UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
---------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
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 (IRS Employer
incorporation) Identification No.)
Park 80 West/Plaza Two, Saddle Brook, NJ 07663
---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (201) 703-2265
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 reports), 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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (check
one):
|_| Large Accelerated Filer |X| Accelerated Filer |_| Non-accelerated Filer
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 July 31, 2006, was 20,442,499.
INTERCHANGE FINANCIAL SERVICES CORPORATION
INDEX
PART I FINANCIAL INFORMATION
Page No.
Item 1 Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2006 and December 31, 2005................................1
Unaudited Condensed Consolidated Statements of Income for the
three and six months ended June 30, 2006 and 2005..................2
Unaudited Condensed Consolidated Statements of Changes in
Stockholders' Equity for the six months ended
June 30, 2006 and 2005.............................................3
Unaudited Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2006 and 2005........................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...........................................39
PART II OTHER INFORMATION
Item 1 Legal Proceedings.................................................40
Item 1A Risk Factors......................................................40
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds.......41
Item 3 Defaults upon Senior Securities...................................41
Item 4 Submission of Matters to a Vote of Security Holders...............41
Item 5 Other Information.................................................41
Item 6 Exhibits..........................................................41
Signatures........................................................42
PART I - FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
<Table>
<Caption>
Interchange Financial Services Corporation
- ----------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------
(dollars in thousands, except share data)
(unaudited) June 30, December 31,
2006 2005
----------- -----------
Assets
Cash and due from banks $ 39,636 $ 42,620
Interest bearing demand deposits 3 4
----------- -----------
Total cash and cash equivalents 39,639 42,624
----------- -----------
Securities held-to-maturity at amortized cost (estimated fair
value of $30,845 and $36,199 for June 30, 2006 and December
31, 2005, respectively) 31,208 35,714
----------- -----------
Securities available-for-sale at estimated fair value
(amortized cost of $329,552 and $324,548 for June 30, 2006
and December 31, 2005, respectively) 323,279 320,752
----------- -----------
Loans held-for-sale 3,070 1,487
----------- -----------
Loans and leases (net of unearned income and deferred fees of
$6,405 and $6,786 for June 30, 2006 and December 31, 2005,
respectively) 1,134,217 1,104,482
Less: Allowance for loan and lease losses 10,649 10,646
----------- -----------
Net loans and leases 1,123,568 1,093,836
----------- -----------
Bank owned life insurance 27,492 26,941
Premises and equipment, net 17,018 17,509
Foreclosed assets and other repossessed assets 112 122
Goodwill 68,922 68,910
Intangible assets 5,089 5,469
Accrued interest receivable and other assets 19,925 18,022
----------- -----------
Total assets $ 1,659,322 $ 1,631,386
=========== ===========
Liabilities
Deposits
Non-interest bearing $ 246,482 $ 260,151
Interest bearing 993,733 999,957
----------- -----------
Total deposits 1,240,215 1,260,108
----------- -----------
Securities sold under agreements to repurchase 6,088 3,939
Short-term borrowings 97,792 46,150
Long-term borrowings 100,330 110,333
Subordinated debentures 20,620 20,620
Accrued interest payable and other liabilities 10,320 11,234
----------- -----------
Total liabilities 1,475,365 1,452,384
----------- -----------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, without par value; 33,750,000 shares authorized;
20,406,124 and 20,138,668 shares issued and outstanding
for June 30, 2006 and December 31, 2005, respectively. 5,397 5,397
Capital surplus 97,075 97,238
Retained earnings 103,792 99,222
Accumulated other comprehensive loss, net of taxes of $2,423 and
$1,497 for June, 2006 and December 31, 2005, respectively. (3,860) (2,310)
----------- -----------
202,404 199,547
Less: Treasury stock 18,447 20,545
----------- -----------
Total stockholders' equity 183,957 179,002
----------- -----------
Total liabilities and stockholders' equity $ 1,659,322 $ 1,631,386
=========== ===========
- ----------------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
</Table>
1
<Table>
<Caption>
Interchange Financial Services Corporation
- ------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
(unaudited) Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2006 2005 2006 2005
--------- ------------ ---------- -----------
Interest income
Interest on loans and leases $ 19,614 $ 15,853 $ 38,440 $ 30,810
Interest on federal funds sold - 1 - 1
Interest and dividends on securities
Taxable interest income 2,710 2,457 5,083 5,122
Interest income exempt from federal income taxes 639 464 1,326 787
Dividends 155 77 258 137
--------- ------------ ---------- -----------
Total interest income 23,118 18,852 45,107 36,857
--------- ------------ ---------- -----------
Interest expense
Interest on deposits 7,284 4,595 13,576 8,517
Interest on securities sold under agreements to repurchase 63 33 97 56
Interest on short-term borrowings 685 350 1,127 530
Interest on long-term borrowings and subordinated debentures 1,374 389 2,808 705
--------- ------------ ---------- -----------
Total interest expense 9,406 5,367 17,608 9,808
--------- ------------ ---------- -----------
Net interest income 13,712 13,485 27,499 27,049
Provision for loan and lease losses 125 225 300 400
--------- ------------ ---------- -----------
Net interest income after provision for loan and lease losses 13,587 13,260 27,199 26,649
--------- ------------ ---------- -----------
Non-interest income
Service fees on deposit accounts 1,008 889 1,900 1,772
Net gain on sale of securities 66 250 89 317
Net gain on sale of loans and leases 495 223 756 379
Bank owned life insurance 282 285 550 549
Commissions on sale of annuities and mutual funds 84 148 277 330
Other 847 681 1,894 1,323
--------- ------------ ---------- -----------
Total non-interest income 2,782 2,476 5,466 4,670
--------- ------------ ---------- -----------
Non-interest expense
Salaries and benefits 5,426 4,954 10,863 9,909
Occupancy 1,645 1,343 3,231 2,806
Furniture and equipment 350 316 722 631
Advertising and promotion 298 423 534 818
Amortization of intangible assets 187 126 380 252
Other 2,562 2,018 4,570 3,918
--------- ------------ ---------- -----------
Total non-interest expense 10,468 9,180 20,300 18,334
--------- ------------ ---------- -----------
Income before income taxes 5,901 6,556 12,365 12,985
Income taxes 1,797 2,041 3,732 4,050
--------- ------------ ---------- -----------
Net income $ 4,104 $ 4,515 $ 8,633 $ 8,935
========= ============ ========== ===========
Basic earnings per common share $0.20 $0.24 $0.43 $0.47
===== ===== ===== =====
Diluted earnings per common share $0.20 $0.23 $0.42 $0.46
===== ===== ===== =====
- -------------------------------------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
</Table>
2
<Table>
<Caption>
Interchange Financial Services Corporation
- -------------------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Six Months Ended June 30,
- -------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
(unaudited) Accumulated
Other
Comprehensive Retained Comprehensive Common Capital Treasury
Income Earnings Income(Loss) Stock Surplus Stock Total
------------- -------- ------------- ------- --------- --------- ---------
Balance at Jauary 1, 2005 $ 86,542 $ (633) $ 5,397 $ 73,320 $ (14,471) $ 150,155
Comprehensive income
Net Income $ 8,935 8,935 8,935
Other comprehensive losses, net of taxes
Less: unrealized losses on AFS debt
securities (808)
Less: net gains on disposition of
securities (119)
---------
Other comprehensive losses, net of taxes (927) (927) (927)
---------
Comprehensive income $ 8,008
=========
Dividends on common stock (3,445) (3,445)
Issued 18,772 shares of common stock in
connection with Executive Compensation Plan 174 162 336
Exercised 24,335 option shares 26 194 220
Purchased 4,532 shares of common stock (76) (76)
Payout of fractional shares resulting from the
three-for-two stock split declared
January 18, 2005 and paid on February
18, 2005 (7) (7)
--------- ----------- ------- --------- --------- ----------
Balance at June 30, 2005 92,025 (1,560) 5,397 73,520 (14,191) 155,191
Comprehensive income
Net Income $ 10,770 10,770 10,770
Other comprehensive losses, net of taxes
Less: unrealized losses on AFS debt
securities (623)
Less: net gains on disposition of
securities (117)
Minimum pension liability adjustment (10)
---------
Other comprehensive losses, net of taxes (750) (750) (750)
---------
Comprehensive income $ 10,020
=========
Dividends on common stock (3,568) (3,568)
Issued 1,323,181 shares of common stock in
connection with the acquisition of
Franklin Bank 23,738 23,738
Exercised 20,687 option shares (20) 189 169
Purchased 323,660 shares of common stock (5,827) (5,827)
Payout of fractional shares in connection with
the acquisition of Franklin Bank (5) (5)
Reacquired 39,228 shares in settlement of lawsuit (716) (716)
--------- ----------- ------- --------- --------- ----------
Balance at December 31, 2005 99,222 (2,310) 5,397 97,238 (20,545) 179,002
Comprehensive income
Net Income 8,633 8,633 8,633
Other comprehensive losses, net of taxes
Less: unrealized losses on AFS debt
securities (1,359)
Less: net gains on disposition of
securities (191)
---------
Other comprehensive losses, net of taxes (1,550) (1,550) (1,550)
---------
Comprehensive income $ 7,083
=========
Dividends on common stock (4,063) (4,063)
Unvested restricted stock (220) (220)
Amortization of deferred compensation of
restricted stock 205 205
Sale of 10,412 of discounted shares of stock 40 108 148
Exercised 190,535 option shares (274) 1,994 1,720
Tax benefit from exercise of 31,350
nonincentive option shares 86 86
Purchased 227 shares of common stock (4) (4)
--------- ----------- ------- --------- --------- ----------
Balance at June 30, 2006 $ 103,792 $ (3,860) $ 5,397 $ 97,075 $ (18,447) $ 183,957
========= =========== ======= ========= ========= ==========
- ------------------------------------------------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
</Table>
3
<Table>
<Caption>
INTERCHANGE FINANCIAL SERVICES CORPORATION
- ---------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30,
- --------------------------------------------------------------------------------------
(in thousands)
(unaudited)
2006 2005
---------- ----------
Cash flows from operating activities
Net income $ 8,633 $ 8,935
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 1,162 1,004
Amortization of securities premiums 1,417 2,080
Accretion of securities discounts (362) (126)
Amortization of loan premiums 37 46
Amortization of premiums in connection with acquisition 342 371
Provision for loan and lease losses 300 400
Increase in cash surrender value of Bank Owned Life Insurance (550) (548)
Net gain on sale of securities (89) (317)
Origination of loans held for sale (23,335) (7,582)
Sale of loans held for sale 22,493 7,056
Net gain on sale of loans and leases (756) (379)
Net gain on sale of fixed assets (3) -
Write off of foreclosed and repossessed assets 68 13
Decrease (increase) in operating assets
Accrued interest receivable 503 (247)
Deferred taxes (189) 1,221
Other Assets (1,447) (3,202)
Increase (decrease) in operating liabilities
Accrued interest payable 195 145
Other (1,109) 1,683
----------- ----------
Cash provided by operating activities 7,310 10,553
----------- ----------
Cash flows from investing activities
(Payments for) proceeds from
Net originations of loans and leases (30,814) (81,876)
Purchase of loans and leases - (4,678)
Sale of loans and leases 686 1,215
Purchase of securities available-for-sale (112,245) (49,538)
Maturities of securities available-for-sale 82,191 17,155
Sale of securities available-for-sale 24,176 77,127
Maturities of securities held-to-maturity 19,048 1,209
Sale of securities held-for-sale - 270
Purchase of securities held-to-maturity (14,634) (21,891)
Purchase of fixed assets (2,890) (503)
Premium in connection with acquisition 6
Sale of fixed assets 2,380 -
---------- ----------
Cash used in investing activities (32,096) (61,510)
---------- ----------
Cash flows from financing activities
Proceeds from (payments for)
Net change in deposits (19,859) 12,021
Securities sold under agreements to repurchase and other
borrowings 635,704 557,077
Retirement of securities sold under agreement to repurchase
and other borrowings (591,916) (532,945)
Issuance of long term subordinated debentures - 20,620
Dividends (4,063) (3,445)
Common stock issued 133 335
Payout of fractional shares resulting from 3-for-2 stock split - (7)
Exercise of nonincentive option shares 417 -
Tax benefit from exercise of nonincentive stock options 86 -
Treasury stock (4) (76)
Exercise of incentive option shares 1,303 220
---------- ----------
Cash provided by financing activities 21,801 53,800
---------- ----------
Increase in cash and cash equivalents (2,985) 2,843
Cash and cash equivalents, beginning of period 42,624 33,110
---------- ----------
Cash and cash equivalents, end of period $ 39,639 $ 35,953
========== ==========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 17,316 $ 9,497
Income taxes 5,180 5,144
Supplemental disclosure of non-cash investing and
financing activities:
Loans transferred to foreclosed real estate and
other repossessed assets 58 11
- --------------------------------------------------------------------------------------
See notes to unaudited condensed consolidated financial statements.
</Table>
4
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006
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 Securiti es and
Exchange Commission. The Company has two wholly owned trusts which are not
consolidated, see Note 13 "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 Amendment No. 1 to the annual
report on Form 10-K/A of the Company for the year ended December 31, 2005.
The condensed consolidated financial data for the six month periods ended
June 30, 2006 and 2005, 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 February 2006, the Financial Accounting
Standards Board ("FASB") issued statement No. 155, "Accounting for Certain
Hybrid Financial Instruments" ("SFAS No. 155"). Under current generally accepted
accounting principles an entity that holds a financial instrument with an
embedded derivative must bifurcate the financial instrument, resulting in the
host and the embedded derivative being accounted for separately. SFAS No. 155
permits, but does not require, entities to account for financial instruments
with an embedded derivative at fair value thus negating the need to bifurcate
the instrument between its host and
5
the embedded derivative. SFAS No. 155 is effective as of the beginning of the
first annual reporting period that begins after September 15, 2006. We expect
that SFAS No. 155 will not have a material effect on our consolidated financial
condition or results of operations.
In March 2006, the FASB issued statement No. 156, "Accounting for Servicing
of Financial Assets" ("SFAS No. 156"). SFAS No. 156 amends FASB Statement No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, to require that all separately recognized
servicing assets and servicing liabilities be initially measured at fair value,
if practicable. SFAS No. 156 permits, but does not require, the subsequent
measurement of separately recognized servicing assets and servicing liabilities
at fair value. An entity that uses derivative instruments to mitigate the risks
inherent in servicing assets and serving liabilities is required to account for
those derivative instruments at fair value. SFAS No. 156 is effective as of the
beginning of the first annual reporting period that begins after September 15,
2006. We expect that SFAS No. 156 will not have a material effect on our
financial condition or results of operations.
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income
Taxes--an interpretation of FASB Statement No. 109, Accounting for Income Taxes,
which clarifies the accounting for uncertainty in income taxes. FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. The Interpretation requires that the Company recognize in
the financial statements, the impact of a tax position, if that position is more
likely than not of being sustained on audit, based on the technical merits of
the position. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods and disclosure. The
provisions of FIN 48 are effective beginning January 1, 2007 with the cumulative
effect of the change in accounting principle recorded as an adjustment to
opening retained earnings. The Company is currently evaluating the impact of
adopting FIN 48 on the financial condition or results of operations.
Stock Based Compensation: The Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), Share-Based Payment ("SFAS No. 123(R)"), on
January 1, 2006 using the "modified prospective" method. Under this method,
awards that are granted, modified, or settled after December 31, 2005, are
measured and accounted for in accordance with SFAS No. 123(R). Also under this
method, expense is recognized for unvested awards that were granted prior to
January 1, 2006, based upon the fair value determined at the grant date under
SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). Prior to
the adoption of SFAS No. 23(R), the Company accounted for stock compensation
under the intrinsic value method permitted by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and
related interpretations. Accordingly, the Company previously recognized no
compensation cost for employee stock options that were granted with an exercise
price equal to the market value of the underlying common stock on the date of
grant.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123(R) in 2005 (in thousands) (unaudited).
6
------------------------------
For the three For the six
months ended months ended
June 30, June 30,
2005 2005
------------- ------------
Net Income
As reported $4,515 $8,935
Less: Total stock-based compensation
expense determined under the fair
value method for all rewards, net of
related tax effects 259 525
------------- ------------
Pro-forma $4,256 $8,410
============= ============
Earnings per share:
Basic:
As reported 0.24 0.47
Pro forma 0.22 0.44
Diluted:
As reported 0.23 0.46
Pro forma 0.22 0.43
On October 18, 2005, the Compensation Committee of the Board approved the
accelerated vesting of all then outstanding unvested options to purchase common
stock of the Company previously awarded to employees, officers and directors. No
options were granted during the six months ended June 30, 2006. As a result of
these actions, there was no option expense or unrecognized costs recorded during
the period.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model. The following weighted-average
assumptions were used for option grants issued during the six months ended June
30, 2005: dividend yield of 2.00%; expected volatility of 23.07%; risk-free
interest rate of 3.87%; and expected lives of approximately 7 years.
Director Stock Compensation Program
In 2000, the Company adopted a stock option plan, titled "Outside
Director's Incentive Compensation Plan" (the "Director's Stock Plan") that
covers those members of the Board of Directors of the Company who have not
served as a full-time employee of the Company or any of its subsidiaries during
the prior twelve-month period. Under this plan, options to purchase a maximum of
225,000 shares of Interchange common stock may be granted at fair market value
at the date of grant. Options to purchase 157,000 shares (net of forfeitures)
have been granted to date. Options granted expire if not exercised within ten
years of date of grant and are exercisable according to a vesting schedule,
starting one year from the date of grant. Only non-qualified stock options are
granted under the Director's Stock Plan. During 2005, the Board of Directors
froze the issuance of any future stock option grants from the plan.
7
Employee Stock Option Plan
The Company maintains two stock option and incentive plans: the Stock
Option and Incentive Plan of 1997, as amended, and the 2005 Omnibus Stock and
Incentive Plan (together "the Plans"), that covers certain key employees. The
Compensation Committee administers the Plans, reviews the awards and submits
recommendations to the full board of directors for action. Options granted
expire if not exercised within ten years of date of grant and are exercisable
according to a vesting schedule, starting one year from the date of grant.
Pursuant to the Plans, incentive stock options or non-qualified stock options
may be granted to employees. In addition, the 2005 Omnibus Stock and Incentive
Plan allows for other types of stock based awards to be issued including stock
appreciation rights. During 2005 the Board of Directors froze the issuance of
any future stock option grants from the Plans.
The following table presents the activity related to options under all
plans for the six months ended June 30, 2006 (in thousands) (unaudited).
Weighted-
Average
Exercise
Options Price
--------------- -------------
Outstanding at January 1 1,407,919 $ 12.41
Granted - -
Exercised (190,535) 9.03
Forfeited - -
--------------- -------------
Outstanding at June 30 1,217,384 $ 12.94
=============== ==============
All options are exercisable as of June 30, 2006. The weighted average remaining
life of options outstanding at June 30, 2006 was 6.5 years.
Restricted Stock
Restricted Stock provides grantees with rights to shares of common stock
upon completion of achievement of Company performance measures. During the
restriction period, all shares are considered outstanding and dividends are paid
on the Restricted Stock. The Restricted Stock vests over three years from date
of grant. The Company recognizes compensation expense, measured as the quoted
market price of the Restricted Stock on the grant date, on a straight-line basis
over the vesting period for service period vesting. Restricted Stock is
cancelled if an employee terminates prior to the vesting of the stock.
As of June 30, 2006, unrecognized compensation cost related to unvested
restricted stock totaled $1.2 million. The cost is expected to be recognized
over a weighted average period of 2.8 years. The total grant date
8
fair value of shares vested during the six months ended June 30, 2006 and 2005
was $263,000 and $253,000, respectively.
The following table presents the activity for restricted stock for the six
months ended June 30, 2006.
Weighted Average
Grant-Date Fair
Number of Shares Value (000)
----------------- -------------------
Unvested as of December 31, 2005 52,782 $ 680
Granted 72,448 1,231
Vested (24,694) (263)
Forfeited (554) (10)
----------------- -------------------
Unvested as of June 30, 2006 99,982 $ 1,638
================= ===================
2. Pending Merger
On April 13, 2006, the Company announced that it had entered into a
definitive agreement whereby TD Banknorth Inc. would acquire the Company for
approximately $480.6 million in an all cash transaction. The terms of the merger
agreement call for each outstanding share of the Company's common stock to be
converted into the right to receive $23.00 in cash per share. The transaction is
subject to approval by shareholders of the Company, as well as customary
regulatory approvals, and is expected to close in early 2007.
3. Acquisitions
On October 13, 2005 the Company completed its acquisition of Franklin Bank
("Franklin"), a one branch bank operating in Nutley, Essex County, New Jersey.
The Company's acquisition of Franklin is intended to further enhance
Interchange's presence in northern New Jersey. At October 13, 2005 Franklin had
approximately, $87.0 million in total assets, $77.2 million in net loans and
$76.0 million in deposits. Under the terms of the agreement, the total
consideration received by Franklin shareholders in the merger is fixed at
1,323,575 shares of the common stock of the Company. Based upon the Company'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 was accounted for as a purchase and the cost in excess of
the fair value of net assets acquired was allocated first to net identified
intangibles and then to goodwill. The goodwill is not tax deductible. The six
months results of operations ending June 30, 2006 also include those of the
acquired bank for the same period.
9
4. 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 restricted stock, and are
determined using the treasury stock method. At June 30, 2006 and 2005, the
weighted average diluted shares outstanding for the six months were
approximately 20.8 million and 19.6 million, respectively.
The following table shows the computation of earnings per shares: (dollars
in thousands, except per share amounts) (unaudited)
<Table>
<Caption>
---------------------------------------------- ------------------------------------------------
Three Months Ended, Six Months Ended,
---------------------------------------------- ------------------------------------------------
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
----------------------- ---------------------- ----------------------- ------------------------
Weighted Per Weighted Per Weighted Per Weighted Per
Average Share Average Share Average Share Average Share
Income Shares Amount Income Shares Amount Income Shares Amount Income Shares Amount
------ -------- ------- ------ -------- ------ ------ -------- ------- ------ --------- -------
Basic Earnings per
Common Share
Income available to
common shareholders $4,104 20,271 $0.20 $4,515 19,153 $0.24 $8,633 20,251 $0.43 $8,935 19,143 $0.47
====== ====== ====== ======
Effect of Dilutive Shares
Options issued to
management 587 444 535 433
-------- -------- -------- --------
Diluted Earnings per
Common Share $4,104 20,858 $0.20 $4,515 19,597 $0.23 $8,633 20,786 $0.42 $8,935 19,576 $0.46
====== ======== ====== ====== ======== ====== ====== ======== ====== ====== ======== ======
</Table>
5. Commitments and Contingent Liabilities
Legal Proceedings
The Company is a party to routine litigations involving various aspects of
its business, none of which, in the opinion of management, is expected to have a
material adverse impact on the condensed consolidated financial condition,
results of operations or liquidity of the Company.
Commitments to Extend Credit
At June 30, 2006, the Company had commitments to extend credit of
approximately $321.7 million, of which approximately $4.2 million represents
standby letters of credit.
6. 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
10
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)
---------------- ------------------
June 30, December 31,
2006 2005
---------------- ------------------
Intangible assets $ 6,975 $ 6,975
Accumulated amortization (1,886) (1,506)
---------------- ------------------
Net intangible assets $ 5,089 $ 5,469
================ ==================
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 month periods ended June 30, 2006 and 2005, the CDI amortized
were $187 thousand and $107 thousand, respectively. For each of the six month
periods ended June 30, 2006 and 2005, the CDI amortized were $373 thousand and
$214 thousand, respectively. The CDI is periodically reviewed for impairment.
At June 30, 2006 the scheduled amortization of the intangible assets is as
follows (in thousands) (unaudited):
2006 for remaining period $ 373
2007 747
2008 747
2009 747
2010 747
Thereafter 1,728
-----------------
Total $ 5,089
=================
7. 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.
11
8. Cash Dividend
On July 18, 2006, the Company declared a cash dividend of $0.10 per share
payable on August 8, 2006, to holders of record as of July 31, 2006.
9. Securities Held-to-Maturity and Securities Available-for-Sale
Securities held-to-maturity ("HTM") and securities available-for-sale
("AFS") consist of the following: (in thousands) (unaudited)
<Table>
<Caption>
------------------------------------------------------------
June 30, 2006
------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- ---------- ---------- -------------
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 1,223 $ 2 $ 1 $ 1,224
Obligations of states & political subdivisions 29,985 213 577 29,621
---------------- ---------- ---------- -------------
$ 31,208 $ 215 $ 578 $ 30,845
================ ========== ========== =============
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 160,068 $ 36 $ 3,871 $ 156,233
Other debt 124,380 - 2,070 122,310
Obligations of states & political subdivisions 31,727 29 397 31,359
Equity securities 13,377 - - 13,377
--------------- ---------- ---------- -------------
329,552 65 6,338 323,279
---------------- ---------- ---------- -------------
Total securities $ 360,760 $ 280 $ 6,916 $ 354,124
================ ========== ========== =============
------------------------------------------------------------
December 31, 2005
------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- ---------- ---------- -------------
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 2,823 $ 15 $ 2 $ 2,836
Other debt 1,920 - - 1,920
Obligations of states & political subdivisions 30,971 481 9 31,443
---------------- ---------- ---------- -------------
$ 35,714 $ 496 $ 11 $ 36,199
================ ========== ========== =============
Securities available-for-sale
Government-Sponsored Enterprises:
Mortgage-backed securities $ 110,408 $ 79 $ 1,709 $ 108,778
Other debt 166,510 6 2,540 163,976
Obligations of states & political subdivisions 36,823 428 60 37,191
Equity securities 10,807 - - 10,807
---------------- ---------- ---------- -------------
324,548 513 4,309 320,752
---------------- ---------- ---------- -------------
Total securities $ 360,262 $ 1,009 $ 4,320 $ 356,951
================ ========== ========== =============
</Table>
12
At June 30, 2006, the contractual maturities of securities HTM and
securities AFS are as follows: (in thousands) (unaudited)
Securities Securities
Held-to-Maturity Available-for-Sale
----------------------- --------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ---------- --------- ---------
Within 1 year $ 3,698 $ 3,704 $ 108,525 $ 107,616
After 1 but within 5 years 5,066 5,160 180,852 176,076
After 5 but within 10 years 16,163 15,901 20,852 20,348
After 10 years 6,281 6,080 5,946 5,862
Equity securities - - 13,377 13,377
----------- ---------- --------- ---------
$ 31,208l $ 30,845 $ 329,552 $ 323,279
=========== ========== ========= =========
Proceeds from the sale of securities AFS amounted to $24.2 million and
$77.1 million for the six months ended June 30, 2006 and 2005, respectively,
which resulted in gross realized gains of $135 thousand and $670 thousand for
those periods, respectively. Gross realized losses from the sale of securities
AFS amounted to $46 thousand and $361 thousand for the six months ended June 30,
2006 and 2005, respectively. Proceeds from the sale of securities HTM amounted
to $270 thousand for the six months ended June 30, 2005, which resulted in
realized gains of $8 thousand. The HTM securities had significantly paid down to
less than 85% of the original purchased balance through normal principal
amortization and prepayments. These amounts are included in net gain on sale of
securities in the unaudited condensed consolidated statements of income.
The investment portfolio is evaluated at least quarterly to determine if
there are any securities with losses that are other-than-temporary. As of June
30, 2006, the Company has concluded that the unrealized losses are temporary in
nature since they are primarily related to market interest rates and are not
related to the underlying credit quality of the issuers of our investment
portfolio. None of the investments are believed to be other-than-temporarily
impaired. The Company has the ability and intent to hold the securities until
maturity to recover the entire value.
The following table summarizes all securities that have an unrealized loss
and the duration of the unrealized loss at June 30, 2006: (in thousands)
(unaudited)
13
<Table>
<Caption>
------------------- ------------------- -------------------
12 months or less 12 months or longer Totals
------------------- ------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------- ------------------- -------------------
Securities AFS
Government-Sponsored Enterprises:
Mortgage-backed securities $ 83,366 $1,672 $ 71,318 $2,199 $154,684 $3,871
Obligations of U.S. agencies 12,874 127 105,838 1,943 118,712 2,070
Obligations of states & political
subdivisions 15,292 344 1,226 53 16,518 397
------------------- ------------------- -------------------
$111,532 $2,143 $178,382 $4,195 $289,914 $6,338
=================== =================== ===================
Securities HTM
Government-Sponsored Enterprises:
Mortgage-backed securities $ 169 $ 1 $59 - $ 228 $ 1
Obligations of states & political
subdivisions 18,821 577 - - 18,821 577
------------------- ------------------- -------------------
$18,990 $578 $59 - $19,049 $578
=================== =================== ===================
</Table>
The following table summarizes all securities that have an unrealized loss
and the duration of the unrealized loss at December 31, 2005: (in thousands)
<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 $ 42,556 $ 561 $ 53,118 $ 1,148 $ 95,674 $ 1,709
Other debt 6,058 89 153,227 2,451 159,285 2,540
Obligations of states & political
subdivions 3,423 33 2,512 27 5,935 60
--------- -------------- --------- ---------- -------- -------------
$ 52,037 $ 683 $208,857 $ 3,626 $260,894 $ 4,309
========= ============== ========= ========== ======== =============
Securities held-to-maturity
Government-Sponsored Enterprises:
Mortgage-backed securities $ 273 $ 2 $ 24 $ - $ 297 $ 2
Obligations of states & political
subdivions 2,577 9 - - 2,577 9
--------- -------------- --------- ---------- -------- -------------
$ 2,850 $ 11 $ 24 $ - $ 2,874 $ 11
========= ============== ========= ========== ======== =============
</Table>
Securities with carrying amounts of $123.2 million and $76.1 million at
June 30, 2006 and December 31, 2005, respectively, were pledged for public
deposits, Federal Home Loan Bank advances, securities sold under repurchase
agreements and other purposes required by law.
14
10. Loans
The composition of the loan portfolio is summarized as follows: (in
thousands) (unaudited)
-------------- ---------------
June 30, December 31,
2006 2005
-------------- ---------------
Real estate
Residential $ 284,458 $ 291,448
Commercial 491,879 479,120
Construction 122,531 92,390
Commercial
Commercial and financial 210,466 211,704
Lease financing 22,050 24,584
Consumer
Lease financing 20 94
Installment 2,813 5,142
-------------- ---------------
1,134,217 1,104,482
Allowance for loan and lease losses (10,649) (10,646)
-------------- ---------------
Net loans and leases $ 1,123,568 $ 1,093,836
============== ===============
Loans are net of unearned income and deferred fees of $6.4 million and $6.8
million at 30, 2006 and 31, 2005, respectively.
Nonperforming Loans
Nonperforming loans include loans that are accounted for on a nonaccrual
basis and troubled debt restructurings. Nonperforming loans are as follows: (in
thousands) (unaudited)
--------------- ---------------
June 30, December 31,
2006 2005
--------------- ---------------
Nonaccrual loans
Residential real estate $ 299 $ 822
Commercial real estate 176 363
Commercial and financial 1,487 997
Commercial lease financing 920 1,290
Consumer 90 86
--------------- ---------------
2,972 3,558
--------------- ---------------
Troubled debt restructurings 1,013 -
--------------- ---------------
Total nonperforming loans $ 3,985 $ 3,558
=============== ===============
15
11. Allowance for Loan and Lease Losses
The Company's recorded investment in impaired loans is as follows: (in
thousands) (unaudited)
<Table>
<Caption>
---------------------- ---------------------
June 30, December 31,
2006 2005
---------------------- --------------------
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 $ 1,012 $ 281 $ 997 $ 281
Commercial real estate 180 4 380 4
Residential real estate - - 594 88
Without a related allowance for loan losses
Commercial and financial 788 - - -
Commercial real estate 536 - - -
----------- ---------- ----------- ---------
$ 2,516 $ 285 $ 1,971 $ 373
=========== ========== =========== =========
</Table>
Changes in the allowance for loan and lease losses are summarized as
follows: (in thousands) (unaudited)
<Table>
<Caption>
--------------------- ---------------------
Three months ended Six months ended
June 30, June 30,
--------------------- ---------------------
2006 2005 2006 2005
---------- --------- ---------- ---------
Balance at beginning of period $ 10,559 $ 9,876 $ 10,646 $ 9,797
Additions (deductions)
Provision charged to operations 125 225 300 400
Recoveries on loans previously charged-off 57 5 61 83
Loans charged-off (92) (161) (358) (335)
---------- --------- ---------- ---------
Balance at end of period $ 10,649 $ 9,945 $ 10,649 $ 9,945
========== ========= ========== =========
</Table>
12. Other Non-interest Expense
Expenses included in other non-interest expense are as follows: (in
thousands) (unaudited)
------------------ ------------------
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2006 2005 2006 2005
-------- -------- ------- -------
Professional fees $ 403 $ 232 $ 765 $ 778
Legal fees 700 256 1,002 441
Directors' fees, travel and retirement 207 205 368 422
Data processing 288 264 549 529
All other 964 1,061 1,886 1,748
------- ------- ------- --------
Total $ 2,562 $ 2,018 $ 4,570 $ 3,918
======= ======= ======= ========
16
13. Long-term Borrowings
Long-term borrowings consist of the following Federal Home Loan Bank of New
York ("FHLB") advances: (in thousands) (unaudited)
June 30, 2006 December 31, 2005
Maturity ---------------------- ------------------------
Date Balance Rate Balance Rate
- ------------------------- ----------- -------- ------------ --------
January 2007 (a) (b) - - $ 10,000 4.22
January 2007 (b) - - 10,000 2.69
January 2010 (c) $ 15,000 3.66 15,000 3.66
October 2015 (d) 50,000 3.99 50,000 3.99
December 2015 (e) 25,000 3.94 25,000 3.94
February 2016 (f) 10,000 4.04 - -
----------- -------- ------------ --------
$ 100,000 3.93% $ 110,000 3.84%
=========== ======== ============ ========
(a) The FHLB has an option to call this advance on a quarterly basis if the
3-month LIBOR resets above 7.50%.
(b) Included in short-term borrowings as of March 31, 2006.
(c) The FHLB has an option to call this advance in January 2008.
(d) The FHLB has an option to call this advance quarterly after October 4, 2008.
(e) The FHLB has an option to call this advance quarterly after December 30,
2007.
(f) The FHLB has an option to call this advance quarterly after August 24, 2006.
Included in long-term borrowings is a capitalized lease of $330 thousand
and $333 thousand at June 30, 2006 and December 31, 2005, respectively.
14. 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 debentures after 5 years on any of the interest payment
dates. The final maturity date on the pool trust preferred securities and
debentures is 2035.
The Company does not meet the criteria as primary beneficiary for the
Trusts in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 46 (FIN 46) and FIN No. 46(R), "Consolidation of Variable
Interest Entities." As a result, these trusts are not consolidated. The Trusts
have no independent
17
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.
15. 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)
------------------- -------------------
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2006 2005 2006 2005
-------- -------- -------- --------
Service cost - $ 198 - $ 396
Interest cost $ 86 102 $ 172 204
Expected return on plan assets (65) (56) (130) (112)
Amortization of prior service cost - 1 - 2
Amortization of net (gain) loss - 1 (1) 2
-------- -------- -------- --------
Net periodic benefit cost $ 21 $ 246 $ 41 $ 492
======== ======== ======== ========
During 2006, the Bank has not contributed to the Pension Plan. At December
31, 2005 the Pension Plan and the defined benefit portion of the Supplemental
Plan and the Directors Plan were frozen.
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
six month periods ended June 30, 2006 and 2005, 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 Amendment No. 1 to the Company's 2005 Annual Report on Form 10-K/A.
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) changes in the interest rate environment, reducing interest margins or
increasing interest rate risk; (iii) deterioration in general economic
conditions, internationally, nationally, or in the State of New Jersey; (iv)
disruptions caused by terrorism, such as the events of September 11, 2001, or
military actions in the Middle East or other areas; (v) legislation or
regulatory requirements or changes adversely affecting the business of the
Company; (vi) the impact of the proposed acquisition of the Company by TD
Banknorth; and (vii) 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 undertake no obligation to
update forward-looking statements or to make any public announcement when we
consider forward-looking statements in this document to be no longer accurate,
whether as a result of new information, what actually happens in the future or
for any other reason.
19
Company
Interchange Financial Services Corporation (the "Company"), a New Jersey
business corporation, is a bank holding company registered with the Board of
Governors of the Federal Reserve System under the Bank Holding Company Act of
1956, as amended. The Company was incorporated in the State of New Jersey on
October 15, 1984. It acquired all of the outstanding stock of Interchange Bank
(formerly known as Interchange State Bank), a New Jersey state chartered bank
(the "Bank" or "Interchange"), in 1986. The Bank is the Company's principal
operating subsidiary. In addition to the Bank, the Company has three other
wholly owned direct subsidiaries: Clover Leaf Mortgage Company, a New Jersey
corporation established in 1988, 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 Company's principal executive office is located at Park 80 West/ Plaza
Two, Saddle Brook, New Jersey 07663, and the telephone number is (201) 703-2265.
As of June 30, 2006, the Company had consolidated assets of approximately
$1.7 billion, deposits of approximately $1.2 billion and shareholders' equity of
approximately $184 million.
As a holding company, the Company provides support services to its direct
and indirect subsidiaries. These include executive management, personnel and
benefits, risk management, data processing, strategic planning, legal, and
accounting and treasury.
Banking Subsidiary
The Bank, established in 1969, is a full-service New Jersey-chartered
commercial bank headquartered in Saddle Brook, New Jersey. The Bank is a member
of the Federal Reserve System and its deposits are insured by the Federal
Deposit Insurance Corporation (the "FDIC"). It offers banking services for
individuals and businesses through thirty (30) banking offices and one (1)
supermarket mini-branch in Bergen and Essex Counties, New Jersey. The Bank
maintains thirty-four (34) automated teller machines (operating within the
StarTM , PlusTM, CIRRUSTM, VISATM, NYCETM, and MasterCardTM networks), which are
located at thirty of the banking offices, a supermarket, and the Bank's
operations center.
Subsidiaries of the Bank include: FBCB, LLC established in 2004 to hold a
49% investment in Benjamin Title LLC, a title insurance company, Clover Leaf
Investment Corporation, established in 1988 to engage in the business of an
investment company pursuant to New Jersey law; Clover Leaf Insurance Agency,
Inc., established in 1990 to engage in sales of tax-deferred annuities; Bridge
View Investment Company, an investment company operating pursuant to New Jersey
law; and Interchange Capital Company, L.L.C., established in 1999 to engage in
equipment lease financing. All of the Bank's subsidiaries are organized under
New Jersey law and are 100%
20
owned by the Bank. Clover Leaf Investment Corporation has 99% ownership of one
subsidiary, Clover Leaf Management Realty Corporation, established in 1998 as a
Real Estate Investment Trust ("REIT") which manages certain real estate assets
of the Company. Bridge View Investment Company has one wholly owned subsidiary,
Bridge View Delaware, Inc. ("BVDI"). BVDI is an investment company operating
pursuant to Delaware law.
Growth of the Company and the Bank
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 October 13, 2005 Franklin had approximately, $87.0 million in total assets,
$77.2 million in total loans and $76.0 million in deposits.
The acquisition was accounted for as a purchase and the cost in excess of
fair value acquired was allocated first to net identified intangibles and then
to goodwill. Based on the fair values the Company recorded goodwill of
approximately $13.0 million.
The Company's acquisition of Franklin is intended to further enhance
Interchange's presence in northern New Jersey. As a result of the acquisition,
the Bank now operates 30 banking offices. The acquisition of Franklin was
accomplished through a merger of Franklin with and into the Bank.
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 Amendment No. 1 to our 2005 Annual Report on Form 10-K/A, 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
21
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 $10.6 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 Amendment
No. 1 to our 2005 Annual Report on Form 10-K/A.
Business Combinations: Business combinations are accounted using the purchase
method of accounting, the assets and liabilities of the companies acquired are
recorded at their estimated fair value at the date of acquisition and include
the results of operations of the acquired business from the date of acquisition.
The excess of the purchase price over the estimated fair value of the net assets
acquired is recognized as goodwill.
Goodwill and Other Intangible Assets: Goodwill is not amortized to expense, but
rather is tested for impairment periodically. Other intangible assets are
amortized to expense using straight-line methods over their respective estimated
useful lives. At least annually, and on an interim basis when conditions
require, management reviews goodwill and other intangible assets and evaluates
events or changes in circumstances that may indicate impairment in the carrying
amount of such assets. If the sum of the expected undiscounted future cash
flows, excluding interest charges, is less than the carrying amount of the
asset, an impairment loss is recognized. An impairment is measured on a
discounted future cash flow basis and a charge is recognized in the period that
the asset has been deemed to be impaired. Based upon management's evaluation, no
impairment loss is required to be recognized.
Securities Held-to-Maturity and Securities Available-for-Sale: Debt securities
purchased with the intent and ability to hold until maturity are classified as
securities held-to-maturity ("HTM") and are carried at cost, adjusted for the
amortization of premiums and accretion of discounts. Management determines
whether the security will be classified as HTM at the time of purchase.
All other securities, including equity securities, are classified as
securities available-for-sale ("AFS"). Securities classified as AFS may be sold
prior to maturity in response to, but not limited to, changes in interest rates,
changes in prepayment risk or for asset/liability management strategies. These
securities are carried at fair
22
value and any unrealized gains and losses are reported, net of taxes, in
accumulated other comprehensive income (loss) included in the consolidated
statement of stockholders' equity. The estimated fair value for securities are
based on quoted market prices, where available. If quoted market prices are not
available, estimated fair values are based on quoted market prices of comparable
instruments. Gains and losses from the sale of these securities are determined
using the specific identification method and are reported in non-interest
income. The Company does not acquire securities for the purpose of engaging in
trading activities.
Interest and dividends are accrued and credited to income as earned.
Purchase premiums and discounts are recognized in interest income using the
effective interest method over the term of the securities.
On a quarterly basis, the Company makes an assessment to determine whether
there have been any events or economic circumstances to indicate that a security
on which there is an unrealized loss is impaired on an other-than-temporary
basis. The Company considers many factors including the severity and duration of
the impairment; the intent and ability of the Company to hold the security for a
period of time sufficient for a recovery in value; recent events specific to the
issuer or industry; and for debt securities, external credit ratings and recent
downgrades. Securities on which there is an unrealized loss that is deemed to be
other-than-temporary are written down to fair value with the write-down recorded
as a realized loss in securities gains (losses).
Pension Plan: The Bank maintains a qualified defined benefit pension plan (the
"Pension Plan"), which covers all eligible employees and an unfunded
supplemental pension plan which provides retirement income to all eligible
employees who would have been paid amounts in excess of the amounts provided by
the Pension Plan but for limitations under the qualified Pension Plan. In
addition, the Company has an unfunded retirement plan for all directors of the
Bank who are not employees of the Company or any subsidiary or affiliate.
Our expected long-term rate of return on plan assets is 8.0% and was based
on our expectations of the long-term return on the balanced mutual fund that we
invest our plan assets which has had a return for the life of the fund of 8.4%.
A 1.0% decrease in the long-term rate of return on plan assets would have
increased the net periodic pension cost of the Pension Plan by approximately $28
thousand.
The discount rates that we utilized for determining the future pension
obligations of the plans ranged between 5.25% and 5.70% and were based upon
comparing expected benefit payouts to yields on bonds available in the market
place. A 1.0% decrease in the discount rate would have increased the net
periodic pension cost by approximately $324 thousand.
During 2005, the Company froze all future service benefits to be accrued
under the plan.
23
THREE MONTHS ENDED JUNE 30, 2006 AND 2005
RESULTS OF OPERATIONS
Summary
For the second quarter of 2006, the Company reported earnings per diluted
common share of $0.20, as compared to $0.23 for the same period in 2005. Net
income for the three months ended June 30, 2006 was approximately $4.1 million
compared to approximately $4.5 million for the same period in 2005. The earnings
per share were primarily affected by increases net interest income of 1.7% and
non-interest income of 12.4% being offset by an increase in non-interest expense
of 14% and the average diluted shares outstanding.
The Company's return on average assets decreased to 1.00% for the three
months ended June 30, 2006 as compared to 1.20% for the three months ended June
30, 2005. In addition, the Company's return on average stockholders' equity
decreased to 8.98% for the second quarter 2006 versus 11.83% for the second
quarter in 2005. The changes in return on average assets and equity were
primarily the result of the decline in the net interest margin.
Net Interest Income
Net interest income is the most significant source of the Company's
operating income. A portion of the Company's total interest income is derived
from investments that are exempt from federal taxation. The amount of pretax
income realized from those investments, due to the tax exemption, is less than
the amount of pretax income realizable from comparable investments subject to
federal taxation. For purposes of the following discussion, interest income
exempt from federal taxation has been restated to a fully tax-equivalent basis
using a corporate federal tax rate of 34% for the quarters ended June 30, 2006
and 2005. 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 $320 thousand, or
2.3%, to $14.1 million for the quarter ended June 30, 2006 as compared to the
same quarter in 2005. The tax equivalent basis adjustments for the quarters
ended June 30, 2006 and 2005 were $350 thousand and $257 thousand, respectively.
The increase in net interest income was due mostly to a 9.5% growth in interest
earning assets. This interest earning asset growth was funded by cash flows from
the securities portfolio, deposit liabilities, and borrowings. The margin for
the second quarter of 2006 was 3.78%, a decrease of 27 basis points as compared
to the same quarter in 2005.
Interest income, on a tax-equivalent basis, totaled $23.5 million for the
second quarter of 2006, an increase of $4.4 million, or 22.8%, as compared to
the same quarter in 2005. The increase was mostly attributable to the growth in
interest earning assets and the shift in asset mix as average loans grew $134.2
million, while investments declined by $5.3 million.
24
Interest expense totaled $9.4 million for the second quarter of 2006, an
increase of $4.0 million, as compared to the same period in 2005. The increase
in interest expense was a result of the increase in rates paid on interest
bearing deposits, an increase in borrowings and subordinated debentures. The
average rate paid on interest bearing deposit liabilities increased by 104 basis
points to 2.88% for the quarter ended June 30, 2006 as compared to the same
period in 2005. Interest bearing deposits grew on average $15.2 million, or
1.5%, for the second quarter of 2006 as compared to the same period in 2005.
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 June 30,
(dollars in thousands) 2006 2005
(unaudited) -------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- ---------- -------- ---------- -------- -------
Assets
Interest earning assets:
Loans (1) $1,125,761 $19,639 6.98 % $ 991,543 $15,877 6.40 %
Taxable securities (4) 296,649 2,865 3.86 314,142 2,534 3.23
Tax-exempt securities (2) (4) 64,244 964 6.00 52,069 697 5.35
Federal funds sold and interest earning deposits 4 - - 98 1 4.08
---------- ---------- -------- ---------- -------- -------
Total interest-earning assets 1,486,658 23,468 6.31 1,357,852 19,109 5.63
---------- --------
Non-interest earning assets:
Cash and due from banks 36,776 37,098
Allowance for loan and lease losses (10,635) (9,993)
Other assets 130,535 115,239
---------- ----------
Total assets $1,643,334 $1,500,196
========== ==========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $1,011,664 7,284 2.88 $ 996,455 4,595 1.84
Borrowings and subordinated debentures 190,722 2,122 4.45 95,446 772 3.24
---------- ---------- -------- ----------- ------- -------
Total interest-bearing liabilities 1,202,386 9,406 3.13 1,091,901 5,367 1.97
---------- -------
Non-interest bearing liabilities
Demand deposits 246,651 245,157
Other liabilities 11,546 10,447
---------- ----------
Total liabilities (3) 1,460,583 1,347,505
Stockholders' equity 182,751 152,691
---------- ----------
Total liabilities and stockholders' equity $1,643,334 $1,500,196
========== ==========
Net interest income (tax-equivalent basis) 14,062 3.18 13,742 3.66
Tax-equivalent basis adjustment (350) (257)
---------- -------
Net interest income $13,712 $13,485
========== =======
Net interest income as a percent of interest-earning
assets (tax-equivalent basis) 3.78 % 4.05 %
- ------------------------------------------------------------------------------------------------------------------------------
(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 losses inherent in the
25
Company's loan and lease portfolio as of the balance sheet date. A more detailed
discussion of the evaluation of the ALLL can be found in the section titled
"Critical Accounting Policies and Judgments: Allowance for Loan and Lease
Losses" above. In the second quarter of 2006 and 2005, the Company's provision
for loan and lease losses was $125 thousand and $225 thousand, respectively.
Non-interest Income
For the quarter ended June 30, 2006, non-interest income totaled $2.8
million, an increase of $306 thousand, or 12.4%, as compared to the same period
in 2005. The change was largely due to an increase in net gains on sale of loans
and leases and "other" non-interest income of $272 thousand and $166 thousand,
respectively. This was partly offset by a decline in net gains on sale of
securities of $184 thousand. The increase in gain on sale of loans was due in
most part to an increase in sales of Small Business Administration loans.
Non-interest Expense
For the quarter ended June 30, 2006, non-interest expense was $10.5
million, an increase of $1.3 million, as compared to the same period in 2005.
This increase was largely due to the operating expenses associated with the
acquisition of Franklin Bank, which was acquired on October 13, 2005, and an
increase in "other" non-interest expense of $544 thousand. The increase in
"other" non-interest expense was principally due to an increase in legal fees of
$444 thousand, of which $319 thousand was related to the Company's anticipated
merger with TD Banknorth Inc., which is expected to close in the first quarter
of 2007. The aforementioned increases were partly offset by a decrease in
advertising and promotion expense of $125 thousand.
Income Taxes
Income tax expense as a percentage of pre-tax income was 30.5% for the
three months ended June 30, 2006 as compared to 31.1% for the same period of
2005. The decline in the tax rate was partly attributable to the increase in
non-taxable interest income.
26
SIX MONTHS ENDED JUNE 30, 2006 AND 2005
RESULTS OF OPERATIONS
Summary
For the six months ended June 30, 2006, the Company reported earnings per
diluted common share of $0.42, as compared to $0.46 for the same period in 2005.
Net income for the six months ended June 30, 2006 was approximately $8.6 million
compared to $8.9 million for the same period in 2005. The earnings per share
were primarily affected by increases in non-interest expense of 10.7% and the
average diluted shares outstanding being offset by increases in net interest
income of 1.7% and non-interest income of 17.0%.
The Company's return on average assets decreased to 1.05% for the six
months ended June 30, 2006 as compared to 1.20% for the six months ended June
30, 2005. For the six months ended June 30, 2006 and 2005, the Company's return
on average stockholders' equity was 9.51% and 11.77%, respectively. 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 six month periods ended June
30, 2006 and 2005. 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 $757 thousand, or
2.8%, to $28.2 million for the six months ended June 30, 2006 as compared to the
same quarter in 2005. The tax equivalent basis adjustments for the six months
ended June 30, 2006 and 2005 were $726 thousand and $419 thousand, respectively.
The increase in net interest income was due mostly to a 10.2% growth in interest
earning assets. This interest earning asset growth was funded by cash flows from
the securities portfolio, deposit liabilities, and borrowings. The margin for
the six months ended June 30, 2006 was 3.81%, a decrease of 28 basis points as
compared to the same period in 2005.
Interest income, on a tax-equivalent basis, totaled $45.8 million for the
six months ended June 30, 2006, an increase of $8.6 million, or 23.0%, as
compared to the same quarter in 2005. The increase was mostly attributable to
the growth in interest earning assets and the shift in asset mix as average
loans grew $148.3 million, while investments declined by $10.7 million.
27
Interest expense totaled $17.6 million for the first six months of 2006, an
increase of $7.8 million, as compared to the same period in 2005. The increase
in interest expense was a result of the increase in rates paid on interest
bearing deposits, an increase in borrowings and subordinated debentures. The
average rate paid on interest bearing deposit liabilities increased by 98 basis
points to 2.69% for the quarter ended June 30, 2006 as compared to the same
period in 2005. Interest bearing deposits grew on average $13.9 million, or
1.4%, for the first six months of 2006 as compared to the same period in 2005.
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 six months ended June 30
(dollars in thousands) 2006 2005
(unaudited) ------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
----------- ---------- ----------- ----------- ---------- --------
Assets
Interest earning assets
Loans (1) $1,117,429 $38,491 6.89 % $ 969,104 $30,862 6.37 %
Taxable securities (4) 293,751 5,341 3.64 330,151 5,259 3.19
Tax-exempt securities (2) (4) 69,278 2,001 5.78 43,563 1,154 5.30
Federal funds sold and interest earning deposits 4 - - 82 1 2.44
----------- ---------- ---------- ----------- --------- ------
Total interest-earning assets 1,480,462 45,833 6.19 1,342,899 37,276 5.55
---------- --------- ------
Non-interest earning assets
Cash and due from banks 36,805 35,992
Allowance for loan and lease losses (10,653) (9,934)
Other assets 131,887 115,337
----------- -----------
Total assets $1,638,501 $1,484,294
=========== ===========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $1,010,671 13,576 2.69 $ 996,796 8,517 1.71
Borrowings and subordinated debentures 185,884 4,032 4.34 83,808 1,291 3.08
----------- ---------- ---------- ----------- --------- ------
Total interest-bearing liabilities 1,196,555 17,608 2.94 $1,080,604 9,808 1.82
---------- ---------
Non-interest bearing liabilities
Demand deposits 248,792 241,871
Other liabilities 11,666 9,943
----------- -----------
Total liabilities (3) 1,457,013 1,332,418
Stockholders' equity 181,488 151,876
----------- -----------
Total liabilities and stockholders' equity $1,638,501 $1,484,294
=========== ===========
Net interest income (tax-equivalent basis) 28,225 3.25 27,468 3.73
Tax-equivalent basis adjustment (726) (419)
---------- ---------
Net interest income $27,499 $27,049
========== =========
Net interest income as a percent of interest-earning
assets (tax-equivalent basis) 3.81 % 4.09 %
- ----------------------------------------------------------------------------------------------------------------------------------
(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 losses inherent in the Company's loan
and lease portfolio as of the balance sheet date. A more detailed discussion of
the evaluation
28
of the ALLL can be found in the section titled "Critical Accounting Policies and
Judgments: Allowance for Loan and Lease Losses" above. In the first six months
of 2006 and 2005, the Company's provision for loan and lease losses was $300
thousand and $400 thousand, respectively.
Non-interest Income
For the six months ended June 30, 2006, non-interest income totaled $5.5
million, an increase of $796 thousand, or 17.0%, as compared to the same period
in 2005. The change was largely due to an increase in "other" non-interest
income and net gains on sale of loans and leases of $571 thousand and $377
thousand, respectively. This was partly offset by a decline in net gains on sale
of securities of $228 thousand. The increase in "other" non-interest income was
due in most part to an increase in referral income and servicing fee income
relating to the sales of Small Business Administration (SBA) loans. In addition,
the increase in gain on sale of loans was also due to the sale of SBA loans.
Non-interest Expense
For the six months ended June 30, 2006, non-interest expense was $20.3
million, an increase of $2.0 million, as compared to the same period in 2005.
This increase was largely due to the operating expenses associated with the
acquisition of Franklin Bank, which was acquired on October 13, 2005, and an
increase in "other" non-interest expense of $652 thousand. The increase in
"other" non-interest expense was principally due to an increase in legal fees of
$561 thousand, of which $319 thousand was related to the Company's anticipated
merger with TD Banknorth Inc., which is expected to close in the first quarter
of 2007. The aforementioned increases were partly offset by a decrease in
advertising and promotion expense of $284 thousand.
Income Taxes
Income tax expense as a percentage of pre-tax income was 30.2% for the six
months ended June 30, 2006 as compared to 31.2% for the same period of 2005. The
decline in the tax rate was partly attributable to the increase in non-taxable
interest income.
29
FINANCIAL CONDITION
Cash and Cash Equivalents
At June 30, 2006, cash and cash equivalents was $39.6 million as compared
to $42.6 million at December 31, 2005.
Securities Portfolio
Under Statement of Financial Accounting Standards No. 115 "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS 115"), each security
is classified as either trading, AFS, or HTM. The Company has no securities held
in a trading account. The securities AFS are recorded at their estimated fair
value. The after-tax difference between amortized cost and estimated fair value
of securities AFS is recorded as "accumulated other comprehensive income" in the
equity section of the balance sheet. The tax impact of such adjustment is
recorded as an adjustment to the amount of the deferred tax liability. The
securities HTM are carried at cost adjusted for the amortization of premiums and
accretion of discounts, which are recognized as an adjustment to income. Under
SFAS No. 115, securities HTM, with some exceptions, may only be sold within
three months of maturity.
The Company's U.S. Government-Sponsored Enterprises securities at June 30,
2006 and 2005 are not guaranteed by the U.S. Government; however, they are
credit rated AAA or Aaa by nationally recognized statistical rating
organizations. Substantially all obligations of states and political
subdivisions are credit rated AAA or Aaa due to insurance, which guarantees the
obligations against default, by private insurance companies. At June 30, 2006
and 2005, approximately $15.1 million and $26.8 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 June 30, 2006, investment securities totaled $354.5 million
and represented 21.4% of total assets, as compared to $356.5 million and 21.9%,
respectively, at December 31, 2005. Securities AFS comprised 91.2% of the total
securities portfolio at June 30, 2006 as compared to 90.0% at December 31, 2005.
At June 30, 2006, the Company had a net unrealized loss of $6.6 million as
compared to a net unrealized loss of $3.3 million at December 31, 2005. The
decrease in value was attributed to an increase in market interest rates during
that period.
Proceeds from the sale of securities AFS amounted to $24.2 million and
$77.1 million for the six months ended June 30, 2006 and 2005, respectively,
which resulted in gross realized gains of $135 thousand and $670 thousand for
those periods, respectively. Gross realized losses from the sale of securities
AFS amounted to $46 thousand and $361 thousand for the six months ended June 30,
2006 and 2005, respectively. Proceeds from the sale of securities HTM amounted
to $270 thousand for the six months ended June 30, 2005, which resulted in
realized gains of $8 thousand. The HTM securities had significantly paid down to
less than 85% of the original
30
purchased balance through normal principal amortization and prepayments. These
amounts are included in net gain on sale of securities in the unaudited
condensed consolidated statements of income.
Loans
Total loans amounted to $1.13 billion at June 30, 2006, an increase of
$29.7 million from $1.10 billion at December 31, 2005. The growth was
attributable to increases in commercial mortgage loans and construction loans of
$12.8 million and $30.1 million, respectively.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans, restructured loans,
foreclosed real estate and other repossessed assets. The Company's nonperforming
assets at June 30, 2006 amounted to $4.1 million as compared to $3.7 million at
December 31, 2005. The ratio of nonperforming assets to total loans and
foreclosed real estate and other repossessed assets increased to 0.36% at June
30, 2006 from 0.33% at December 31, 2005.
The following table lists nonaccrual loans and foreclosed real estate and
other repossessed assets at June 30, 2006, and December 31, 2005: (in thousands)
------------- -------------
June 30, December 31,
2006 2005
------------- -------------
Nonaccrual loans $ 2,972 $ 3,558
Troubled debt restructurings 1,013 -
Foreclosed and other repossessed assets 112 122
------------- -------------
Total nonperforming assets $ 4,097 $ 3,680
============= =============
Allowance for Loan and Lease Losses
The ALLL is generally established through periodic charges to income
through the provision for loan and lease losses. During the six months ended
June 30, 2006, the ALLL remained flat at $10.6 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 $10.6 million adequate to cover estimated
losses inherent in the loan portfolio that may become uncollectible based on
management's periodic evaluations of the loan portfolio and other relevant
factors. The evaluations are inherently subjective as they require material
estimates including such factors as potential loss factors, changes in trend of
non-performing loans, current 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
31
these factors may be susceptible to significant change. Also, the allocation of
the allowance for credit losses to specific loan pools is based on historical
loss trends and management's judgment concerning those trends.
The following table presents the provisions for loan and lease losses,
loans charged-off and recoveries on loans previously charged-off, the amount of
the allowance, the average loans outstanding and certain pertinent ratios for
the three and six months ended June 30, 2006 and 2005: (dollars in thousands)
(unaudited)
<Table>
<Caption>
-------------------- --------------------
Three months ended Six months ended
June 30, June 30,
-------------------- --------------------
2006 2005 2006 2005
---------- --------- ---------- ---------
Average loans outstanding $1,125,761 $ 991,543 $1,117,429 $969,104
========== ========= ========== =========
Allowance at beginning of period $ 10,559 $ 9,876 $10,646 $9,797
---------- --------- ---------- ---------
Loans charged-off:
Commercial and financial - - 158 89
Commercial lease financing 90 151 197 233
Consumer loans 2 10 3 13
---------- --------- ---------- ---------
Total 92 161 358 335
---------- --------- ---------- ---------
Recoveries of loans previously charged-off:
Real estate - - - 72
Commercial and financial 57 1 57 1
Commercial lease financing - - - -
Consumer loans - 4 4 10
---------- --------- ---------- ---------
Total 57 5 61 83
---------- --------- ---------- ---------
Net loans charged-off 35 156 297 252
---------- --------- ---------- ---------
Provision for loan and lease losses 125 225 300 400
---------- --------- ---------- ---------
Allowance at end of period $ 10,649 $ 9,945 $10,649 $9,945
========== ========= ========== =========
Allowance to loans (end of period) 0.94% 0.98% 0.94% 0.98
Ratio of net charge-offs to average loans
(annualized) 0.01% 0.06% 0.05% 0.05
</Table>
Deposits
Deposits, which include non-interest bearing demand deposits, time deposits
and other interest-bearing deposits, are an essential and cost-effective funding
source for the Company. Other interest-bearing deposits, which include
interest-bearing demand, money market and savings accounts, comprise the largest
segment of the Company's total deposits. The Company emphasizes building core
customer relationships by offering a variety of products designed to meet the
financial needs of its customers based on their identifiable "life stages".
At June 30, 2006 total deposits declined $19.9 million, or 1.6%, to $1.24
billion from December 31, 2005. The decrease was largely in non-interest bearing
demand deposits, which declined $13.7 million, or 5.3%, to $246.5 million at
June 30, 2006 from December 31, 2005. At June 30, 2006, non-interest bearing
demand deposits amounted to $246.5 million, which equates to 19.9% of total
deposits, which was down slightly from 20.6% at December 31, 2005. Other
interest-bearing deposits decreased $9.7 million to $677.8 million at June 30,
2006 and remained at 54.6% of total deposits as compared to December 31, 2005.
Time deposits amounted to $316.0 million, or 25.5%, of total deposits at June
30, 2006, as compared to $312.5 million, or 24.8% of total deposits at December
31, 2005.
32
The following table reflects the composition of deposit liabilities:
(dollars in thousands) (unaudited)
-------------- -------------
June 30, December 31,
2006 2005
-------------- -------------
Non-interest bearing demand deposits $ 246,482 $ 260,151
Interest bearing demand deposits 460,357 466,436
Savings deposits 114,063 121,093
Money market deposits 103,353 99,907
Time deposits 315,960 312,521
-------------- -------------
Total $ 1,240,215 $ 1,260,108
============== =============
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 six months of 2006. The Company's real estate loan portfolio,
concentrated primarily in northern New Jersey, is subject to risks associated
with the local and regional economies. The Company's primary source of market
risk exposure arises from changes in market interest rates ("interest rate
risk").
Interest Rate Risk
Interest rate risk is generally described as the exposure to potentially
adverse changes in current and future net interest income resulting from:
fluctuations in interest rates; product spreads; and imbalances in the repricing
opportunities of interest-rate-sensitive assets and liabilities. Therefore,
managing the Company's interest rate sensitivity is a primary objective of the
Company's senior management. The Company's Asset/Liability Committee ("ALCO")
manages our exposure to changes in market interest rates. ALCO attempts to
maintain stable net interest margins by periodically evaluating the relationship
between interest-rate-sensitive assets and liabilities. The evaluation, which is
performed at least quarterly and presented to the board of directors, attempts
to determine the impact on net interest margin from current and prospective
changes in market interest rates.
The Company manages interest rate risk exposure with the utilization of
financial modeling and simulation techniques. These methods assist the Company
in determining the effects of market rate changes on net interest income and
future economic value of equity. The objective of the Company is to maximize net
interest income within acceptable levels of risk established by policy. The
techniques utilized for managing exposure to market rate changes involve a
variety of interest rate, pricing and volume assumptions. These assumptions
include projections on growth, prepayment and withdrawal levels as well as other
embedded options inherently found in financial instruments. The Company reviews
and validates these assumptions at least annually or more frequently if economic
or other conditions change. At June 30, 2006, 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 2.3%. At June 30, 2006, the Company was within policy
limits established by the board of directors for changes in net interest income
and
34
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 twelse month horizon
--------------------------------------------------
June 30, June 30,
2006 2005
------------------- --------------------
+200 basis points -2.3 % -3.3 %
+100 basis points -0.8 -1.4
- -100 basis points 0.8 -1.6
- -200 basis points 0.9 -4.4
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 among bank holding companies and banks, to account
for off-balance sheet exposure and to minimize disincentives for holding liquid
assets. Assets
35
and off-balance sheet items are assigned to broad risk categories, each with
appropriate relative risk weights. The resulting capital ratios represent
capital as a percentage of total risk-weighted assets and off balance sheet
items.
A banking organization's total qualifying capital includes two components:
core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core
capital, which must comprise at least half of total capital, includes common
shareholders' equity, qualifying perpetual preferred stock, trust preferred
securities (subject to certain limitations) and minority interests, less
goodwill and any unrealized gains or losses. Supplementary capital includes the
allowance for loan losses (subject to certain limitations), other perpetual
preferred stock, trust preferred securities that exceed Tier 1 limits, certain
other capital instruments and term subordinated debt. Total capital is the sum
of core and supplementary capital. The Company's $20 million of trust preferred
securities is considered Tier 1 capital by the Federal Reserve Board.
At June 30, 2006, the minimum risk-based capital requirements to be
considered adequately capitalized were 4% for Tier 1 capital and 8% for total
capital.
Federal banking regulators have also adopted leverage capital guidelines to
supplement the risk-based measures. The leverage ratio is determined by dividing
Tier 1 capital as defined under the risk-based guidelines by average total
assets (non risk-adjusted) for the preceding quarter. At June 30, 2006, the
minimum leverage ratio requirement to be considered adequately capitalized was
3%.
The capital levels of the Company and the Bank at June 30, 2006, 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.
36
The Company's and the Bank's capital amounts and ratios are as follows:
(dollars in thousands)
<Table>
<Caption>
To Be "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- ---------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ---------- ------------ -------- ---------- ---------
As of June 30, 2006 (unaudited):
Total Capital (to Risk Weighted Assets):
The Company $ 146,245 12.14 % $ 96,349 8.00 % N/A N/A
The Bank 146,517 12.14 % 96,563 8.00 % $ 120,704 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 135,576 11.26 % 48,175 4.00 % N/A N/A
The Bank 135,848 11.25 % 48,282 4.00 % 72,422 6.00 %
Tier 1 Capital (to Average Assets):
The Company 135,576 8.60 % 47,316 3.00 % N/A N/A
The Bank 135,848 8.60 % 47,363 3.00 % 78,939 5.00 %
As of December 31, 2005:
Total Capital (to Risk Weighted Assets):
The Company $ 139,560 11.93 % $ 93,595 8.00 % N/A N/A
The Bank 140,863 11.98 % 94,042 8.00 % $ 117,553 10.00 %
Tier 1 Capital (to Risk Weighted Assets):
The Company 128,894 11.02 % 46,797 4.00 % N/A N/A
The Bank 130,197 11.08 % 47,021 4.00 % 70,532 6.00 %
Tier 1 Capital (to Average Assets):
The Company 128,894 8.20 % 47,158 3.00 % N/A N/A
The Bank 130,197 8.29 % 47,110 3.00 % 78,516 5.00 %
</Table>
Liquidity
Liquidity is the ability to provide sufficient resources to meet all
current financial obligations and finance prospective business opportunities.
The Company's liquidity position over any given period of time is a product of
its operating, financing and investing activities. The extent of such activities
is often shaped by such external factors as competition for deposits and demand
for loans.
The Company's most liquid assets are cash and cash equivalents. At June 30,
2006, the total of such assets amounted to $39.6 million, or 2.4%, of total
assets, compared to $42.6 million, or 2.6%, of total assets at December 31,
2005.
Financing for the Company's loans and investments is derived primarily from
deposits, along with interest and principal payments on loans and investments.
At June 30, 2006 and December 31, 2005, total deposits amounted to $1.24 billion
and $1.26 billion, respectively. In addition, the Company supplemented the more
traditional funding sources with borrowings from the Federal Home Loan Bank of
New York ("FHLB") and with securities sold under agreements to repurchase
("REPOS"). At June 30, 2006, short-term borrowings from the FHLB and REPOS
amounted to $97.8 million and $6.1 million, respectively, as compared to $46.2
million and $3.9 million, respectively, at December 31, 2005.
Another significant liquidity source is the Company's securities portfolio.
Total securities at June 30, 2006 amounted to $354.5 million, a decrease of $2.0
million, from $356.5 million at December 31, 2005. At
37
June 30, 2006 securities AFS amounted to $323.3 million, or 91.2%, of total
securities compared to $320.8 million, or 90.0%, of total securities at December
31, 2005.
In addition to the aforementioned sources of liquidity, the Company has
available various other sources of liquidity, including federal funds purchased
from other banks and the Federal Reserve discount window. The Bank also has a
$101.8 million line of credit available through its membership in the FHLB of
which $37.8 million was utilized at June 30, 2006.
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 June 30, 2006 outstanding commitments to fund
loans totaled $317.5 million and outstanding standby letters of credit totaled
$4.2 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 19 "Restrictions of
Subsidiary Bank Dividends" in the Notes to Consolidated Financial Statements in
Amendment No. 1 to the Company's 2005 Annual Report on Form 10-K/A. 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.
38
Item 4: CONTROLS AND PROCEDURES
In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934
(the "Exchange Act"), as of the end of the quarter ended June 30, 2006, 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.
The Company maintains internal control over financial reporting. There were
no changes in our internal controls over financial reporting identified in
connection with our evaluation of the Company's disclosure controls and
procedures that occurred during the last fiscal quarter that materially
affected, or are reasonably likely to materially affect, those controls.
39
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of business, the Company and it subsidiaries
are involved in routine litigation involving various aspects of their
business, none of which, individually or in the aggregate, in the
opinion of management and its legal counsel, is expected to have a
material adverse effect on the consolidated financial condition,
results of operations or liquidity of the Company.
Item 1A. Risk Factors
Except for the risk factors set forth below relating to the proposed
acquisition of the Company by TD Banknorth Inc., there have been no
material changes to any of the risk factors disclosed in Amendment No.
1 to the Company's Annual Report on Form 10-K/A for the fiscal year
ended December 31, 2005.
Our business could be adversely affected by uncertainty related to the
proposed merger and contractual restrictions while the proposed merger
is pending.
Uncertainty about when and whether the merger will be completed
and the effects of the merger may have an adverse effect on us. These
uncertainties could cause depositors and others that deal with to seek
to change their existing business relationships with us, which could
negatively affect our growth, revenues and results of operations. In
addition, the merger agreement restricts us from taking specified
actions without the buyer's approval. These restrictions could prevent
us from pursuing attractive business opportunities that may arise
prior to the completion of the proposed merger.
Failure to complete the proposed merger could negatively impact our
stock price, future business and financial results.
Completion of the merger is subject to the satisfaction of
various conditions, including the approval by our shareholders, as
well as regulatory approvals. Although our board of directors will,
subject to fiduciary exceptions, recommend that our stockholders
approve and adopt the merger agreement, there is no assurance that the
merger agreement and the merger will be approved, and there is no
assurance that the other conditions to the completion of the merger
will be satisfied. If the merger is not completed, we will be subject
to several risks, including the following:
o under certain circumstances, if the merger is not completed, we
may be required to pay the buyer a termination fee of $20 million;
40
o the current market price of our common stock may reflect a
market assumption that the merger will occur, and a failure to
complete the merger could result in a negative perception by the stock
market of us generally and a decline in the market price of our common
stock;
o certain costs relating to the merger, such as legal, accounting
and financial advisory fees, are payable by us whether or not the
merger is completed;
o matters related to the merger may focus our management and
employees away from day-to-day operations and require substantial
commitments of time and resources which could otherwise have been
devoted to other opportunities that could have been beneficial to us;
o we would continue to face the risks that we currently face as
an independent company.
Item 2. Unregistered Sales of Equity in Securities and Use of Proceeds
None.
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
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Interchange Financial Services Corporation
By: /s/ Charles T. Field
-----------------------------------
Charles T. Field
Senior Vice President and CFO
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Dated: August 9, 2006
42