital requirements more sensitive to
differences in risk profiles among bank holding companies and banks, to account
for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Assets and off-balance sheet items are assigned to broad risk
categories, each with appropriate relative risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and off
balance sheet items.
A banking organization's total qualifying capital includes two components:
core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core
capital, which must comprise at least half of total capital, includes common
shareholders' equity, qualifying perpetual preferred stock, trust preferred
securities (subject to certain limitations) and minority interests, less
goodwill and any unrealized gains or losses. Supplementary capital includes the
allowance for loan losses (subject to certain limitations), other perpetual
preferred stock, trust preferred securities that exceed Tier 1 limits, certain
other capital instruments and term subordinated debt. Total capital is the sum
of core and supplementary capital. The Company's $20 million of trust preferred
securities is considered Tier 1 capital by the Federal Reserve Board.
At June 30, 2005, the minimum risk-based capital requirements to be
considered adequately capitalized were 4% for Tier 1 capital and 8% for total
capital.
Federal banking regulators have also adopted leverage capital guidelines to
supplement the risk-based measures. The leverage ratio is determined by dividing
Tier 1 capital as defined under the risk-based guidelines by average total
assets (non risk-adjusted) for the preceding quarter. At June 30, 2005, the
minimum leverage ratio requirement to be considered adequately capitalized was
3%.
The capital levels of the Company and the Bank at June 30, 2005, and the
two highest capital adequacy levels recognized under the guidelines established
by the federal banking agencies are included in the following table. The
Company's and the Bank's ratios all exceeded the well-capitalized guidelines
shown in the table.
-33-
The Company's and the Bank's capital amounts and ratios are as follows:
(dollars in thousands)
<Table>
<Caption>
To Be "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------ ----------- ------------- -------- ----------- ----------
As of June 30, 2005:
Total Capital (to Risk Weighted Assets):
The Company $128,450 12.03 % $85,427 8.00 % N/A N/A
The Bank 127,553 11.94 % 85,488 8.00 % 106,859 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 118,485 11.10 % $42,713 4.00 % N/A N/A
The Bank 117,588 11.00 % 42,744 4.00 % 64,116 6.00 %
Tier 1 Capital (to Average Assets):
The Company 118,485 8.21 % 43,301 3.00 % N/A N/A
The Bank 117,588 8.14 % 43,322 3.00 % 72,204 5.00 %
As of December 31, 2004:
Total Capital (to Risk Weighted Assets):
The Company $102,175 10.35 % $78,959 8.00 % N/A N/A
The Bank 101,442 10.27 % 79,007 8.00 % $98,759 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 92,338 9.36 % 39,480 4.00 % N/A N/A
The Bank 91,605 9.28 % 39,504 4.00 % 59,256 6.00 %
Tier 1 Capital (to Average Assets):
The Company 92,338 6.49 % 42,692 3.00 % N/A N/A
The Bank 91,605 6.43 % 42,735 3.00 % 71,225 5.00 %
</Table>
Liquidity
Liquidity is the ability to provide sufficient resources to meet all
current financial obligations and finance prospective business opportunities.
The Company's liquidity position 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 demand
for loans.
The Company's most liquid assets are cash and cash equivalents. At June 30,
2005, the total of such assets amounted to $36.0 million, or 2.4%, of total
assets, compared to $33.1 million, or 2.3%, of total assets at December 31,
2004.
Financing for the Company's loans and investments is derived primarily from
deposits, along with interest and principal payments on loans and investments.
At June 30, 2005 and December 31, 2004, total deposits amounted to $1.3 billion
and $1.2 billion, respectively. In addition, the Company supplemented the more
traditional funding sources with borrowings from the Federal Home Loan Bank of
New York ("FHLB") and with securities sold under agreements to repurchase
("REPOS"). At June 30, 2005, short-term borrowings from the FHLB and REPOS
amounted to $43.5 million and $4.7 million, respectively, as compared to $24.6
million and $4.4 million, respectively, at December 31, 2004.
Another significant liquidity source is the Company's securities portfolio.
Total securities at June 30, 2005 amounted to $361.2 million, a decrease of
$27.5 million, from $388.7 million at December 31, 2004. At June 30, 2005
securities AFS amounted to $326.5 million, or 90.4%, of total securities
compared to $374.2 million, or 96.3%, of total securities at December 31, 2004.
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
-34-
window. The Bank also has a $100.0 million line of credit available through its
membership in the FHLB of which $6.1 million was utilized at June 30, 2005.
The Company is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These instruments, which include commitments to extend credit and standby
letters of credit, involve, to a varying degree, elements of credit and interest
rate risk in excess of the amount recognized in the unaudited Condensed
Consolidated Balance Sheets. Commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates and may require
collateral from the borrower if deemed necessary by the Company. Standby letters
of credit are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party up to a stipulated amount and with
specified terms and conditions. Commitments to extend credit and standby letters
of credit are not recorded on the Company's Condensed Consolidated Balance Sheet
until the instrument is exercised. At June 30, 2005 outstanding commitments to
fund loans totaled $280.5 million and outstanding standby letters of credit
totaled $2.6 million.
The Company has historically paid quarterly cash dividends and anticipates
continuing paying quarterly dividends in the future. The Company's Board of
Directors could, if they deemed it necessary, modify the amount or frequency, of
dividends as an additional source of liquidity. There are imposed dividend
restrictions on the Bank, which are described in Note 18 "Restrictions of
Subsidiary Bank Dividends" in the Notes to Consolidated Financial Statements in
the Company's 2004 Annual Report on Form 10-K. Management believes that the
Company has sufficient cash flow and borrowing capacity to fund all outstanding
commitments and letters of credit and to maintain proper levels of liquidity.
Item 4: CONTROLS AND PROCEDURES
In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934
(the "Exchange Act"), as of the end of the quarter ended June 30, 2005, we
carried out an evaluation under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as defined in Rule 13a-15(e) under the Exchange Act.
Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are effective
to ensure that information required to be disclosed by us in the reports we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the Securities and
Exchange Commission, and accumulated and communicated to our management,
including our chief executive officer and chief financial officer, as
appropriate to allow timely decisions regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives and in reaching a reasonable level of assurance our
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management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
The Company maintains internal control over financial reporting. During the
quarter ended June 30, 2005, there were no changes in our internal controls over
financial reporting that materially affected, or are reasonably likely to
materially affect, those controls.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Reference is also made to Note 3 of the Company's Consolidated
Financial Statements in this Form 10-Q.
Item 2. Unregistered Sales of Equity in Securities and Use of Proceeds
During June 2005, Interchange Statutory Trust I and Interchange
Statutory Trust II (together the "Trusts") each issued $10 million of
pooled trust preferred securities. In conjunction with the issuance of
the Trust's preferred securities, the Company issued subordinated
debentures to the Trusts totaling $20.6 million. The rates of interest
paid on the securities issued by the Trusts and the Company have been
fixed for 5 years, at an average rate of 6.10%, after which time the
rates will float at the 3-month LIBOR plus 1.71%. The Company has the
right to call the notes after 5 years on any of the interest payment
dates.
The issuance of the Trust's preferred securities and the
subordinated debentures was made in a private placement in reliance
upon the exemption from compliance with the registration requirements
of the Securities Act contained in Section 4(2) of the Securities Act
and applicable state securities law exemptions.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
(a) The company held its Annual Meeting of Shareholders on April 28,
2005.
(b) Each of the persons nominated for director was elected; Approval
and Adoption of the Company's 2005 Omnibus Stock and Incentive
Plan and the selection of Deloitte & Touche LLP as the Company's
independent auditors for 2005 was ratified. The following are the
voting results on each of these matters:
Against or
For Withheld Abstentions
--- -------- -----------
(1) ELECTION OF DIRECTORS
Anthony S. Abbate 16,170,407 286,949 0
Anthony R. Coscia 16,184,527 272,829 0
John J. Eccleston 16,169,323 288,032 0
Eleanore s. Nissley 16,171,058 286,297 0
William P. Schuber 16,070,558 386,798 0
(2) Approval and Adoption of the Company's 2005 Omnibus Stock and
Incentive Plan to Increase Shares of Common Stock Reserved for
Issuance:
For Against Abstain Not Voted
--- ------- ------- ---------
9,610,966 1,825,601 57,523 4,963,266
(3) Ratification of the selection of Deloitte & Touche LLP as the
Company's independent Auditors for 2005:
Against or
For Withheld Abstentions
--- -------- -----------
15,916,008 527,905 13,443
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Item 5. Other Information
None
Item 6. Exhibits
The following exhibits are furnished herewith:
Exhibit
-------
11 Statement re computation of per share earnings
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certifications pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Interchange Financial Services Corporation
By: /s/ Charles T. Field
-----------------------------------
Charles T. Field
Senior Vice President and CFO
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Dated: August 9, 2005
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