UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM____ TO ____
Commission File number 1-10518
INTERCHANGE FINANCIAL SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
New Jersey 22-2553159
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Park 80 West/Plaza Two, Saddle Brook, NJ 07663
- ---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(201) 703-2265
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(Registrant's telephone number, including area code)
None
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such report) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No ___
The number of outstanding shares of the Registrant's common stock, no par
value per share, as of July 31, 2004, was 12,744,282 shares.
INTERCHANGE FINANCIAL SERVICES CORPORATION
INDEX
PART I FINANCIAL INFORMATION
Page No.
Item 1 Financial Statements
Consolidated Balance Sheets as of
June 30, 2004 (unaudited) and December 31, 2003 ............ 1
Unaudited Consolidated Statements of Income for the three
and six-month periods ended June 30, 2004 and 2003 ......... 2
Unaudited Consolidated Statements of Changes in
Stockholders' Equity for the six months ended
June 30, 2004 and 2003 ..................................... 3
Unaudited Consolidated Statements of Cash Flows for the
six months ended June 30, 2004 and 2003 .................... 4
Notes to Unaudited Consolidated Financial Statements ....... 5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................ 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk
(Disclosures about quantitative and qualitative market risk
are located in Management's Discussion and Analysis of
Financial Condition and Results of Operation in the section
on Market Risk) ............................................ 31
Item 4 Controls and Procedures .................................... 36
PART II OTHER INFORMATION
Item 1 Legal Proceedings .......................................... 37
Item 2 Changes in Securities and Use of Proceeds. ................. 37
Item 3 Defaults upon Senior Securities ............................ 37
Item 4 Submission of Matters to a Vote of Security Holders ........ 37
Item 5 Other Information .......................................... 37
Item 6 Exhibits and Reports on Form 8-K ........................... 37
Signatures ................................................. 38
Item 1: Financial Statements
Interchange Financial Services Corporation
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
(dollars in thousands)
June 30, December 31,
2004 2003
----------- -------------
(unaudited)
Assets
Cash and due from banks $ 32,343 $ 31,423
Interest earning deposits 6 12
----------- -----------
Total cash and cash equivalents 32,349 31,435
----------- -----------
Securities held to maturity at amortized cost (estimated market value
of $21,315 and $20,223 for June 30, 2004 and December 31, 2003,
respectively) 20,569 19,107
----------- -----------
Securities available for sale at estimated market value (amortized cost
of $360,751 and $428,597 for June 30, 2004 and December 31, 2003,
respectively) 359,363 432,953
----------- -----------
Loans and leases (net of unearned income and deferred fees of $5,116 and
$6,057 for June 30, 2004 and December 31, 2003, respectively) 883,266 796,581
Less: Allowance for loan and lease losses 9,788 9,641
----------- -----------
Net loans and leases 873,478 786,940
----------- -----------
Bank owned life insurance 22,340 21,853
Premises and equipment, net 19,992 20,343
Foreclosed real estate and other repossesed assets 201 230
Goodwill 55,953 55,924
Intangible assets 3,913 4,165
Accrued interest receivable and other assets 15,532 12,922
----------- -----------
Total assets $ 1,403,690 $ 1,385,872
=========== ===========
Liabilities
Deposits
Non-interest bearing $ 238,317 $ 223,745
Interest bearing 948,521 933,053
----------- -----------
Total deposits 1,186,838 1,156,798
----------- -----------
Securities sold under agreements to repurchase 12,320 15,618
Short-term borrowings 16,525 46,491
Long-term borrowings 30,000 10,000
Accrued interest payable and other liabilities 14,790 13,772
----------- -----------
Total liabilities 1,260,473 1,242,679
----------- -----------
Commitments and contingent liabilities
Stockholders' equity:
Common stock, without par value; 22,500,000 shares authorized;
12,741,782 and 12,810,193 shares issued and outstanding at
June 30, 2004 and December 31, 2003, respectively 5,397 5,397
Capital surplus 73,324 73,231
Retained earnings 79,857 74,710
Accumulated other comprehensive income (842) 2,434
----------- -----------
157,736 155,772
Less: Treasury stock 14,519 12,579
----------- -----------
Total stockholders' equity 143,217 143,193
----------- -----------
Total liabilities and stockholders' equity $ 1,403,690 $ 1,385,872
=========== ===========
- --------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
-1-
Interchange Financial Services Corporation
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
(dollars in thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Interest income
Interest and fees on loans $13,125 $12,469 $25,832 $23,326
Interest on federal funds sold 31 121 37 184
Interest on interest bearing deposits - 9 - 21
Interest and dividends on securities
Taxable interest income 2,561 2,329 5,211 4,612
Interest income exempt from federal income taxes 279 221 548 400
Dividends 2 53 41 109
------- ------- ------- -------
Total interest income 15,998 15,202 31,669 28,652
------- ------- ------- -------
Interest expense
Interest on deposits 2,760 3,416 5,587 6,823
Interest on securities sold under agreements to repurchase 36 79 78 165
Interest on short-term borrowings 41 - 111 -
Interest on long-term borrowings 225 107 423 212
------- ------- ------- -------
Total interest expense 3,062 3,602 6,199 7,200
------- ------- ------- -------
Net interest income 12,936 11,600 25,470 21,452
Provision for loan and lease losses 300 530 675 795
------- ------- ------- -------
Net interest income after provision
for loan losses 12,636 11,070 24,795 20,657
------- ------- ------- -------
Non-interest income
Service fees on deposit accounts 935 908 1,777 1,561
Net gain on sale of securities 305 19 819 19
Net gain on sale of loans and leases 57 147 133 345
Bank owned life insurance 226 784 487 1,062
Commissions on sale of annuities and mutual funds 256 175 468 388
Other 913 611 1,523 1,113
------- ------- ------- -------
Total non-interest income 2,692 2,644 5,207 4,488
------- ------- ------- -------
Non-interest expense
Salaries and benefits 4,664 4,193 9,512 7,821
Net occupancy 1,287 1,095 2,652 2,023
Furniture and equipment 326 353 660 606
Advertising and promotion 470 423 863 737
Federal Deposit Insurance Corporation assessment 45 37 91 71
Foreclosed real estate 5 - 5 -
Amortization of intangible assets 126 90 252 109
Other 1,875 1,505 3,680 2,856
------- ------- ------- -------
Total non-interest expense 8,798 7,696 17,715 14,223
------- ------- ------- -------
Income before income taxes 6,530 6,018 12,287 10,922
Income taxes 2,175 1,831 3,946 3,379
------- ------- ------- -------
Net income $ 4,355 $ 4,187 $ 8,341 $ 7,543
======= ======= ======= =======
Basic earnings per common share $ 0.34 $ 0.35 $ 0.65 $ 0.70
======= ======= ======= =======
Diluted earnings per common share $ 0.34 $ 0.35 $ 0.64 $ 0.69
======= ======= ======= =======
- --------------------------------------------------------------------------------
See notes to consolidated financial statements
-2-
Interchange Financial Services Corporation
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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 Stock Surplus Stock Total
------------- -------- ------------- ------ ------- -------- ---------
Balance at January 1, 2003 $63,314 $3,596 $5,397 $21,097 $ (12,724) $ 80,680
Comprehensive income
Net Income $7,543 7,543 7,543
Other comprehensive income, net of taxes
Unrealized gains on AFS debt securities 282
Less: realized gains on disposition
of securities (206)
Minimum pension liability adjustment (19)
------
Other comprehensive income 57 57 57
------
Comprehensive income $7,600
======
Dividends on common stock (2,164) (2,164)
Issued 20,833 shares of common stock in
connection with Executive Compensation Plan 109 245 354
Exercised 7,141 option shares (31) 77 46
Issued 2,949,719 shares of common stock in
connection with the acquisition of Bridge
View Bancorp 52,180 52,180
Reacquired 35,959 shares in lieu of
non-performing asset (693) (693)
------- ------ ------ ------- --------- --------
Balance at June 30, 2003 68,693 3,653 5,397 73,355 (13,095) 138,003
Comprehensive income
Net Income $8,823 8,823 8,823
Other comprehensive income, net of taxes
Unrealized gains on AFS debt securities (756)
Less: realized gains on disposition of
securities (614)
Unrealized gains on equity securities 137
Minimum pension liability adjustment 14
------
Other comprehensive income (1,219) (1,219) (1,219)
------
Comprehensive income $7,604
======
Dividends on common stock (2,806) (2,806)
Exercised 52,554 option shares (124) 516 392
------- ------ ------ ------- --------- --------
Balance at December 31, 2003 74,710 2,434 5,397 73,231 (12,579) 143,193
Comprehensive income
Net Income $8,341 8,341 8,341
Other comprehensive income, net of taxes
Unrealized gains on AFS debt securities (2,624)
Less: realized gains on disposition of
securities (652)
------
Other comprehensive income (3,276) (3,276) (3,276)
------
Comprehensive income $5,065
======
Dividends on common stock (3,194) (3,194)
Issued 7,793 shares of common stock in
connection with Executive Compensation Plan 103 102 205
Exercised 9,332 option shares (10) 112 102
Purchased 84,786 shares of common stock (2,154) (2,154)
------- ------ ------ ------- --------- --------
Balance at June 30, 2004 $79,857 $ (842) $5,397 $73,324 $ (14,519) $143,217
======= ====== ====== ======= ========= ========
- --------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
-3-
Interchange Financial Services Corporation
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30,
- --------------------------------------------------------------------------------
(in thousands)
(unaudited)
2004 2003
-------- --------
Cash flows from operating activities
Net income $ 8,341 $ 7,543
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 976 801
Amortization of securities premiums 2,973 1,649
Accretion of securities discounts (122) (166)
Amortization of loan premiums 23 -
Amortization of premiums in connection with acquisition 656 250
Provision for loan and lease losses 675 795
Increase in cash surrender value of Bank Owned Life Insurance (487) (268)
Origination of loans held for sale (1,437) (7,549)
Sale of loans held for sale 1,532 7,775
Net gain on sale of securities available for sale (819) (475)
Net gain on sale of loans and leases (130) (345)
Net gain on sale of fixed assets - 10
Net gain on the sale of repossessed assets (14) (7)
Other than temporary impairment of securities - 415
Decrease (increase) in operating assets
Accrued interest receivable 864 (554)
Other (1,115) (5,309)
(Decrease) increase in operating liabilities
Accrued interest payable (74) (319)
Other 1,092 1,962
------- --------
Cash provided by operating activities 12,934 6,208
------- --------
Cash flows from investing activities
(Payments for) proceeds from
Purchase of loans (36,449) (53)
Net repayments (originations) of loans (51,898) (6,343)
Sale of loans 744 1,520
Purchase of securities available for sale (38,840) (134,890)
Maturities of securities available for sale 46,525 64,603
Sale of securities available for sale 58,235 13,029
Purchase of securities held to maturity (6,820) -
Maturities of securities held to maturity 5,205 3,342
Purchase of fixed assets (546) (560)
Sale of reposessed assets 77 100
Net cash proceeds from acquisition of Bridge View Bancorp - 20,191
------- --------
Cash used in investing activities (23,767) (39,061)
------- --------
Cash flows from financing activities
Proceeds from (payments for)
Deposits in excess of withdrawals 30,052 62,272
Decrease in short term debt (33,264) (5,969)
Increase in long term debt 20,000 -
Minimum pension liability, net of taxes - (19)
Dividends (3,194) (2,164)
Treasury stock (2,154) -
Common stock issued 205 354
Exercise of option shares 102 46
------- --------
Cash provided by financing activities 11,747 54,520
------- --------
Increase in cash and cash equivalents 914 21,667
Cash and cash equivalents, beginning of year 31,435 33,916
------- --------
Cash and cash equivalents, end of period $32,349 $ 55,583
======= ========
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 6,275 $ 7,101
Income taxes 4,100 4,365
Supplemental disclosure of non-cash investing activities:
Loans transferred to foreclosed real estate and other
repossessed assets 34 89
Stock issued related to Bridge View acquisition - 52,180
- --------------------------------------------------------------------------------
See notes to consolidated financial statements.
-4-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX-MONTH PERIODS ENDED JUNE 30, 2004
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Interchange Financial Services Corporation and its
wholly owned subsidiaries (on a consolidated basis, the "Company") including its
principal operating subsidiary, Interchange Bank (the "Bank"), and have been
prepared in conformity with accounting principles generally accepted in the
United States of America ("GAAP") and in accordance with the rules and
regulations of the Securities and Exchange Commission. 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
financial statements and schedules thereto included in the annual report on Form
10-K of the Company for the year ended December 31, 2003.
The consolidated financial data for the three and six month periods ended
June 30, 2004 and 2003, are unaudited but reflect all 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 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.
Stock Based Compensation: The Company accounts for stock option plans under the
recognition and measurement principles of Accounting Principles Board ("APB")
Opinion No. 25. "Accounting for Stock Issued to Employees," and related
interpretations. No stock-based employee compensation costs are reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and diluted earnings per
common share if the Company had applied the fair value recognition provisions of
Financial Accounting Standards Board ("FASB") Statement No. 123, " Accounting
for Stock-
-5-
Based Compensation," to stock-based compensation for the three and six months
ended June 30, 2004 and 2003: (in thousands, except share data) (unaudited)
-------------------------- ------------------------
For the three months ended For the six months ended
June 30, June 30,
2004 2003 2004 2003
------ ------ ------ ------
Net Income
As reported $4,355 $4,187 $8,341 $7,543
Less: Total stock-based
compensation expense determined
under the fair value method for all
rewards, net of related tax effects 147 90 273 173
------ ------ ------ ------
Pro-forma $4,208 $4,097 $8,068 $7,370
====== ====== ====== ======
Earnings per share:
Basic:
As reported 0.34 0.35 0.65 0.70
Pro forma 0.33 0.35 0.63 0.68
Diluted:
As reported 0.34 0.35 0.64 0.69
Pro forma 0.32 0.34 0.62 0.67
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 three months ended
June 30, 2004 and March 31, 2004, respectively: dividend yield of 2.09% and
2.22%; expected volatility of 24.00% and 24.92%; risk-free interest rate of
3.83% and 3.34%; and expected lives of 7 years. Prior period assumptions are
described in Note 13 "Stock Option and Incentive Plan in the Notes to
Consolidated Financial Statements" in the Company's 2003 Annual Report on Form
10-K. The effects of applying these assumptions in determining the pro-forma net
income may not be representative of the effects on pro-forma net income for
future years.
2. Acquisition and Pro Forma Disclosure
On April 30, 2003 the Company completed its acquisition of 100% of the
common stock of Bridge View Bancorp ("Bridge View"), a Bergen County-based bank
holding company with eleven locations, which expanded the Company's presence
into eastern Bergen County. The results of Bridge View's operations have been
included in the consolidated financial statements since that date. At April 30,
2003, Bridge View had approximately $291 million of total assets, $184 million
of loans and $259 million of deposits. The aggregate purchase price paid to
Bridge View shareholders was approximately $85.7 million and consisted of
approximately 2.9 million shares of the Company's common stock with an
approximate market value of $52.2 million, based upon the average closing price
over the periods three days prior to and after the acquisition date, and $33.5
million in cash. The transaction was accounted for as a purchase and the cost
-6-
in excess of net assets acquired of approximately $58.7 million was allocated to
net identified intangibles of approximately $4.3 million and goodwill of
approximately $54.4 million.
The following pro forma condensed consolidated statements of income for
the three and six months ended June 30, 2003 give effect to the merger as if the
merger had been consummated on January 1, 2003.
The unaudited pro forma information is not necessarily indicative of the
results of operations in the future or the results of operations, which would
have been realized had the merger been consummated during the periods or as of
the dates for which the unaudited pro forma information is presented.
Interchange Financial Services Corporation and Subsidiaries
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -------------------
2004 2003 2004 2003
Pro Forma Pro Forma
Interest income $ 15,998 $ 16,243 $ 31,669 $ 32,912
Interest expense 3,062 3,726 6,199 7,743
-------- -------- -------- --------
Net interest income 12,936 12,517 25,470 25,169
-------- -------- -------- --------
Provision for loan and lease losses 300 530 675 810
-------- -------- -------- --------
Net interest income after provision
for loan and lease losses 12,636 11,987 24,795 24,359
Non-interest income 2,692 2,877 5,207 5,272
Non-interest expense
Salaries and benefits 4,664 4,619 9,512 9,315
Occupancy and FF&E 1,613 1,618 3,312 3,246
Other expenses 2,521 2,353 4,891 4,773
-------- -------- -------- --------
8,798 8,590 17,715 17,334
Net income before taxes 6,530 6,274 12,287 12,297
Income Taxes 2,175 1,936 3,946 3,931
-------- -------- -------- --------
Net income $ 4,355 $ 4,338 $ 8,341 $ 8,366
======== ======== ======== ========
Earnings per common share:
Basic $ 0.34 $ 0.34 $ 0.65 $ 0.66
======== ======== ======== ========
Diluted $ 0.34 $ 0.33 $ 0.64 $ 0.65
======== ======== ======== ========
See Accompanying Notes to the Unaudited Pro Forma Condensed Combined Financial
Statements.
3. 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
-7-
common shares had been issued, as well as any adjustment to income that would
result from the assumed issuance. Potential common shares that may be issued by
the Company relate solely to outstanding stock options, and are determined using
the treasury stock method.
4. Commitments and Contingent Liabilities
Legal Proceedings
The Company is a party to routine litigation involving various aspects of
its business, none of which, in the opinion of management, is expected to have a
material adverse impact on the consolidated financial condition, results of
operations or liquidity of the Company.
Commitments to Extend Credit
At June 30, 2004, the Company had commitments of approximately $277.4
million to extend credit, of which approximately $1.9 million represents standby
letters of credit.
5. Goodwill and Other Intangibles
With the adoption of Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), on January 1,
2002, goodwill is no longer amortized to expense, but rather is tested for
impairment periodically. Other intangible assets are amortized to expense using
straight-line methods over their respective estimated useful lives. At least
annually, 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. Goodwill is reviewed for impairment annually
and on an interim basis when conditions require. If necessary an impairment
charge is recognized in the period that goodwill has been deemed to be impaired.
At the date of adoption, there was no unamortized goodwill.
At June 30, 2004 and December 31, 2003, gross intangible assets amounted
to $4.6 million at the end of each period while accumulated amortization
amounted to $556 thousand and $430 thousand, respectively. Amortization of
intangible assets as a result of acquisitions, which is included in non-interest
expense, amounted to $126 thousand, and $90 thousand for the three months ended
June 30, 2004 and 2003, respectively. During the second quarter of 2003, the
Company recorded a core deposit intangible of $4.3 million in connection with
the Bridge View merger. The core deposit intangible has an estimated life of 10
years and the Company amortized $107 thousand for the three months ended June
30, 2004. The core deposit intangible will be periodically reviewed for
impairment. In addition, the Company recorded goodwill of $54.4 million in
connection with the Bridge View merger. The goodwill will be tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
-8-
At June 30, 2004 the scheduled amortization of the core deposit intangible
is as follows (in thousands):
2005 $ 430
2006 430
2007 430
2008 430
2009 and thereafter 1,859
-------
$ 3,579
=======
6. 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.
7. Recent Accounting Pronouncements
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards No. 132 (revised 2003), Employers' Disclosures about Pensions and
Other Postretirement Benefits ("SFAS 132"). The revised SFAS 132 retains the
disclosure requirements in the original statement and requires additional
disclosures about pension plan assets, benefit obligations, benefit costs and
other relevant information. The Company has included the new interim disclosures
that are required for financial statements for periods ending after December 15,
2003.
In March 2004, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments. EITF Issue 03-1 is effective for all
annual or interim financial statements for periods beginning after June 15,
2004. EITF Issue 03-1 addresses the identification of other than temporarily
impaired investments, and requires that an impairment charge be recognized for
other than temporarily impaired investments for which there is neither the
ability nor intent to hold either until maturity or until the market value of
the investment recovers. Management is evaluating what effect, if any, EITF
Issue No. 03-1 will have on the Company's consolidated financial statements.
8. Cash Dividend
The Company paid a cash dividend of $0.125 per share on May 21, 2004 to
holders of record as of May 3, 2004.
-9-
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)
-------------------------------------------------
June 30, 2004
-------------------------------------------------
(unaudited)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ---------
Securities HTM
Mortgage-backed securities $ 7,643 $ 234 $ - $ 7,877
Obligations of U.S. agencies 3,000 - - 3,000
Obligations of states & political subdivisions 9,926 512 - 10,438
--------- ------- ------- ---------
$ 20,569 $ 746 $ - $ 21,315
--------- ------- ------- ---------
Securities AFS
Mortgage-backed securities $ 104,222 $ 1,070 $ 576 $ 104,716
Obligations of U.S. agencies 221,304 777 2,964 219,117
Obligations of states & political subdivisions 30,638 581 372 30,847
Equity securities 4,587 96 - 4,683
--------- ------- ------- ---------
360,751 2,524 3,912 359,363
--------- ------- ------- ---------
Total securities $ 381,320 $ 3,270 $ 3,912 $ 380,678
========= ======= ======= =========
-------------------------------------------------
December 31, 2003
-------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ---------
Securities HTM
Mortgage-backed securities $ 9,850 $ 330 $ 1 $ 10,179
Obligations of states & political subdivisions 9,257 787 - 10,044
--------- ------- ------- ---------
$ 19,107 $ 1,117 $ 1 $ 20,223
--------- ------- ------- ---------
Securities AFS
Obligations of U.S. Treasury $ 6,032 $ 5 $ 2 $ 6,035
Mortgage-backed securities 112,981 1,363 157 114,187
Obligations of U.S. agencies 271,339 2,583 762 273,160
Obligations of states & political subdivisions 33,849 1,257 68 35,038
Equity securities 4,396 137 - 4,533
--------- ------- ------- ---------
428,597 5,345 989 432,953
--------- ------- ------- ---------
Total securities $ 447,704 $ 6,462 $ 990 $ 453,176
========= ======= ======= =========
At June 30, 2004, the contractual maturities of securities HTM and
securities AFS are as follows: (in thousands) (unaudited)
-10-
Securities Securities
HTM AFS
---------------------- --------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------------- --------------------
Within 1 year $ 4,307 $ 4,339 $ 29,825 $ 29,621
After 1 but within 5 years 9,679 10,005 290,761 289,510
After 5 but within 10 years 5,505 5,831 22,208 22,320
After 10 years 1,078 1,140 13,370 13,230
Equity securities - - 4,587 4,682
--------------------- -------------------
Total $20,569 $21,315 $360,751 $359,363
===================== ===================
Proceeds from the sale of securities AFS amounted to $58.2 million and
$13.0 million for the six months ended June 30, 2004 and 2003, which resulted in
gross realized gains of $913 thousand and $478 thousand for those periods,
respectively. Gross realized losses from the sale of securities AFS amounted to
$94 thousand and $44 thousand for the six months ended June 30, 2004 and 2003,
respectively. These amounts are included in net gain on sale of securities in
the Consolidated Statements of Income.
During the first half of 2003, the Company realized gross losses resulting
from an acceleration of premium amortization on certain collateralized mortgage
obligations of $415 thousand. The acceleration of premium amortization was
largely driven by the historically high mortgage prepayment speeds due to the
low interest rate environment.
The investment portfolio is evaluated at least quarterly to determine if
there are any securities with losses that are other than temporary. One criteria
in assessing for an other than temporary impairment charge is if a security has
an unrealized loss that exceeds one year. At June 30, 2004, the Company had
$12.9 million of securities with unrealized losses of $269 thousand that were in
excess of one year. It is expected that the Company will recover all amounts due
under the contractual obligations of those securities and as such, no other than
temporary impairment charge was necessary. The Company did not have any
unrealized losses in its' HTM portfolio. The following table summarizes all
securities that have an unrealized loss and the duration of the unrealized loss
at June 30, 2004: (in thousands) (unaudited)
12 months or less 12 months or longer Totals
---------------------- --------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---------------------- --------------------- -------------------
Securities AFS
Mortgage-backed securities $ 52,761 $ 544 $ 3,216 $ 32 $ 55,977 $ 576
Obligations of U.S. agencies 187,518 2,755 9,292 209 196,810 2,964
Obligations of states & political subdivisions 10,504 344 441 28 10,945 372
-------------------- ------------------ ------------------
$250,783 $3,643 $12,949 $269 $263,732 $3,912
==================== ================== ==================
Securities with carrying amounts of $46.6 million and $46.1 million at
June 30, 2004 and December 31, 2003, respectively, were pledged for public
deposits, Federal Home Loan Bank advances, securities sold under repurchase
agreements and other purposes required by law.
-11-
10. Loans
The composition of the loan portfolio is summarized as follows: (in
thousands)
June 30, December 31,
2004 2003
----------- ------------
(unaudited)
Amount of loans by type
Real estate-mortgage
1-4 family residential
First liens $141,948 $100,286
Junior liens 3,191 4,138
Home equity 146,313 136,477
Commercial 353,878 330,040
Construction 29,557 31,077
-------- --------
674,887 602,018
-------- --------
Commercial loans
Commercial and financial 174,498 149,462
Lease financing 24,315 28,440
-------- --------
198,813 177,902
-------- --------
Consumer loans
Lease financing 4,624 12,416
Installment 4,942 4,245
-------- --------
9,566 16,661
-------- --------
Total $883,266 $796,581
======== ========
Nonperforming Assets
Nonperforming loans include loans that are accounted for on a nonaccrual
basis and troubled debt restructurings. Nonperforming loans are as follows: (in
thousands)
June 30, December 31,
2004 2003
--------------------------
(unaudited)
Nonaccrual loans
Residential real estate $1,469 $1,364
Commercial real estate 747 1,603
Commercial and financial 2,176 2,858
Commercial lease financing 1,760 2,365
Consumer 421 380
------------------------
$6,573 $8,570
========================
-12-
11. Allowance for Loan and Lease Losses
The Company's recorded investment in impaired loans is as follows: (in
thousands)
---------------------- ---------------------
June 30, December 31,
2004 2003
---------------------- ---------------------
(unaudited)
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 $1,963 $381 $2,864 $463
Commercial real estate 747 19 1,603 40
Residential mortgages 821 123 816 122
Consumer 201 5 - -
Without a related allowance for
loan losses - - - -
------ ---- ------ ----
$3,732 $528 $5,283 $625
====== ==== ====== ====
- --------------------------------------------------------------------------------
The impairment of the above loans was estimated based on the fair value of
collateral.
Changes in the allowance for loan and lease losses are summarized as follows:
(in thousands)
------------------ ----------------
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
2004 2003 2004 2003
------ ------ ------ ------
(unaudited) (unaudited)
Balance at beginning of period $9,635 $7,226 $9,641 $7,207
Additions (deductions)
Provision for loan and lease
losses 300 530 675 795
Recoveries on loans previously
charged off 24 4 60 5
Loans charged off (171) (152) (588) (399)
Additions due to merger - 1,929 - 1,929
------ ------ ------ ------
Balance at end of year $9,788 $9,537 $9,788 $9,537
====== ====== ====== ======
12. Other Non-interest Expense
Expenses included in other non-interest expense that exceed one percent of
the aggregate of total interest income and non-interest income for the periods
noted, are as follows: (in thousands) (unaudited)
---------------- ---------------
Three months Six months
ended June 30, ended June 30,
---------------- ---------------
2004 2003 2004 2003
------ ------ ------ ------
Professional fees $ 361 $ 329 $ 677 $ 533
Data processing 283 308 564 523
Directors's fees, retirement
and travel 194 181 410 309
Legal fees 240 98 450 178
All other 797 589 1,579 1,313
------ ------ ------ ------
$1,875 $1,505 $3,680 $2,856
====== ====== ====== ======
-13-
13. Long-term Borrowings
Long-term borrowings consist of the following FHLB advances: (in thousands)
(unaudited)
Maturity June 30, December 31,
Date Rate 2004 2003
- ---------------- ---- -------- ------------
(unaudited)
January 2006 2.09% $10,000 -
January 2007 (a) 4.22 10,000 $10,000
January 2007 2.69 10,000 -
---- ------- -------
3.00% $30,000 $10,000
==== ======= =======
(a) The FHLB has an option to call this advance on a quarterly basis if
the 3-month LIBOR resets above 7.50%.
14. 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,
------------------ -----------------
2004 2003 2004 2003
------- -------- ------ ------
Service cost $166 $151 $333 $302
Interest cost 95 79 190 158
Expected return on plan assets (39) (31) (79) (62)
Amortization of prior service cost 1 1 2 2
---- ---- ---- ----
Net periodic benefit cost $223 $200 $446 $400
==== ==== ==== ====
For the year ended December 31, 2004, the Bank anticipates contributing
approximately $775 thousand to the Pension Plan.
-14-
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion is an analysis of the consolidated financial
condition and results of operations of the Company for the three and six month
periods ended June 30, 2004 and 2003, and should be read in conjunction with the
consolidated financial statements and notes thereto included in Item 1 hereof.
In addition, you should read this section in conjunction with Management's
Discussion and Analysis and Results of Operations included in the Company's 2003
Annual Report on Form 10-K.
On April 30, 2003, the Company completed its acquisition of Bridge View
Bancorp ("Bridge View"). Accordingly the results of operations for the three and
six month periods ending June 30, 2004 include the results of Bridge View.
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," "will" and other similar
expressions (including when preceded or followed by the word "not") are
generally intended to identify such forward-looking statements. Such statements
are intended to be covered by the safe harbor provisions for forward-looking
statements contained in such Act, and we are including this statement for
purposes of invoking these safe harbor provisions. Such forward-looking
statements include, but are not limited to, statements about the operations of
the Company, the adequacy of the Company's allowance for losses associated with
the loan and lease portfolio, the quality of the loan and lease portfolio, the
prospects of continued loan and deposit growth, and improved credit quality. The
forward-looking statements in this report involve certain estimates or
assumptions, known and unknown risks and uncertainties, many of which are beyond
the control of the Company, and reflect what we currently anticipate will happen
in each case. What actually happens could differ materially from what we
currently anticipate will happen due to a variety of factors, including, among
others, (i) increased competitive pressures among financial services companies;
(ii) changes in the interest rate environment, reducing interest margins or
increasing interest rate risk; (iii) deterioration in general economic
conditions, internationally, nationally, or in the State of New Jersey; (iv) the
occurrence of acts of terrorism, such as the events of September 11, 2001, or
acts of war; (v) legislation or regulatory requirements or changes adversely
affecting the business of the Company; (vi) expected revenue synergies from the
Company's acquisition of Bridge View may not be fully realized or realized
within the expected time frame; (vii) revenues following the Company's
acquisition of Bridge View may be lower than expected; (viii) deposit attrition,
operating costs, customer loss and business disruption following the Company's
acquisition of Bridge View, including, without limitation, difficulties in
maintaining relationships
-15-
with employees, may be greater than expected and (ix) other risks detailed in
reports filed by the Company with the Securities and Exchange Commission.
Readers should not place undue expectations on any forward-looking statements.
We are not promising to make any public announcement when we consider
forward-looking statements in this document to be no longer accurate, whether as
a result of new information, what actually happens in the future or for any
other reason.
Company
The Company is a bank holding company headquartered in Bergen County, New
Jersey. The Company's principal operating subsidiary is Interchange Bank, a New
Jersey-chartered commercial bank. In addition to the Bank, the Company has one
other wholly owned direct subsidiary: Clover Leaf Mortgage Company, a New Jersey
corporation, which is not currently engaged in any business activity. The Bank
has five direct subsidiaries: Clover Leaf Investment Corporation, an investment
company operating pursuant to New Jersey law; Clover Leaf Insurance Agency,
Inc., a New Jersey corporation engaged in the sale of tax-deferred annuities and
insurance; Clover Leaf Management Realty Corporation, a Real Estate Investment
Trust ("REIT"), which manages certain real estate assets of the Company; Bridge
View Investment Company, an investment company operating pursuant to New Jersey
law; and Interchange Capital Company, L.L.C. ("ICC"), a New Jersey limited
liability company which engages in equipment lease financing. All of the Bank's
subsidiaries are 100% owned by the Bank, except for the REIT, which is 99% owned
by the Bank. Bridge View Investment Company has one wholly owned subsidiary,
Bridge View Delaware, Inc. ("BVDI"). BVDI is an investment company operating
pursuant to Delaware law.
Critical Accounting Policies and Judgments
The Company's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 1 "Accounting Policies in the Notes to Consolidated Financial
Statements and in the Management's Discussion and Analysis of Financial
Condition and Results of Operations: Critical Accounting Policies and Judgments"
in our 2003 Annual Report on Form 10-K. 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.
-16-
Allowance for Loan and Lease Losses: The ALLL is generally established through
periodic charges to income. Loan losses are charged against the ALLL when
management believes that the probable future collection of principal is
unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL
is considered inadequate to absorb future loan losses on existing loans, based
on, but not limited to, increases in the size of the loan portfolio, increases
in charge-offs or changes in the risk characteristics of the loan portfolio,
then the provision for loan and lease losses is increased.
The Company considers the ALLL of $9.8 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 it requires material
estimates including such factors as potential loss factors, changes in trend of
non-performing loans, current state of local and national economy, value of
collateral changes in the composition and volume of the loan portfolio, review
of specific problem loans and management's assessment of the inherent risk and
overall quality of the loan portfolio. All of these factors may be susceptible
to significant change. Also, the allocation of the allowance for credit losses
to specific loan pools is based on historical loss trends and management's
judgment concerning those trends.
Business Combinations: Business combinations are accounted for using the
purchase method of accounting, the net assets 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: With the adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"), on January 1, 2002, goodwill is no longer amortized to
expense, but rather is tested for impairment periodically. Other intangible
assets are amortized to expense using straight-line methods over their
respective estimated useful lives. At least annually, 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. Goodwill is reviewed for impairment annually and on an interim basis
when conditions require. If necessary, an impairment charge is recognized in the
period that goodwill has been deemed to be impaired. At the date of adoption,
there was no unamortized goodwill.
-17-
THREE MONTHS ENDED JUNE 30, 2004 AND 2003
RESULTS OF OPERATIONS
Summary
Net income for the three months ended June 30, 2004 was approximately $4.4
million, an increase of $168 thousand, or 4.0%, over the same period last year.
The increase in earnings resulted from an increase in our interest earning
assets during the quarter of approximately $179.4 million, which was partly
offset by an 18 basis point decline in our net interest margin. The increase in
interest earning assets was partly attributed to the acquisition of Bridge View
during the second quarter of 2003. For the second quarter of 2004, the Company
reported earnings per diluted common share of $0.34, as compared to $0.35 for
the same period in 2003. The decline in diluted earnings per share was a result
of a compression in the net interest margin as compared to the second quarter in
2003 and an increase in average diluted shares outstanding as a result of the
Bridge View transaction.
For the three months ended June 30, 2004 and 2003, the Company's Return on
Average Assets ("ROA") was 1.25% and 1.40%, respectively. The change in ROA for
the quarter was a result of a decline in net interest margin. Return on Average
Equity ("ROE") was 12.08% a decline from 14.03% when compared to the same period
last year. ROE declined principally due to an increase in equity as a result of
the acquisition of Bridge View and, to a lesser extent, compression in 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 the corporate federal tax rate of 34% for the quarter ended June 30, 2004
and 2003. 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 $1.4 million, or
11.8%, to $13.1 million for the quarter ended June 30, 2004 as compared to the
same quarter in 2003. The tax equivalent basis adjustments for the quarters
ended June 30, 2004 and 2003 were $162 thousand and $112 thousand, respectively.
The increase in net interest income was due mostly to a 16.8% growth in interest
earning assets. This interest earning asset growth was funded primarily by
deposit liabilities, which grew 14.1% on average for the second quarter of 2004
as compared to the same quarter in 2003. The growth in interest earning assets
and deposits were attributed to the Company's internal growth and to a lesser
extent, the Bridge View acquisition. The margin for the second quarter of 2004
was 4.20%, a decline of
-18-
18 basis points as compared to the same quarter in 2003 due to earning asset
yields declining faster than the Company's cost of funds. The decline in asset
yields was mainly attributable to maturities and prepayments in the loan and
securities portfolio, while the Company's deposit pricing reached historical
lows and appears to have become inelastic. During the quarter, the Company did
experience expansion in its net interest margin as a shift in asset mix
benefited the overall net interest margin.
Interest income, on a tax-equivalent basis, totaled $16.2 million for the
second quarter of 2004, an increase of $846 thousand, or 5.5%, as compared to
the same quarter in 2003. The increase was mostly attributed to a $179.4
million, or 16.8%, growth in interest earning assets. The growth in interest
earning assets was the result of increases in average loans and average
investments of $113.2 million and $98.4 million, respectively. The increase in
interest income was partly offset by a 55 basis point decline in interest
earning asset yields for the second quarter of 2004 as compared to the same
quarter in 2003.
Interest expense, which totaled $3.1 million for the second quarter of
2004, decreased $540 thousand, or 15.0%, as compared to the same period in 2003.
The decrease in interest expense was a byproduct of the decline in market
interest rates, particularly short-term rates, during 2003. In addition, a
beneficial shift in the composition of the Company's deposits, which is
discussed further in the analysis of financial condition, also had a favorable
impact on the Company's interest expense. The improved deposit mix combined with
lower short-term interest rates reduced the average rate paid on interest
bearing liabilities by 42 basis points to 1.22% for the quarter ended June 30,
2004 as compared to the same period in 2003. The magnitude of the benefit
derived from the decrease in rates paid on interest bearing liabilities was
partially reduced by the positive growth of deposits. Interest bearing deposits
grew on average $91.6 million, or 10.7%, for the second quarter of 2004 as
compared to the same period in 2003.
-19-
- ------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ------------------------------------------------------------------------------------------------------------------------
for the quarter ended June 30,
(dollars in thousands) 2004 2003
(unaudited) ------------------------------- ------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
----------- -------- ------- ----------- -------- -------
Assets
Interest earning assets:
Loans (1) $ 845,747 $13,160 6.22% $ 732,516 $12,499 6.83%
Taxable securities (4) 363,281 2,563 2.82 265,753 2,381 3.58
Tax-exempt securities (2) (4) 26,930 406 6.03 26,095 304 4.66
Interest earning deposits 6 - - 3,846 9 0.94
Federal funds sold 12,848 31 0.97 41,180 121 1.18
---------- ------- ---- ---------- ------- ----
Total interest-earning assets 1,248,812 16,160 5.18 1,069,390 15,314 5.73
------- -------
Non-interest earning assets:
Cash and due from banks 36,326 37,642
Allowance for loan and lease losses (9,818) (8,606)
Other assets 118,411 97,087
---------- ----------
Total assets $1,393,731 $1,195,513
========== ==========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $ 946,834 2,760 1.17 $ 855,189 3,416 1.60
Borrowings 54,862 302 2.20 25,035 186 2.96
---------- ------- ---- ---------- ------- ----
Total interest-bearing liabilities 1,001,696 3,062 1.22 880,224 3,602 1.64
------- -------
Non-interest bearing liabilities
Demand deposits 232,734 178,434
Other liabilities 15,129 17,463
---------- ----------
Total liabilities (3) 1,249,559 1,076,121
Stockholders' equity 144,172 119,392
---------- ----------
Total liabilities and stockholders' equity $1,393,731 $1,195,513
========== ==========
Net interest income (tax-equivalent basis) 13,098 3.96 11,712 4.09
Tax-equivalent basis adjustment (162) (112)
------- -------
Net interest income $12,936 $11,600
======= =======
Net interest income as a percent of interest-earning
assets (tax-equivalent basis) 4.20% 4.38%
- --------------------------------------------------------------------------------
(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.
Provision for Loan and Lease Losses
The provision for loan and lease losses represents management's
calculation of the amount necessary to bring the allowance for loan and lease
losses ("ALLL") to a level that management considers adequate to reflect the
risk of estimated losses inherent in the Company's loan portfolio as of the
balance sheet date. A more detailed discussion of the evaluation of the ALLL can
be found in the section titled "Critical Accounting Policies and Judgments:
Allowance for Loan and Lease Losses" above. In the second quarter of 2004 and
2003, the Company's provision for loan and lease losses was $300 thousand and
$530 thousand, respectively.
Non-interest Income
For the quarter ended June 30, 2004, non-interest income totaled $2.7
million, an increase of $48 thousand, or 1.8%, as compared to the same period in
2003. The increase was largely due to growth in "other" non-interest income, net
gains on the sale of securities and commissions on sale of annuities and mutual
funds of $302 thousand, $286 thousand and $81 thousand, respectively. The growth
in "other" non-interest income was largely attributed to an increase in
commercial loan prepayment penalties of $171 thousand. The Company experienced
strong loan growth during 2004 that was funded by deposit growth and security
sales, which contributed to the improvement in non-interest income. The
improvement in non-interest income was partly offset by a decrease in Bank Owned
Life Insurance
-20-
("BOLI") income and a decline in net gain on sale of loans and leases of $558
thousand and $90 thousand, respectively. The decline in BOLI income was
attributed to a claim on insurance policies in 2003 of $499 thousand, while the
decrease in net gain on sale of loans and leases was due to lower demand for
thirty-year residential mortgage loans.
Non-interest Expense
For the quarter ended June 30, 2004, non-interest expense was $8.8
million, an increase of $1.1 million, or 14.3%, when compared to the same period
one year ago. The increase was due largely to the additional operating costs
resulting from the merger with Bridge View. Also contributing to the increase
were higher salary and benefits, legal and advertising expenses.
Income Taxes
Income tax expense as a percentage of pre-tax income was 33.3% for the
three months ended June 30, 2004 as compared to 30.4% for the same period of
2003. The increase in percentage of income tax expense was in part due to the
effect of a decline in non-taxable BOLI income.
-21-
SIX MONTHS ENDED JUNE 30, 2004 AND JUNE 30, 2003
RESULTS OF OPERATIONS
Summary
Net income for the six months ended June 30, 2004 was approximately $8.3
million, an increase of $798 thousand, or 10.6%, over the same period last year.
The increase in earnings resulted from an increase in interest earning assets
from organic growth and the acquisition of Bridge View during the second quarter
of 2003. The improvement in earnings was partly offset by a 29 basis point
decline in the net interest margin. For the first six months of 2004, the
Company reported earnings per diluted common share of $0.64, as compared to
$0.69 for the same period in 2003. The decline in diluted earnings per share was
a result of a compression in the net interest margin as compared to the same
period in 2003 and an increase in average diluted shares outstanding as a result
of the Bridge View transaction.
For the six months ended June 30, 2004 and 2003, the Company's Return on
Average Assets ("ROA") was 1.20% and 1.41%, respectively. The change in ROA for
the period was a result of a decline in net interest margin. Return on Average
Equity ("ROE") was 11.61% a decline from 14.97% when compared to the same period
last year. ROE declined principally due to an increase in equity as a result of
the acquisition of Bridge View and, to a lesser extent, compression in net
interest margin.
Net Interest Income
Net interest income on a tax-equivalent basis increased $4.1 million, or
19%, to $25.8 million for the six months ended June 30, 2004 as compared to the
same quarter in 2003. The tax equivalent basis adjustments for the six months
ended June 30, 2004 and 2003 were $322 thousand and $220 thousand, respectively.
The increase in net interest income was due mostly to a 27.2% growth in interest
earning assets. This interest earning asset growth was funded primarily by
deposit liabilities, which grew 25.7% on average for the six months of 2004 as
compared to the same period in 2003. The increase in interest earning assets and
deposits were attributed to the Company's internal growth and the Bridge View
acquisition. The aforementioned improvement in net interest income was partly
offset by a 29 basis point decline in the net interest margin for the six months
ended June 30, 2004 as compared to the same period in 2003. The decrease in the
net interest margin was due to earning asset yields declining faster than the
Company's cost of funds. The decline in asset yields was mainly attributable to
maturities and prepayments in the loan and securities portfolio, while the
Company's deposit pricing reached historical lows and appears to have become
inelastic.
Interest income, on a tax-equivalent basis, totaled $32.0 million for the
six months ended June 30, 2004, an increase of $3.1 million, or 10.8%, as
compared to the same period in 2003. The increase was mostly attributed to a
$265.6 million, or 27.2%, growth in interest earning assets. The growth in
interest earning assets was the result of increases in average loans and average
investments of $152.3 million
-22-
and $141.1 million, respectively. The increase in interest income was partly
offset by a 76 basis point decline in interest earning asset yields for the six
months ended June 30, 2004 as compared to the same period in 2003.
Interest expense, which totaled $6.2 million for the six months ended June
30, 2004, decreased $1 million, or 13.9%, as compared to the same period in
2003. The decrease in interest expense was a byproduct of the decline in market
interest rates, particularly short-term rates, during 2003. In addition, a
beneficial shift in the composition of the Company's deposits, which is
discussed further in the analysis of financial condition below, also had a
favorable impact on the Company's interest expense. The improved deposit mix
combined with lower short-term interest rates reduced the average rate paid on
interest bearing liabilities by 55 basis points to 1.24% for the six months
ended June 30, 2004 as compared to the same period in 2003. The magnitude of the
benefit derived from the decrease in rates paid on interest bearing liabilities
was partially reduced by the positive growth of deposits. Interest bearing
deposits grew on average 159.2 million, or 20.4%, for the second quarter of 2004
as compared to the same period in 2003.
- ----------------------------------------------------------------------------------------------------------------------------
Analysis of Net Interest Income
- ----------------------------------------------------------------------------------------------------------------------------
for the six months ended June 30,
(dollars in thousands) 2004 2003
(unaudited) ----------------------------------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ------- -------- -------
Assets
Interest earning assets
Loans (1) $ 826,067 $25,908 6.27% $673,735 $23,395 6.94%
Taxable securities (4) 383,388 5,252 2.74 240,454 4,721 3.93
Tax-exempt securities (2) (4) 24,964 794 6.36 26,770 551 4.12
Interest earning deposits 9 - - 4,088 21 1.03
Federal funds sold 7,677 37 0.96 31,436 184 1.17
---------- ------- --------- -------
Total interest-earning assets 1,242,105 31,991 5.15 976,483 28,872 5.91
------- -------
Non-interest earning assets
Cash and due from banks 35,937 29,947
Allowance for loan and lease losses (9,727) (7,910)
Other assets 118,672 72,658
---------- ---------
Total assets $1,386,987 1,071,178
========== =========
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest bearing deposits $940,178 5,588 1.19 $ 780,986 6,823 1.75
Borrowings 60,112 611 2.03 25,629 377 2.94
---------- ------- --------- -------
Total interest-bearing liabilities 1,000,290 6,199 1.24 $ 806,615 7,200 1.79
------- -------
Non-interest bearing liabilities
Demand deposits 228,417 148,771
Other liabilities 14,575 15,006
---------- ---------
Total liabilities (3) 1,243,282 970,392
Stockholders' equity 143,705 100,786
---------- ---------
Total liabilities and stockholders' equity $1,386,987 1,071,178
========== =========
Net interest income (tax-equivalent basis) 25,792 3.91 21,672 4.12
Tax-equivalent basis adjustment (322) (220)
------- -------
Net interest income $25,470 21,452
======= =======
Net interest income as a percent of interest-earning
assets (tax-equivalent basis) 4.15% 4.44%
- --------------------------------------------------------------------------------
(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.
-23-
Provision for Loan and Lease Losses
The provision for loan and lease losses represents management's
calculation of the amount necessary to bring the allowance for loan and lease
losses ("ALLL") to a level that management considers adequate to reflect the
risk of estimated losses inherent in the Company's loan portfolio as of the
balance sheet date. A more detailed discussion of the evaluation of the ALLL can
be found in the section titled "Critical Accounting Policies and Judgments:
Allowance for Loan and Lease Losses" above. In the first six months of 2004 and
2003, the Company's provision for loan and lease losses was $675 thousand and
$795 thousand, respectively.
Non-interest Income
For the six months ended June 30, 2004, non-interest income totaled $5.2
million, an increase of $719 thousand, or 16.0%, as compared to the same period
in 2003. The improvement in non-interest income was mostly due to increases in
net gains on the sale of securities, "other" non-interest income and service
charges on deposits of $800 thousand, $410 thousand and $216 thousand,
respectively. Net gains on the sale of securities for the six months ended June
30, 2004 and 2003, were $819 thousand and $19 thousand, respectively. The
Company experienced strong loan growth during 2004 that was funded by deposit
growth and security sales, which contributed to the improvement in non-interest
income. The growth in "other" non-interest income was largely attributed to an
increase in commercial loan prepayment penalties of $249 thousand. The
improvement in non-interest income was partly offset by a decrease in BOLI
income and a decline in net gain on sale of loans and leases of $575 thousand
and $212 thousand, respectively. The decline in BOLI income was attributed to a
claim on insurance policies in 2003 of $499 thousand, while the decrease in net
gain on sale of loans and leases was due to lower demand for thirty-year
residential mortgage loans.
Non-interest Expense
For the six months ended June 30, 2004, non-interest expense was $17.7
million, an increase of $3.5 million, or 24.5%, when compared to the same period
one year ago. The increase was due largely to the additional operating costs
resulting from the addition of eleven branch locations and the staffing of those
branches acquired as part of the merger with Bridge View. Also contributing to
the increase were normal increases related to salaries, benefits and occupancy
expense.
Income Taxes
Income tax expense as a percentage of pre-tax income was 32.1% for the six
months ended June 30, 2004 as compared to 30.9% for the same period of 2003. The
increase in percentage of income tax expense was in part due to the effect of a
decline in non-taxable BOLI income.
-24-
FINANCIAL CONDITION
Cash and Cash Equivalents
At June 30, 2004, cash and cash equivalents increased $914 thousand to
$32.3 million as compared to December 31, 2003.
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, available for sale ("AFS"), or held to maturity
("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 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, 2004, investment securities totaled $379.9
million and represented 27.1% of total assets, as compared to $452.1 million and
32.6%, respectively, at December 31, 2003. Securities AFS comprised 94.6% of the
total securities portfolio at June 30, 2004 as compared to 95.8% at December 31,
2003. At June 30, 2004, the Company had an unrealized loss of $642 thousand as
compared to a net unrealized gain of $5.5 million at December 31, 2003. The
decrease was attributed to a decline in market interest rates during that
period.
During the first half of 2004, the Company sold securities with a book
value of approximately $57.4 million and recognized $913 thousand in gross gains
and $94 thousand in gross losses. During 2003, the Company sold securities with
a book value of approximately $13.0 million and recognized $478 thousand in
gross gains and $44 thousand in gross losses. In addition during the first half
of 2003, the Company realized gross losses resulting from an acceleration of
premium amortization on certain collateralized mortgage obligations of $415
thousand. The acceleration of premium amortization was largely driven by the
historically high mortgage prepayment speeds due to the low interest rate
environment.
The following table reflects the composition of the securities portfolio:
(in thousands)
-25-
----------------------------------------------
June 30, 2004
----------------------------------------------
(unaudited)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
Securities HTM
Mortgage-backed securities $ 7,643 $ 234 $ - $ 7,877
Obligations of U.S. agencies 3,000 - - 3,000
Obligations of states & political subdivisions 9,926 512 - 10,438
-------- ------ ------ --------
$ 20,569 $ 746 $ - $ 21,315
======== ====== ====== ========
Securities AFS
Mortgage-backed securities $104,222 $1,070 $ 576 $104,716
Obligations of U.S. agencies 221,304 777 2,964 219,117
Obligations of states & political subdivisions 30,638 581 372 30,847
Equity securities 4,587 96 - 4,683
-------- ------ ------ --------
360,751 2,524 3,912 359,363
-------- ------ ------ --------
Total securities $381,320 $3,270 $3,912 $380,678
======== ====== ====== ========
----------------------------------------------
December 31, 2003
----------------------------------------------
(unaudited)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
Securities HTM
Mortgage-backed securities $ 9,850 $ 330 $ 1 $ 10,179
Obligations of states & political subdivisions 9,257 787 - 10,044
-------- ------ ---- --------
$ 19,107 $1,117 $ 1 $ 20,223
-------- ------ ---- --------
Securities AFS
Obligations of U.S. Treasury $ 6,032 $ 5 $ 2 $ 6,035
Mortgage-backed securities 112,981 1,363 157 114,187
Obligations of U.S. agencies 271,339 2,583 762 273,160
Obligations of states & political subdivisions 33,849 1,257 68 35,038
Equity securities 4,396 137 - 4,533
-------- ------ ---- --------
428,597 5,345 989 432,953
-------- ------ ---- --------
Total securities $447,704 $6,462 $990 $453,176
======== ====== ==== ========
At June 30, 2004, the contractual maturities of securities HTM and
securities AFS are as follows: (in thousands) (unaudited)
Securities Securities
HTM AFS
---------------------- ----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------------- ----------------------
Within 1 year $ 4,307 $ 4,339 $ 29,825 $ 29,621
After 1 but within 5 years 9,679 10,005 290,761 289,510
After 5 but within 10 years 5,505 5,831 22,208 22,320
After 10 years 1,078 1,140 13,370 13,230
Equity securities - - 4,587 4,682
-------------------- ---------------------
Total $20,569 $21,315 $360,751 $359,363
==================== =====================
-26-
Loans
Total loans amounted to $883.3 million at June 30, 2004, an increase of
$86.7 million from $796.6 million at December 31, 2003. The growth was
attributed to increases in commercial loans of $43.2 million and residential
mortgage loans of $50.6 million. The increase in commercial loans was largely in
commercial and financial loans and commercial mortgages, which increased $25.0
million and $23.8 million, respectively, for the six month period ended June 30,
2004. The growth in residential mortgage loans was due in part to purchases of
$36.4 million. These loans were subjected to the Company's independent credit
analysis prior to purchase. Somewhat offsetting the aforementioned increases
were decreases in consumer and commercial leases of $7.8 million and $4.1
million, respectively.
----------- ------------
June 30, December 31,
(in thousands) 2004 2003
----------- ------------
(unaudited)
Amount of loans by type
Real estate-mortgage
1-4 family residential
First liens $141,948 $100,286
Junior liens 3,191 4,138
Home equity 146,313 136,477
Commercial 353,878 330,040
Construction 29,557 31,077
-------- --------
674,887 602,018
-------- --------
Commercial loans
Commercial and financial 174,498 149,462
Lease financing 24,315 28,440
-------- --------
198,813 177,902
-------- --------
Consumer loans
Lease financing 4,624 12,416
Installment 4,942 4,245
-------- --------
9,566 16,661
-------- --------
Total $883,266 $796,581
======== ========
-27-
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, 2004 amounted to $6.8 million as compared to
$8.8 million at December 31, 2003. The ratio of nonperforming assets to total
loans and foreclosed real estate and other repossessed assets decreased to 0.77%
at June 30, 2004 from 1.10% at December 31, 2003.
The following table lists nonaccrual loans, restructured loans and
foreclosed real estate and other repossessed assets at June 30, 2004, and
December 31, 2003: (in thousands)
----------- ------------
June 30, December 31,
2004 2003
----------- ------------
(unaudited)
Nonperforming loans $6,573 $8,570
Foreclosed real estate and other
repossessed assets 201 230
------ ------
Total nonperforming assets $6,774 $8,800
====== ======
Allowance for Loan and Lease Losses
The ALLL is generally established through periodic charges to income.
During the six months ended June 30, 2004, the ALLL remained relatively stable
at $9.8 million. Loan losses are charged against the ALLL when management
believes that the probable future collection of principal is unlikely.
Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is
considered inadequate to absorb future loan losses on existing loans, based on,
but not limited to, increases in the size of the loan portfolio, increases in
charge-offs or changes in the risk characteristics of the loan portfolio, then
the provision for loan and lease losses is increased.
The Company considers the ALLL of $9.8 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 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.
-28-
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 months ended June 30, 2004 and 2003: (dollars in thousands)
(unaudited)
Three months ended Six months ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Average loans outstanding $845,747 $732,516 $826,067 $673,735
======== ======== ======== ========
Allowance at beginning of period 9,635 7,226 9,641 7,207
-------- -------- -------- --------
Loans charged off
Real estate 9 - 76 -
Commercial and financial 2 - 57 25
Commercial lease financing 134 147 411 355
Consumer loans 26 5 44 19
-------- -------- -------- --------
Total 171 152 588 399
-------- -------- -------- --------
Recoveries of loans previously charged off
Real estate 4 - 4 -
Commercial and financial 6 - 6 -
Commercial lease financing 12 2 48 2
Consumer loans 2 2 2 3
-------- -------- -------- --------
Total 24 4 60 5
-------- -------- -------- --------
Additions due to merger - 1,929 - 1,929
Provision for loan and lease losses 300 530 675 795
-------- -------- -------- --------
Allowance at end of period $9,788 $9,537 $9,788 $9,537
======== ======== ======== ========
Allowance to total loans (end of period) 1.11% 1.18% 1.11% 1.17%
Ratio of net charge-offs to average loans (annualized) 0.07% 0.08% 0.13% 0.12%
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. At June 30, 2004,
such deposits amounted to $666.2 million representing 56.1% of total deposits
compared to 56.3% of total deposits at December 31, 2003. The Company attributes
its success in growing deposits to the emphasis it places on 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, 2004, total deposits increased $30.0 million, or 2.5%,
remaining relatively stable at $1.2 billion. We benefited, however from a change
in the mix as we experienced growth in core deposits (non time deposits) of
$29.7 million, or 3.4% and time deposits increased $309 thousand, or 0.1%,
respectively, at June 30, 2004 as compared to December 31, 2003. The growth in
core deposits was due to increases in interest bearing demand and non-interest
demand of $14.8 million and $14.6 million,
-29-
respectively. Time deposits amounted to $282.3 million, or 23.8%, of total
deposits at June 30, 2004, as compared to $282.0 million, or 24.4%, at December
31, 2003.
For the six months ended June 30, 2004, the Company's overall yield on
deposits declined by 51 basis points from 1.47% to 0.96%, as compared to the
same period last year. The decrease was attributed predominately to changes in
market interest rates and a change in the composition of deposit liabilities.
The following table reflects the composition of deposit liabilities:
(dollars in thousands)
----------- ------------
June 30, December 31,
2004 2003
----------- ------------
(unaudited)
Non-interest Demand $ 238,317 $ 223,745
Interest Bearing Demand 461,559 446,786
Savings 116,613 120,136
Money Market Savings 88,071 84,162
Time Deposits <$100,000 261,004 265,356
Time Deposits >$100,000 21,274 16,613
---------- ----------
Total $1,186,838 $1,156,798
========== ==========
-30-
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Market risk is generally described as the sensitivity of income to adverse
changes in interest rates, foreign currency exchange rates, commodity prices,
and other relevant market rates or prices. Market rate sensitive instruments
include: financial instruments such as investments, loans, mortgage-backed
securities, deposits, borrowings and other debt obligations; derivative
financial instruments, such as futures, forwards, swaps and options; and
derivative commodity instruments, such as commodity futures, forwards, swaps and
options that are permitted to be settled in cash or another financial
instrument.
The Company does not have any material exposure to foreign currency
exchange rate risk or commodity price risk. The Company did not enter into any
market rate sensitive instruments for trading purposes nor did it engage in any
trading or hedging transactions utilizing derivative financial instruments
during the first six months of 2004. 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, 2004, the Company simulated the effects
on net interest income given an instantaneous and parallel shift in the yield
curve of up to a 200 basis point rising interest rate environment and a 100
basis point declining interest rate environment. Based on that simulation, it
was
-31-
estimated that net interest income, over a twelve-month horizon, would not
decrease by more than 7.1%. At June 30, 2004, the Company was within policy
limits established by the board of directors for changes in net interest income
and future economic value of equity. The following table illustrates the effects
on net interest income given an instantaneous and parallel shift in the yield
curve of up to a 200 basis point rising interest rate environment and a 100
basis point declining interest rate environment: (unaudited)
Net Interest Income Sensitivity Simulation
Percentage Change in Estimated Net Interest
Income over a twelve month horizon
-------------------------------------------
June 30,
2004 2003
---- ----
+200 basis points -7.1 % -1.3 %
+100 basis points -2.6 0.6
-100 basis points -3.4 -6.6
-200 basis points * * %
* Not simulated due to the historically low interest rate environment.
The simulation described above does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape;
prepayments on loans and securities; deposit decay rates; pricing decisions on
loans and deposits; reinvestment/replacement of asset and liability cashflows;
and others. While assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions including how customer preferences or
competitor influences might change.
Further, as market conditions vary from those assumed in the simulation,
actual results will also differ due to: prepayment/refinancing levels deviating
from those assumed; the varying impact of interest rate changes on caps or
floors on adjustable rate assets; the potential effect of changing debt service
levels on customers with adjustable rate loans; depositor early withdrawals and
product preference changes; and other internal/external variables. Furthermore,
the simulation does not reflect actions that ALCO might take in response to
anticipated changes in interest rates or competitive conditions in the market
place.
In addition to the above-mentioned techniques, the Company utilizes
sensitivity gap analysis as an interest rate risk measurement. The sensitivity
gap analysis is determined by analyzing the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest bearing liabilities maturing or repricing within that
same period of time. Sensitivity gap analysis provides an indication of the
extent to which the Company's net interest income may be affected
-32-
by future changes in market interest rates. The cumulative gap position
expressed as a percentage of total assets provides one relative measure of the
Company's interest rate exposure.
The cumulative gap between the Company's interest-rate-sensitive assets
and its interest-rate-sensitive liabilities repricing within a one-year period
was a negative 14.8% at June 30, 2004. Since the cumulative gap was negative,
the Company has a "negative gap" position, which theoretically will cause its
assets to reprice more slowly than its deposit liabilities. In a declining
interest rate environment, interest costs may be expected to fall faster than
the interest received on earning assets, thus increasing the net interest
spread. If interest rates increase, theoretically a negative gap means that the
interest received on earning assets may be expected to increase more slowly than
the interest paid on the Company's liabilities therefore decreasing the net
interest spread.
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 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.
At June 30, 2004, 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, 2004,
the minimum leverage ratio requirement to be considered adequately capitalized
was 3%.
-33-
The capital levels of the Company and the Bank at June 30, 2004, 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.
The Company's and the Bank's capital amounts and ratios are as follows:
(dollars in thousands)
To Be "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of June 30, 2004: (unaudited)
Total Capital (to Risk Weighted Assets):
The Company $95,294 10.16% $74,998 8.00% N/A N/A
The Bank 95,073 10.14 74,973 8.00 $93,717 10.00%
Tier 1 Capital (to Risk Weighted Assets):
The Company 85,366 9.11 $37,499 4.00 N/A N/A
The Bank 85,146 9.09 37,487 4.00 56,230 6.00
Tier 1 Capital (to Average Assets):
The Company 85,366 6.40 $40,012 3.00 N/A N/A
The Bank 85,146 6.40 39,886 3.00 66,476 5.00
As of December 31, 2003:
Total Capital (to Risk Weighted Assets):
The Company $91,694 10.46% $70,146 8.00% N/A N/A
The Bank 91,358 10.35 70,637 8.00 $88,296 10.00%
Tier 1 Capital (to Risk Weighted Assets):
The Company 81,913 9.34 35,073 4.00 N/A N/A
The Bank 81,576 9.24 35,319 4.00 52,978 6.00
Tier 1 Capital (to Average Assets):
The Company 81,913 6.24 39,367 3.00 N/A N/A
The Bank 81,576 6.22 39,318 3.00 65,530 5.00
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, 2004, the total of such assets amounted to $32.3 million, or 2.3%, of total
assets, compared to $31.4 million, or 2.3%, of total assets at December 31,
2003. Fluctuations in cash and cash equivalents are largely due to sales of
securities, deposit growth and loan prepayments, which produce funds that are
placed in federal funds sold or interest earning deposits pending investment in
loans and securities.
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, 2004 and December 31, 2003, total deposits amounted to
$1.2 billion. 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, 2004,
advances from the FHLB and REPOS amounted to $46.5 million and $12.3 million,
respectively, as compared to $56.5 million and $15.6 million, respectively, at
December 31, 2003.
-34-
Net loans and leases at June 30, 2004 amounted to $873.5 million, an
increase of $86.6 million, from $786.9 million at December 31, 2003. Another
significant liquidity source is the Company's securities portfolio. Total
securities at June 30, 2004 amounted to $379.9 million, a decrease of $72.2
million, from $452.1 million at December 31, 2003. At June 30, 2004 securities
AFS amounted to $359.4 million, or 94.6%, of total securities compared to $433.0
million, or 95.8%, of total securities at December 31, 2003.
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
$100.0 million line of credit available through its membership in the FHLB.
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 Condensed Consolidated
Balance Sheets. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates and may require
collateral from the borrower if deemed necessary by the Company. Standby letters
of credit are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party up to a stipulated amount and with
specified terms and conditions. Commitments to extend credit and standby letters
of credit are not recorded on the Company's condensed consolidated balance sheet
until the instrument is exercised. At June 30, 2004 outstanding commitments to
fund loans totaled $277.4 million and outstanding standby letters of credit
totaled $1.9 million.
The Company historically paid quarterly cash dividends and anticipates
continuing paying quarterly dividends in the future. The Company could, if
necessary, modify the amount or frequency, of dividends as an additional source
of liquidity. There are imposed dividend restrictions on the Bank, which are
described in Note 18 "Restrictions of Subsidiary Bank Dividends" in the Notes to
Consolidated Financial Statements in the Company's 2003 Annual Report on Form
10-K. Management believes that the Company has sufficient cash flow and
borrowing capacity to fund all outstanding commitments and letters of credit and
to maintain proper levels of liquidity.
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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, 2004, 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.
The Company maintains internal control over financial reporting. During the
quarter ended June 30, 2004, there have been no changes in our internal controls
over financial reporting that have materially affected, or are reasonably likely
to materially affect, those controls.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Reference is also made to Note 4 of the Company's Consolidated
Financial Statements in this Form 10-Q.
Item 2. Change in Securities and Use of Proceeds
Set forth below is certain information regarding repurchases of our
common stock during the quarter.
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
(a) The company held its Annual Meeting of Shareholders on April
22, 2004.
(b) Each of the persons nominated for director was elected; and
the selection of Deloitte & Touche LLP as the Company's
independent auditors for 2004 was ratified. The following are
the voting results on each of these matters:
Against
Or
For Withheld Abstentions
---------- ---------- -----------
(1) ELECTION OF DIRECTORS
Anthony D. Andora 9,927,737 857,088 0
Gerald A. Calabrese, Jr. 10,512,611 272,214 0
David R. Ficca 10,658,661 126,164 0
Nicholas R. Marcalus 10,455,293 329,532 0
Benjamin Rosenzweig 9,844,587 940,238 0
John A. Schepisi 10,655,228 129,597 0
Joseph C. Parisi 10,327,941 456,884 0
(2) Ratification of the selection of Deloitte &
Touche LLP as the Company's independent
Auditors for 2004. 10,663,599 33,267 87,958
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) 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
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32 Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
During the quarter ended June 30, 2004, the Company filed the
following Current Report on Form 8-K:
Form 8-K filed April 21, 2004, declaring a dividend for the
second quarter of 2004.
Form 8-K filed April 3, 2004, reporting earnings for the
period ending March 31, 2004.
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, 2004
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