EX-13 4 exhibit13.txt PORTIONS OF THE ANNUAL REPORT TO SHAREHOLDERS Management's Discussion and Analysis of Financial Condition and Results of Operations This section presents management's discussion and analysis of the consolidated results of operations and financial condition of Interchange Financial Services Corporation (the "Company"). The discussion and analysis should be read in conjunction with the Company's consolidated financial statements and notes thereto on pages 29 through 47 and the summary consolidated data included elsewhere in this report. On May 31, 1998, the Company acquired The Jersey Bank for Savings ("Jersey Bank"), which maintained two banking offices, both located within the Company's delineated market area. At that date, Jersey Bank had total assets of $78.6 million and total deposits of $69.8 million. The transaction was accounted for as a pooling-of-interests. Each outstanding share of Jersey Bank's common stock, including shares of common stock that had been converted from outstanding shares of preferred stock, was converted into 1.5 shares of the Company's common stock. Total consideration tendered in the transaction amounted to 780,198 shares of the Company's common stock. Earnings Summary Diluted earnings per of common share for the year ended December 31, 2000 increased $0.05, or 3.7%, to $1.41 when compared to 1999. Basic earnings per of common share for the year ended December 31, 2000 amounted to $1.42, an increase of $0.05, or 3.6%, when compared to 1999. Net income for the year 2000 declined $379 thousand, or 3.9%, to $9.3 million when compared to 1999. The decline was due to the Company benefiting from non-recurring items in 1999 and incurring costs associated with expansion programs in 2000. These items are described in detail in the sections titled "non-interest income" and "non-interest expenses". Adjusting for the major non-recurring items in each of the periods, net income increased $465 thousand or 5.6% and diluted earnings per of common share increased $0.16 or 13.6% in 2000 as compared to the 1999 period. These results produced a return on average assets of 1.24% and a return on average equity of 16.18%. Furthermore, the favorable earnings growth resulted in an increase in the quarterly dividend paid on common stock to an annualized rate of $0.50 in 2000 as compared to $0.48 in 1999. The Company's operating performance for 2000 reflects favorable loan and deposit growth, healthy asset quality and a disciplined approach in managing non-interest expenses while expanding operations and the Company's investment in technology. Net income for the year ended December 31, 1999 was $9.6 million as compared with $8.6 million in 1998, an increase of 11.9%. For the same period, diluted earnings per share rose 14.3% to $1.36 in 1999 from $1.19 in 1998. Basic earnings per share in 1999 were $1.37 as compared to $1.20 in 1998. Excluding the 1998 merger related charge of $898 thousand, net of tax, net income for 1999 would have increased $128 thousand or 1.3% as compared to 1998. Diluted earnings per share would have increased 3.8% to $1.36 in 1999 as compared to $1.31 in 1998. Basic earnings per share would have increased 3.8% to $1.37 as compared to $1.32 in 1998. The Company's returns on average equity and average assets were 15.52% and 1.39%, respectively, in 1999 as compared to 14.53% and 1.31%, respectively, in 1998.
Table 1 ------------------------------------------------------------------------------------------------------- Summary of Operating Results ------------------------------------------------------------------------------------------------------- 2000 1999 1998 ------------- ----------- ----------- Net income (in thousands) $9,256 $ 9,635 $8,609 Basic earnings per common share 1.42 1.37 1.20 Diluted earnings per common share 1.41 1.36 1.19 Return on average total assets 1.24 % 1.39 % 1.31 % Return on average total equity 16.18 15.52 14.53 Dividend payout ratio* 35.24 35.04 32.81 Average total stockholders' equity to average total assets 7.64 8.99 9.00 * Cash dividends declared on common shares to net income.
Results of Operations Net Interest Income Net interest income is the difference between the interest the company earns on its assets, principally loans and investment securities, and interest it pays on its deposits and borrowings. When expressed as a percentage of average interest-earning assets, it is referred to as net interest margin. Table 2 sets forth a summary of average interest-earning assets and interest-bearing liabilities for the years ended December 31, 2000, 1999 and 1998, together with the interest earned and paid on each major type of asset and liability account during such periods. The average rates on the earning assets and the average cost of interest-bearing liabilities during such periods are also summarized. Table 3, which presents changes in interest income and interest expense by each major asset and liability category for 2000 and 1999, illustrates the impact of average volume growth (estimated according to prior year rates) and rate changes (estimated on the basis of prior year volumes). Changes not due solely to changes in either volume or rates have been allocated based on the relationship of changes in volume and changes in rates. Figures are adjusted to a taxable equivalent basis to recognize the income from tax-exempt assets as if the interest was taxable, thereby allowing a uniform comparison to be made between yields on assets. 13
Table 2 ------------------------------------------------------------------------------------------------------------------------------------ Analysis of Net Interest Income ------------------------------------------------------------------------------------------------------------------------------------ for the years ended December 31, (dollars in thousands) 2000 1999 1998 --------------------------- --------------------------- -------------------------- Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate --------------------------- --------------------------- -------------------------- Assets Interest earning assets Loans (1) $536,971 $44,499 8.29 % $494,022 $39,521 8.00 % $462,296 $38,904 8.42 % Taxable securities (4) 154,947 10,054 6.49 142,786 8,692 6.09 132,433 8,206 6.20 Tax-exempt securities (2)(4) 12,251 696 5.68 11,578 650 5.61 4,428 234 5.28 Federal funds sold 10,944 700 6.40 12,142 596 4.91 27,318 1,474 5.40 Interest-bearing demand deposits - - - - - - 1,024 55 5.37 -------- -------- -------- ------- ------- ------- Total interest-earning assets 715,113 55,949 7.82 660,528 49,459 7.49 627,499 48,873 7.79 ------- ------ ------- Non-interest earning assets Cash and due from banks 19,403 18,386 17,618 Allowance for loan and lease losses (5,953) (5,638) (5,437) Other assets 19,829 17,682 18,336 -------- -------- ------- Total assets $748,392 $690,958 $658,016 ======== ======== ======== Liabilities and stockholders' equity Interest-bearing liabilities Demand deposits $231,480 7,754 3.35 $201,150 6,055 3.01 $171,546 5,573 3.25 Savings deposits 117,037 3,624 3.10 128,700 2,992 2.33 132,735 3,790 2.86 Time deposits 190,890 10,682 5.60 172,005 8,653 5.03 171,462 9,104 5.31 Short-term borrowings 24,565 1,417 5.77 18,501 1,000 5.41 14,723 807 5.48 Long-term borrowings 11,707 750 6.41 1,302 83 6.37 9,828 590 6.00 -------- -------- -------- ----- ------- ------ Total interest-bearing liabilities 575,679 24,227 4.21 521,658 18,783 3.60 500,294 19,864 3.97 -------- ----- ------ Non-interest bearing liabilities Demand deposits 109,039 102,194 94,568 Other liabilities 6,470 5,012 3,903 -------- -------- ------- Total liabilities (3) 691,188 628,864 598,765 Stockholders' equity 57,204 62,094 59,251 -------- -------- ------- Total liabilities and stockholders' equity $748,392 $690,958 $658,016 ======== ======== ======== Net interest income (tax-equivalent basis) 31,722 3.61 30,676 3.89 29,009 3.82 Tax-equivalent basis adjustment (158) (158) (53) ----- ----- ---- Net interest income $31,564 $30,518 $28,956 ======== ======== ======= Net interest income as a percent of interest-earning assets (tax-equivalent basis) 4.44 % 4.64 % 4.62 % ------------------------------------------------------------------------------------------------------------------------------------ (1) Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan portfolio. (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.
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Table 3 ------------------------------------------------------------------------------------------------------------------------------ Effect of Volume and Rate Changes on Net Interest Income ------------------------------------------------------------------------------------------------------------------------------ (in thousands) Year ended December 31, Year ended December 31, 2000 compared with 1999 1999 compared with 1998 increase (decrease) increase (decrease) due to change in: due to change in: --------------------------------------------- ------------------------------------ Net Net Average Average Increase Average Average Increase Volume Rate (Decrease) Volume Rate (Decrease) ------------- -------------- ---------------- ---------- ----------- ------------- Interest income Loans $3,522 $1,456 $ 4,978 $2,671 $(2,054) $617 Taxable securities 769 593 1,362 641 (155) 486 Tax-exempt securities 38 8 46 401 15 416 Federal funds sold (77) 181 104 (755) (123) (878) Interest-bearing demand deposits - - - (55) - (55) ------------- -------------- ---------------- ---------- ----------- ------------- Total interest income 4,252 2,238 6,490 2,903 (2,317) 586 ------------- -------------- ---------------- --------- ----------- ------------- Interest expense Demand deposits 972 727 1,699 962 (480) 482 Savings deposits (354) 986 632 (112) (686) (798) Time deposits 1,003 1,026 2,029 29 (480) (451) Short-term borrowings 346 71 417 207 (14) 193 Long-term borrowings 667 - 667 (546) 39 (507) ------------- -------------- ---------------- ---------- ----------- ------------- Total interest expense 2,634 2,810 5,444 540 (1,621) (1,081) ------------- -------------- ---------------- ---------- ----------- ------------- Change in net interest income $ 1,618 $ (572) $ 1,046 $2,363 $ (696) $ 1,667 ============= ============== ================ ========== =========== ============= --------------------------------------------------------------------------------------------------------------------------- Non-performing loans are included in interest-earning assets.
Net interest income, on a taxable equivalent basis, amounted to $31.7 million in 2000, an increase of $1.0 million, or 3.4%, from $30.7 million in 1999. The increase in net interest income was primarily due to growth in average interest-earning assets of $54.6 million, which was largely funded by a $44.4 million growth in average deposits. The growth in average deposits occurred mostly in interest-bearing demand and time deposits. The growth in interest-bearing liabilities along with an increase in the Company's cost of funds partly offset some of the growth in interest income. The net interest margin decreased 20 basis points to 4.44% for 2000 as compared to 4.64% for 1999, due largely to an increase in the Company's funding cost resulting from an increase in short-term market interest rates and a change in the composition ("mix") of retail deposits. Interest income, on a taxable equivalent basis, totaled $55.9 million in 2000, an increase of $6.5 million or 13.1% from $49.5 million in 1999. The increase was largely driven by the growth in average interest-earning assets. Contributing to the growth in interest income was an increase of 33 basis points in the average yield on interest-earning assets to 7.82% in 2000 as compared to 1999. The increase in average interest-earning assets was principally due to growth in loans. The average balance of commercial and commercial mortgage loans increased by $27.0 million or 12.1% to $250.1 million in 2000, as compared to $223.1 million in 1999. In addition, equipment-financing leases generated by the Bank's leasing subsidiary, Interchange Capital Company L.L.C. ("ICC") grew $11.2 million, on average, for 2000 at an average lease yield of 12.36%. The average balance of consumer loans (comprised mostly of home equity loans) totaled $275.6 million in 2000, compared to $270.1 million in 1999, an increase of $5.5 million or 2.1%. The increase in average loans outstanding and an increase in average loan yields of 29 basis points had the most significant impact on interest income growth for 2000 as compared to 1999. Also, contributing to the growth in interest income was a $1.4 million or 15.1% increase in interest income from investment securities, which benefited from an average growth of $12.9 million and a 38 basis points increase in average yield for 2000 as compared to 1999. Interest expense totaled $24.2 million in 2000, an increase of $5.4 million or 29.0% as compared to 1999. Of the total growth in interest expense, $2.8 million was predominantly due to a 61 basis point increase in the average rates paid on interest-bearing liabilities, which increased to 4.21% in 2000 as compared to 3.60% in 1999. This increase in average rates was largely due to increases in short-term market interest rates and a growth in time deposits. In addition, growth in average interest-bearing liabilities of $54.0 million contributed to the increase in interest expense for 2000. Average interest-bearing demand deposits grew $30.3 million or 15.1% in 2000, which is largely attributable to the Company's efforts in marketing and sales. Contributing to the growth in average interest-bearing liabilities was an increase in average time deposits and borrowings of $18.9 million or 11.0% and $16.5 million or 83.2%, respectively in 2000 as compared to 1999. The growth in average interest- bearing liabilities was tempered by a decline in average savings deposits of $11.7 million or 9.1%. Net interest income, on a taxable equivalent basis, amounted to $30.7 million in 1999, an increase of $1.7 million, or 5.7%, from $29.0 million in 1998. The increase in net interest income was principally due to the growth in interest earning assets of $33.0 million that was funded largely by a $33.7 million growth in deposits. The growth in deposits, which occurred predominantly in interest and non-interest-bearing demand deposits, had a positive effect on the mix of retail deposits. Net interest income was favorably affected by a change in the retail deposit mix, which served to reduce the yield on total deposits. The net interest 15 margin increased 2 basis points to 4.64% for 1999 as compared to 4.62% for 1998, due largely to the positive effects on the Company's funding cost resulting from the decline in market interest rates. Interest income, on a taxable equivalent basis, totaled $49.5 million in 1999, an increase of $586 thousand or 1.2% from $48.9 million in 1998. The increase was principally driven by the growth in average interest-earning assets. Average yields on interest-earning assets decreased 30 basis points to 7.49% in 1999 as compared to 1998. The increase in average interest-earning assets was principally due to growth in loan originations. The average balance of commercial and commercial mortgage loans increased by $23.1 million or 11.6% to $223.1 million in 1999, as compared to $200.0 million in 1998. The average balance of consumer loans totaled $270.2 million in 1999, compared to $256.9 million in 1998, an increase of $13.3 million or 5.2%. The increase in average loans outstanding more than offset the effects of the decline in yield on interest earning assets resulting from a decrease in market interest rates. Interest income also benefited from a $17.5 million growth in the securities portfolio. The growth was partly offset by a decline in the average yield of the securities portfolio. The decline in average yield was largely due to the decline in market interest rates during 1999. A decline in average federal funds sold of $15.2 million also negatively impacted interest income. Interest expense totaled $18.8 million in 1999, a decrease of $1.1 million or 5.4% as compared to 1998. The decrease was principally due to a decline of 37 basis points in the average rates paid on interest-bearing liabilities to 3.60% in 1999 as compared to 3.97% in 1998. This decline in average rates was largely due to a decrease in market interest rates and a more favorable retail deposit mix. The positive effects of the decline in interest rates were partly offset by a $21.4 million growth in average interest-bearing liabilities, specifically interest-bearing demand deposits. The average balance of interest-bearing demand deposits grew $29.6 million or 17.3% to $201.2 million in 1999 as compared to 1998. Total average interest and non-interest-bearing demand deposits grew $37.2 million or 14.0%, in 1999, which is largely attributable to the Company's continued efforts in marketing and sales. In addition, commercial loans resulting from these selling efforts generally carry compensating deposit balances in the form of demand deposits and further contributed to the growth. Non-interest income Non-interest income consists of all income other than interest and dividend income and is principally derived from: service charges on deposits; loan fees; commissions on sales of annuities and mutual funds; rental of safe deposit space; income from the collection of principal on acquired loans in excess of their carrying value and net gains on sales of assets, which includes lease syndication fee income. The Company recognizes the importance of supplementing net interest income with other sources of income and maintains a management committee that explores new opportunities to generate non-interest income. In 2000, non-interest income decreased $1.1 million to $4.2 million from 1999. The change was largely attributable to non-recurring items during 1999. These non-recurring items included gains from the sales of securities, collections of principal on acquired loans in excess of their carrying value, and sale of the Company's VISA(TM) and merchant credit card portfolio. Adjusted for non-recurring items, non-interest income for 2000 increased $287 thousand or 8.5% as compared to 1999. The increase for 2000 was comprised of increases in lease syndication fee income, service charges on deposits and other non-interest income in the amount of $136 thousand, $86 thousand and $65 thousand, respectively. Other non-interest income includes, but is not limited to, income from servicing fees, commissions on sales of annuities and mutual funds, loan fees and safe deposit rental fees. In 2000, the net gain from the sale of securities amounted to $312 thousand, a decrease of $547 thousand or 63.7% from $859 thousand in 1999. Included in the net gain is $311 thousand from the sale of available for sale securities and $1 thousand from the sale of a held to maturity security (scheduled to mature within 3 months). In 1999, the net gain included $856 thousand from the sale of available for sale securities and $3 thousand from the sale of a held to maturity security (scheduled to mature within 3 months). In 2000, the collection of principal on acquired loans in excess of their carrying value decreased $453 thousand as compared to 1999. Gains recorded on the sales of the Company's VISA(TM) and merchant credit card portfolio of $86 thousand and $329 thousand, respectively, occurred in 1999. In 1999, non-interest income totaled $5.3 million, an increase of $411 thousand or 8.3% over 1998. The growth in non-interest income was largely due to an increase in the collection of principal on acquired loans in excess of their carrying value and gains from the sale of the Company's VISA(TM) and merchant credit card portfolios. In 1999, the net gain from the sale of securities amounted to $859 thousand, a decrease of $162 thousand or 15.9% from $1.0 million in 1998. Included in the net gain is $856 thousand from the sale of available for sale securities and $3 thousand from the sale of a held to maturity security (scheduled to mature within 3 months). In 1998, the net gain included $876 thousand from the sale of available for sale securities and $145 thousand from the call of a security before its maturity. The gain from the VISA(TM) portfolio sale is included in net gain on sale of loans and the gain from the sale of the merchant credit card portfolio is included in other income. The VISA(TM) and merchant credit card portfolios were sold following an evaluation of the risk/reward profiles of the portfolios, which determined that the risk associated with the portfolios exceeded the levels deemed acceptable by the Company. During 1998, there were no gains from the sale of VISA(TM) and merchant credit card portfolios. In 1999, the collection of principal on acquired loans in excess of their carrying value increased $508 thousand as compared to 1998. The increase in non-interest income for 1999 was negatively impacted by a decrease in service charges on deposits and other non-interest income in the amount of $251 thousand and $99 thousand, respectively. Included in other income for 1998 was $53 thousand from the sale of the reverse mortgage-servicing portfolio.
Table 4 ----------------------------------------------------------------------------------------------------------- Non-interest Income ----------------------------------------------------------------------------------------------------------- for the years ended December 31, (in thousands) 2000 1999 1998 ------ ------ ------- Service fees on deposit accounts $2,386 $2,300 $2,551 Net gain on sale of securities 312 859 1,021 Net gain on sale of loans 136 86 - Net gains on sale of merchant credit card portfolio - 329 - Collection of principal on acquired loans in excess of their carrying value 229 682 174 All other 1,148 1,083 1,182 ------ ------ ------- $4,211 $5,339 $4,928 ====== ====== =======
16 Non-interest Expenses Non-interest expenses increased by $1.1 million, or 5.6%, to $21.2 million in 2000 as compared to 1999. This increase was due mostly to the Bank's expansion of its operations, which included, but was not limited to ICC, the Bank-Line center and two new branches, Waldwick and Ramsey, New Jersey. Salaries and benefits, the largest component of non-interest expenses, increased $769 thousand or 7.5% during 2000. The Bank's expansion programs described above, which resulted in approximately $824 thousand of growth in salaries and benefits, comprised most of the increase. Staffing vacancies and consolidations offset some of the growth in salaries and benefits. The same expansion also was the principal cause for the increase in occupancy and furniture and equipment expense of $252 thousand, of which $231 thousand was due to the expansion. The increase in non-interest expenses was also impacted by increases in Federal Deposit Insurance Corporation premiums and data processing fees of $50 thousand and $58 thousand, respectively. During 2000, two non-recurring items occurred which affect the earning comparison with 1999: the Company paid $118 thousand for a legal settlement relating to the interpretation of past rental adjustments on a branch office and offsetting this expense was a credit of $165 thousand arising from an adjustment to an actuarial assumption related to the outside directors retirement plan. Non-interest expenses totaled $20.1 million for 1999; an increase of $647 thousand or 3.3% from $19.4 million as compared to 1998. Excluding the one-time charges that occurred in 1998 associated with the acquisition of Jersey Bank and the 1998 recognition of $474 thousand in cash surrender value of certain directors' life insurance policies, non-interest expenses for 1999 increased $1.6 million or 8.5% as compared to 1998. In 1999, salaries and benefits increased $828 thousand or 8.8% when compared to the same period in 1998 due to normal promotions, salary increases and the additions to staff associated with the new branch opening in Paramus, New Jersey. Occupancy and furniture and equipment expense increased $303 thousand when compared to the same period in 1998 of which approximately $176 thousand of the increase can be attributed to a full year of operations of the Paramus branch, which was opened in the fourth quarter of 1998. Contributing to the increase in non-interest expenses for 1999 were higher advertising and promotion expenses of $168 thousand, an increase in Y2K expenses of $61 thousand, and approximately $70 thousand in expenses associated with the establishment of ICC. All other expenses increased by $151 thousand or 3.6% for 1999 as compared to 1998. One of the Company's goals is to control expenses in order to maximize earnings and shareholder value. Generally, the efficiency ratio is one method utilized to measure operating expenses. The lower the efficiency ratio the more effective the Company is in utilizing its resources to produce income. The Company's efficiency ratio was 58.5%, 56.8% and 53.6% in 2000, 1999 and 1998, respectively. In 2000, the efficiency ratio rose due to the overhead impact of the Waldwick and Ramsey offices as well as the ICC leasing subsidiary and the Bank-Line center, all as a result of the Company's expansion programs, which are intended to enhance the Company's franchise value in its trade area. However, the Company still managed to outperform its peers as the national peer group average was 60.6% (peer group data as of September 30, 2000 - based upon the most recent published report by SNL Securities). The national peer group average was 60.0% for 1999 and 1998 (published by SNL Securities).
Table 5 ------------------------------------------------------------------------- Non-interest Expenses ------------------------------------------------------------------------- for the years ended December 31, (in thousands) 2000 1999 1998 -------- ------- ------- Salaries and benefits $ 11,034 $ 10,265 $ 9,437 Occupancy, furniture and equipment 3,995 3,743 3,440 Advertising and promotion 1,065 1,033 865 Acquisition - - 1,392 Other expenses Professional fees 1,120 1,101 1,184 Directors' fees, travel and retirement 504 546 88 Data Processing 575 517 538 All other 2,884 2,858 2,472 -------- ------- ------- $21,177 $20,063 $19,416 ======== ======= =======
Income Taxes In 2000, income taxes amounted to $4.6 million as compared to $5.0 million and $4.9 million for 1999 and 1998, respectively. The effective tax rate in 2000 was 33.2% as compared to 34.0% and 36.3% for 1999 and 1998, respectively. Detailed information on income taxes is shown in Notes 1 and 16 to the Consolidated Financial Statements. Financial Condition Loan Portfolio At December 31, 2000, total loans amounted to $560.9 million, an increase of $48.9 million or 9.6% over the previous year. The growth was predominately in commercial loans and lease financing, which increased $28.4 million and $19.3 million, respectively. Of the total commercial loan growth, commercial real estate mortgage loans grew $15.4 million to $181.7 million and represented 32.4% of total loans as compared to $166.4 million or 32.5% of all loans at the end of 1999. These loans are secured primarily by first priority mortgage liens on owner-occupied commercial properties. Commercial and financial loans grew $13.0 million and were primarily in adjustable rate time and demand loan products. The growth in lease financing was attributed to ICC, which in its first year of operations produced approximately $17.4 million in equipment financing leases in 2000, of which $2.3 million were syndicated (sold). ICC generated $136 thousand in non-interest income from syndication activity. In addition, ICC purchased $7.4 million of equipment leases during 2000. The average equipment lease balance at December 31, 2000 was approximately $22 thousand. The commercial loan growth was largely within the subsidiary Bank's delineated community, which confirms the Company's pledge of striving to be the largest community-based banking organization in Bergen County, New Jersey dedicated to community service and helping its customers grow and prosper. While a significant portion of the Company's loans are collateralized by real estate located in northern New Jersey, the Company does not have any concentration of loans in any single industry classified under the North American Industry Classification System, which exceeds 6% of its total loans. 17
Table 6 ---------------------------------------------------------------------------------------------------------- Loan Portfolio ---------------------------------------------------------------------------------------------------------- at December 31, 2000 1999 1998 1997 1996 --------------- ------------ ----------- ------------ ------------ Amounts of loans by type (in thousands) Commercial and financial $ 76,702 $ 63,684 $ 64,067 $ 51,573 $ 51,908 Real estate-construction 3,755 4,008 974 4,229 4,799 Real estate-mortgage 1-4 family residential First liens 110,369 110,269 89,852 73,309 62,170 Junior liens 11,195 9,829 14,322 16,795 18,645 Available for sale - - - - 1,195 Home equity 142,610 144,747 142,781 143,177 121,504 Commercial 181,722 166,354 148,875 134,972 117,641 Installment Credit cards and related plans 879 947 2,033 2,415 2,704 Other 4,924 2,756 1,200 1,702 3,494 Lease financing 28,723 9,382 9,613 10,101 - Term federal funds - - 5,000 - - --------------- ------------ ----------- ------------ ------------ Total $560,879 $511,976 $478,717 $438,273 $384,060 =============== ============ =========== ============ ============ Percent of loans by type Commercial and financial 13.6 % 12.5 % 13.3 % 11.8 % 13.5 % Real estate-construction 0.7 0.8 0.2 1.0 1.2 Real estate-mortgage 1-4 family residential First liens 19.7 21.5 18.8 16.7 16.2 Junior liens 2.0 1.9 3.0 3.8 4.9 Available for sale - - - - 0.3 Home equity 25.4 28.3 29.8 32.7 31.6 Commercial 32.4 32.5 31.1 30.8 30.6 Installment Credit cards and related plans 0.2 0.2 0.4 0.5 0.7 Other 0.9 0.5 0.3 0.4 1.0 Lease financing 5.1 1.8 2.0 2.3 - Term federal funds - - 1.1 - - --------------- ------------ ----------- ------------ ------------ Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % =============== ============ =========== ============ ============ The following table sets forth the maturity distribution of the Company's loan portfolio as of December 31, 2000. The table excludes real estate loans (other than construction loans), and installment loans: (in thousands) Due after Due in one year Due after one year through five or less five years years Total --------------- ------------ ----------- ------------ Commercial and financial $1,346 $32,423 $42,933 $76,702 Lease financing 570 27,255 898 28,723 Real estate-construction 140 3,615 0 3,755 --------------- ------------ ----------- ------------ Total $2,056 $63,293 $43,831 $109,180 =============== ============ =========== ============ The following table sets forth, as of December 31, 2000, the sensitivity of the amounts due after one year to changes in interest rates: (in thousands) Due after one year Due after through five five years years --------------- ------------ Fixed interest rate $ 43,274 $ 7,761 Variable interest rate 20,019 36,070 --------------- ------------ Total $ 63,293 $ 43,831 =============== ============
18 Loan Quality The lending activities of the Company are guided by the basic lending policy established by the Company's Board of Directors. Loans must meet the tests of a prudent loan, which include criteria regarding the character, capacity and capital of the borrower, collateral provided for the loan and prevailing economic conditions. Generally, the Company obtains an independent appraisal of real property, within regulatory guidelines, when it is considered the primary collateral for a loan. The Company employs a full-time loan review officer who evaluates the credit risk for substantially all large commercial loans. This review process is intended to identify adverse developments in individual credits, regardless of whether such credits are also included on the "watchlist" discussed below and whether or not the loans are delinquent. The loan review officer reports directly to the Executive Vice President and Chief Financial Officer of the Company and provides quarterly reports to the Board of Directors. Management maintains a "watchlist" system under which credit officers are required to provide early warning of possible deterioration in the credit quality of loans. These loans may not currently be delinquent, but may present indications of financial weakness, such as deteriorating financial ratios of the borrowers, or other concerns. Identification of such financial weaknesses at an early stage allows early implementation of responsive credit strategies. The "watchlist" report is presented to Executive Management monthly and to the Board of Directors on a quarterly basis. Allowance for Loan and Lease Losses and Related Provision The provision for loan and lease losses represents management's determination 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 future estimated losses inherent in the Company's loan portfolio as of the balance sheet date. In its evaluation of the adequacy of the ALLL, management considers past loss experience, changes in the composition of performing and nonperforming loans, concentrations of credit, economic conditions, collateral coverage, the condition of borrowers facing financial pressure and the relationship of the current level of the ALLL to the credit portfolio and to nonperforming loans. While the ALLL is management's best estimate of loan losses incurred as of the balance sheet date, the process of determining the adequacy of the ALLL is necessarily judgmental and subject to changes in external conditions. Accordingly, there can be no assurance that existing levels of the ALLL will ultimately prove adequate to cover actual loan losses. Loan loss provisions for 2000 amounted to $750 thousand, a decrease of $450 thousand from the prior year. In 1999, the loan loss provision amounted to $1.2 million, an increase of $249 thousand from 1998. The decrease in the loan loss provision for 2000 was attributable, in part, to the decline in loans charged off experience. During 2000, loans charged off amounted to $219 thousand as compared to $1.4 million in 1999. The decrease was primarily due to the charge off of one commercial loan amounting to $1.1 million in 1999. In 2000, management determined that the ALLL was at a level sufficient to absorb probable losses in the loan portfolio, and, accordingly, smaller provisions were taken during the period.
Table 7 -------------------------------------------------------------------------------------------------------------- Loan Loss Experience -------------------------------------------------------------------------------------------------------------- for the years ended December 31, (dollars in thousands) 2000 1999 1998 1997 1996 ------------- ----------- ----------- ---------- ----------- Average loans outstanding $536,971 $494,022 $462,296 $402,799 $353,659 ============= =========== =========== ========== =========== Allowance at beginning of year $5,476 $5,645 $5,231 $3,968 $3,926 ------------- ----------- ----------- ---------- ----------- Loans charged off Commercial - 1,234 15 293 8 Installment 25 59 135 141 78 Real estate 186 120 470 139 770 Lease financing 8 - - - 57 ------------- ----------- ----------- ---------- ----------- Total 219 1,413 620 573 913 ------------- ----------- ----------- ---------- ----------- Recoveries of loans previously charged off Commercial 27 14 35 84 75 Installment 21 20 18 29 45 Real estate 99 10 30 70 88 ------------- ----------- ----------- ---------- ----------- Total 147 44 83 183 208 ------------- ----------- ----------- ---------- ----------- Net loans charged off 72 1,369 537 390 705 ------------- ----------- ----------- ---------- ----------- Additions to allowance charged to expense 750 1,200 951 1,653 747 ------------- ----------- ----------- ---------- ----------- Allowance at end of year $6,154 $5,476 $5,645 $5,231 $3,968 ============= =========== =========== ========== =========== Allowance to total loans 1.10 % 1.07 % 1.18 % 1.19 % 1.03 % Allowance to nonaccrual loans 441.15 491.12 471.20 345.51 157.02 Allowance to nonaccrual loans and loans past due 90 days or more 441.15 491.12 471.20 316.07 155.49 Ratio of net charge-offs to average loans 0.01 0.28 0.12 0.10 0.20
19 At December 31, 2000, the ratio of the ALLL to total loans was 1.10% as compared to 1.07% at the end of the prior year. The ALLL represented 441.2% of nonaccrual loans and loans past due 90 days or more at December 31, 2000, down from 491.1% at the end of 1999. Each of the ratios were impacted by a $280 thousand increase in nonaccrual loans and loans past due 90 days or more in 2000 as compared to the end of the year in 1999. Refer to the section titled "Nonperforming Assets" and table 9 for more detail on the nonaccrual loans and loans past due 90 days or more.
Table 8 ------------------------------------------------------------------------------------------------------------------------------------ Allocation of Allowance for Loan and Lease Losses ------------------------------------------------------------------------------------------------------------------------------------ at December 31, (dollars in thousands) 2000 1999 1998 1997 1996 ---------------------- -------------------- -------------------- ----------------- ----------------- % of % of % of % of % of Loans to Loans to Loans to Loans to Loans to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ---------------------- -------------------- -------------------- ----------------- ----------------- Commercial and financial $ 931 13.6 % $ 634 12.5 % $ 917 14.4 % $773 11.8 % $ 982 13.5 % Installment 35 1.1 82 0.7 93 90.7 147 0.9 165 1.7 Real estate 2,713 80.2 2,191 85.0 2,330 82.9 2,628 85.0 2,101 84.8 Lease financing 435 5.1 81 1.8 119 2.0 115 2.3 - - Unallocated 2,040 - 2,488 - 2,186 - 1,568 - 720 - --------- ------------ ------- ------------ ------- ---------- ------ --------- ----------------- $6,154 100.0 % $5,476 100.0 % $5,645 100.0 % $5,231 100.0 % $3,968 100.0 % ========= ============ ======= ============ ======= ========== ====== ========= ================= The above allocation is intended for analytical purposes and may not be indicative of the categories in which further loan loses occur.
20 Nonperforming Assets Nonperforming assets consist of nonaccrual loans, restructured loans and foreclosed real estate. Loans are placed on nonaccrual status when, in the opinion of management, the future collection of interest or principal according to contractual terms may be doubtful or when principal or interest payments are in arrears 90 days or more. Foreclosed real estate, representing real estate collateral acquired by legal foreclosure procedures, is valued using independent appraisals, and the Company's policy is to obtain revised appraisals annually. The Company intends to dispose of each property at or near its current valuation. However, there can be no assurance that disposals will be made as soon as anticipated or at expected values. Table 9 below presents the detail of nonperforming assets and the aggregate of loans whose principal and/or interest has not been paid according to contractual terms. At December 31, 2000, nonperforming assets increased $58 thousand or 3.7% as compared to the end of the prior year and can be attributed to the $280 thousand increase in nonaccrual loans and loans past due 90 days or more. The increase in nonaccrual loans is due to $304 thousand of nonaccrual leases in the Company's equipment lease finance portfolio. Nonperforming assets decreased $223 thousand or 12.3% in 1999 as compared to 1998. Based on the current information available, except for the loans included in the table, management believes that there were no material potential problem loans or leases, either individually or in the aggregate, at December 31, 2000.
Table 9 ---------------------------------------------------------------------------------------------------------------------------- Loan Delinquencies and Nonperforming Assets ---------------------------------------------------------------------------------------------------------------------------- at December 31, (dollars in thousands) 2000 1999 1998 1997 1996 ------------ ---------- ----------- ---------- ----------- Loans delinquent and accruing interest Loans past due 30-89 days $2,058 $190 $379 $832 $838 Loans past due 90 days or more - - - 141 25 ------------ ---------- ----------- ---------- ----------- Total loans delinquent and accruing interest $2,058 $190 $379 $973 $863 ============ ========== =========== ========== =========== Nonaccrual loans $1,395 $1,115 $1,198 $1,514 $2,527 Foreclosed real estate 250 250 84 - 610 Restructured loans - 222 528 573 725 ------------ ---------- ----------- ---------- ----------- Total nonperforming assets $1,645 $1,587 $1,810 $2,087 $3,862 ============ ========== =========== ========== =========== Total nonperforming assets and loans past due 90 days or more $1,645 $1,587 $1,810 $2,228 $3,887 ============ ========== =========== ========== =========== Nonaccrual loans to total loans 0.25 % 0.22 % 0.25 % 0.35 % 0.66 % Nonperforming assets to total loans and foreclosed real estate 0.29 0.31 0.38 0.48 1.00 Nonperforming assets to total assets 0.21 0.22 0.26 0.33 0.67 Nonaccrual loans and loans past due 90 days or more to total loans 0.25 0.22 0.25 0.38 0.66 Nonperforming assets and loans past due 90 days or more to total loans and foreclosed real estate 0.29 0.31 0.38 0.51 1.01 Nonperforming assets and loans past due 90 days or more to total assets 0.21 0.22 0.26 0.36 0.68
21 Securities Held to Maturity and Securities Available for Sale The Company identifies as "securities available for sale" securities used as part of its asset/ liability management strategy, or securities that may be sold in response to, among other things, changes in interest rates and prepayment risk. Debt securities purchased with the intent and ability to hold until maturity are classified as "held to maturity". See Notes 1 and 4 of Notes to Consolidated Financial Statements for additional information concerning securities. Table 10 presents a summary of the contractual maturities and weighted average yields (adjusted to a taxable equivalent basis) of "securities held to maturity" and "securities available for sale". Historical cost was used to calculate the weighted average yields.
Table 10 -------------------------------------------------------------------------------------------------------------------- Securities -------------------------------------------------------------------------------------------------------------------- at December 31, 2000 (dollars in thousands) After 1 After 5 Weighted Within But Within But Within After Average 1 Year 5 Years 10 Years 10 Year Total Yield --------- ---------- ----------- -------- -------- ---------- Securities held to maturity at amortized cost Mortgage-backed securities $ 598 $4,999 $2,377 $4,672 $ 12,646 6.96 % Obligations of U.S. agencies 5,998 9,163 - - 15,161 6.81 Obligations of states & political subdivisions 2,801 2,051 1,497 6,464 12,813 6.78 Other debt securities 322 100 - - 422 6.78 --------- ---------- ----------- -------- -------- 9,719 16,313 3,874 11,136 41,042 6.35 --------- ---------- ----------- -------- -------- Securities available for sale at market value Obligations of U.S. Treasury - 2,022 - - 2,022 6.43 Mortgage-backed securities 4,544 35,954 12,448 26,899 79,845 6.98 Obligations of U.S. agencies 11,987 8,127 - - 20,114 6.29 Obligations of states & political subdivisions 1,233 9,855 - 2,653 13,741 6.82 Other debt securities - 620 - - 620 8.99 --------- ---------- ------------- -------- -------- Total 17,764 56,578 12,448 29,552 116,342 6.39 --------- ---------- ------------- -------- -------- $27,483 $72,891 $16,322 $40,688 $157,384 ========= ========== ============= ======= ======== Weighted average yield 6.28 % 6.77 % 6.73 % 7.41 % 6.84 % The following table sets forth the carrying value of the Company's held to maturity and available for sale securities portfolios for the years ended, December 31: (dollars in thousands) 2000 1999 1998 --------------------- ---------------------- -------------------- Amount % Amount % Amount % --------- ---------- ------------- ------- ------- ----------- Securities held to maturity Obligations of U.S. Treasury - - $ 9,997 18.3 % $15,992 29.6 % Mortgage-backed securities $ 12,646 30.8 % 20,232 37.1 18,921 34.9 Obligations of U.S. agencies 15,161 37.0 7,992 14.7 7,986 14.7 Obligations of states & political subdivisions 12,813 31.2 16,195 29.7 11,111 20.5 Other debt securities 422 1.0 124 0.2 149 0.3 --------- ---------- ------------- ------- ------- ----------- $ 41,042 100.0 % $ 54,540 100.0 % $54,159 100.0 % ========= ========== ============= ======= ======= =========== Securities available for sale Obligations of U.S. Treasury $ 2,022 1.7 % $ 6,103 5.7 % $34,041 35.5 % Mortgage-backed securities 79,845 66.4 67,453 62.9 43,066 45.0 Obligations of U.S. agencies 20,114 16.7 27,080 25.2 13,824 14.4 Obligations of states & political subdivisions 13,741 11.4 2,941 2.7 - - Other debt securities 620 0.5 - - - - Equity securities 3,970 3.3 3,772 3.5 4,840 5.1 --------- ---------- ------------- ------- ------- ----------- $120,312 100.0 % $107,349 100.0 % $95,771 100.0 % ========= ========== ============= ======= ======= ===========
22 The Company's total investment portfolio decreased by $535 thousand or 0.3% to $161.4 million at December 31, 2000 as compared to the prior year. The composition of investment securities continued to shift from U.S. Treasury securities to obligations of states and political subdivisions and mortgage-backed securities. Mortgage-backed securities include collateralized mortgage obligations ("CMO"). Substantially all of the mortgage-backed securities held by the Company are issued or backed by federal agencies. The decline in U.S. Treasury securities was largely due to maturities. Total gross unrealized gains and total gross unrealized losses for the investment portfolio amounted to $1.7 million and $337 thousand, respectively, at December 31, 2000. During 2000, a shift in the composition of the investment portfolio from investments held to maturity to the available for sale portfolio was principally due to market conditions and the Company's asset/liability management strategy. At December 31, 2000, available for sale securities amounted to $120.3 million or 74.6% of total securities, compared to $107.3 million or 66.3% of total securities at year-end 1999. The Company's held to maturity portfolio decreased by $13.5 million or 24.7% to $41.0 million at December 31, 2000 as compared to the prior year. The decrease was mostly due to a decline in U.S. Treasury notes and state and political subdivision notes as a result of maturities. The decrease was in part offset by an increase in obligations of U.S. agencies. The Company's available for sale portfolio increased by $13.0 million or 12.1% to $120.3 million at December 31, 2000 as compared to the prior year. The growth was largely due to purchases of securities in 2000. During 2000, there were two limited portfolio restructures. The first restructuring occurred in the first quarter of 2000, which involved the sale of short-term U.S. Treasury and U.S. Agency securities and floating rate U.S. Agency securities. The Company used the proceeds to purchase non-callable U.S. Agency medium term notes and state and political subdivision medium term notes. The second restructuring occurred in the fourth quarter of 2000, which involved the sale of short-term U.S. Agency securities and the purchase of longer-term state and political subdivision notes and mortgage-backed securities. The limited portfolio restructurings were aimed at improving the risk/reward characteristics of the securities portfolio. Deposits Deposits, which include non-interest-bearing demand deposits, interest-bearing demand deposits, savings and time deposits, are an essential and cost-effective funding source for the Company. The Company attributes its success in growing deposits to the emphasis it places on building core customer relationships. The Company offers a variety of products designed to meet the financial needs of the customers based on their identifiable "life stages". Deposits in 2000 averaged $648.4 million as compared to $604.0 million in 1999, an increase of $44.4 million or 7.3%. At December 31, 2000, total deposits amounted to $668.9 million, an increase of $69.9 million or 11.7% from year-end 1999. During 2000, the Company ran several marketing campaigns to generate time deposits to fund asset growth. In addition to funding asset growth, the marketing campaigns provided the Company an opportunity to cross sell new customers with other products and services, aimed at expanding core customer relationships. The growth in the deposit base occurred mostly in time deposits and other interest bearing deposits, which increased on average $18.9 million and $18.7 million, respectively, at December 31, 2000 as compared to the prior year. Other interest bearing deposits include interest bearing demand, money market and savings accounts. During 2000, the Company's overall yield on deposits increased by 47 basis points due mostly to an increase in interest rates and a change in the deposit mix. Time deposits amounted to $208.5 million at December 31, 2000, an increase of $46.1 million or 28.4% from year-end 1999. The growth in time deposits occurred principally in time deposits less than $100,000, which was largely the result of successful marketing campaigns during 2000. Time deposits greater than $100,000, which represents an alternate source of wholesale funding for the Company, did not materially change for 2000 as compared to 1999. Time deposits greater than $100,000 represented 3.2% of total deposits at December 31, 2000 and 3.5% at December 31, 1999. The Company's yield on total time deposits increased by 57 basis points to 5.60% for 2000 as compared to 1999. Other interest bearing deposits, which comprise the largest segment of the Company's total deposits, amounted to $352.6 million at December 31, 2000, an increase of $18.5 million or 5.5% from year-end 1999. The growth was largely in commercial and municipal money market checking and savings deposits. The Company's yield on other interest bearing deposits increased by 52 basis points to 3.26% for 2000 as compared to 1999. Contributing to the growth in deposits and positively impacting the overall yield on deposit liabilities was a $5.3 million or 5.2% increase in non-interest bearing demand at December 31, 2000 as compared to year-end 1999.
Table 11 ------------------------------------------------------------------------------------------------------------------------------------ Deposit Summary ------------------------------------------------------------------------------------------------------------------------------------ at December 31, (dollars in thousands) 2000 1999 1998 1997 1996 ------------------ ----------------- ------------------ ---------------- ----------------- Non-interest bearing demand $107,702 16.1 % $ 102,392 17.1 % $ 107,408 17.9 % $ 95,436 17.6 % $ 78,450 % 16.0 % Interest bearing demand 229,713 34.3 213,970 35.8 194,177 32.4 154,301 28.6 121,878 24.8 Money market 56,646 8.5 49,256 8.2 50,665 8.5 41,815 7.7 41,372 8.4 Savings 66,270 9.9 70,907 11.8 76,026 12.7 81,202 15.0 82,817 16.8 Time deposits less than $100,000 187,330 28.0 141,444 23.6 145,337 24.3 134,287 24.9 139,994 28.5 Time deposits greater than $100,000 21,199 3.2 $21,023 3.5 25,119 4.2 33,724 6.2 27,126 5.5 --------- ------ ---------- ------- -------- ------- -------- ------- -------- ------- $668,860 100.0 % $598,992 100.0 % $598,732 100.0 % $540,765 100.0 % $491,637 100.0 % ========= ====== ========== ====== ========== ======= ========= ======= ======== ======= The following table shows the time remaining to maturity of time certificates of deposit of $100,000 or more as of December 31, 2000: (in thousands) Three months or less $ 11,717 Over three months through six months 2,282 Over six months through twelve months 4,501 Over twelve months 2,699 --------- $21,199 =========
23 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 hedging transactions utilizing derivative financial instruments during 2000. The Company's real estate loan portfolio, concentrated primarily in northern New Jersey, is subject to risks associated with the local and regional economies. The Company's primary source of market risk exposure arises from changes in market interest rates ("interest rate risk"). Interest Rate Risk Interest rate risk is generally described as the exposure to potentially adverse changes in current and future net interest income resulting from: fluctuations in interest rates; product spreads; and imbalances in the repricing opportunities of interest-rate-sensitive assets and liabilities. Therefore, managing the Company's interest rate sensitivity is a primary objective of the Company's senior management. The Company's Asset/Liability Committee ("ALCO") is responsible for managing the exposure to changes in market interest rates. ALCO attempts to maintain stable net interest margins by periodically evaluating the relationship between interest-rate-sensitive assets and liabilities. The evaluation, which is performed at least quarterly, 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 December 31, 2000, the Company simulated the effects on net interest income given an instantaneous and parallel shift in the yield curve of up to 200 basis points in either direction. Based on the simulation, it was estimated that net interest income, over a twelve-month horizon, would not decrease by more than 10.3%. At December 31, 2000, the Company was within policy limits established for changes in net interest income and future economic value of equity. The simulation described above does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape; prepayments on loans and securities; deposit decay rates; pricing decisions on loans and deposits; reinvestment/replacement of asset and liability cashflows; and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Further, as market conditions vary from those assumed in the simulation, actual results will also differ due to: prepayment/refinancing levels deviating from those assumed; the varying impact of interest rate changes on caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other internal/external variables. Furthermore, the simulation does not reflect actions that ALCO might take in response to anticipated changes in interest rates or competitive conditions in the market place. In addition to the above-mentioned techniques, the Company utilizes sensitivity gap analysis as an interest rate risk measurement. Sensitivity gap is determined by analyzing the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest bearing liabilities maturing or repricing within that same period of time. Sensitivity gap analysis provides an indication of the extent to which the Company's net interest income may be affected by future changes in market interest rates. The cumulative gap position expressed as a percentage of total assets provides one relative measure of the Company's interest rate exposure. The cumulative gap between the Company's interest-rate-sensitive assets and its interest-rate-sensitive liabilities repricing within a one-year period was (13.4%) at December 31, 2000. Since the cumulative gap was negative, the Company has a "negative gap" position, which theoretically will cause its assets to reprice more slowly than its deposit liabilities. In a declining interest rate environment, interest costs may be expected to fall faster than the interest received on earning assets, thus increasing the net interest spread. If interest rates increase, a negative gap means that the interest received on earning assets may be expected to increase more slowly than the interest paid on the Company's liabilities therefore decreasing the net interest spread. Certain shortcomings are inherent in the method of analysis presented in Table 12. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while rates on other types of assets and liabilities may lag behind changes in market rates. In the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the table. The ability of borrowers to service their debt may decrease in the event of an interest rate increase. Management considers these factors when reviewing its sensitivity gap position and establishing its ongoing asset/liability strategy. 24
Table 12 ------------------------------------------------------------------------------------------------------------------------------------ Interest Rate Sensitivity Analysis ------------------------------------------------------------------------------------------------------------------------------------ at December 31, 2000 (dollars in thousands) Non- 3 6 6 Mos. to 1 to 3 3 to 5 Over interest Subject to rate change within Months Months 1 Year Years Years 5 Years Sensitive Total ---------- --------- -------- --------- -------- --------- ---------- ------- Assets Net loans $138,065 $ 31,418 $ 59,095 $175,668 $94,786 $60,621 $ (4,928) $554,725 Investment securities 17,152 23,210 27,246 56,219 22,021 14,500 1,006 161,354 Cash and amounts due from banks 11,050 - - - - - 22,100 33,150 Other noninterest earning assets - - - - - - 21,015 21,015 ---------- --------- -------- --------- -------- --------- ---------- ------- Total assets 166,267 54,628 86,341 231,887 116,807 75,121 39,193 770,244 ---------- --------- -------- --------- -------- --------- ---------- -------- Liabilities and stockholders' equity Demand deposits 36,986 36,986 73,974 94,858 46,455 48,157 - 337,415 Savings deposits 5,799 5,799 11,597 29,788 9,189 4,098 - 66,270 Fixed maturity certificates of deposits 46,125 31,898 96,022 27,343 7,141 - - 208,529 Money market accounts 8,497 8,497 16,993 12,184 5,632 4,842 - 56,646 Securities sold under agreements to repurchase 17,500 1,000 - - - - - 18,500 Short-term borrowings 6,000 - 7,000 - - - - 13,000 Other liabilities - - - - - - 7,900 7,900 Stockholders' equity - - - - - - 61,984 61,984 ---------- --------- -------- --------- -------- --------- ---------- ------- Total liabilities and stockholders' equity 120,907 84,180 205,586 164,173 68,417 57,097 69,884 $770,244 ---------- --------- -------- --------- -------- --------- ---------- ------- Gap $ 45,360 $(29,552) $(119,245) $ 67,714 $48,390 $18,024 $(30,691) ========== ========= ======== ========= ======== ========= ========== Gap to total assets 5.89 % (3.84)% (15.48)% 8.79 % 6.28 % 2.34 % Cumulative Gap $45,360 $15,808 $(103,437) $(35,723) $12,667 $30,691 ========== ========= ======== ========= ======== ========= Cumulative Gap to total assets 5.89 % 2.05 % (13.43)% (4.64)% 1.64 % 3.98 %
Liquidity A fundamental component of the Company's business strategy is to manage liquidity to ensure the availability of sufficient resources to meet all financial obligations and to finance prospective business opportunities. Liquidity management is critical to the stability of the Company. The liquidity position of the Company over any given period of time is a product of it's operating, financing and investing activities. The extent of such activities is often shaped by such external factors as competition for deposits and loan demand. Traditionally, financing for the Company's loans and investments is derived primarily from deposits, along with interest and principal payments on loans and investments. At December 31, 2000, total deposits amounted to $668.9 million, an increase of $69.9 million or 11.7% over the prior comparable year. At December 31, 2000, advances from the FHLB, overnight borrowings and securities sold under agreements to repurchase totaled $31.5 million and represented 4.1% of total assets as compared to $43.4 million and 6.1% of total assets, at December 31, 1999. In 2000, the Company's deposit liabilities grew faster than its earning assets resulting in a decrease in borrowings. Loan production continued to be the Company's principal investing activity. Net loans at December 31, 2000 amounted to $554.7 million, an increase of $48.2 million or 9.5% compared to the same period in 1999. The Company's most liquid assets are cash and due from banks and federal funds sold. At December 31, 2000, the total of such assets amounted to $33.2 million or 4.3% of total assets, compared to $17.7 million or 2.5% of total assets at year-end 1999. The increase in liquid assets, principally federal funds sold, was driven by the growth in deposit liabilities. Another significant liquidity source is the Company's available for sale securities. At December 31, 2000, available for sale securities amounted to $120.3 million or 74.6% of total securities, compared to $107.3 million or 66.3% of total securities at year-end 1999. 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 $72.2 million line of credit available through its membership in the FHLB. Management believes that the Company's sources of funds are sufficient to meet its present funding requirements. Capital Adequacy Stockholders' equity totaled $62.0 million or 8.0% of total assets at December 31, 2000, compared to $58.3 million or 8.3% of total assets at December 31, 1999. The $3.7 million increase was largely attributable to net income of $9.3 million and a $1.2 million change in other comprehensive income. The increase was largely offset by stock repurchases and cash dividends of $3.8 million and $3.3 million, respectively, during 2000. Guidelines issued by the Federal Reserve Board and the Federal Deposit Insurance Corporation ("FDIC") establish capital adequacy guidelines for bank holding companies and state-chartered banks. The guidelines establish a risk-based capital framework consisting of (1) a definition of capital and (2) a system for assigning risk weights. Capital consists of Tier 1 capital, which includes common stockholders' equity less certain intangibles, and a supplementary component called Tier 2 capital, which includes a portion of the allowance for loan and lease losses. Effective October 1, 1998, the Federal Reserve Board and the FDIC adopted an amendment to their risk-based capital guidelines that permits insured depository institutions to include in their Tier 2 capital up to 45% of the pre-tax net unrealized gains on certain available for sale equity securities. All assets and off-balance-sheet items are assigned to one of four weighted risk categories ranging from 0% to 100%. Higher levels of capital are required for the categories perceived as representing greater risks. An institution's risk-based capital ratio is determined by dividing 25 its qualifying capital by its risk-weighted assets. The guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking institutions, take off-balance sheet items into account in assessing capital adequacy and minimize the disincentive to holding liquid, low-risk assets. Banking organizations are generally expected to operate with capital positions well above the minimum rates. Institutions with higher levels of risk, or which experience or anticipate significant growth, are also expected to operate well above minimum capital standards. At December 31, 2000, the Company's and the Bank's Tier 1 risk-based capital ratio was 11.75% and 11.66%, respectively, well in excess of minimum capital standards. These guidelines focus principally on broad categories of credit risk, although the framework for assigning assets and off-balance sheet items to risk categories does incorporate elements of transfer risk. The risk-based capital ratio does not, however, incorporate other factors that may affect a company's financial condition, such as overall interest rate exposure, liquidity, funding and market risks, the quality and level of earnings, investment or loan concentrations, the quality of loans and investments, the effectiveness of loan and investment policies and management's ability to monitor and control financial and operating risks. In addition to the risk-based guidelines discussed above, the Federal Reserve Board and the FDIC require that a bank holding company and bank which meet the regulators' highest performance and operation standards and which are not contemplating or experiencing significant growth maintain a minimum leverage ratio (Tier 1 capital as a percent of quarterly average adjusted assets) of 3%. For those financial institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be increased. At December 31, 2000, the Company's and the Bank's leverage ratio was 8.02% and 7.99%, respectively. Effects of Inflation and Changing Prices The financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same magnitude as the prices of goods and services. Recently issued accounting pronouncements On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments, and Hedging Activities". SFAS 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The adoption of SFAS 133 did not have a significant impact on the financial position or results of operations of the Company because the Company does not have any derivative activity. On December 31, 2000, the Company adopted SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS 140 requires the reclassification of certain pledged assets and disclosures regarding collateral for the December 31, 2000 Consolidated Balance Sheet. The Company's pledged assets to secured parties cannot be sold or repledged by those parties, therefore, no reclassification of pledged assets on the consolidated balance sheet was necessary for such transactions. Other provisions of SFAS 140 are not required to be implemented until after March 31, 2001. The Company is currently assessing the impact, if any, from the full implementation of this standard. 26 Forward Looking Statements In addition to discussing historical information, certain statements included in or incorporated into this report relate to the financial condition, results of operations and business of the Company which are not historical facts, but which are "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 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. These forward looking statements include, but are not limited to, statements about the operations of the Company, the adequacy of the Company's allowance for future losses associated with the loan 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; (iii) general economic conditions, internationally, nationally, or in the State of New Jersey; and (iv) legislation or regulatory requirements or changes adversely affecting the business of the Company. 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 are no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason.
Table 13 ---------------------------------------------------------------------------------------------------------------------- Quarterly Common Stock Price Range ---------------------------------------------------------------------------------------------------------------------- for the years ended December 31, The Company's common stock is quoted on the NASDAQ National Market System under the symbol "IFCJ." High Low Cash Sales Sales Dividends Price Price Declared -------- -------- ----------- 1998 First quarter (1) . . . . . . . . . . $21.25 $18.17 $0.100 Second quarter . . . . . . . . . . . . 23.25 19.25 0.100 Third quarter . . . . . . . . . . . . 20.88 15.31 0.100 Fourth quarter . . . . . . . . . . . 17.75 14.06 0.100 1999 First quarter . . . . . . . . . . . $17.50 $16.00 $0.120 Second quarter . . . . . . . . . . . . 17.38 15.50 0.120 Third quarter . . . . . . . . . . . . 19.63 16.63 0.120 Fourth quarter . . . . . . . . . . . . 18.13 16.13 0.120 2000 First quarter . . . . . . . . . . . $17.50 $13.63 $0.125 Second quarter . . . . . . . . . . . . 14.38 12.13 0.125 Third quarter . . . . . . . . . . . . 13.75 12.00 0.125 Fourth quarter . . . . . . . . . . . . 15.00 12.94 0.125 The number of stockholders of record as of February 15, 2001 was 1,208. ---------------------------------------------------------------------------------------------------------------------- (1) On February 26, 1998, the Company declared a 3 for 2 Stock Split distributed on April 17, 1998 to shareholders of record on March 20, 1998. The high and low sales prices and the cash dividends have been restated to reflect the effects of the stock split.
27 Independent Auditors' Report Board of Directors and Stockholders Interchange Financial Services Corporation Saddle Brook, New Jersey We have audited the accompanying consolidated balance sheets of Interchange Financial Services Corporation and subsidiaries (the "Company") as of December 31, 2000 and 1999 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Interchange Financial Services Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche, LLP Deloitte & Touche LLP Parsippany, New Jersey January 18, 2001 28
Interchange Financial Services Corporation ------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS ------------------------------------------------------------------------------------------------------------- December 31, (dollars in thousands) 2000 1999 ------------- --------- Assets Cash and due from banks $ 22,100 $ 17,669 Federal funds sold 11,050 - ------------- --------- Total cash and cash equivalents 33,150 17,669 ------------- --------- Securities held to maturity at amortized cost (estimated market value of $41,400 and $53,784 for 2000 and 1999, respectively) 41,042 54,540 ------------- --------- Securities available for sale at estimated market value (amortized cost of $119,306 and $108,399 for 2000 and 1999, respectively) 120,312 107,349 ------------- --------- Loans 560,879 511,976 Less: Allowance for loan and lease losses 6,154 5,476 ------------- --------- Net loans 554,725 506,500 ------------- --------- Premises and equipment, net 11,239 10,289 Foreclosed real estate 250 250 Accrued interest receivable and other assets 9,526 9,528 ------------- --------- Total assets $770,244 $706,125 ============= ========= Liabilities Deposits Non-interest bearing $107,702 $102,392 Interest bearing 561,158 496,600 ------------- --------- Total deposits 668,860 598,992 ------------- --------- Securities sold under agreements to repurchase 18,500 16,431 Short-term borrowings 13,000 13,975 Long-term borrowings - 13,000 Accrued interest payable and other liabilities 7,900 5,451 ------------- --------- Total liabilities 708,260 647,849 ------------- --------- Commitments and contingent liabilities Stockholders' equity: Common stock, without par value; 15,000,000 shares authorized; 6,530,498 and 6,728,098 shares issued and outstanding for 2000 and 1999, respectively 5,397 5,397 Capital surplus 21,077 21,244 Retained earnings 47,735 41,741 Accumulated other comprehensive income/(loss) 526 (675) ------------- ---------- 74,735 67,707 Less: Treasury stock 12,751 9,431 ------------- ---------- Total stockholders' equity 61,984 58,276 ------------- ---------- Total liabilities and stockholders' equity $770,244 $706,125 ============= ========== ------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements.
29
Interchange Financial Services Corporation ----------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME ----------------------------------------------------------------------------------------------------------------------------- For the Years Ended December 31, (in thousands, except per share data) 2000 1999 1998 -------------- ----------- ----------- Interest income Interest and fees on loans $44,499 $39,521 $38,904 Interest on federal funds sold 700 596 1,474 Interest on interest bearing deposits - - 55 Interest and dividends on securities Taxable interest income 9,796 8,432 7,934 Interest income exempt from federal income taxes 537 492 181 Dividends 259 260 272 -------------- ----------- ----------- Total interest income 55,791 49,301 48,820 -------------- ----------- ----------- Interest expense Interest on deposits 22,060 17,700 18,467 Interest on securities sold under agreements to repurchase 1,235 392 806 Interest on short-term borrowings 182 608 1 Interest on long-term borrowings 750 83 590 -------------- ----------- ----------- Total interest expense 24,227 18,783 19,864 -------------- ----------- ----------- Net interest income 31,564 30,518 28,956 Provision for loan and lease losses 750 1,200 951 -------------- ----------- ----------- Net interest income after provision for loan and lease losses 30,814 29,318 28,005 -------------- ----------- ----------- Non-interest income Service fees on deposit accounts 2,386 2,300 2,551 Net gain on sale of securities 312 859 1,021 Net gain on sale of loans and leases 136 86 - Other 1,377 2,094 1,356 -------------- ----------- ----------- Total non-interest income 4,211 5,339 4,928 -------------- ----------- ----------- Non-interest expenses Salaries and benefits 11,034 10,265 9,437 Occupancy 2,939 2,698 2,405 Furniture and equipment 1,056 1,045 1,035 Advertising and promotion 1,065 1,033 865 Acquisition - - 1,392 Other 5,083 5,022 4,282 -------------- ----------- ----------- Total non-interest expenses 21,177 20,063 19,416 -------------- ----------- ----------- Income before income taxes 13,848 14,594 13,517 Income taxes 4,592 4,959 4,908 -------------- ----------- ----------- Net income $ 9,256 $ 9,635 $ 8,609 ============== =========== =========== Basic earnings per common share $1.42 $1.37 $1.20 Diluted earnings per common share $1.41 $1.36 $1.19 -------------------------------------------------------------------------------------------------------------------------- See notes to consolidated financial statements.
30
Interchange Financial Services Corporation ------------------------------------------------------------------------------------------------------------------------------------ CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY ------------------------------------------------------------------------------------------------------------------------------------ For the Years Ended December 31, (dollars in thousands, except share data) Accumulated Other Comprehensive Retained Comprehensive Common Capital Treasury Income Earnings Income Stock Surplus Stock Total ----------- ---------- ------------- ------- --------- --------- --------- Balance at January 1, 1998 $29,698 $1,185 $5,396 $21,557 $ (1,706) $56,130 Comprehensive income Net Income $8,609 8,609 8,609 Other comprehensive income, net of taxes Unrealized gains on debt securities 207 Unrealized losses securities transferred from held to maturity to available for sale - Acquisition (17) Unrealized lossess on equity securities 343 Less: gains on disposition of equity securities (526) ----------- Other comprehensive income 7 7 7 ----------- Comprehensive income $8,616 =========== Dividends on common stock (2,825) (2,825) Fractional shares on 3 for 2 stock split and merger shares (5) (5) Forfeiture of bonus stock (49) (49) Issued 12,769 shares of common stock in connection with Executive Compensation Plan 70 162 232 Exercise of 50,394 option shares 1 (366) 638 273 ---------- ------------ --------- ------- ----------- ------- Balance at December 31, 1998 35,482 1,192 5,397 21,256 (955) 62,372 Comprehensive income Net Income $9,635 9,635 9,635 Other comprehensive income, net of taxes Unrealized losses on AFS debt securities (1,354) Less: gains on disposition of securities (excludes equities) (90) Unrealized gains securities transferred from held to maturity to available to sale - Acquisition 23 Unrealized loss on equity securities (18) Less: gains on disposition of equity securities (428) ----------- Other comprehensive loss (1,867) (1,867) (1,867) ----------- Comprehensive income $7,768 =========== Dividends on common stock (3,376) (3,376) Issued 14,489 shares of common stock in connection with Executive Compensation Plan 62 184 246 Exercised 7,836 option shares (74) 121 47 Purchased 494,360 shares of common stock (8,781) (8,781) ---------- ------------ --------- --------- --------- ------- Balance at December 31, 1999 41,741 (675) 5,397 21,244 (9,431) 58,276 Net Income $9,256 9,256 9,256 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities 1,262 Less: gains on disposition of securities (61) ----------- Other comprehensive income 1,201 1,201 1,201 ----------- ----------- Comprehensive income $10,457 =========== Dividends on common stock (3,262) (3,262) Issued 11,406 shares of common stock in connection with Executive Compensation Plan (6) 196 190 Exercised 16,634 option shares (161) 281 120 Purchased 225,640 shares of common stock (3,797) (3,797) ---------- ------------ --------- --------- ---------- ------ Balance at December 31, 2000 $47,735 $526 $5,397 $21,077 $(12,751) $61,984 ========== ============ ========= ========= ========== ====== ------------------------------------------------------------------------------------------------------------------------------------ See notes to consolidated financial statements
31
INTERCHANGE FINANCIAL SERVICES CORPORATION ------------------------------------------------------------------------------------------------------------ CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------------------------------------ For the Years Ended, December 31, (in thousands) 2000 1999 1998 ---------- ---------- ---------- Cash flows from operating activities Net income $ 9,256 $ 9,635 $ 8,609 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 1,377 1,400 1,374 Amortization of securities premiums 371 675 964 Accretion of securities discounts (297) (178) (168) Amortization of premiums in connection with acquisition 312 312 384 Provision for loan and lease losses 750 1,200 951 Net gain on sale of loans and leases (136) (86) - Net gain on sale of merchant credit card portfolio - (329) - Net gain on sale of securities (313) (859) (1,021) Net gain on sale of foreclosed real estate - (36) - Net loss on disposal of fixed assets - 2 3 Decrease (increase) in operating assets Accrued interest receivable (396) (72) (270) Deferred taxes (186) (1,059) 228 Other (789) 1,442 437 (Decrease) increase in operating liabilities Accrued interest payable 737 (32) (88) Other 1,712 (229) 552 ---------- ---------- ---------- Cash provided by operating activities 12,398 11,786 11,955 ---------- ---------- ---------- Cash flows from investing activities (Payments for) proceeds from Net originations of loans and leases (38,030) (25,751) (31,848) Purchase of loans and leases (13,548) (15,196) (4,627) Purchase of term federal funds - - (7,500) Repayment of term federal funds - 5,000 2,500 Sale of loans and leases 2,739 1,155 409 Sale of merchant credit card portfolio - 329 - Purchase of securities available for sale (55,687) (56,347) (28,688) Maturities of securities available for sale 11,135 16,152 16,971 Sale of securities available for sale 33,902 26,193 1,622 Sale of foreclosed real estate - 120 - Purchase of securities held to maturity (11,479) (18,949) (30,435) Maturities of securities held to maturity 22,958 16,402 26,808 Sale of securities held to maturity 2,002 2,003 - Purchase of fixed assets (2,122) (1,769) (1,703) Sale of fixed assets - 3 4 ---------- ---------- ---------- Cash used in investing activities (48,130) (50,655) (56,487) ---------- ---------- ---------- Cash flows from financing activities Proceeds from (payments for) Deposits in excess of withdrawals 69,868 260 57,967 Securities sold under agreements to repurchase and other borrowings 57,300 57,906 17,300 Retirement of securities sold under agreement to repurchase and other borrowings (69,206) (33,048) (21,659) Dividends (3,262) (3,376) (2,825) Common stock issued 190 246 226 Treasury stock (3,797) (8,781) (49) Exercise of option shares 120 47 273 ---------- ---------- ---------- Cash provided by financing activities 51,213 13,254 51,233 ---------- ---------- ---------- (Decrease) increase in cash and cash equivalents 15,481 (25,615) 6,701 Cash and cash equivalents, beginning of year 17,669 43,284 36,583 ---------- ---------- ---------- Cash and cash equivalents, end of year $33,150 $17,669 $43,284 ========== ========== ========== Supplemental disclosure of cash flow information: Cash paid for: Interest $16,907 $18,815 $19,953 Income taxes 4,645 7,028 3,844 Supplemental disclosure of non-cash investing and financing activities: Loans transferred to foreclosed real estate - 250 84 Decrease (increase) - market valuation of securities available for sale (2,057) 2,949 15 Reclassification of long term borrowings to short term borrowings 13,000 - - ------------------------------------------------------------------------------------------------------------ See notes to consolidated financial statements.
32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies The consolidated financial statements have been prepared in accordance with accounting principles and practices generally accepted in the United States of America within the banking industry. The following is a description of the business of Interchange Financial Services Corporation and subsidiaries (the "Company") and its significant accounting and reporting policies used in the preparation of the consolidated financial statements: Nature of Business The Company, a New Jersey business corporation, is a registered bank holding company whose principal subsidiary is Interchange Bank (the "Bank"), formerly known as Interchange State Bank. The Bank is principally engaged in the business of attracting commercial and retail deposits and investing those funds into commercial business and commercial mortgage loans as well as residential mortgage and consumer loans. When available funding exceeds loan demand, the Bank generally invests in high quality debt securities. Currently, the Bank conducts operations typical of a community bank in the northeast region of New Jersey (primarily Bergen County). In addition, the Bank is also engaged in providing its customers a broad range of financial services, such as equipment leasing, mutual funds and annuities, brokerage services, conventional insurance, internet banking and title insurance. Principles of consolidation The accompanying consolidated financial statements include the accounts of the Company, including its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform with the financial statement presentation of 2000. These reclassifications have no effect on stockholders' equity or net income as previously reported. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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 and the fair value of financial instruments. Cash and cash equivalents For the purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing demand deposits and federal funds sold. Securities held to maturity and securities available for sale Debt securities purchased with the intent and ability to hold until maturity are classified as securities held to maturity and are carried at cost, adjusted for the amortization of premiums and accretion of discounts. Management determines whether the security will be classified as held to maturity at the time of purchase. All other securities, including equity securities, are classified as securities available for sale. Securities classified as available for sale may be sold prior to maturity in response to, but not limited to, changes in interest rates, changes in prepayment risk or for asset/liability management strategies. These securities are carried at fair value and any unrealized gains and losses are reported, net of taxes, as a separate component of stockholders' equity. Gains and losses from the sale of these securities are determined using the specific identification method. Loans Generally, loans are carried at the principal amounts outstanding, net of unearned discount and deferred loan origination fees and costs. Interest income is accrued and credited to income as earned. Origination fees and certain direct loan origination costs are deferred and amortized to interest income over the estimated life of the loan as an adjustment to the yield. Mortgage loans held for sale are carried at lower of aggregate cost or market value. Gains and losses on loans sold are included in non-interest income. Direct finance leases have terms ranging from three to seven years. Under direct finance lease accounting, the balance sheet includes the gross minimum lease payments receivable, unguaranteed estimated residual values of the leased equipment, and capitalized indirect costs, reduced by unearned lease income. The lease residual values represent the expected proceeds from the sale of leased equipment at the end of the term of the lease and are determined on the basis of analyses prepared by the Bank's equipment leasing subsidiary, Interchange Capital Company L.L.C. ("ICC"), based upon professional appraisals, historical experience and industry data. Management reviews the estimated residual values on a periodic basis, and impairments in value, if any, are recognized as an immediate charge to income. Loans are placed on nonaccrual status when, in the opinion of management, the future collection of interest or principal according to contractual terms may be doubtful or when principal or interest payments are in arrears 90 days or more. Amounts accrued are evaluated for collectibility. Interest income on nonaccrual loans is recognized on a cash basis, to the extent there is no doubt of the future collection of principal. Loans are returned to accrual status when management deems that collection of principal and interest is reasonable and probable. Loans are considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to contractual terms of the loan agreement. The collection of all amounts due according to contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. All commercial and commercial mortgage loans are evaluated for impairment. One-to-four family residential mortgage loans and consumer loans with small balances are pooled together as homogeneous loans and, accordingly, are not covered by Statement of Financial Accounting Standards 114. "Accounting by Creditors for Impairment of a Loan." All nonaccrual commercial and commercial mortgage loans as well as non-homogeneous one-to-four family residential mortgage loans and consumer loans are considered impaired. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the underlying collateral. The fair value of collateral, reduced by costs to sell on a discounted basis, is utilized if a loan is collateral dependent or foreclosure is probable. 33 Allowance for loan and lease losses The allowance for loan and lease losses ("ALLL") is established through charges to income. Loan losses are charged against the ALLL when management believes that the future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is considered inadequate to absorb future loan losses on existing loans, based on, but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan and lease losses is increased. The Company's ALLL is an amount considered adequate to absorb estimated losses on existing loans and leases that may become uncollectible based on management's evaluations of the size and current risk characteristics of the loan portfolio as of the balance sheet date. The evaluations consider such factors as changes in the composition and volume of the loan portfolio, the impact of changing economic conditions on the credit worthiness of the borrowers, review of specific problem loans and management's assessment of the inherent risk and overall quality of the loan portfolio. Premises and equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Premises and equipment are depreciated over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the lease, if shorter. Estimated lives are 30 to 40 years for premises and 3 to 20 years for furniture and equipment. Maintenance and repairs are charged to expenses as incurred, while renewals and major improvements are capitalized. Foreclosed real estate Foreclosed real estate is carried at the lower of cost or estimated fair value, less estimated selling costs, at time of foreclosure. When a property is acquired, the excess of the carrying amount over fair value, if any, is charged to the ALLL. Subsequent valuations are performed periodically and the carrying value is adjusted by a charge to foreclosed real estate expense to reflect any subsequent declines in the estimated fair value. As a result, further declines in real estate values may result in increased foreclosed real estate expense. Routine holding costs are charged to foreclosed real estate expense as incurred. Income taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current tax rates. The effect on deferred taxes of a change in tax rates is recognized in income in the period the change occurs. Deferred tax assets are reduced, through a valuation allowance, if necessary, by the amount of such benefits that are not expected to be realized based on current available evidence. Per share amounts Basic earnings per common share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed similar to that of basic earnings per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares were issued during the reporting period. Recently issued accounting pronouncements On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments, and Hedging Activities. SFAS 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The adoption of SFAS 133 did not have a significant impact on the financial position or results of operations of the Company because the Company does not have any derivative activity. On December 31, 2000, the Company adopted SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS 140 requires the reclassification of certain pledged assets and disclosures regarding collateral for the December 31, 2000 Consolidated Balance Sheet. The Company's pledged assets to secured parties cannot be sold or repledged by those parties, therefore, no reclassification of pledged assets on the consolidated balance sheet was necessary for such transactions. Other provisions of SFAS 140 are not required to be implemented until after March 31, 2001. The Company is currently assessing the impact, if any, from the full implementation of this standard. Note 2. Acquisitions On May 31, 1998, the Company completed its acquisition of Jersey Bank. The transaction was accounted for as a pooling of interests. Each of the outstanding shares of Jersey Bank's common stock, including shares of common stock that had been converted from outstanding shares of preferred stock, was converted into 1.5 shares of the Company's common stock. Total consideration tendered in the transaction amounted to 780,198 shares of the Company's common stock. In 1994, the Bank assumed the deposit liabilities of Volunteer Federal Savings Association of Little Ferry, New Jersey. The premiums paid to acquire the deposits in the Volunteer transaction and in a 1991 branch acquisition are being amortized over a period ranging from seven to ten years. Amortization in 2000, 1999 and 1998, which is included in non-interest expenses, amounted to $313,000, $313,000 and $383,000, respectively. Note 3. Restrictions on Cash and Due from Banks The subsidiary bank is required to maintain a reserve balance with the Federal Reserve Bank of New York based upon the level of its deposit liability. The average amount of this reserve balance for 2000 and 1999 was approximately $775,000. 34 Note 4. Securities Held to Maturity and Securities Available for Sale Securities held to maturity and securities available for sale consist of the following: (in thousands)
---------------------------------------------------------- December 31, 2000 ---------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value ------------- ------------ ------------- ------------ Mortgage-backed securities $12,646 $96 $48 $ 12,694 Obligations of U.S. agencies 15,161 244 8 15,397 Obligations of states & political subdivisions 12,813 137 64 12,886 Other debt securities 422 1 - 423 ------------- ------------ ------------- ------------ 41,042 478 120 41,400 ------------- ------------ ------------- ------------ Obligations of U.S. Treasury 1,996 26 - 2,022 Mortgage-backed securities 79,242 758 155 79,845 Obligations of U.S. agencies 19,924 194 4 20,114 Obligations of states & political subdivisions 13,562 237 58 13,741 Other debt securities 612 8 - 620 Equity securities 3,970 - - 3,970 ------------- ------------ ------------- ------------ 119,306 1,223 217 120,312 ------------- ------------ ------------- ------------ Total securities $160,348 $1,701 $337 $161,712 ============= ============ ============= ============ ---------------------------------------------------------- December 31, 1999 ---------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value ------------- ------------ ------------- ------------ Obligations of U.S. Treasury $ 9,997 $ 5 $ 8 $ 9,994 Mortgage-backed securities 20,232 60 289 20,003 Obligations of U.S. agencies 7,992 8 51 7,949 Obligations of states & political subdivisions 16,195 - 481 15,714 Other debt securities 124 - - 124 ------------- ------------ ------------- ------------ 54,540 73 829 53,784 ------------- ------------ ------------- ------------ Obligations of U.S. Treasury 6,016 87 - 6,103 Mortgage-backed securities 68,331 104 982 67,453 Obligations of U.S. agencies 27,141 51 112 27,080 Obligations of states & political subdivisions 3,139 - 198 2,941 Equity securities 3,772 - - 3,772 ------------- ------------ ------------- ------------ 108,399 242 1,292 107,349 ------------- ------------ ------------- ------------ Total securities $162,939 $315 $2,121 $161,133 ============= ============ ============= ============ At December 31, 2000, the contractual maturities of securities held to maturity and securities available for sale are as follows: (in thousands) Securities Securities Held to Maturity Available for Sale ---------------------------- --------------------------- Amortized Market Amortized Market Cost Value Cost Value ------------- ------------ ------------- ------------ Within 1 year $9,720 $9,717 $17,766 $17,764 After 1 but within 5 years 16,313 16,581 56,038 56,578 After 5 but within 10 years 3,874 3,968 12,409 12,448 After 10 years 11,135 11,134 29,123 29,552 Equity securities - - 3,970 3,970 ------------- ------------ ------------- ------------ Total $41,042 $41,400 $119,306 $120,312 ============= ============ ============= ============
35 Gross realized gains from the sale of securities available for sale amounted to $341,000 and $860,000 in 2000 and 1999, respectively. Gross realized losses from the sale of securities available for sale amounted to $31,000 and $4,000 in 2000 and 1999, respectively. There were no gross realized losses in 1998. These amounts are included in net gain on sale of securities. Also, included in net gain on sale of securities for 1998 is a gain of $145,000 realized from the call of a security before its maturity. Proceeds from the sale of securities held to maturity (scheduled to mature within 3 months) amounted to $2.0 million in each of the years ended December 31, 2000 and 1999 and resulted in realized gains of $2,000 and $3,000 for those periods, respectively. There were no sales of securities held to maturity during 1998. Securities with carrying amounts of $49.3 million and $48.3 million at December 31, 2000 and 1999, respectively, were pledged for public deposits, Federal Home Loan Bank advances, securities sold under repurchase agreements and other purposes required by law. Note 5. Loans The composition of the loan portfolio is summarized as follows: (in thousands)
---------------------- December 31, ---------------------- 2000 1999 ----------- --------- Commercial and financial $76,702 $63,684 Real estate Residential 264,174 264,845 Commercial 181,722 166,354 Construction 3,755 4,008 Installment 5,803 3,703 Lease financing 28,723 9,382 ----------- --------- 560,879 511,976 Allowance for loan and lease losses 6,154 5,476 ----------- --------- Net loans $554,725 $506,500 =========== ========= Nonperforming loans include loans which are accounted for on a nonaccrual basis and troubled debt restructurings. Nonperforming loans are as follows: (in thousands) -------------------------------- D e c e m b e r 31, -------------------------------- 2000 1999 1998 ----------- --------- -------- Nonaccrual loans Commercial and financial $ 305 $ 308 $ 266 Residential real estate 419 398 583 Commercial real estate 367 409 346 Lease financing 304 - - Installment - - 3 ----------- --------- -------- 1,395 1,115 1,198 ----------- --------- -------- Troubled debt restructurings Commercial and financial - 222 528 ----------- --------- -------- Total nonperforming assets $1,395 $1,337 $1,726 =========== ========= ======== Interest income that would have been recorded during the year on nonaccrual loans outstanding at year-end in accordance with original terms $143 $120 $147 Interest income included in net income during the year on nonaccrual loans outstanding at year-end $93 $74 $71 At December 31, 2000, 1999 and 1998, there were no loans or leases on which interest is accruing and included in income, but which were contractually past due 90 days or more as to principal or interest payments. Certain officers and directors of the Company and their affiliated companies are customers of and are engaged in transactions with the Company in the ordinary course of business on substantially the same terms as those prevailing with other non-affiliated borrowers and suppliers. The following table summarizes activity with respect to these loans: (in thousands) ------------------------ Years Ended December 31, ------------------------ 2000 1999 ---------- --------- Balance at beginning of year $7,354 $7,623 Additions 491 1,776 Reductions (478) (2,045) ---------- --------- Balance at end of year $7,367 $7,354 ========== =========
36 Note 6. Allowance for Loan and Lease Losses The Company's recorded investment in impaired loans is as follows: (in thousands)
-------------------------------------------- December 31, -------------------------------------------- 2000 1999 ---------------------- --------------------- 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 $ 298 $ 7 $272 $41 Commercial real estate 367 10 667 17 Without a related allowance for loan losses - - - - ---------- ----------- ---------- --------- $665 $ 17 $939 $58 ========== =========== ========== ========= -------------------------------------------------------------------------------------------- The impairment of the above loans was measured based on the fair value of collateral. The following table sets forth-certain information about impaired loans: (in thousands) ------------------------ Years Ended December 31, ------------------------ 2000 1999 ---------- ---------- Average recorded investment $677 $1,181 ========== ========== Interest income recognized during time period that loans were impaired, using cash-basis method of accounting $41 $90 ========== ========== Changes in the allowance for loan and lease losses are summarized as follows: (in thousands) ------------------------------- Year Ended December 31, ------------------------------- 2000 1999 1998 --------- ---------- ---------- Balance at beginning of year $5,476 $5,645 $5,231 Additions (deductions) Provision charged to operations 750 1,200 951 Recoveries on loans previously charged off 147 44 83 Loans charged off (219) (1,413) (620) --------- ---------- ---------- Balance at end of year $6,154 $5,476 $5,645 ========= ========== ========== ------------------------------------------------------------------------ For years ended December 31, 2000, 1999 and 1998, the provisions charged to expense for federal income tax purposes amounted to approximately $71,000, $1,369,000, and $537,000, respectively.
Note 7. Premises and Equipment, net Premises and equipment are summarized as follows: (in thousands) --------------------- December 31, --------------------- 2000 1999 --------- --------- Land $1,980 $1,980 Buildings 3,019 3,009 Furniture, fixtures and equipment 6,397 6,154 Leasehold improvements 9,047 7,899 --------- --------- 20,443 19,042 Less: accumulated depreciation and amortization 9,204 8,753 --------- --------- $11,239 $10,289 ========= ========= Note 8. Deposits Deposits are summarized as follows: (in thousands) ------------------------------------- December 31, ------------------------------------- 2000 1999 ------------------ ------------------ Non-interest bearing demand deposits $107,702 $102,392 Interest bearing demand deposits 229,712 213,970 Money market deposits 56,646 49,256 Savings deposits 66,270 70,907 Time deposits 208,530 162,467 ------------------ ------------------ $668,860 $598,992 ================== ================== At December 31, 2000 and 1999, the carrying amounts of certificates of deposit that individually exceed $100 thousand amounted to $21,199,000, and $21,023,000, respectively. Interest expense relating to certificates of deposit that individually exceed $100 thousand was approximately $1,156,000, $1,371,000, and $1,616,000 in 2000, 1999, and 1998, respectively. 37 Note 9. Securities Sold Under Agreements to Repurchase and Short-term Borrowings Securities sold under agreements to repurchase and short-term borrowings are summarized as follows: (in thousands) --------------------------- December 31, --------------------------- 2000 1999 --------------- ----------- Securities sold under agreements to repurchase $18,500 $16,431 Federal Funds Purchased - 13,975 Federal Home Loan Bank advances 13,000 - --------------- ----------- $31,500 $30,406 =============== =========== Federal Home Loan Bank ("FHLB") advances, which amounted to $13.0 million at December 31, 2000, was comprised of two borrowings. One of the borrowings consists of a $7.0 million advance that has a fixed rate of 6.28% maturing in October 2002 and is collateralized by U.S. Treasury and U.S. agency securities. The FHLB has an option to call the $7.0 million advance on October 26, 2001. The other borrowing consists of a $6.0 million advance that has a fixed rate of 6.30% maturing in December 2001 and is collateralized by U.S. Treasury and U.S. agency securities. The FHLB has an option to call the $6.0 million advance after December 2000. In addition, the Bank has a $72.2 million line of credit available through its membership in the FHLB of New York. Note 10. Long-term Borrowings Long-term borrowings were comprised of two FHLB advances, which amounted to $13.0 million at December 31, 1999. These advances have been classified as short-term borrowings in 2000 since they are callable within one year. Note 11. Benefit Plans In 1993, the Bank established a non-contributory defined benefit pension plan covering all eligible employees (the "Pension Plan"). The funding policy is to contribute an amount that is at least the minimum required by law. The plan assets consist of investments in fixed income funds and equity mutual funds. Retirement income is based on years of service under the plan and, subject to certain limits, on final average compensation. Effective January 1, 1994, the Bank established a supplemental plan covering all eligible employees (the "Supplemental Plan") that provides for retirement income that would have been paid but for the limitation under the qualified Pension Plan. Effective August 1, 1994, the Company established a retirement plan for all directors of the Bank who are not employees of the Company or of any subsidiary or affiliate of the Company (the "Directors' Plan"). As a part of this Directors' Plan, the Company contributes annually to a life insurance policy or annuity contract for each director with 5 years or more of service, as follows: Years of Service Amount Contributed ----------------- ------------------ 6 $5,000 7 6,000 8 7,000 9 8,000 10 9,000 11 or more 10,000 The Bank owns the life insurance policies or annuity contracts. Retirement income to a director who has completed five years of service through ten years of service will be based on the cash value of the life insurance policy or annuity contract. After ten years of service, the retirement income will be based on the greater of the cash value of the life insurance policy or annuity contract or an amount determined by multiplying the Bank's standard annual retainer fees (currently $10,000) at the director's retirement date by the director's years of service. Net pension cost of each plan consists of the following: (in thousands)
Pension Plan Supplemental Plan Directors' Plan ---------------------- ------------------- ---------------------- 2000 1999 1998 2000 1999 1998 2000 1999 1998 -------- ------ ------ ------- ----- ----- -------- ------ ------ Service cost $197 $251 $222 $24 $25 $22 $57 $61 $59 Interest cost 95 85 65 17 14 12 88 80 76 Expected return on plan assets (88) (85) (71) - - - - - - Amortization of prior service cost - - - 8 8 8 - 92 147 Recognized net actuarial gain (27) (8) (6) - - - - - - -------- ------ ------ ------- ----- ----- -------- ------ ------ Net periodic benefit cost $177 $243 $210 $49 $47 $42 $145 $233 $282 ======== ====== ====== ======= ===== ===== ======== ====== ======
38 The following table sets forth the funded status, as of December 31, of each plan and amounts recognized in the Company's Consolidated Balance Sheets and the major assumptions used to determine these amounts: (dollars in thousands)
Pension Plan Supplemental Plan Directors' Plan ------------------------ ----------------------- ------------------------- 2000 1999 2000 1999 2000 1999 ---------- ---------- --------- ---------- ----------- ---------- Change in pension obligation Pension obligation at beginning of year $1,233 $1,223 $ 215 $ 200 $ 1,251 $ 1,195 Service cost 197 251 24 25 57 61 Interest cost 95 85 18 14 88 80 Actuarial (gain) loss 131 (303) 17 (24) (28) (85) Benefits paid (30) (23) - - - - Other - - - - (109) - ---------- ---------- --------- ---------- ----------- ---------- Pension obligation at end of year 1,626 1,233 274 215 1,259 1,251 ---------- ---------- --------- ---------- ----------- ---------- Change in plan assets Fair value of plan assets at beginning of year 1,088 1,064 - - - - Actual return on plan assets 113 47 - - - - Employer contribution 27 - - - - - Benefits paid (30) (23) - - - - ---------- ---------- --------- ---------- ----------- ---------- Fair value of plan assets at end of year 1,198 1,088 - - - - ---------- ---------- --------- ---------- ----------- ---------- Funded Status (428) (145) (274) (215) (1,259) (1,251) Unrecognized net actuarial (gain) loss (351) (483) 9 (9) (73) (46) Unrecognized prior service cost (5) (5) 65 73 - - ---------- ---------- --------- ---------- ----------- ---------- Accrued pension cost $ (784) $ (633) $ (200) $ (151) $(1,332) $ (1,297) ========== ========== ========= ========== =========== ========== Weighted-average assumptions (1) Discount rate 8.00 % 8.00 % 8.00 % 8.00 % 8.00 % 8.00 % Expected return on plan assets 8.00 8.00 8.00 8.00 8.00 8.00 Rate of compensation increase 5.00 5.00 N/A N/A N/A N/A ------------------------------------------------------------------------------------------------------------------------- (1) Weighted average assumptions were applied at the beginning of the period.
In 1976, the Bank established a Capital Investment Plan (the "Investment Plan") which permits employees to make basic contributions up to 4% of base compensation. In 1998, the Investment Plan was amended to permit employees to make basic contributions up to 6%. Additional contributions up to 10% of compensation may be made when coupled with basic contributions. Under the Investment Plan, the Bank provides a matching contribution equal to 50% of the basic contribution of each participant. In addition, the Bank makes a fixed contribution on behalf of each participant equal to 1% of such participant's base compensation, which is in the form of the Company's stock. The Bank's contribution to the Investment Plan amounted to $165,000 and $163,000 in 2000 and 1999, respectively. 39 Note 12. Stock Option and Incentive Plan In 1989, the Company adopted a stock option plan, retitled the Stock Option and Incentive Plan of 1997 (the "Stock Plan") that covers certain key employees. Under this plan, as amended, a maximum of 637,875 options to purchase shares of common stock may be granted at fair market value at the date of grant. Options granted expire if not exercised within ten years of date of grant and are exercisable according to a vesting schedule, starting one year from the date of grant. Pursuant to the Stock Plan, incentive stock options or non-qualified stock options may be granted to employees. In 2000, the Company adopted a stock option plan, titled "Outside Director's Incentive Compensation Plan" (the "Director's Stock Plan") that covers those members of the Board of Directors of the Company who have not served as a full-time employee of the Company or any of its subsidiaries during the prior twelve-month period. Under this plan, a maximum of 100,000 options to purchase shares of common stock may be granted at fair market value at the date of grant. Options granted expire if not exercised within ten years of date of grant and are exercisable according to a vesting schedule, starting one year from the date of grant. Only non-qualified stock options are granted under the Director's Stock Plan. The status of options granted under the Stock Plan and Director's Stock Plan as of December 31, and changes during each of the three years then ended is summarized below:
2000 1999 1998 ------------------------ ----------------- ----------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Incentive Stock Options Options Price Options Price Options Price ----------------------------------- ------------ ---------- ------- -------- ------- -------- Outstanding at January 1 152,988 $ 13.85 110,824 $ 11.91 121,935 $ 6.62 Granted 57,250 16.50 58,750 16.97 49,875 18.17 Exercised (16,634) 7.36 (7,836) 6.05 (50,394) 5.27 Forfeited (8,875) 17.36 (8,750) 17.30 (10,592) 12.05 --------- ------- ------- Outstanding at December 31 184,729 15.09 152,988 13.85 110,824 11.91 ========= ======= ======= Options exercisable at December 31 83,560 12.93 71,238 9.79 58,440 7.29 ========= ======= ======= Weighted-average fair value of options granted during the year ended December 31(per option) $4.46 $5.03 $5.98 2000 ------------------------ Weighted- Average Exercise Non-Qualified Stock Options Options Price ------------------------------------------------ ---------- Outstanding at January 1 - - Granted 11,000 $ 14.00 Exercised - - Forfeited - - --------- Outstanding at December 31 11,000 14.00 ========= Options exercisable at December 31 - - ========= Weighted-average fair value of options granted during the year ended December 31 (per option) $3.76 The following table summarizes information about options outstanding under the Stock Plan and Director's Stock Plan at December 31, 2000: Options Outstanding Options Exercisable ----------------------------------------------------------------- ------------------------- Weighted- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price ------------------------- ------------- ------------- ----------- ------------------------- Incentive Stock Options $ 5 - $10 38,729 3.32 $ 7.48 38,729 $ 7.48 $15 - $20 146,000 8.22 17.10 44,831 17.63 ------------- ------------- 184,729 83,560 ------------- ------------- Non-Qualified Stock Options $10 - $15 11,000 9.32 14.00 - - ------------- ------------- Total 195,729 83,560 ============= =============
40 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2000, 1999 and 1998, respectively: dividend yield of 3.21%, 2.76%, 2.20%; expected volatility of 23.89%, 22.63% and 23.33%; risk-free interest rate of 6.48%, 5.31% and 5.62%; and expected lives of 7 years. The effects of applying these assumptions in determining the pro-forma net income may not be representative of the effects on pro-forma net income for future years. If compensation cost for Stock Plan and Director's Stock Plan awards had been measured based on the fair value of the stock options awarded at the grant dates, net income and diluted earnings per common share would have been reduced to the pro-forma amounts below for the years ended December 31: (in thousands, except share data) 2000 1999 1998 --------- ------- ------- Net Income As reported $9,256 $9,635 $8,609 Pro-forma 9,174 9,572 8,572 Diluted earnings per common share As reported $1.41 $1.36 $1.19 Pro-forma 1.40 1.36 1.18 Pursuant to the Stock Plan, restricted stock is awarded to key employees providing for the award of Interchange's common stock subject to certain vesting and restrictions. The awards are recorded at fair market value and amortized into salary expense over the vesting period. The following table sets forth the changes in restricted stock awards outstanding for the years ended December 31, 2000, 1999 and 1998. Restricted Stock Awards 2000 1999 1998 ------------- ------------- ----------- Outstanding at beginning of year 24,172 21,591 23,783 Granted 11,406 14,489 12,769 Vested (12,375) (11,908) (11,320) Forfeited - - (3,641) ------------- ------------- ----------- Outstanding at end of year 23,203 24,172 21,591 ============= ============= =========== The amount of compensation costs related to restricted stock awards included in salary expense in 2000, 1999 and 1998 amounted to $167,939, $144,908 and $101,381, respectively. 41 Note 13. Stockholders' Equity The Company and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital levels that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and the Bank's classification, under the regulatory framework for prompt corrective action, are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. Management believes, as of December 31, 2000, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2000, the most recent notification from the Federal Reserve Bank categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category. 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 December 31, 2000: Total Capital (to Risk Weighted Assets): The Company $67,632 12.92 % $41,864 8.00 % N/A N/A The Bank 67,165 12.83 41,865 8.00 $52,331 10.00% Tier 1 Capital (to Risk Weighted Assets): The Company 61,478 11.75 20,932 4.00 N/A N/A The Bank 61,011 11.66 20,932 4.00 31,398 6.00 Tier 1 Capital (to Average Assets): The Company 61,478 8.02 22,992 3.00 N/A N/A The Bank 61,011 7.99 22,917 3.00 38,196 5.00 As of December 31, 1999: Total Capital (to Risk Weighted Assets): The Company $64,209 13.91 % $36,925 8.00 % N/A N/A The Bank 64,877 14.01 37,054 8.00 $46,318 10.00% Tier 1 Capital (to Risk Weighted Assets): The Company 58,733 12.72 18,463 4.00 N/A N/A The Bank 59,401 12.82 18,527 4.00 27,791 6.00 Tier 1 Capital (to Average Assets): The Company 58,733 8.32 21,167 3.00 N/A N/A The Bank 59,401 8.45 21,080 3.00 35,133 5.00
42 Shares of common stock On June 2, 1999, the Board of Directors authorized a program to repurchase up to 10 percent, or approximately 720 thousand shares, of the Company's outstanding common stock. The Company completed the purchases pursuant to this program during the first quarter of 2000. The total cost of the purchases was approximately $12.6 million, of which $3.8 million was purchased in 2000. The repurchased shares are held as treasury stock and will be principally used for the exercise of stock options, incentive plan stock awards and other general corporate purposes. The following table summarizes the activity in common shares: Shares in Shares Issued Treasury ------------ ---------- Balance, December 31, 1998 7,200,133 74,500 Purchase of treasury stock (494,360) 494,360 Issuance of stock from treasury 22,325 (22,325) ------------ ---------- Balance, December 31, 1999 6,728,098 546,535 Purchase of treasury stock (225,640) 225,640 Issuance of stock from treasury 28,040 (28,040) ------------ ---------- Balance, December 31, 2000 6,530,498 744,135 ============ ========== Note 14. Earnings Per Share The reconciliation of the numerators and denominators of the basic and diluted earnings per common share computations for the years ended December 31, are as follows: (in thousands, except per share data)
2000 1999 1998 ------------------------------- ---------------------------------------------------- Weighted Per Weighted Per Weighted Per Average Share Average Share Average Share Income Shares Amount Income Shares Amount Income Shares Amount ---------- ---------- --------- ------- --------- ------- --------- -------- -------- Basic Earnings per Common Share Income available to common shareholders $9,256 6,540 $1.42 $9,635 7,031 $1.37 $8,609 7,189 $1.20 ========= ======== ======== Effect of Dilutive Shares Options issued 18 31 48 ---------- --------- -------- Diluted Earnings per Common Share Income available to common shareholders $9,256 6,558 $1.41 $9,635 7,062 $1.36 $8,609 7,237 $1.19 ========== ========== ========= ================= ================ ======== ========
Note 15. Other Non-interest Expenses Expenses included in other non-interest expenses which exceed one percent of the aggregate of total interest income and non-interest income for the years ended, December 31, are as follows: (in thousands) 2000 1999 1998 ----------- --------- --------- Professional fees $1,120 $1,101 $1,184 Data Processing 575 517 538 Directors' fees, travel and retirement 504 546 88 43 Note 16. Income Taxes Income tax expense for the years ended December 31, is summarized as follows: (in thousands) 2000 1999 1998 ------- ------- -------- Federal: current $5,264 $5,114 $4,399 deferred (789) (316) (344) State: current 117 161 315 deferred - - 538 ---------- -------- --------- $4,592 $4,959 $4,908 ========== ======== ========= The effects of temporary differences that give rise to significant portions of the Company's deferred tax assets and liabilities as of December 31, are as follows: (in thousands) 2000 1999 ---------- -------- Deferred tax assets Excess of book over tax allowance for loan losses $ 2,099 $1,638 Excess of book over tax depreciation 359 253 Excess of book over tax provision for benefit plan expense 791 714 Core deposit premium 276 223 Other 242 108 Unrealized losses - securities available for sale - 367 ---------- -------- Total deferred tax assets 3,767 3,303 ---------- -------- Deferred tax liabilities Unrealized gains - securities available for sale 342 - Loan origination fees 200 199 Other 219 179 ---------- -------- Total deferred tax liabilities 761 378 ---------- -------- Net deferred tax assets $3,006 $2,925 ========== ======== Net deferred tax assets are included in other assets on the consolidated balance sheet. It is more likely than not that deferred tax assets of $3.0 million will be principally realized through future reversals of existing taxable temporary differences and, to a lesser extent, future taxable income and tax planning strategies. The provision for income taxes differs from the expected statutory provision as follows: ----------------------------------- December 31, ----------------------------------- 2000 1999 1998 ---------- --------- --------- Expected provision at statutory rate 35% 35% 34% Difference resulting from: State income tax, net of federal benefit 1 1 2 Interest income exempt from federal taxes (2) (1) (1) Other (1) (1) 1 ---------- -------- --------- 33% 34% 36% ========== ======== ========= Note 17. Restrictions of Subsidiary Bank Dividends Under New Jersey State law, the Bank may declare a dividend only if, after payment thereof, its capital would be unimpaired and its remaining surplus would equal 50 percent of its capital. At December 31, 2000, undistributed net assets of the Bank were $61,517,000 of which $57,199,000 was available for the payment of dividends. In addition, payment of dividends is limited by the requirement to meet the capital guidelines issued by the Board of Governors of the Federal Reserve System. Note 18. Commitments and Contingent Liabilities The Company has contingent liabilities and outstanding commitments that include agreements to extend credit which arise in the normal course of business and which are not shown in the accompanying financial statements. Loan commitments are made to accommodate the financial needs of the Company's customers. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. They are issued primarily to support performance bonds. Both arrangements have credit risks essentially the same as that involved in extending loans to customers and are subject to the normal credit policies of the Company. A summary of commitments to extend credit at December 31, are summarized as follows: (in thousands) 2000 1999 --------- ---------- Home equity loans $60,697 58,523 Other loans 50,313 43,153 Standby letters of credit 440 449 --------- ---------- $111,450 $102,125 ========= ========== The minimum annual rental under non-cancelable operating leases for premises and equipment, exclusive of payments for maintenance, insurance and taxes, is summarized as follows: (in thousands) 2001 $1,341 2002 1,283 2003 1,241 2004 1,128 2005 1,060 thereafter 4,721 ---------- Total minimum lease payments $10,774 ========== Rent expense for all leases amounted to approximately $1,400,000, $1,256,000 and $1,101,000 in 2000, 1999, and 1998, respectively. A director of the Company provided legal services through his affiliated firm. Fees paid for these services amounted to approximately $335,000, $325,000 and $331,000 in 2000, 1999, and 1998, respectively. The Company is also a party to routine litigation involving various aspects of its business, none of which, in the opinion of management and its legal counsel, is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company. 44 Note 19. Fair Value of Financial Instruments Fair value estimates of the Company's financial instruments are made at a particular point in time, based on relevant market information and information about the financial instrument. Fair values are most commonly derived from quoted market prices. In the event market prices are not available, fair value is determined using the present value of anticipated future cash flows. This method is sensitive to the various assumptions and estimates used and the resulting fair value estimates may be significantly affected by minor variations in those assumptions or estimates. In that regard, it is likely the Company in immediate settlement of the financial instruments would realize amounts different from the fair value estimates. The following table sets forth the carrying amounts and estimated fair values of the Company's financial instruments: (in thousands)
------------------------------------------------------------ December 31, ------------------------------------------------------------ 2000 1999 --------------------------- ---------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------------ ------------ ---------- ---------- Cash and cash equivalents $33,150 $33,150 $17,669 $17,669 Securities held to maturity 41,042 41,400 54,540 53,784 Securities available for sale 120,312 120,312 107,349 107,349 Loans, net 554,725 561,819 506,500 495,452 ------------ ------------ ---------- ---------- $749,229 $756,681 $686,058 $674,254 ============ ============ ========== ========== Deposits $668,860 $669,533 $598,992 $597,887 Short-term borrowings 31,500 31,500 30,406 30,406 Long-term borrowings - - 13,000 12,906 ------------ ------------ ---------- ---------- $700,360 $701,033 $642,398 $641,199 ============ ============ ========== ==========
The methods and significant assumptions used to determine the estimated fair values of the Company's financial instruments are as follows: Cash and cash equivalents Cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. The estimated fair values of these financial instruments approximate their carrying values since they mature overnight or are due on demand. Securities held to maturity and securities available for sale Estimated fair values are based principally on quoted market prices, where available, or dealer quotes. In the event quoted market prices are not available, fair values are estimated using market prices of similar securities. Loans The loan portfolio is segregated into various categories for purposes of estimating fair value. The fair values of certain loans that reprice frequently and have no significant change in credit risk is assumed to equal their carrying values. The fair value of other types of loans is estimated by discounting the future cash flows using interest rates that are currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of nonperforming loans is estimated using methods employed by management in evaluating the ALLL. Deposits The estimated fair values of deposits with no stated maturity, such as demand deposits, savings, NOW and money market accounts are, by definition, equal to the amount payable on demand at the reporting date. The fair values of fixed-rate certificates of deposit are based on discounting the remaining contractual cash flows using interest rates currently being offered on certificates of deposit with similar attributes and remaining maturities. Short-term borrowings The fair value of short-term borrowings is assumed to equal the carrying value in the financial statements, as these instruments are short-term. Long-term borrowings Fair value estimates of long-term borrowings are based on discounting the remaining contractual cash flows using rates, which are comparable to rates currently being offered for borrowings with similar remaining maturities. Off-balance-sheet financial instruments The fair values of commitments to extend credit and unadvanced lines of credit approximate the fees currently charged to enter into similar transactions, considering the remaining terms of the commitments and the credit-worthiness of the potential borrowers. At December 31, 2000 and 1999, the estimated fair values of these off-balance-sheet financial instruments were immaterial. 45 Note 20. Parent Company Information (in thousands)
-------------------------- December 31, -------------------------- Condensed balance sheets 2000 1999 1998 ---------- ------- ------- Assets Cash $467 $641 $355 Securities available for sale - - 1,321 Investment in subsidiaries Bank 61,517 58,944 59,591 Other 142 646 646 Dividends receivable 816 - 720 Other assets - - 602 ---------- ------- ------- Total assets $62,942 $60,231 $63,235 ========== ======= ======= Liabilities Dividends payable $815 $805 $720 Loans from subsidiaries - 1,000 - Other liabilities 142 150 143 ---------- ------- ------- 957 1,955 863 ---------- ------- ------- Stockholders' equity Common stock 5,397 5,397 5,397 Capital Surplus 21,077 21,244 21,256 Retained earnings 47,736 41,741 35,482 Accumulated other comprehensive income 526 (675) 1,192 ---------- ------- ------- 74,736 67,707 63,327 Less: Treasury stock 12,751 9,431 955 ---------- ------- ------- Total stockholders' equity 61,985 58,276 62,372 ---------- ------- ------- Total liabilities and stockholders' equity $62,942 $60,231 $63,235 ========= ======== ======= ----------------------------------------------------------------------- -------------------------- Years Ended December 31, -------------------------- Condensed statements of income 2000 1999 1998 --------- -------- ------- Dividends from subsidiary bank $8,587 $8,641 $2,556 Dividends on equity securities - 8 37 Net gain on sale of securities - 714 876 Management fees - 39 39 ---------- ------- ------- Total revenues 8,587 9,402 3,508 ---------- ------- ------- Interest on short-term borrowings 77 92 - Operating expenses 122 448 643 ----------- ------ ------- Income before equity in undistributed earnings of subsidiaries 8,388 8,862 2,865 Equity in undistributed earnings of subsidiaries 868 773 5,744 ----------- ------ ------- Net income $9,256 $9,635 $8,609 ========== ======= ======= ----------------------------------------------------------------------- -------------------------- Years Ended December 31, -------------------------- Condensed statements of cash flows 2000 1999 1998 --------- -------- ------- Cash flows from operating activities: Net income $ 9,256 $ 9,635 $ 8,609 Adjustments to reconcile net income to net cash provided by operating activities Net gain on sale of securities - (714) (876) Decrease (increase) in other assets (816) 1,618 (1,048) Increase in dividends payable 11 86 150 Increase (decrease) in other liabilities (8) 7 - Equity in undistributed income of subsidiaries (868) (774) (5,744) ---------- ------- ------- Net cash provided by operating activities 7,575 9,858 1,091 ---------- ------- ------- Cash flows from investing activities: Sale of securities available for sale - 1,292 1,622 ----------- ------ ------- Net cash provided by investing activities - 1,292 1,622 ----------- ------ ------- Cash flows from financing activities: Cash dividends paid (3,262) (3,376) (2,801) Loan from subsidiary - 1,000 - Repayment of loan from subsidiary (1,000) - - Treasury stock (3,797) (8,781) (49) Common stock issued 190 246 226 Exercise of option shares 120 47 266 ---------- ------- ------- Net cash used in financing activities (7,749)(10,864) (2,358) ---------- ------- ------- Net increase/(decrease) in cash (174) 286 355 Cash at beginning of year 641 355 - ---------- ------- ------- Cash at end of year $ 467 $ 641 $ 355 ========== ======= =======
46 Note 21. Quarterly Financial Data (unaudited) (in thousands, except per share data)
-------------------------------------------------------------------------------------------------------- First Second Third Fourth 2000 Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------------------------------- Interest income $12,926 $13,656 $14,519 $14,690 Interest expense 5,326 5,773 6,546 6,583 Net interest income 7,600 7,884 7,973 8,107 Provision for loan losses 300 300 150 - Net gain on sale of securities 97 - - 215 Income before income taxes 2,832 3,406 3,621 3,989 Net income 1,890 2,292 2,416 2,658 Basic earnings per common share 0.29 0.35 0.37 0.41 Diluted earnings per common share 0.29 0.35 0.37 0.41 -------------------------------------------------------------------------------------------------------- First Second Third Fourth 1999 Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------------------------------- Interest income $11,850 $12,228 $12,567 $12,656 Interest expense 4,512 4,580 4,732 4,959 Net interest income 7,338 7,648 7,835 7,697 Provision for loan losses 300 300 300 300 Net gain on sale of securities 527 329 3 - Income before income taxes 3,460 3,761 4,068 3,306 Net income 2,286 2,478 2,705 2,166 Basic earnings per common share 0.32 0.34 0.38 0.32 Diluted earnings per common share 0.32 0.34 0.38 0.32
47