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 SEPTEMBER 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 ___
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ___ No X
The number of outstanding shares of the Registrant's common stock, no
par value per share, as of September 30, 2005, was 19,162,015 shares.
INTERCHANGE FINANCIAL SERVICES CORPORATION
INDEX
PART I FINANCIAL INFORMATION
Page No.
Item 1 Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of
September 30, 2005 and December 31, 2004..........................1
Unaudited Condensed Consolidated Statements of Income for the
three and nine-month periods ended September 30, 2005 and 2004....2
Unaudited Condensed Consolidated Statements of
Changes in Stockholders' Equity for the nine months
ended September 30, 2005 and 2004.................................3
Unaudited Condensed Consolidated Statements of Cash Flows for
the nine months ended September 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..............................19
Item 3 Quantitative and Qualitative Disclosures About Market Risk.......34
Item 4 Controls and Procedures..........................................38
PART II OTHER INFORMATION
Item 1 Legal Proceedings................................................40
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds......40
Item 3 Defaults upon Senior Securities..................................40
Item 4 Submission of Matters to a Vote of Security Holders..............40
Item 5 Other Information................................................40
Item 6 Exhibits.........................................................40
Signatures.....................................................41
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) September 30, December 31,
2005 2004
------------- ------------
Assets
Cash and due from banks $ 34,643 $ 33,108
Interest bearing demand deposits 4 2
-------------- ------------
Total cash and cash equivalents 34,647 33,110
-------------- ------------
Securities held-to-maturity at amortized cost (estimated fair value
of $34,827 and $15,276 for September 30, 2005 and December 31, 2004,
respectively) 34,183 14,530
-------------- ------------
Securities available-for-sale at estimated fair value (amortized cost of
$327,095 and $375,241 for September 30, 2005 and
December 31, 2004 respectively) 323,376 374,199
-------------- ------------
Loans and leases (net of unearned income and deferred fees of $6,421 and
$5,514 for September 30, 2005 and December 31, 2004, respectively) 1,049,332 934,181
Less: Allowance for loan and lease losses 10,159 9,797
-------------- ------------
Net loans and leases 1,039,173 924,384
-------------- ------------
Bank owned life insurance 26,666 25,847
Premises and equipment, net 16,301 17,713
Foreclosed assets and other repossessed assets 156 156
Goodwill 55,952 55,952
Intangible assets 3,282 3,660
Accrued interest receivable and other assets 18,204 14,590
-------------- ------------
Total assets $1,551,940 $1,464,141
============== ============
Liabilities
Deposits
Non-interest bearing $239,796 $235,036
Interest bearing 1,026,332 1,011,102
-------------- ------------
Total deposits 1,266,128 1,246,138
-------------- ------------
Securities sold under agreements to repurchase 4,408 4,401
Short-term borrowings 58,047 24,600
Long-term borrowings 35,000 30,000
Subordinated debentures 20,620 -
Accrued interest payable and other liabilities 10,260 8,847
-------------- ------------
Total liabilities 1,394,463 1,313,986
-------------- ------------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, without par value; 33,750,000 shares authorized;
19,162,015 and 19,119,814 shares issued and outstanding for
September 30, 2005 and December 31, 2004, respectively 5,397 5,397
Capital surplus 73,531 73,320
Retained earnings 94,976 86,542
Accumulated other comprehensive loss, net of taxes of $1,472 and
$408 for September 30, 2005 and December 31, 2004, respectively (2,247) (633)
-------------- ------------
171,657 164,626
Less: Treasury stock 14,180 14,471
-------------- ------------
Total stockholders' equity 157,477 150,155
-------------- ------------
Total liabilities and stockholders' equity $1,551,940 $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 Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2005 2004 2005 2004
-------------- -------------- ---------------- -------------
Interest income
Interest on loans and leases $ 17,097 $ 13,877 $ 47,907 $ 39,709
Interest on federal funds sold 17 33 18 70
Interest and dividends on securities
Taxable interest income 2,342 2,630 7,464 7,841
Interest income exempt from federal income taxes 545 303 1,332 851
Dividends 59 33 196 74
-------------- -------------- ---------------- -------------
Total interest income 20,060 16,876 56,917 48,545
-------------- -------------- ---------------- -------------
Interest expense
Interest on deposits 5,265 3,085 13,782 8,672
Interest on securities sold under agreements to repurchase 35 34 91 112
Interest on short-term borrowings 370 60 900 171
Interest on long-term borrowings and subordinated debentures 686 237 1,391 660
-------------- -------------- ---------------- -------------
Total interest expense 6,356 3,416 16,164 9,615
-------------- -------------- ---------------- -------------
Net interest income 13,704 13,460 40,753 38,930
Provision for loan and lease losses 300 300 700 975
-------------- -------------- ---------------- -------------
Net interest income after provision for loan and lease losses 13,404 13,160 40,053 37,955
-------------- -------------- ---------------- -------------
Non-interest income
Service fees on deposit accounts 910 1,001 2,682 2,778
Net gain on sale of securities 77 163 394 982
Net gain on sale of loans and leases 498 273 877 406
Bank owned life insurance 270 245 819 732
Commissions on sale of annuities and mutual funds 237 266 567 734
Other 685 929 2,008 2,452
-------------- -------------- ---------------- -------------
Total non-interest income 2,677 2,877 7,347 8,084
-------------- -------------- ---------------- -------------
Non-interest expense
Salaries and benefits 5,236 5,029 15,145 14,541
Occupancy 1,382 1,325 4,188 3,977
Furniture and equipment 309 327 940 987
Advertising and promotion 242 346 1,060 1,209
Amortization of intangible assets 126 126 378 378
Other 1,952 2,114 5,870 5,890
-------------- -------------- ---------------- -------------
Total non-interest expense 9,247 9,267 27,581 26,982
-------------- -------------- ---------------- -------------
Income before income taxes 6,834 6,770 19,819 19,057
Income taxes 2,158 2,109 6,208 6,055
-------------- -------------- ---------------- -------------
Net income $ 4,676 $ 4,661 $ 13,611 $ 13,002
============== ============== ================ =============
Basic earnings per common share $0.24 $0.24 $0.71 $0.68
===== ===== ===== =====
Diluted earnings per common share $0.24 $0.24 $0.69 $0.67
===== ===== ===== =====
- ------------------------------------------------------------------------------------------------------------------------------
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 Nine Months Ended September 30
- ----------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
(unaudited)
Accumulated
Other
Comprehensive Retained Comprehensive Common Capital Treasury
Income Earnings Income 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 $ 13,002 13,002 13,002
Other comprehensive income, net of taxes
Unrealized net losses on AFS debt securities (1,087)
Less: net gains on disposition of securities (729)
-------------
Other comprehensive income, net of taxes (1,816) (1,816) (1,816)
-------------
Comprehensive income $ 11,186
=============
Dividends on common stock (4,788) (4,788)
Issued 11,690 shares of common stock in
connection with Executive Compensation Plan 103 102 205
Exercised 20,115 option shares (8) 143 135
Purchased 127,179 shares of common stock (2,154) (2,154)
-------- ------------- -------- --------- ---------- ----------
Balance at September 30, 2004 82,924 618 5,397 73,326 (14,488) 147,777
Comprehensive income
Net Income $ 5,212 5,212 5,212
Other comprehensive losses, net of taxes
Unrealized net losses on AFS debt securities (925)
Less: net gains on disposition of securities (331)
Minimum pension liability 5
-------------
Other comprehensive losses, net of taxes (1,251) (1,251) (1,251)
-------------
Comprehensive income $ 3,961
=============
Dividends on common stock (1,594) (1,594)
Exercised 1,950 option shares (6) 17 11
-------- ------------- -------- --------- ---------- -----------
Balance at December 31, 2004 86,542 (633) 5,397 73,320 (14,471) 150,155
Comprehensive income
Net Income $ 13,611 13,611 13,611
Other comprehensive losses, net of taxes
Unealized losses on AFS debt securities (1,378)
Less: net gains on disposition of securities (236)
-------------
Other comprehensive losses, net of taxes (1,614) (1,614) (1,614)
-------------
Comprehensive income $ 11,997
=============
Dividends on common stock (5,170) (5,170)
Issued 18,772 shares of common stock in connection
with Executive Compensation Plan 173 162 335
Exercised 30,585 option shares 38 241 279
Purchased 6,455 shares of common stock (112) (112)
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 September 30, 2005 $ 94,976 $ (2,247) $ 5,397 $ 73,531 $ (14,180) $ 157,477
======== ============= ======== ========= ========== ==========
- ----------------------------------------------------------------------------------------------------------------------------------
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 Nine Months Ended September 30,
- --------------------------------------------------------------------------------------
(in thousands)
(unaudited)
2005 2004
------------- ----------
Cash flows from operating activities
Net income $ 13,611 $ 13,002
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 1,495 1,438
Amortization of securities premiums 3,043 4,121
Accretion of securities discounts (175) (200)
Amortization of loan premiums 67 36
Amortization of premiums in connection with acquisition 518 877
Provision for loan and lease losses 700 975
Increase in cash surrender value of Bank Owned Life Insurance (819) (732)
Net gain on sale of securities (394) (982)
Origination of loans held for sale (22,766) (6,077)
Sale of loans held for sale 23,584 6,433
Net gain on sale of loans and leases (877) (406)
Net gain on sale of fixed assets - (16)
Write off of foreclosed and repossessed assets 13 -
Net gain on sale of foreclosed and repossessed assets - (14)
Decrease (increase) in operating assets
Accrued interest receivable (673) 380
Other Assets (2,070) (3,157)
Increase in operating liabilities
Accrued interest payable 528 61
Other 885 554
------------- ----------
Cash provided by operating activities 16,670 16,293
------------- ----------
Cash flows from investing activities
(Payments for) proceeds from
Net originations of loans and leases (112,778) (92,659)
Purchase of loans and leases (4,678) (40,459)
Sale of loans and leases 1,792 1,193
Purchase of securities available-for-sale (136,466) (71,960)
Maturities of securities available-for-sale 92,475 79,126
Sale of securities available-for-sale 89,926 63,612
Maturities of securities held-to-maturity 1,705 9,059
Sale of securities held-to-maturity 270 -
Purchase of securities held-to-maturity (21,891) (6,820)
Sale of foreclosed and other repossessed assets - 77
Purchase of fixed assets (1,054) (1,591)
Sale of fixed assets 1,171 2,766
------------- ----------
Cash used in investing activities (89,528) (57,656)
------------- ----------
Cash flows from financing activities
Proceeds from (payments for)
Net change in deposits 19,996 88,532
Securities sold under agreements to repurchase and other borrowings 801,865 319,132
Retirement of securities sold under agreement to repurchase and
other borrowings (763,411) (337,485)
Issuance of long term subordinated debentures 20,620 -
Dividends (5,170) (4,788)
Common stock issued 335 205
Payout of fractional shares resulting from 3-for-2 stock split (7) -
Treasury stock (112) (2,154)
Exercise of option shares 279 135
------------- ----------
Cash provided by financing activities 74,395 63,577
------------- ----------
Increase in cash and cash equivalents 1,537 22,214
Cash and cash equivalents, beginning of period 33,110 31,435
------------- ----------
Cash and cash equivalents, end of period $ 34,647 $ 53,649
============= ==========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 15,883 $6,275
Income taxes 7,217 4,100
Supplemental disclosure of non-cash investing and financing activities:
Loans transferred to foreclosed and repossessed assets 13 34
- --------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
</Table>
-4-
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE-MONTH PERIODS ENDED SEPTEMBER 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 nine months
ended September 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 third 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. During the Board's September
meetings the Board determined that the FSP will retain the paragraph pertaining
to the accounting for debt securities subsequent to an other-than temporary
impairment, but add a footnote clarifying that this FSP does not address when a
security should be placed on a nonaccrual status. The effective date of the FSP
is for periods beginning after December 15, 2005, but is not expected to have a
material impact on our condensed consolidated financial statements. Prospective
transition will be provided for debt securities subsequent to an other-than
- -temporary impairment.
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
-6-
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 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
September 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 nine
months ended September 30, 2005 and 2004: (in thousands, except per share data)
(unaudited)
-7-
<Table>
<Caption>
-------------------------------------- ------------------------------------
For the three months ended For the nine months ended
September 30, September 30,
-------------------------------------- ------------------------------------
2005 2004 2005 2004
----------------- ---------------- ---------------- ----------------
Net Income
As reported $4,676 $4,661 $13,611 $13,002
Less: Total stock-based
compensation expense determined
under the fair value method for all
rewards, net of related tax effects 260 218 782 619
----------------- ---------------- ---------------- ----------------
Pro-forma $4,416 $4,443 $12,829 $12,383
================= ================ ================ ================
Earnings per share:
Basic:
As reported 0.24 0.24 0.71 0.68
Pro forma 0.23 0.23 0.67 0.65
Diluted:
As reported 0.24 0.24 0.69 0.67
Pro forma 0.23 0.23 0.66 0.64
</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 nine months ended
September 30, 2005 and 2004, respectively: dividend yield of 2.00% and 2.01%;
expected 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 September 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 each of the nine month periods ended
September 30, 2005 and 2004, the weighted average diluted shares outstanding
were approximately 19.6 million.
-8-
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 September 30, 2005, the Company had commitments to extend credit of
approximately $268.1 million, of which approximately $3.8 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. There have been no events that have caused
the Company to consider the need to test goodwill for impairment since the
Company's last assessment.
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)
---------------- -----------------
September 30, December 31,
2005 2004
---------------- -----------------
Intangible assets $ 4,595 $ 4,595
Accumulated amortization (1,313) (935)
---------------- -----------------
Net intangible assets $ 3,282 $ 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 nine month periods ended September 30, 2005 and 2004, the
CDI amortized were $107 thousand and $322 thousand, respectively. The CDI will
be periodically reviewed for impairment.
At September 30, 2005 the scheduled amortization of the intangible assets
is as follows (in thousands) (unaudited):
-9-
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 October 18, 2005, the Company declared a cash dividend of $0.09 per
share payable on November 18, 2005, to holders of record as of October 31, 2005.
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)
-10-
<Table>
<Caption>
--------------------------------------------------------
September 30, 2005
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ----------- ------------ --------------
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 3,327 $ 30 $ 1 $ 3,356
Obligations of states & political subdivisions 30,856 616 1 31,471
------------- ----------- ------------ --------------
$ 34,183 $ 646 $ 2 $ 34,827
============= =========== ============ ==============
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 110,110 $ 65 $ 1,562 $ 108,613
Other debt 171,372 - 2,757 168,615
Obligations of states & political subdivisions 39,775 580 45 40,310
Equity securities 5,838 - - 5,838
------------- ----------- ------------ --------------
327,095 645 4,364 323,376
------------- ----------- ------------ --------------
Total securities $361,278 $ 1,291 $ 4,366 $ 358,203
============= =========== ============ ==============
--------------------------------------------------------
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 September 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 $ 14,476 $ 14,498 $ 131,423 $ 130,256
After 1 but within 5 years 4,380 4,553 174,252 171,181
After 5 but within 10 years 11,864 12,237 5,593 5,743
After 10 years 3,463 3,539 9,989 10,358
Equity securities - - 5,838 5,838
------------- ------------- ----------- ------------
Total $ 34,183 $ 34,827 $ 327,095 $ 323,376
============= ============= =========== ============
</Table>
Proceeds from the sale of securities AFS amounted to $89.9 million and
$63.6 million for the nine months ended September 30, 2005 and 2004,
respectively, which resulted in gross realized gains of $747 thousand and $1.1
million for those periods, respectively. Gross realized losses from the sale of
securities AFS amounted to $361 thousand and $94 thousand for the nine months
ended September 30, 2005 and
-11-
2004, respectively. Proceeds from the sale of securities HTM amounted to $270
thousand for the nine months ended September 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 nine
months ended September 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 September 30, 2005 and 2004.
The following table summarizes all securities that have an unrealized loss
and the duration of the unrealized loss at September 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 $ 60,784 $ 834 $ 38,309 $ 728 $ 99,093 $ 1,562
Other debt 9,488 182 159,128 2,575 168,616 2,757
Obligations of states & political subdivisions 2,265 32 1,832 13 4,097 45
------------ ------------ ----------- ----------- ------------ ------------
$ 72,537 $ 1,048 $ 199,269 $ 3,316 $ 271,806 $ 4,364
============ ============ =========== =========== ============ ============
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 153 $ 1 $ 28 $ - $ 181 $ 1
Obligations of states & political subdivisions 362 1 - - 362 1
------------ ------------ ----------- ----------- ------------ ------------
$ 515 $ 2 $ 28 $ - $ 543 $ 2
============ ============ =========== =========== ============ ============
</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)
-12-
<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 $ 121,597 $ 1,593 $ 268,274 $ 2,995
============ ============ =========== =========== ============ ============
</Table>
Securities with carrying amounts of $137.1 million and $62.2 million at
September 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)
------------- ------------
September 30, December 31,
2005 2004
------------- ------------
(unaudited)
Real estate
Residential $286,578 $292,406
Commercial 431,372 375,985
Construction 90,575 51,162
Commercial
Commercial and financial 213,481 186,386
Lease financing 22,853 23,535
Consumer
Lease financing 113 680
Installment 4,360 4,027
--------- --------
1,049,332 934,181
Allowance for loan and lease losses (10,159) (9,797)
--------- --------
Net loans and leases $1,039,173 $924,384
========== ========
Loans are net of unearned income and deferred fees of $6.5 million and $5.5
million for the periods ended September 30, 2005 and December 31, 2004,
respectively. Loans held for sale amounted to $2.3 million and $650 thousand at
September 30, 2005 and December 31, 2004, respectively, which are carried at
lower of cost or market.
Nonperforming Loans
Nonperforming loans include loans that are accounted for on a nonaccrual
basis. Nonperforming loans are as follows: (in thousands)
-13-
------------- ------------
September 30, December 31,
2005 2004
------------- ------------
(unaudited)
Nonaccrual loans
Residential real estate $ 818 $ 1,660
Commercial real estate 185 2,320
Commercial and financial 3,392 2,981
Commercial lease financing 1,411 1,836
Consumer 111 336
---------- ---------
$5,917 $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>
---------------------- -----------------------
September 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 $ 4,637 $ 1,023 $2,981 $420
Commercial real estate 190 5 2,320 98
Residential real estate 594 88 822 123
Without a related allowance for loan losses - - - -
---------- ----------- ------------- ---------
$5,421 $ 1,115 $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 Nine months ended
September 30, September 30,
---------------------- ------------------------
2005 2004 2005 2004
---------- ----------- ----------- ------------
Balance at beginning of period $9,945 $9,788 $9,797 $9,641
Additions (deductions)
Provision charged to operations 300 300 700 975
Recoveries on loans previously charged-off 18 16 101 76
Loans charged-off (104) (307) (439) (895)
---------- ----------- ----------- ------------
Balance at end of period $10,159 $9,797 $10,159 $9,797
========== =========== =========== ============
</Table>
-14-
10. Other Non-interest Expense
Expenses included in other non-interest expense are as follows: (in
thousands) (unaudited)
<Table>
<Caption>
--------------------------- ---------------------------
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------- ------------- ------------
Professional fees $ 406 $ 385 $ 1,184 $ 1,062
Legal fees 254 310 695 760
Directors' fees, travel and retirement 230 198 652 609
Data processing 271 284 800 848
All other 791 894 2,539 2,472
------------ ------------- ------------- ------------
Total $ 1,952 $ 2,071 $ 5,870 $ 5,751
============ ============= ============= ============
</Table>
11. Long-term Borrowings
Long-term borrowings consist of the following FHLB advances: (in thousands)
Maturity September 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),
-15-
"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 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 Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
Service cost $ 198 $ 166 $ 594 $ 499
Interest cost 102 95 306 286
Expected return on plan assets (56) (39) (168) (118)
Amortization of prior service cost 1 1 3 4
Amortization of net (gain) loss 1 - 3 -
------------- ------------- ------------- -------------
Net periodic benefit cost $ 246 $ 223 $ 738 $ 671
============= ============= ============= =============
</Table>
During 2005, the Bank contributed approximately $43 thousand to the Pension
Plan.
-16-
14. Subsequent Events
On October 13, 2005 the Company completed its acquisition of Franklin Bank
("Franklin"), a one branch bank operating in Nutley, Essex County, New Jersey.
At September 30, 2005 Franklin had approximately, $87.5 million in total assets,
$76.3 million in total loans and $75.4 million in deposits.
Under the terms of the agreement, the total consideration to be received by
Franklin shareholders in the merger is fixed at 1,323,575 shares of the common
stock of the Company. Based upon Interchange's average closing stock price three
days prior to and after the date of announcement of the acquisition which
occurred on June 23, 2005 of $17.94; the transaction represents total
consideration of approximately $24.9 million, including approximately $1.2
million for the cash payment for option holders. Under the definitive agreement,
each Franklin shareholder received 1.2264 Company shares for each Franklin share
held immediately prior to the merger.
The acquisition will be accounted for as a purchase and the cost in excess
of the net assets acquired will be allocated first to net identified intangibles
and then to goodwill.
The Company's acquisition of Franklin is intended to further enhance
Interchange's presence in northern New Jersey. As a result of the acquisiton,
the Bank will now operate 30 banking offices and will have approximately $1.6
billion in assets. The acquisition of Franklin was accomplished through a merger
of Franklin with and into the Bank, a wholly-owned subsidiary of Interchange.
During October the Board authorized the accelerated vesting of 564,528
stock options, representing all unvested stock options on such date. The number
of shares and exercise prices of the options subject to the acceleration are
unchanged. The remaining terms for each of the options granted remain the same.
On October 27, 2005, the Board of Directors of the Bank, adopted a
resolution to "freeze" all future benefit accruals under the Pension Plan,
effective December 31, 2005. The purpose of the "freeze" was to afford
flexibility in the retirement benefits that the Company provides while
preserving all retirement plan participants' earned and vested benefits and
managing the increasing costs associated with the retirement plan. The Company
anticipates recognizing a one-time gain of approximately $1 million in
connection with the freezing of the retirement plan primarily based upon the
difference between the projected benefit obligation and the accumulated benefit
obligation. In 2006 it is anticipated that the freezing of the benefit accruals
will result in annual service cost savings of approximately $500 thousand.
The Board also authorized the "freeze" of all future benefit accruals,
Directors' Plan and the defined benefit portion of the Supplemental Plan. The
anticipated annual service cost savings of freezing both plans is approximately
$100 thousand.
-17-
In addition, the Board approved amending the Interchange Bank Capital
Investment Plan, a 401(k) plan available to all employees who are age 21 or
older. The amendment to the 401(k) plan will increase the fixed contribution to
employees to 2% from 1%. The fixed contribution is made in the form of shares of
Company stock based upon an employee's base salary. In 2006 it is anticipated
that the annual cost of the increase in the fixed contribution will be
approximately $140 thousand. The estimated savings for the freezing of the plans
and cost for the increase in fixed contributions is only an estimate and is
subject to change based upon a number of factors including but not limited to
the number of employees, base salaries and actuarial assumptions.
-18-
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
nine month periods ended September 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
-19-
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.
On October 13, 2005 the Company completed its acquisition of Franklin Bank
("Franklin"), a one branch bank operating in Nutley, Essex County, New Jersey.
At September 30, 2005 Franklin had approximately, $87.5 million in total assets,
$76.3 million in total loans and $75.4 million in deposits.
Under the terms of the agreement, the total consideration to be received by
Franklin shareholders in the merger is fixed at 1,323,575 shares of the common
stock of the Company. Based upon Interchange's average closing stock price three
days prior to and after the date of announcement of the acquisition which
occurred on June 23, 2005 of $17.94; the transaction represents total
consideration of approximately $24.9 million, including approximately $1.2
million for the cash payment for option holders. Under the definitive agreement,
each Franklin shareholder received 1.2264 Company shares for each Franklin
share held immediately prior to the merger.
The acquisition will be accounted for as a purchase and the cost in excess
of the net assets acquired will be allocated first to net identified intangibles
and then to goodwill.
The Company's acquisition of Franklin is intended to further enhance
Interchange's presence in northern New Jersey. As a result of the acquisiton,
the Bank will now operate 30 banking offices and will
-20-
have approximately $1.6 billion in assets. The acquisition of Franklin was
accomplished through a merger of Franklin with and into the Bank, a wholly-owned
subsidiary of Interchange.
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 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 $10.2 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.
-21-
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. Any 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 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).
-22-
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.
-23-
THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
RESULTS OF OPERATIONS
Summary
For the third quarter of 2005, the Company reported earnings per diluted
common share of $0.24, as compared to $0.24 for the same period in 2004. Net
income for the three months ended September 30, 2005 was approximately $4.7
million. The earnings were primarily affected by an increase in net interest
income of 1.9% being offset by a decline in service charges on deposits and
gains on sales of securities.
The Company's return on average assets decreased to 1.22% as compared to
1.31% for the three months ended September 30, 2005 and 2004, respectively. In
addition, the Company's return on average stockholders' equity decreased to
11.98% for the third quarter 2005 versus 12.90% for the third 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 September 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 $354 thousand, or
2.6%, to $14.0 million for the quarter ended September 30, 2005 as compared to
the same quarter in 2004. The tax equivalent basis adjustments for the quarters
ended September 30, 2005 and 2004 were $287 thousand and $177 thousand,
respectively. The increase in net interest income was due mostly to an 8.3%
growth in interest earning assets. This interest earning asset growth was funded
primarily by deposit liabilities, which grew $51.3 million, or 4.2% on average,
for the third quarter of 2005 as compared to the same quarter in 2004. The
margin for the third quarter of 2005 was 4.02%, a decrease of 22 basis points as
compared to the same quarter in 2004.
Interest income, on a tax-equivalent basis, totaled $20.3 million for the
third quarter of 2005, an increase of $3.3 million, or 19.3%, 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 $123.5
million, while investments declined by $10.0 million.
-24-
Interest expense totaled $6.4 million for the third quarter of 2005, an
increase of $2.9 million, as compared to the same period in 2004. The increase
in interest expense was a result of the increase in short-term market interest
rates during the second half of 2004 and throughout 2005. The increase in
short-term interest rates increased the average rate paid on interest bearing
deposit liabilities by 82 basis points to 2.09% for the quarter ended September
30, 2005 as compared to the same period in 2004. Interest bearing deposits grew
on average $40.3 million, or 4.2%, for the third 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 2035.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ---------------------------------------------------------------------------------------------------------------------------------
for the quarter ended September 30,
(dollars in thousands)
(unaudited) 2005 2004
---------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------------- --------- ------- ------------ --------- ---------
Assets
Interest earning assets:
Loans (1) $1,026,631 $17,120 6.67 % $903,113 $13,913 6.16 %
Taxable securities (4) 299,663 2,401 3.20 346,836 2,663 3.07
Tax-exempt securities (2) (4) 64,078 809 5.05 26,930 444 6.59
Interest earning deposits 4 - - 12 - -
Federal funds sold 1,964 17 3.46 8,899 33 1.48
-------------- --------- ------- ------------ --------- ---------
Total interest-earning assets 1,392,340 20,347 5.85 1,285,790 17,053 5.31
--------- ---------
Non-interest earning assets:
Cash and due from banks 36,446 36,837
Allowance for loan and lease losses (10,113) (9,981)
Other assets 116,003 114,422
-------------- ------------
Total assets $1,534,676 $1,427,068
============== ============
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $1,009,488 5,265 2.09 $969,217 3,085 1.27
Borrowings and subordinated debentures 111,292 1,091 3.92 61,043 331 2.17
-------------- --------- ------- ------------ --------- ---------
Total interest-bearing liabilities 1,120,780 6,356 2.27 1,030,260 3,416 1.33
--------- ---------
Non-interest bearing liabilities
Demand deposits 246,923 235,869
Other liabilities 10,867 16,427
-------------- ------------
Total liabilities (3) 1,378,570 1,282,556
Stockholders' equity 156,106 144,512
-------------- ------------
Total liabilities and stockholders' equity $1,534,676 $1,427,068
============== ============
Net interest income (tax-equivalent basis) 13,991 3.58 13,637 3.98
Tax-equivalent basis adjustment (287) (177)
--------- ---------
Net interest income $13,704 $13,460
========= =========
Net interest income as a percent of interest-earning assets
(tax-equivalent basis) 4.02 % 4.24 %
- -----------------------------------------------------------------------------------------------------------------------------------
(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 ALLL to a level that management considers
adequate to reflect the risk of estimated
-25-
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 third quarter of 2005 and
2004, the Company's provision for loan and lease losses was $300 thousand.
Non-interest Income
For the quarter ended September 30, 2005, non-interest income totaled $2.7
million, a decrease of $200 thousand, or 7.0%, as compared to the same period in
2004. The change was largely due to a decline in "other" non-interest income,
service fees on deposit accounts and net gains on sale of securities of $244
thousand, $91 thousand and $86 thousand, respectively. This was partly offset by
growth in gain on sale of loans and leases of $225 thousand. The increase in
gain on sale of loans was due in most part to an increase in sales of Small
Business Administration originated loans.
Non-interest Expense
For the quarter ended September 30, 2005, non-interest expense was $9.2
million, a slight decrease of $20 thousand, as compared to the same period in
2004. This decrease was due to a decline in "other" non-interest expense and
advertising and promotion of $162 thousand and $104 thousand, respectively,
offset by an increase in Salaries and benefits and occupancy expense of $207
thousand and $57 thousand, respectively.
Income Taxes
Income tax expense as a percentage of pre-tax income was 31.6% for the
three months ended September 30, 2005 as compared to 31.2% for the same period
of 2004.
-26-
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND SEPTEMBER 30, 2004
RESULTS OF OPERATIONS
Summary
Net income for the nine months ended September 30, 2005 was approximately
$13.6 million, an increase of $609 thousand, or 4.7%, over the same period last
year. The increase in earnings resulted from an increase primarily in the
average balance of loans outstanding of $136.6 million. The improvement in
earnings was partly offset by an 11 basis point decline in the net interest
margin and a $588 thousand decrease in gains on sales of securities, or 60%, and
a 2.2%, or $599 thousand, increase in non-interest expense. For the first nine
months of 2005, the Company reported earnings per diluted common share of $0.69
as compared to $0.67 for the same period in 2004.
For the nine months ended September 30, 2005 and 2004, the Company's Return
on Average Assets ("ROA") was 1.21% and 1.24%, respectively. Return on Average
Equity ("ROE") for the nine months ended September 30, 2005 was 11.84% a
decrease from 12.04% when compared to the same period last year.
Net Interest Income
Net interest income on a tax-equivalent basis increased $2.0 million, or
5.1%, to $41.5 million for the nine months ended September 30, 2005 as compared
to the same period in 2004. The tax equivalent basis adjustments for the nine
months ended September 30, 2005 and 2004 were $706 thousand and $499 thousand,
respectively. The increase in net interest income was due mostly to an 8.2%
growth in interest earning assets. This interest earning asset growth was funded
primarily by deposit liabilities, which grew 5.4% on average for the first nine
months of 2005 as compared to the same period in 2004. The aforementioned
improvement in net interest income was partly offset by an 11 basis point
decline in the net interest margin for the nine months ended September 30, 2005
as compared to the same period in 2004. The margin was primarily affected by a
62 basis point increase in the cost of interest bearing deposits and borrowings.
Interest income, on a tax-equivalent basis, totaled $57.6 million for the
nine months ended September 30, 2005, an increase of $8.6 million, or 17.5%, as
compared to the same period in 2004. The increase was mostly attributed to a
$102.8 million, or 8.2%, growth in interest earning assets. The growth in
interest earning assets was the result of increases in average loans of $136.6
million, while investments declined by $26.4 million.
Interest expense, which totaled $16.2 million for the nine months ended
September 30, 2005, increased $6.5 million, or 68.1%, as compared to the same
period in 2004. The increase in interest expense was primarily a result of the
increase in short-term market interest rates, during the second half of 2004 and
throughout 2005. The increase in short-term interest rates increased the average
rate paid on interest bearing liabilities by 62 basis points to 1.84% for the
nine months ended September 30, 2005 as compared to the same period in 2004.
Interest bearing deposits grew on average $51.1 million,
-27-
or 5.4%, for the third 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 $32.6 million in average borrowings during the first
nine months 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 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 2035.
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ----------------------------------------------------------------------------------------------------------------------------------
for the nine months ended September 30,
(dollars in thousands)
(unaudited) 2005 2004
---------------------------------- -------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ----------- -------- ----------- ---------- --------
Assets
Interest earning assets
Loans (1) $988,490 $47,982 6.47 % $851,936 $39,821 6.23 %
Taxable securities (4) 319,940 7,660 3.19 371,774 7,915 2.84
Tax-exempt securities (2) (4) 50,413 1,963 5.19 24,964 1,238 6.61
Interest earning deposits 3 - - 10 - -
Federal funds sold 714 18 3.36 8,088 70 1.15
------------ ----------- -------- ----------- ---------- --------
Total interest-earning assets 1,359,560 57,623 5.65 1,256,772 49,044 5.20
----------- ----------
Non-interest earning assets
Cash and due from banks 36,145 36,239
Allowance for loan and lease losses (9,994) (9,812)
Other assets 115,561 117,245
------------ -----------
Total assets $1,501,272 $1,400,444
============ ===========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $1,001,073 13,782 1.84 $949,929 8,672 1.22
Borrowings and subordinated debentures 93,071 2,382 3.41 60,426 943 2.08
------------ ----------- -------- ----------- ---------- --------
Total interest-bearing liabilities 1,094,144 16,164 1.97 $1,010,355 9,615 1.27
----------- ----------
Non-interest bearing liabilities
Demand deposits 243,574 230,919
Other liabilities 10,253 15,194
------------ -----------
Total liabilities (3) 1,347,971 1,256,468
Stockholders' equity 153,301 143,976
------------ -----------
Total liabilities and stockholders' equity $1,501,272 $1,400,444
============ ===========
Net interest income (tax-equivalent basis) 41,459 3.68 39,429 3.93
Tax-equivalent basis adjustment (706) (499)
---------- ---------
Net interest income $40,753 38,930
=========== ==========
Net interest income as a percent of interest-earning assets
(tax-equivalent basis) 4.07 % 4.18 %
- -----------------------------------------------------------------------------------------------------------------------------------
(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 nine months of 2005 and 2004, the
Company's provision for loan and lease losses was $700 thousand and $975
thousand, respectively.
-28-
Non-interest Income
Non-interest income totaled $7.3 million for the nine months ended
September 30, 2005, a decrease of $737 thousand, or 9.1%, as compared to the
same period in 2004. The decline in non-interest income 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 $588 thousand, $444
thousand and $167 thousand, respectively. The decline in non-interest income was
partly offset by an increase in net gain on sale of loans and leases of $471
thousand.
Non-interest Expense
For the nine months ended September 30, 2005, non-interest expense was
$27.6 million, an increase of $599 thousand, or 2.2%, when compared to the same
period in 2004. Contributing to the increase was an increase in salaries and
benefits, and occupancy expenses of $604 thousand and $211 thousand,
respectively, offset somewhat by a decrease of $149 thousand in advertising and
promotion, as compared to the same period in 2004. The Company continually
evaluates its process and workflow in determining its allocation of resources.
As technological advances occur or customer trends change the Company will
realign its staffing needs in seeking to maximize productivity. As such, the
Company has eliminated or curtailed certain positions in October which should
produce estimated annual cost savings of $400 thousand; however the cost savings
realized will likely be somewhat offset by an increase in personnel in other
revenue producing areas such as lending or new branch personnel.
Income Taxes
Income tax expense as a percentage of pre-tax income was 31.3% for the nine
months ended September 30, 2005 as compared to 31.8% for the same period of
2004. The decline in income tax expense was partly a result of an increase in
income for securities exempt from federal income taxes.
-29-
FINANCIAL CONDITION
Cash and Cash Equivalents
At September 30, 2005, cash and cash equivalents was $34.6 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 September
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 September 30,
2005 and 2004, approximately $32.4 million and $9.9 million, respectively, 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 September 30, 2005, investment securities totaled $357.6
million and represented 23.0% 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 September 30, 2005 as compared to 96.3% at
December 31, 2004. At September 30, 2005, the Company had a net unrealized loss
of $3.1 million as compared to a net unrealized loss of $296 thousand at
December 31, 2004. The decrease in value was attributed to an increase in market
interest rates during that period. The average life of securities with
unrealized losses is approximately one year.
Proceeds from the sale of securities AFS amounted to $89.9 million and
$63.6 million for the nine months ended September 30, 2005 and 2004, which
resulted in gross realized gains of $747 thousand and $1.1 million for those
periods, respectively. Gross realized losses from the sale of securities AFS
amounted to $361 thousand and $94 thousand for the nine months ended September
30, 2005 and 2004, respectively. Proceeds from the sale of securities HTM
amounted to $270 thousand for the nine months ended September 30, 2005, which
resulted in realized gains of $8 thousand. The securities had
-30-
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 nine months ended September 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 September 30, 2005, an increase of
$115.2 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 $55.4 million, $27.1 million, and $39.4
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 September 30, 2005 amounted to $6.1 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 0.58% at
September 30, 2005 from 0.99% at December 31, 2004.
The following table lists nonaccrual loans and foreclosed real estate and
other repossessed assets at September 30, 2005, and December 31, 2004: (in
thousands)
------------ ------------
September 30, December 31,
2005 2004
------------ ------------
(unaudited)
Nonaccrual loans $ 5,917 $ 9,133
Foreclosed and other repossessed assets 156 156
------------ ------------
Total nonperforming assets $ 6,073 $ 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 nine months ended
September 30, 2005, the ALLL increased $362 thousand to $10.2 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 $10.2 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
-31-
estimates including such factors as potential loss factors, changes in trend of
non-performing loans, current state of local and national economy, value of
collateral changes in the composition and volume of the loan portfolio, review
of specific problem loans and management's assessment of the inherent risk and
overall quality of the loan portfolio. All of these factors may be susceptible
to significant change. Also, the allocation of the allowance for credit losses
to specific loan pools is based on historical loss trends and management's
judgment concerning those trends.
The 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 nine months ended September 30, 2005 and 2004: (dollars in
thousands) (unaudited)
<Table>
<Caption>
------------------------- -----------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- -----------------------
2005 2004 2005 2004
------------- ---------- ----------- ----------
Average loans outstanding $1,026,631 $903,113 $988,490 $851,936
============= ========== =========== ==========
Allowance at beginning of period $9,945 $9,788 $9,797 $9,641
------------- ---------- ----------- ----------
Loans charged-off:
Real estate - 202 - 278
Commercial and financial 68 30 157 87
Commercial lease financing 31 67 264 478
Consumer loans 5 8 18 52
------------- ---------- ----------- ----------
Total 104 307 439 895
------------- ---------- ----------- ----------
Recoveries of loans previously charged-off:
Real estate - 15 72 19
Commercial and financial 12 - 12 6
Commercial lease financing - - - 48
Consumer loans 6 1 17 3
------------- ---------- ----------- ----------
Total 18 16 101 76
------------- ---------- ----------- ----------
Provision for loan and lease losses 300 300 700 975
------------- ---------- ----------- ----------
Allowance at end of period $10,159 $9,797 $10,159 $9,797
============= ========== =========== ==========
Allowance to loans (end of period) 0.97 % 1.06 % 0.97 % 1.06 %
Ratio of net charge-offs to average loans
(annualized) 0.03 % 0.13 % 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 September 30, 2005 total deposits grew $20.0 million, or 2.1%
annualized, to $1.27 billion from December 31, 2004 and experienced a favorable
shift in deposit mix. The increase was largely in other interest bearing demand
deposits, which increased $37.1 million, or 5.5%, to $710.8 million at September
30, 2005 from December 31, 2004. Non-interest bearing demand deposits also
experienced an increase
-32-
of $4.8 million to $239.8 million. The aforementioned increase was offset by a
decline in time deposits of $21.9 million.
At September 30, 2005, non-interest bearing deposits amounted to $239.8
million, which equates to 18.9% of total deposits reported at September 30,
2005. Other interest-bearing deposits amounted to $710.8 million at September
30, 2005 and increased to 56.2% of total deposits compared to 54.1% of total
deposits at December 31, 2004. Time deposits amounted to $315.5 million, or
24.9%, of total deposits at September 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)
September 30, December 31,
2005 2004
--------------- ------------
(unaudited)
Non-interest bearing demand $ 239,796 $ 235,036
Interest bearing demand 480,063 472,807
Money market 121,990 87,595
Savings 108,785 113,352
Time deposits < $100,000 279,790 286,471
Time deposits > $100,000 35,704 50,877
--------------- ------------
$ 1,266,128 $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.
The trust preferred securities were issued as part of our overall capital
management plan and in support of our continued loan growth.
-33-
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 nine 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 September 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 4.9%. At September 30, 2005, the
-34-
Company was 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
---------------------------------------------------
September 30, September 30,
2005 2004
-------------------- -----------------
+200 basis points -4.9 % -5.3 %
+100 basis points -2.1 -2.5
- -100 basis points 1.1 -2.0
- -200 basis points 0.0 *
* 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
in effect are designed to make regulatory capital requirements more sensitive to
differences in risk profiles
-35-
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 September 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 September 30, 2005, the
minimum leverage ratio requirement to be considered adequately capitalized was
3%.
The capital levels of the Company and the Bank at September 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.
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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 September 30, 2005 (unaudited):
Total Capital (to Risk Weighted Assets):
The Company $131,730 11.93 % $88,335 8.00 % N/A N/A
The Bank 131,220 11.88 % 88,360 8.00 % $110,450 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 121,551 11.01 % $44,168 4.00 % N/A N/A
The Bank 121,041 10.96 % 44,180 4.00 % 66,270 6.00 %
Tier 1 Capital (to Average Assets):
The Company 121,551 8.21 % 44,404 3.00 % N/A N/A
The Bank 121,041 8.18 % 44,406 3.00 % 74,010 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
September 30, 2005, the total of such assets amounted to $34.6 million, or 2.2%,
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 September 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 September 30, 2005, short-term borrowings from the FHLB
and REPOS amounted to $58.0 million and $4.4 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 September 30, 2005 amounted to $357.6 million, a decrease of
$31.2 million, from $388.7 million at December 31, 2004. At September 30, 2005
securities AFS amounted to $323.4 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
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window. The Bank also has a $101.8 million line of credit available through its
membership in the FHLB of which $40.6 million was utilized at September 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. At September 30, 2005 outstanding commitments to
fund loans totaled $268.1 million and outstanding standby letters of credit
totaled $3.8 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 September 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
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
-38-
The Company maintains internal control over financial reporting. During the
quarter ended September 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.
-39-
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
Set forth below is certain information regarding repurchases of our
common stock during the quarter.
Total Number Average
of Shares Price Paid
Period Purchased per Share
--------------- ---------------- -------------
7/1/05-7/31/05 1,923 $ 18.95
================ =============
The shares were owned and tendered by employees to the Company as
payment for option exercises in accordance with the Outside Director
Incentive Compensation Plan and the Stock Option and Incentive Plan of
1997, as amended.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
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: November 9, 2005
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