10-Q 1 e17817_10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-Q ------------------ [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED, March 31, 2004 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM____ TO ____ Commission File number 1-10518 INTERCHANGE FINANCIAL SERVICES CORPORATION ------------------------------------------ (Exact name of registrant as specified in its charter) New Jersey 22-2553159 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Park 80 West/Plaza Two, Saddle Brook, NJ 07663 ---------------------------------------- ----- (Address of principal executive offices) (Zip Code) (201) 703-2265 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) None -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No --- --- The number of outstanding shares of the Registrant's common stock, no par value per share, as of April 30, 2004, was 12,740,782 shares. INTERCHANGE FINANCIAL SERVICES CORPORATION INDEX PART I FINANCIAL INFORMATION Page No. -------- Item 1 Financial Statements Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 ........................1 Condensed Consolidated Statements of Income for the three months ended March 31, 2004 and 2003 ..............2 Condensed Consolidated Statements of Changes in Stockholders' Equity for the three months ended March 31, 2004 and 2003 .....................................3 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 ........................................................4 Notes to Condensed Consolidated Financial Statements ..................................................5 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ..............16 Item 3 Quantitative and Qualitative Disclosures About Market Risk (Disclosures about quantitative and qualitative market risk are located in Management's Discussion and Analysis of Financial Condition and Results of Operation in the section on Market Risk) ................................29 Item 4 Controls and Procedures ....................................34 PART II OTHER INFORMATION Item 1 Legal Proceedings ..........................................35 Item 2 Changes in Securities and Use of Proceeds ..................35 Item 3 Defaults upon Senior Securities ............................35 Item 4 Submission of Matters to a Vote of Security Holders ....................................................35 Item 5 Other Information ..........................................35 Item 6 Exhibits and Reports on Form 8-K ...........................35 Signatures .................................................36 Item 1: Financial Statements Interchange Financial Services Corporation -------------------------------------------------------------------------------- CONDENSED CONSOLIDATED BALANCE SHEETS -------------------------------------------------------------------------------- (dollars in thousands)
March 31, December 31, 2004 2003 ---------- ------------ (unaudited) Assets Cash and due from banks $ 35,488 $ 31,423 Interest earning deposits 11 12 Federal funds sold 20,700 -- ---------- ---------- Total cash and cash equivalents 56,199 31,435 ---------- ---------- Securities held to maturity at amortized cost (estimated market value of $19,088 and $20,223 for March 31, 2004 and December 31, 2003, respectively) 17,916 19,107 ---------- ---------- Securities available for sale at estimated market value (amortized cost of $363,655 and $428,597 for March 31, 2004 and December 31, 2003, respectively) 370,239 432,953 ---------- ---------- Loans and leases (net of unearned income and deferred fees of $5,809 and $6,057 for March 31, 2004 and December 31, 2003, respectively) 831,286 796,581 Less: Allowance for loan and lease losses 9,635 9,641 ---------- ---------- Net loans and leases 821,651 786,940 ---------- ---------- Bank owned life insurance 22,114 21,853 Premises and equipment, net 20,217 20,343 Foreclosed real estate and other repossesed assets 219 230 Goodwill 55,952 55,924 Intangible assets 4,039 4,165 Accrued interest receivable and other assets 10,219 12,922 ---------- ---------- Total assets $1,378,765 $1,385,872 ========== ========== Liabilities Deposits Non-interest bearing $ 228,547 $ 223,745 Interest bearing 937,579 933,053 ---------- ---------- Total deposits 1,166,126 1,156,798 ---------- ---------- Securities sold under agreements to repurchase 13,242 15,618 Short-term borrowings 10,000 46,491 Long-term borrowings 30,000 10,000 Accrued interest payable and other liabilities 14,579 13,772 ---------- ---------- Total liabilities 1,233,947 1,242,679 ---------- ---------- Commitments and contingent liabilities Stockholders' equity: Common stock, without par value; 22,500,000 shares authorized; 12,740,407 and 12,810,193 shares issued and outstanding at March 31, 2004 and December 31, 2003, respectively 5,397 5,397 Capital surplus 73,325 73,231 Retained earnings 77,094 74,710 Accumulated other comprehensive income 3,549 2,434 ---------- ---------- 159,365 155,772 Less: Treasury stock 14,547 12,579 ---------- ---------- Total stockholders' equity 144,818 143,193 ---------- ---------- Total liabilities and stockholders' equity $1,378,765 $1,385,872 ========== ==========
-------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 3 Interchange Financial Services Corporation -------------------------------------------------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF INCOME For the Three Months Ended March 31, -------------------------------------------------------------------------------- (dollars in thousands, except per share data) (unaudited)
2004 2003 ------- ------- Interest income Interest and fees on loans $12,707 $10,857 Interest on federal funds sold 6 63 Interest on interest earning deposits -- 12 Interest and dividends on securities Taxable interest income 2,650 2,283 Interest income exempt from federal income taxes 269 179 Dividends 39 56 ------- ------- Total interest income 15,671 13,450 ------- ------- Interest expense Interest on deposits 2,827 3,407 Interest on securities sold under agreements to repurchase 42 86 Interest on short-term borrowings 70 -- Interest on long-term borrowings 198 105 ------- ------- Total interest expense 3,137 3,598 ------- ------- Net interest income 12,534 9,852 Provision for loan and lease losses 375 265 ------- ------- Net interest income after provision for loan and lease losses 12,159 9,587 ------- ------- Non-interest income Service fees on deposit accounts 842 653 Net gain on sale of securities 514 -- Net gain on sale of loans and leases 76 198 Bank owned life insurance 261 278 Commissions on sale of annuities and mutual funds 212 213 Other 610 502 ------- ------- Total non-interest income 2,515 1,844 ------- ------- Non-interest expense Salaries and benefits 4,848 3,628 Occupancy 1,365 928 Furniture and equipment 334 253 Advertising and promotion 393 315 Amortization of intangible assets 126 19 Other 1,851 1,384 ------- ------- Total non-interest expense 8,917 6,527 ------- ------- Income before income taxes 5,757 4,904 Income taxes 1,771 1,548 ------- ------- Net income $ 3,986 $ 3,356 ======= ======= Basic earnings per common share $ 0.31 $ 0.34 ======= ======= Diluted earnings per common share $ 0.31 $ 0.34 ======= =======
-------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 4 Interchange Financial Services Corporation -------------------------------------------------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Three Months Ended March 31, -------------------------------------------------------------------------------- (dollars in thousands, except per share data) (unaudited)
Accumulated Other Comprehensive Retained Comprehensive Common Income Earnings Income Stock -------- -------- ------------- -------- Balance at January 1, 2003 $ 63,314 $ 3,596 $ 5,397 Comprehensive income Net Income $ 3,356 3,356 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities 143 Minimum pension liability adjustment (19) -------- Other comprehensive income 124 124 -------- Comprehensive income $ 3,480 ======== Dividends on common stock (1,082) Issued 20,833 shares of common stock in connection with Executive Compensation Plan Exercised 3,740 option shares -------- -------- -------- Balance at March 31, 2003 65,588 3,720 5,397 Comprehensive income Net Income $ 13,010 13,010 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities (617) Less: realized gains on disposition of securities (820) Unrealized gains on equity securities 137 Minimum pension liability adjustment 14 -------- Other comprehensive income (1,286) (1,286) -------- Comprehensive income $ 11,724 ======== Dividends on common stock (3,888) Exercised 55,955 option shares Issued 2,949,719 shares of common stock in connection with the acquisition of Bridge View Bancorp Reacquired 35,959 shares in lieu of non-performing asset -------- -------- -------- Balance at December 31, 2003 74,710 2,434 5,397 Comprehensive income Net Income $ 3,986 3,986 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities 1,402 Less: realized gains on disposition of securities (287) -------- Other comprehensive income 1,115 1,115 -------- Comprehensive income $ 5,101 ======== Dividends on common stock (1,602) Issued 7,793 shares of common stock in connection with Executive Compensation Plan Exercised 7,207 option shares Purchased 84,786 shares of common stock -------- -------- -------- Balance at March 31, 2004 $ 77,094 $ 3,549 $ 5,397 ======== ======== ======== Capital Treasury Surplus Stock Total --------- -------- -------- Balance at January 1, 2003 $ 21,097 $(12,724) $ 80,680 Comprehensive income Net Income 3,356 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities Minimum pension liability adjustment Other comprehensive income 124 Comprehensive income Dividends on common stock (1,082) Issued 20,833 shares of common stock in connection with Executive Compensation Plan 109 245 354 Exercised 3,740 option shares (28) 38 10 -------- -------- -------- Balance at March 31, 2003 21,178 (12,441) 83,442 Comprehensive income Net Income 13,010 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities Less: realized gains on disposition of securities Unrealized gains on equity securities Minimum pension liability adjustment Other comprehensive income (1,286) Comprehensive income Dividends on common stock Exercised 55,955 option shares (127) 555 428 Issued 2,949,719 shares of common stock in connection with the acquisition of Bridge View Bancorp 52,180 52,180 Reacquired 35,959 shares in lieu of non-performing asset (693) (693) -------- -------- -------- Balance at December 31, 2003 73,231 (12,579) 143,193 Comprehensive income Net Income 3,986 Other comprehensive income, net of taxes Unrealized gains on AFS debt securities Less: realized gains on disposition of securities Other comprehensive income 1,115 Comprehensive income Dividends on common stock (1,602) Issued 7,793 shares of common stock in connection with Executive Compensation Plan 103 102 205 Exercised 7,207 option shares (9) 84 75 Purchased 84,786 shares of common stock (2,154) (2,154) -------- -------- ------- Balance at March 31, 2004 $ 73,325 $(14,547) $144,818 ======== ======== =======
-------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 5 Interchange Financial Services Corporation -------------------------------------------------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months Ended March 31, -------------------------------------------------------------------------------- (dollars in thousands) (unaudited)
2004 2003 -------- -------- Cash flows from operating activities Net income $ 3,986 $ 3,356 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 498 357 Amortization of securities premiums 1,590 776 Accretion of securities discounts (58) (77) Amortization of premiums in connection with acquisition 375 18 Provision for loan losses 375 265 Increase in cash surrender value of Bank Owned Life Insurance (261) (277) Origination of Loans available for sale (880) (4,068) Sale of loans available for sale 941 4,173 Net gain on sale of securities (514) -- Net gain on sale of loans (76) (198) Net gain on sale of fixed assets -- 10 Net gain on sale of foreclosed assets (14) -- Decrease (increase) in operating assets Accrued interest receivable 425 (209) Other 1,074 (725) (Decrease) increase in operating liabilities Accrued interest payable (29) 12 Other 836 (49) -------- -------- Cash provided by operating activities 8,268 3,364 -------- -------- Cash flows from investing activities (Payments for) proceeds from Purchase of loans (20,608) -- Net repayments (originations) of loans (15,005) 7,499 Sale of loans 282 1,196 Purchase of securities available-for-sale (2,799) (12,947) Maturities of securities available-for-sale 21,990 13,893 Sale of securities available-for-sale 44,793 -- Maturities of securities held-to-maturity 1,119 1,311 Purchase of fixed assets (328) (413) Sale of reposessed assets 59 33 -------- -------- Cash used in investing activities 29,503 10,572 -------- -------- Cash flows from financing activities Proceeds from (payments for) Deposits in excess of withdrawals 9,336 25,243 Decrease in short-term debt (18,867) (1,433) Minimum pension liability, net of taxes -- (19) Dividends (1,602) (1,082) Treasury stock (2,154) -- Common stock issued 205 354 Exercise of option shares 75 10 -------- -------- Cash provided by financing activities (13,007) 23,073 -------- -------- Increase in cash and cash equivalents 24,764 37,009 Cash and cash equivalents, beginning of year 31,435 33,916 -------- -------- Cash and cash equivalents, end of period $ 56,199 $ 70,925 ======== ======== Supplemental disclosure of cash flow information: Cash paid for: Interest $ 3,168 $ 3,586 Income taxes -- 45 Supplemental disclosure of non-cash investing activities: Loans transferred to foreclosed real estate and other repossessed assets 34 54
-------------------------------------------------------------------------------- See notes to condensed consolidated financial statements. 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 2004 (Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Interchange Financial Services Corporation and its wholly owned subsidiaries (on a consolidated basis, the "Company") including its principal operating subsidiary, Interchange Bank (the "Bank"), and have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and in accordance with the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations, certain information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and schedules thereto included in the annual report on Form 10-K of the Company for the year ended December 31, 2003. The consolidated financial data for the three month periods ended March 31, 2004 and 2003, are unaudited but reflect all adjustments consisting of only normal recurring adjustments which are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the interim periods. The results of operations for interim periods are not necessarily indicative of results to be expected for any other period or the full year. Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates pertain to the allowance for loan and lease losses, the fair value of financial instruments, goodwill, intangibles and retirement benefits. Stock Based Compensation: The Company accounts for stock option plans under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25. "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation costs are reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and diluted earnings per common share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board ("FASB") Statement No. 123, " Accounting for Stock-Based Compensation," to stock-based compensation for the three months ended March 31, 2004 and 2003: (in thousands, except share data) (unaudited) 7 -------------------------- For the three months ended March 31, 2004 2003 ----------- ---------- Net Income As reported $ 3,986 $ 3,356 Less: Total stock-based compensation expense determined under the fair value method for all rewards, net of related tax effects 128 84 ---------- ---------- Pro-forma $ 3,858 $ 3,272 ========== ========== Earnings per share: Basic: As reported 0.31 0.34 Pro forma 0.30 0.33 Diluted: As reported 0.31 0.34 Pro forma 0.30 0.33 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions were used for option grants issued during the three months ended March 31, 2004: dividend yield of 2.22%; expected volatility of 24.92%; risk-free interest rate of 3.34%; and expected lives of 7 years. Prior period assumptions are described in Note 13 "Stock Option and Incentive Plan" in the Notes to Condensed Consolidated Financial Statements in the Company's 2003 Annual Report on Form 10-K. The effects of applying these assumptions in determining the pro-forma net income may not be representative of the effects on pro-forma net income for future years. 2. Acquisition and Pro Forma Disclosure On April 30, 2003 the Company completed its acquisition of 100% of the common stock of Bridge View Bancorp ("Bridge View"), a Bergen County-based bank holding company with eleven locations, which expanded the Company's presence into eastern Bergen County. The results of Bridge View's operations have been included in the consolidated financial statements since that date. At April 30, 2003, Bridge View had approximately $291 million of total assets, $184 million of loans and $259 million of deposits. The aggregate purchase price paid to Bridge View shareholders was approximately $85.7 million and consisted of approximately 2.9 million shares of the Company's common stock with an approximate market value of $52.2 million, based upon the average closing price over the periods three days prior to and after the 8 acquisition date, and $33.5 million in cash. The transaction was accounted for as a purchase and the cost in excess of net assets acquired of approximately $58.7 million was allocated to net identified intangibles of approximately $4.3 million and goodwill of approximately $54.4 million. The following pro forma condensed consolidated statements of income for the three months ended March 31, 2003 give effect to the merger as if the merger had been consummated on January 1, 2003. The unaudited pro forma information is not necessarily indicative of the results of operations in the future or the results of operations, which would have been realized had the merger been consummated during the periods or as of the dates for which the unaudited pro forma information is presented. Interchange Financial Services Corporation and Subsidiaries CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) (unaudited) Three Months Ended March 31, ---------------------- 2004 2003 ------- ------- Pro Forma Interest income $15,671 $16,637 Interest expense 3,137 4,197 ------- ------- Net interest income 12,534 12,440 ------- ------- Provision for loan and lease losses 375 280 ------- ------- Net interest income after provision for loan and lease losses 12,159 12,160 Non-interest income 2,515 2,395 Non-interest expense Salaries and benefits 4,848 4,644 Occupancy and FF&E 1,699 1,630 Other expenses 2,370 2,256 ------- ------- 8,917 8,530 Net income before taxes 5,757 6,025 Income Taxes 1,771 1,991 ------- ------- Net income $ 3,986 $ 4,034 ======= ======= Earnings per common share: Basic 0.31 0.32 Diluted 0.31 0.32 3. Earnings Per Common Share Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential 9 common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. 4. Commitments and Contingent Liabilities Legal Proceedings The Company is a party to routine litigation involving various aspects of its business, none of which, in the opinion of management, is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company. Commitments to Extend Credit At March 31, 2004, the Company had commitments of approximately $260.3 million to extend credit, of which approximately $2.5 million represents standby letters of credit. 5. Goodwill and Other Intangibles With the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), on January 1, 2002, goodwill is no longer amortized to expense, but rather is tested for impairment periodically. Other intangible assets are amortized to expense using straight-line methods over their respective estimated useful lives. At least annually, management reviews goodwill and other intangible assets and evaluates events or changes in circumstances that may indicate impairment in the carrying amount of such assets. If the sum of the expected undiscounted future cash flows, excluding interest charges, is less than the carrying amount of the asset, an impairment loss is recognized. Impairment, if any, is measured on a discounted future cash flow basis. Goodwill is reviewed for impairment annually and on an interim basis when conditions require. If necessary an impairment charge is recognized in the period that goodwill has been deemed to be impaired. At the date of adoption, there was no unamortized goodwill. At March 31, 2004 and December 31, 2003, gross intangible assets amounted to $4.6 million at the end of each period while accumulated amortization amounted to $556 thousand and $430 thousand, respectively. Amortization of intangible assets as a result of acquisitions, which is included in non-interest expense, amounted to $126 thousand, and $19 thousand for the three months ended March 31, 2004 and 2003, respectively. During the second quarter of 2003, the Company recorded a core deposit intangible of $4.3 million in connection with the Bridge View merger. The core deposit intangible has an estimated life of 10 years and the Company amortized $107 thousand for the three months ended March 31, 2004. The core deposit intangible will be periodically reviewed for impairment. In addition, the Company recorded goodwill of $54.4 million in connection with the Bridge View merger. The goodwill will be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. 10 The estimated aggregate annual amortization expense for core deposit intangible is summarized as follows: (in thousands) 2005 $ 430 2006 430 2007 430 2008 430 2009 430 thereafter 1,429 -------- Total $ 3,579 ======== 6. Segment Reporting SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"), requires disclosures for each reportable operating segment. As a community-oriented financial institution, substantially all of the Company's operations entail the delivery of loan and deposit products and various other financial services to customers in its primary market area, which is Bergen County, New Jersey. The Company's community-banking operation constitutes the Company's only operating segment for financial reporting purposes under SFAS No. 131. 7. Recent Accounting Pronouncements On December 23, 2003, the FASB issued Statement of Financial Accounting Standards No. 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits ("SFAS 132"). The revised SFAS 132 retains the disclosure requirements in the original statement and requires additional disclosures about pension plan assets, benefit obligations, benefit costs and other relevant information. The Company has included the new interim disclosures that are required for financial statements for periods ending after December 15, 2003. 8. Cash Dividend The Company paid a cash dividend of $0.125 per share on February 20, 2004 to holders of record as of January 30, 2004. 9. Securities Held-to-Maturity and Securities Available-for-Sale Securities held-to-maturity ("HTM") and securities available-for-sale ("AFS") consist of the following: (in thousands) 11
------------------------------------------------ March 31, 2004 ------------------------------------------------ (unaudited) Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Securities HTM Mortgage-backed securities $ 8,824 $ 318 $ 1 $ 9,141 Obligations of states & political subdivisions 9,092 855 -- 9,947 -------- ------ -------- -------- $ 17,916 $1,173 $ 1 $ 19,088 -------- ------ -------- -------- Securities AFS Mortgage-backed securities $101,439 $1,752 $ 23 $103,168 Obligations of U.S. agencies 223,768 3,716 67 227,417 Obligations of states & political subdivisions 34,034 1,099 30 35,103 Other debt securities -- -- -- -- Equity securities 4,414 137 -- 4,551 -------- ------ -------- -------- 363,655 6,704 120 370,239 -------- ------ -------- -------- Total securities $381,571 $7,877 $ 121 $389,327 ======== ====== ======== ======== ------------------------------------------------ December 31, 2003 ------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Securities HTM Mortgage-backed securities $ 9,850 $ 330 $ 1 $ 10,179 Obligations of states & political subdivisions 9,257 787 -- 10,044 -------- ------ -------- -------- $ 19,107 $1,117 $ 1 $ 20,223 -------- ------ -------- -------- Securities AFS Obligations of U.S. Treasury $ 6,032 $ 5 $ 2 $ 6,035 Mortgage-backed securities 112,981 1,363 157 114,187 Obligations of U.S. agencies 271,339 2,583 762 273,160 Obligations of states & political subdivisions 33,849 1,257 68 35,038 Equity securities 4,396 137 -- 4,533 -------- ------ -------- -------- 428,597 5,345 989 432,953 -------- ------ -------- -------- Total securities $447,704 $6,462 $ 990 $453,176 ======== ====== ======== ========
At March 31, 2004, the contractual maturities of securities HTM and securities AFS are as follows: (in thousands) (unaudited) 12 Securities Securities HTM AFS -------------------- ---------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value ---------------------- ----------------------- Within 1 year $ 1,150 $ 1,190 $ 19,474 $ 19,510 After 1 but within 5 years 10,130 10,606 296,481 301,833 After 5 but within 10 years 5,667 6,217 31,167 31,786 After 10 years 969 1,075 12,119 12,559 Equity securities -- -- 4,414 4,551 -------------------- ---------------------- Total $17,916 $19,088 $363,655 $370,239 ==================== ====================== Proceeds from the sale of securities AFS amounted to $44.8 million for the three months ended March 31, 2004, which resulted in gross realized gains of $520 thousand and gross realized losses of $6 thousand. These amounts are included in net gain on sale of securities in the Consolidated Statements of Income. There were no sales of securities for the three months ended March 31, 2003. The investment portfolio is evaluated at least quarterly to determine if there are any securities with losses that are other than temporary. One criteria in assessing for an other than temporary impairment charge is if a security has an unrealized loss that exceeds one year. At March 31, 2004, the Company had $2.8 million of securities with unrealized losses of $8 thousand that were in excess of one year. It is expected that the Company will recover all amounts due under the contractual obligations of those securities and as such, no other than temporary impairment charge was necessary. The following table summarizes all securities that have an unrealized loss and the duration of the unrealized loss at March 31, 2004: (in thousands) (unaudited)
--------------------- --------------------- --------------------- 12 months or less 12 months or longer Totals --------------------- --------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses --------------------- --------------------- --------------------- AVAILABLE-FOR-SALE Obligations of U.S. agencies $39,091 $ 67 -- -- $39,091 $ 67 Mortgage-backed securities 4,467 15 $2,808 $ 8 7,275 23 Obligations of states and political subdivisions 3,372 30 -- -- 3,372 30 --------------------- --------------------- --------------------- $46,930 $ 112 $2,808 $ 8 $49,738 $120 ===================== ===================== ===================== HELD-TO-MATURITY Mortgage-backed securities $ 229 $ 1 -- -- $ 229 $ 1 --------------------- --------------------- --------------------- $ 229 $ 1 $ 0 $ 0 $ 229 $ 1 ===================== ===================== =====================
Securities with carrying amounts of $51.1 million and $46.1 million at March 31, 2004 and December 31, 2003, respectively, were pledged for public deposits, Federal Home Loan Bank advances, securities sold under repurchase agreements and other purposes required by law. 13 10. Loans The composition of the loan portfolio is summarized as follows: (in thousands) ----------- ----------- March 31, December 31, 2004 2003 ----------- ----------- (unaudited) Amount of loans by type Real estate-mortgage 1-4 family residential First liens $119,224 $100,286 Junior liens 3,722 4,138 Home equity 145,085 136,477 Commercial 333,212 330,040 Construction 26,253 31,077 -------- -------- 627,496 602,018 -------- -------- Commercial loans Commercial and financial 160,497 149,462 Lease financing 29,737 28,440 -------- -------- 190,234 177,902 -------- -------- Consumer loans Lease financing 9,794 12,416 Installment 3,762 4,245 -------- -------- 13,556 16,661 -------- -------- Total $831,286 $796,581 ======== ======== Nonperforming Assets Nonperforming loans include loans that are accounted for on a nonaccrual basis and troubled debt restructurings. Nonperforming loans are as follows: (in thousands) ----------- ------------ March 31, December 31, 2004 2003 ----------- ------------ (unaudited) Nonaccrual loans Residential real estate $1,502 $1,364 Commercial real estate 1,685 1,603 Commercial and financial 2,808 2,858 Commercial lease financing 1,848 2,365 Consumer 622 380 ------ ------ $8,465 $8,570 ====== ====== 14 11. Allowance for Loan and Lease Losses The Company's recorded investment in impaired loans is as follows: (in thousands)
--------------------- --------------------- March 31, December 31, 2004 2003 --------------------- --------------------- (unaudited) Investment Related Investment Related in Allowance in Allowance Impaired for Loan Impaired for Loan Loans Losses Loans Losses --------------------- ---------- --------- Impaired loans With a related allowance for loan losses Commercial and financial $2,820 $ 429 $2,864 $463 Commercial real estate 1,685 42 1,603 40 Residential mortgages 824 124 816 122 Consumer 205 5 -- -- Without a related allowance for loan losses -- -- -- -- ------ ------ ------ ---- $5,534 $ 600 $5,283 $625 ====== ====== ====== ====
-------------------------------------------------------------------------------- The impairment of the above loans was measured based on the fair value of collateral. Changes in the allowance for loan and lease losses are summarized as follows: (in thousands) ----------------------------- Three months ended March 31, ----------------------------- 2004 2003 ------------- ------------- (unaudited) Balance at beginning of period $9,641 $7,207 Additions (deductions) Provision for loan and lease losses 375 265 Recoveries on loans previously charged off 36 1 Loans charged off (417) (247) ------------- ------------- Balance at end of year $9,635 $7,226 ============= ============= 12. Other Non-interest Expense Expenses included in other non-interest expense which exceed one percent of the aggregate of total interest income and non-interest income for the periods noted, are as follows: (in thousands) (unaudited) 15 -------------------------- Three months ended March 31, -------------------------- 2004 2003 ----------- ------ (unaudited) Professional fees $ 317 $ 204 Data processing 281 193 Directors's fees, retirement and travel 216 128 Legal Fees 210 80 Other 827 779 ------ ------ $1,851 $1,384 ====== ====== 13. Long-term Borrowings Long-term borrowings consist of the following FHLB advances: (in thousands) Maturity March 31, December 31, Date Rate 2004 2003 --------------- ------- ----------- ------------ (unaudited) January 2006 2.09% $10,000 -- January 2007(a) 4.22 10,000 $10,000 January 2007 2.69 10,000 -- ------ ------- ------- 3.00% $30,000 $10,000 ====== ======= ======= (a) The FHLB has an option to call this advance on a quarterly basis if the 3-month LIBOR resets above 7.50%. 14. Benefit Plans In 1993, the Bank established a non-contributory defined benefit pension plan covering all eligible employees (the "Pension Plan"). In 1994, the Bank established a supplemental plan covering all eligible employees (the "Supplemental Plan") that provides for income that would have been paid out but for the limitation under the qualified Pension Plan. Also in 1994, the Company established a retirement plan for all directors of the Bank who are not employees of Interchange or of any subsidiary or affiliate of Interchange (the "Directors' Plan"). The following table shows the aggregated components of net periodic benefit costs for the periods noted: (in thousands) (unaudited) 16 ------------------ Three Months Ended March 31, ------------------ 2004 2003 ------- ------- Service Cost $ 166 $ 151 Interest Cost 95 79 Expected return on plan assets (39) (31) Amortization of prior service cost 1 1 Amortization of net (gain) loss -- -- ------ ------ Net periodic benefit cost $ 223 $ 200 ====== ====== For the year ended December 31, 2004, the Bank anticipates contributing approximately $775 thousand to the Pension Plan. 17 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The following discussion is an analysis of the consolidated financial condition and results of operations of the Company for the three month periods ended March 31, 2004 and 2003, and should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1 hereof. In addition, you should read this section in conjunction with Management's Discussion and Analysis and Results of Operations included in the Company's 2003 Annual Report on Form 10-K. On April 30, 2003, the Company completed its acquisition of Bridge View Bancorp ("Bridge View"). Accordingly the results of operations for the three month period ending March 31, 2004 include the results of Bridge View. Forward Looking Information In addition to discussing historical information, certain statements included in or incorporated into this report relating to the financial condition, results of operations and business of the Company which are not historical facts may be deemed "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When used herein, the words "anticipate," "believe," "estimate," "expect," "will" and other similar expressions (including when preceded or followed by the word "not") are generally intended to identify such forward-looking statements. Such statements are intended to be covered by the safe harbor provisions for forward-looking statements contained in such Act, and we are including this statement for purposes of invoking these safe harbor provisions. Such forward-looking statements include, but are not limited to, statements about the operations of the Company, the adequacy of the Company's allowance for losses associated with the loan and lease portfolio, the quality of the loan and lease portfolio, the prospects of continued loan and deposit growth, and improved credit quality. The forward-looking statements in this report involve certain estimates or assumptions, known and unknown risks and uncertainties, many of which are beyond the control of the Company, and reflect what we currently anticipate will happen in each case. What actually happens could differ materially from what we currently anticipate will happen due to a variety of factors, including, among others, (i) increased competitive pressures among financial services companies; (ii) changes in the interest rate environment, reducing interest margins or increasing interest rate risk; (iii) deterioration in general economic conditions, internationally, nationally, or in the State of New Jersey; (iv) the occurrence of acts of terrorism, such as the events of September 11, 2001, or acts of war; (v) legislation or regulatory requirements or changes adversely affecting the business of the Company; (vi) losses in the Company's leasing subsidiary exceeding management's expectations; (vii) expected revenue synergies from the Company's acquisition of Bridge View may not be fully realized or realized within the expected time frame; (viii) revenues following the Company's acquisition of Bridge View may be lower than expected; (ix) deposit attrition, operating costs, customer loss and business disruption following the Company's 18 acquisition of Bridge View, including, without limitation, difficulties in maintaining relationships with employees, may be greater than expected and (x) other risks detailed in reports filed by the Company with the Securities and Exchange Commission. Readers should not place undue expectations on any forward-looking statements. We are not promising to make any public announcement when we consider forward-looking statements in this document to be no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason. Company The Company is a bank holding company headquartered in Bergen County, New Jersey. The Company's principal operating subsidiary is Interchange Bank, a New Jersey-chartered commercial bank. In addition to the Bank, the Company has one other wholly owned direct subsidiary: Clover Leaf Mortgage Company, a New Jersey corporation, which is not currently engaged in any business activity. The Bank has five direct subsidiaries: Clover Leaf Investment Corporation, an investment company operating pursuant to New Jersey law; Clover Leaf Insurance Agency, Inc., a New Jersey corporation engaged in the sale of tax-deferred annuities and insurance; Clover Leaf Management Realty Corporation, a Real Estate Investment Trust ("REIT"), which manages certain real estate assets of the Company; Bridge View Investment Company, an investment company operating pursuant to New Jersey law; and Interchange Capital Company, L.L.C. ("ICC"), a New Jersey limited liability company which engages in equipment lease financing. All of the Bank's subsidiaries are 100% owned by the Bank, except for the REIT, which is 99% owned by the Bank. Bridge View Investment Company has one wholly owned subsidiary, Bridge View Delaware, Inc. ("BVDI"). BVDI is an investment company operating pursuant to Delaware law. Critical Accounting Policies and Judgments The Company's consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 "Accounting Policies in the Notes to Consolidated Financial Statements and in the Management's Discussion and Analysis of Financial Condition and Results of Operations: Critical Accounting Policies and Judgements" in our 2003 Annual Report on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect the Company's reported results and financial position for the period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments primarily by using internal cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on the Company's future financial condition and results of operations. 19 Allowance for Loan and Lease Losses: The ALLL is generally established through periodic charges to income. Loan losses are charged against the ALLL when management believes that the probable future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is considered inadequate to absorb future loan losses on existing loans, based on, but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan and lease losses is increased. The Company considers the ALLL of $9.6 million adequate to cover estimated losses inherent in the loan portfolio that may become uncollectible based on management's periodic evaluations of the loan portfolio and other relevant factors. The evaluations are inherently subjective as it requires material estimates including such factors as potential loss factors, changes in trend of non-performing loans, current state of local and national economy, value of collateral changes in the composition and volume of the loan portfolio, review of specific problem loans and management's assessment of the inherent risk and overall quality of the loan portfolio. All of these factors may be susceptible to significant change. Also, the allocation of the allowance for credit losses to specific loan pools is based on historical loss trends and management's judgment concerning those trends. Business Combinations: Business combinations are accounted for using the purchase method of accounting, the net assets of the companies acquired are recorded at their estimated fair value at the date of acquisition and include the results of operations of the acquired business from the date of acquisition. The excess of the purchase price over the estimated fair value of the net assets acquired is recognized as goodwill. Goodwill: With the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), on January 1, 2002, goodwill is no longer amortized to expense, but rather is tested for impairment periodically. Other intangible assets are amortized to expense using straight-line methods over their respective estimated useful lives. At least annually, management reviews goodwill and other intangible assets and evaluates events or changes in circumstances that may indicate impairment in the carrying amount of such assets. If the sum of the expected undiscounted future cash flows, excluding interest charges, is less than the carrying amount of the asset, an impairment loss is recognized. Impairment, if any, is measured on a discounted future cash flow basis. Goodwill is reviewed for impairment annually and on an interim basis when conditions require. If necessary, an impairment charge is recognized in the period that goodwill has been deemed to be impaired. At the date of adoption, there was no unamortized goodwill. 20 THREE MONTHS ENDED MARCH 31, 2004 AND 2003 RESULTS OF OPERATIONS Summary On April 30, 2003, the Company completed its acquisition of Bridge View. Accordingly the results of operations for the three month period ending March 31, 2004 include the results of Bridge View. Net income for the three months ended March 31, 2004 was approximately $4.0 million, an increase of $0.6 million, or 18.8%, over the same period last year. The increase in earnings resulted from the acquisition of Bridge View during the second quarter of 2003 and an increase in non-interest income. For the first quarter of 2004, the Company reported earnings per diluted common share of $0.31, as compared to $0.34 for the same period in 2003. The decline in diluted earnings per share was a result of a compression in the net interest margin as compared to the first quarter in 2003 and an increase in average diluted shares outstanding as a result of the Bridge View transaction. For the three months ended March 31, 2004 and 2003, the Company's Return on Average Assets ("ROA") was 1.16% and 1.42%, respectively. The change in ROA for the quarter was a result of a decline in net interest margin. Return on Average Equity ("ROE") was 11.13% a decline from 16.38% when compared to the same period last year. ROE declined principally due to an increase in equity as a result of the acquisition of Bridge View and, to a lesser extent, compression in net interest margin. Net Interest Income Net interest income is the most significant source of the Company's operating income. A portion of the Company's total interest income is derived from investments that are exempt from federal taxation. The amount of pretax income realized from those investments, due to the tax exemption, is less than the amount of pretax income realizable from comparable investments subject to federal taxation. For purposes of the following discussion, interest income exempt from federal taxation has been restated to a fully tax-equivalent basis using the corporate federal tax rate of 34% for the three months ended March 31, 2004 and 2003. This was accomplished by adjusting this income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes. Net interest income on a tax-equivalent basis increased $2.7 million, or 27.5%, to $12.7 million for the quarter ended March 31, 2004 as compared to the same quarter in 2003. The tax equivalent basis adjustments for the quarters ended March 31, 2004 and 2003, were $160 thousand and $108 thousand, respectively. The increase in net interest income was due mostly to a 40.0% growth in interest earning assets. This interest earning asset growth was funded primarily by deposit liabilities, which grew 40.4% on average for the first quarter of 2004 as compared to the same quarter in 2003. The growth in interest earning assets and deposits were primarily attributed to the acquisition and the Company's internal growth. The Company's average deposits grew 11.0% organically. The margin for the first quarter of 2004 was 4.11%, a decline of 40 basis points as compared to the same quarter in 2003 due to earning 21 asset yields declining faster than the Company's cost of funds. The decline in asset yields was mainly attributable to maturities and prepayments in the loan and securities portfolio, while the Company's deposit pricing reached historical lows and appears to have become inelastic. However, we would anticipate that as market interest rates rise we would experience assets repricing more quickly, at least in the short-term, as deposit pricing typically lags increases in market rates. Interest income, on a tax-equivalent basis, totaled $15.8 million for the first quarter of 2004, an increase of $2.3 million, or 16.8%, as compared to the same quarter in 2003. The increase was mostly attributed to a $352.9 million, or 40.0%, growth in interest earning assets. The growth in interest earning assets was the result of increases in average loans and average investments of $192.1 million and $184.2 million, respectively. The increase in interest income was partly offset by a 101 basis point decline in interest earning asset yields for the first quarter of 2004 as compared to the same quarter in 2003. The decline in interest earning asset yields was largely attributed to the historically low market interest rate environment. Interest expense, which totaled $3.1 million for the first quarter of 2004, decreased $461 thousand, or 12.8%, as compared to the same period in 2003. The decrease in interest expense was a byproduct of the decline in market interest rates, particularly short-term rates, during 2003. In addition, a beneficial shift in the composition of the Company's deposits, which is discussed further in the analysis of financial condition below, also had a favorable impact on the Company's interest expense. The improved deposit mix combined with lower short-term interest rates reduced the average rate paid on interest bearing liabilities by 71 basis points to 1.26% for the quarter ended March 31, 2004 as compared to the same period in 2003. The magnitude of the benefit derived from the decrease in rates paid on interest bearing liabilities was partially reduced by the positive growth of deposits. Interest bearing deposits grew on average $227.6 million, or 32.2%, for the first quarter of 2004 as compared to the same period in 2003. 22 -------------------------------------------------------------------------------- Analysis of Net Interest Income -------------------------------------------------------------------------------- for the quarter ended March 31, (dollars in thousands) (unaudited)
2004 2003 ----------------------------------- ---------------------------- Average Average Average Average Balance Interest Rate Balance Interest Rate ----------- --------- ------- -------- -------- ------- Assets Interest earning assets: Loans (1) $ 806,387 $ 12,748 6.32% $614,301 $10,897 7.10% Taxable securities (4) 397,591 2,689 2.71 221,386 2,339 4.23 Tax-exempt securities (2) (4) 28,898 388 5.37 20,940 247 4.72 Interest earning deposits 12 -- -- 4,333 12 1.11 Federal funds sold 2,507 6 0.96 21,585 63 1.17 ----------- --------- ---- -------- ------- ---- Total interest-earning assets 1,235,395 15,831 5.13 882,545 13,558 6.14 --------- ------- Non-interest earning assets: Cash and due from banks 35,547 22,167 Allowance for loan and lease losses (9,636) (7,207) Other assets 118,933 47,958 ----------- -------- Total assets $ 1,380,239 $945,463 =========== ======== Liabilities and stockholders' equity Interest-bearing liabilities Interest bearing deposits $ 933,522 2,827 1.21 $705,960 3,407 1.93 Borrowings 65,364 310 1.90 26,229 191 2.90 ----------- --------- ---- -------- ------- ---- Total interest-bearing liabilities 998,886 3,137 1.26 732,189 3,598 1.97 --------- ------- Non-interest bearing liabilities Demand deposits 224,100 118,779 Other liabilities 14,013 12,521 ----------- -------- Total liabilities (3) 1,236,999 863,489 Stockholders' equity 143,240 81,974 ----------- -------- Total liabilities and stockholders' equity $ 1,380,239 $945,463 =========== ======== Net interest income (tax-equivalent basis) 12,694 3.87 9,960 4.17 Tax-equivalent basis adjustment (160) (108) --------- ------- Net interest income $ 12,534 $ 9,852 ========= ======= Net interest income as a percent of interest- earning assets (tax-equivalent basis) 4.11% 4.51%
-------------------------------------------------------------------------------- (1) Nonaccrual loans and any related interest recorded have been included in computing the average rate earned on the loan portfolio. When applicable, tax exempt loans are computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%. (2) Computed on a fully taxable equivalent basis using the corporate federal tax rate of 34%. (3) All deposits are in domestic bank offices. (4) The average balances are based on historical cost and do not reflect unrealized gains or losses. Provision for Loan and Lease Losses The provision for loan and lease losses represents management's calculation of the amount necessary to bring the allowance for loan and lease losses ("ALLL") to a level that management considers adequate to reflect the risk of estimated losses inherent in the Company's loan portfolio as of the balance sheet date. A more detailed discussion of the evaluation of the ALLL can be found in the section titled "Critical Accounting Policies and Judgements: Allowance for Loan and Lease Losses" above. In the first quarter of 2004 and 2003, the Company's provision for loan and lease losses was $375 thousand and $265 thousand, respectively. 23 Non-interest Income For the quarter ended March 31, 2004, non-interest income totaled $2.5 million, an increase of $671 thousand, or 36.4%, as compared to the same period in 2003. The improvement in non-interest income, excluding net gains from the sales of securities, was mostly due to increases in service charges on deposits and "other" non-interest income of $189 thousand and $108 thousand, respectively. The growth in service charges on deposits was mostly due to the acquisition. During the quarter, the Company recognized net gains on the sale of securities of $514 thousand while there were no gains recorded for the same period in 2003. The funds generated from the sales of securities were mainly utilized to fund loan growth. Non-interest Expense For the quarter ended March 31, 2004, non-interest expense was $8.9 million an increase of $2.4 million, or 36.6%, when compared to the same period one year ago. The increase was due largely to the additional operating costs resulting from the merger with Bridge View. Also contributing to the increase were normal increases related to salaries, benefits and occupancy expense. Income Taxes Income tax expense as a percentage of pre-tax income was 30.8% for the three months ended March 31, 2004 as compared to 31.6% for the first quarter of 2003. 24 FINANCIAL CONDITION Cash and Cash Equivalents At March 31, 2004, cash and cash equivalents increased $24.8 million to $56.2 million as compared to December 31, 2003. This was primarily attributed to federal funds sold increasing to $20.7 million while the Company was in a net borrowing position at December 31, 2003. Securities Portfolio Under Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), each security is classified as either trading, available for sale ("AFS"), or held to maturity ("HTM"). The Company has no securities held in a trading account. The securities AFS are recorded at their estimated fair value. The after-tax difference between amortized cost and estimated fair value of securities AFS is recorded as "accumulated other comprehensive income" in the equity section of the balance sheet. The tax impact of such adjustment is recorded as an adjustment to the amount of the deferred tax liability. The securities HTM are carried at cost adjusted for the amortization of premiums and accretion of discounts, which are recognized as an adjustment to income. Under SFAS No. 115, securities HTM, with some exceptions, may only be sold within three months of maturity. The Company uses its securities portfolio to ensure liquidity for cash flow requirements, to manage interest rate risk, provide a source of income, ensure collateral is available for pledging requirements and manage asset quality diversification. At March 31, 2004, investment securities totaled $388.2 million and represented 28.2% of total assets, as compared to $452.1 million and 32.6%, respectively, at December 31, 2003. Securities AFS comprised 95.4% of the total securities portfolio at March 31, 2004 as compared to 95.8% at December 31, 2003. During the first quarter of 2004, the Company sold securities with a book value of approximately $44.3 million and recognized $520 thousand in gross gains and $6 thousand in gross losses. There were no sales of securities during the first quarter of 2003. 25 The following table reflects the composition of the securities portfolio: (dollars in thousands)
---------------------------------------------- March 31, 2004 ---------------------------------------------- (unaudited) Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Securities HTM Mortgage-backed securities $ 8,824 $ 318 $ 1 $ 9,141 Obligations of states & political subdivisions 9,092 855 -- 9,947 -------- ------ -------- -------- $ 17,916 $1,173 $ 1 $ 19,088 ======== ====== ======== ======== Securities AFS Mortgage-backed securities $101,439 $1,752 $ 23 $103,168 Obligations of U.S. agencies 223,768 3,716 67 227,417 Obligations of states & political subdivisions 34,034 1,099 30 35,103 Equity securities 4,414 137 -- 4,551 -------- ------ -------- -------- 363,655 6,704 120 370,239 -------- ------ -------- -------- Total securities $381,571 $7,877 $ 121 $389,327 ======== ====== ======== ======== ---------------------------------------------- December 31, 2003 ---------------------------------------------- (unaudited) Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Securities HTM Mortgage-backed securities $ 9,850 $ 330 $ 1 $ 10,179 Obligations of states & political subdivisions 9,257 787 -- 10,044 -------- ------ -------- -------- $ 19,107 $1,117 $ 1 $ 20,223 ======== ====== ======== ======== Securities AFS Obligations of U.S. Treasury $ 6,032 $ 5 $ 2 $ 6,035 Mortgage-backed securities 112,981 1,363 157 114,187 Obligations of U.S. agencies 271,339 2,583 762 273,160 Obligations of states & political subdivisions 33,849 1,257 68 35,038 Equity securities 4,396 137 -- 4,533 -------- ------ -------- -------- 428,597 5,345 989 432,953 -------- ------ -------- -------- Total securities $447,704 $6,462 $ 990 $453,176 ======== ====== ======== ========
At March 31, 2004, the contractual maturities of securities HTM and securities AFS are as follows: (dollars in thousands) (unaudited) 26 Securities Securities HTM AFS -------------------- -------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value -------------------- -------------------- Within 1 year $ 1,150 $ 1,190 $ 19,474 $ 19,510 After 1 but within 5 years 10,130 10,606 296,481 301,833 After 5 but within 10 years 5,667 6,217 31,167 31,786 After 10 years 969 1,075 12,119 12,559 Equity securities -- -- 4,414 4,551 ------------------ -------------------- Total $17,916 $19,088 $363,655 $370,239 ================== ==================== Loans Total loans amounted to $831.3 million at March 31, 2004, an increase of $34.7 million from $796.6 million at December 31, 2003. The growth was predominately in residential mortgage loans which increased $27.1 million. Also contributing to the increase were commercial and financial loans and commercial mortgages which increased $11.0 million and $3.2 million, respectively for the three month period ended March 31, 2004. Somewhat offsetting the aforementioned increases were decreases in construction loans and consumer leases of $4.8 million and $2.6 million, respectively. The following table reflects the composition of the loan and lease portfolio: (dollars in thousands) ----------- ------------ March 31, December 31, 2004 2003 ----------- ------------ (unaudited) Amount of loans by type Real estate-mortgage Residential $268,031 $240,901 Commercial 333,212 330,040 Construction 26,253 31,077 -------- -------- 627,496 602,018 -------- -------- Commercial loans Commercial and financial 160,497 149,462 Lease financing 29,737 28,440 -------- -------- 190,234 177,902 -------- -------- Consumer loans Lease financing 9,794 12,416 Installment 3,762 4,245 -------- -------- 13,556 16,661 -------- -------- Total $831,286 $796,581 ======== ======== 27 Nonperforming Assets Nonperforming assets are comprised of nonaccrual loans, restructured loans, foreclosed real estate and other repossessed assets. With the completion of the Bridge View acquisition, the Company's, nonperforming assets at March 31, 2004 amounted to $8.7 million as compared to $8.8 million at December 31, 2003. The ratio of nonperforming assets to total loans and foreclosed real estate and other repossessed assets decreased to 1.04% at March 31, 2004 from 1.10% at December 31, 2003. The following table lists nonaccrual loans, restructured loans and foreclosed real estate and other repossessed assets at March 31, 2004, and December 31, 2003: (dollars in thousands) ----------- ------------ March 31, December 31, 2004 2003 ----------- ------------ (unaudited) Nonperforming loans $8,465 $8,570 Foreclosed real estate and other repossessed assets 219 230 ------ ------ $8,684 $8,800 ====== ====== Allowance for Loan and Lease Losses The ALLL is generally established through periodic charges to income. During the three months ended March 31, 2004, the ALLL remained relatively stable at $9.6 million. Loan losses are charged against the ALLL when management believes that the probable future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is considered inadequate to absorb future loan losses on existing loans, based on, but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan and lease losses is increased. The Company considers the ALLL of $9.6 million adequate to cover estimated losses inherent in the loan portfolio that may become uncollectible based on management's periodic evaluations of the loan portfolio and other relevant factors. The evaluations are inherently subjective as they require material estimates including such factors as potential loss factors, changes in trend of non-performing loans, current state of local and national economy, value of collateral changes in the composition and volume of the loan portfolio, review of specific problem loans and management's assessment of the inherent risk and overall quality of the loan portfolio. All of these factors may be susceptible to significant change. Also, the allocation of the allowance for credit losses to specific loan pools is based on historical loss trends and management's judgment concerning those trends. 28 The following table presents the provisions for loan and lease losses, loans charged off and recoveries on loans previously charged off, the amount of the allowance, the average loans outstanding and certain pertinent ratios for the three months ended March 31, 2004 and 2003: (dollars in thousands) (unaudited) Three months ended March 31, ---------------------- 2004 2003 -------- --------- Average loans outstanding $806,387 $614,301 ======== ======== Allowance at beginning of period 9,641 7,207 -------- -------- Loans charged off Real estate 67 -- Commercial and financial 55 25 Commercial lease financing 277 208 Consumer loans 18 14 -------- -------- Total 417 247 -------- -------- Recoveries of loans previously charged off Real Estate -- -- Commercial and financing -- -- Commercial lease financing 36 -- Consumer loans -- 1 -------- -------- Total 36 1 -------- -------- Additions due to merger -- -- Provision for loan and lease losses 375 265 -------- -------- Allowance at end of period $ 9,635 $ 7,226 ======== ======== Allowance to total loans (end of period) 1.16% 1.19% Ratio of net charge-offs to average loans (annualized) 0.19% 0.16% Deposits Deposits, which include non-interest-bearing demand deposits, time deposits and other interest-bearing deposits are an essential and cost-effective funding source for the Company. The Company attributes its success in growing deposits to the emphasis it places on building core customer relationships by offering a variety of products designed to meet the financial needs of its customers based on their identifiable "life stages". At March 31, 2004, total deposits increased $9.3 million, or 0.8%, remaining relatively stable at $1.2 billion at December 31, 2003. We benefited from a change in the mix as we experienced a growth in core deposits (non time deposits) of $14.9 million, or 1.7%, while time deposits decreased $5.6 million, or 2.0%, respectively, at March 31, 2004 as compared to December 31, 2003. Other interest-bearing deposits, which include interest-bearing demand, money market and savings accounts, comprise the largest segment of the Company's total deposits. At March 31, 2004, such deposits amounted to $661.2 29 million representing 56.7% of total deposits compared to 56.3% of total deposits at December 31, 2003. The growth in core deposits was due to increases in interest bearing demand, money market savings and non-interest demand of $8.3 million, $4.8 million and $4.8 million, respectively, offset somewhat by a decrease in savings accounts of $3.0 million. Time deposits amounted to $276.4 million, or 23.7%, of total deposits at March 31, 2004, as compared to $282.0 million, or 24.4%, at December 31, 2003. For the three months ended March 31, 2004, the Company's overall yield on deposits declined by 72 basis points from 1.93% to 1.21%, as compared to the same period last year. The decrease was attributed predominately to changes in market interest rates and a change in the composition of deposit liabilities. The following table reflects the composition of deposit liabilities: (dollars in thousands) ----------- --------- March 31, March 31, 2004 2003 ----------- --------- (Unaudited) Non-interest Demand $ 228,547 $118,218 Interest Bearing Demand 455,098 332,322 Savings 117,121 83,873 Money Market Savings 88,997 65,617 Time Deposits <$100,000 260,446 221,492 Time Deposits >$100,000 15,917 19,393 ---------- -------- Total $1,166,126 $840,915 ========== ======== 30 Item 3: Quantitative and Qualitative Disclosures About Market Risk Market risk is generally described as the sensitivity of income to adverse changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates or prices. Market rate sensitive instruments include: financial instruments such as investments, loans, mortgage-backed securities, deposits, borrowings and other debt obligations; derivative financial instruments, such as futures, forwards, swaps and options; and derivative commodity instruments, such as commodity futures, forwards, swaps and options that are permitted to be settled in cash or another financial instrument. The Company does not have any material exposure to foreign currency exchange rate risk or commodity price risk. The Company did not enter into any market rate sensitive instruments for trading purposes nor did it engage in any trading or hedging transactions utilizing derivative financial instruments during the first three months of 2004. The Company's real estate loan portfolio, concentrated primarily in northern New Jersey, is subject to risks associated with the local and regional economies. The Company's primary source of market risk exposure arises from changes in market interest rates ("interest rate risk"). Interest Rate Risk Interest rate risk is generally described as the exposure to potentially adverse changes in current and future net interest income resulting from: fluctuations in interest rates; product spreads; and imbalances in the repricing opportunities of interest-rate-sensitive assets and liabilities. Therefore, managing the Company's interest rate sensitivity is a primary objective of the Company's senior management. The Company's Asset/Liability Committee ("ALCO") 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 and presented to the Board, 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 March 31, 2004, the Company simulated the effects on net interest income given an instantaneous and parallel shift in the yield curve of up to a 200 basis point rising interest rate environment and a 100 basis point declining interest rate environment. Based on that simulation, it was estimated that net interest income, over a twelve-month horizon, would not decrease by more than 5.6%. At March 31, 2004, the Company was within policy limits established by the board of directors for changes in net interest income and future economic value of equity. The following table illustrates the effects on net interest income given 31 an instantaneous and parallel shift in the yield curve of up to a 200 basis point rising interest rate environment and a 100 basis point declining interest rate environment: (unaudited) Net Interest Income Sensitivity Simulation Percentage Change in Estimated Net Interest Income over a twelve month horizon ------------------------------------------- March 31, 2004 2003 ------------ ------------- +200 basis points -5.6% -1.3% +100 basis points -1.7 0.7 -100 basis points -4.8 -6.7 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 32 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 a negative 11.06% at March 31, 2004. Since the cumulative gap was negative, the Company has a "negative gap" position, which theoretically will cause its assets to reprice more slowly than its deposit liabilities. In a declining interest rate environment, interest costs may be expected to fall faster than the interest received on earning assets, thus increasing the net interest spread. If interest rates increase, a negative gap means that the interest received on earning assets may be expected to increase more slowly than the interest paid on the Company's liabilities therefore decreasing the net interest spread. Capital Adequacy The Company is subject to capital adequacy requirements imposed by the Board of Governors of the Federal Reserve System (the "Federal Reserve"); and the Bank is subject to similar capital adequacy requirements imposed by the Federal Deposit Insurance Corporation (the "FDIC"). The Federal Reserve and the FDIC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and offbalance sheet items. A banking organization's total qualifying capital includes two components: core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common shareholders' equity, qualifying perpetual preferred stock, trust preferred securities (subject to certain limitations) and minority interests, less goodwill and any unrealized gains or losses. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, trust preferred securities that exceed Tier 1 limits, certain other capital instruments and term subordinated debt. Total capital is the sum of core and supplementary capital. At March 31, 2004, the minimum risk-based capital requirements to be considered adequately capitalized were 4% for Tier 1 capital and 8% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non risk-adjusted) for the preceding quarter. At March 31, 2004, the minimum leverage ratio requirement to be considered adequately capitalized was 3%. 33 The capital levels of the Company and the Bank at March 31, 2004, and the two highest capital adequacy levels recognized under the guidelines established by the federal banking agencies are included in the following table. The Company's and the Bank's ratios all exceeded the well-capitalized guidelines shown in the table. The Company's and the Bank's capital amounts and ratios are as follows: (dollars in thousands)
To Be "Well Capitalized" Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------ ------------------ ------------------ Amount Ratio Amount Ratio Amount Ratio ------- ----- -------- ------ ------- ----- As of March 31, 2004: (unaudited) Total Capital (to Risk Weighted Assets): The Company $92,264 10.32% $71,522 8.00% N/A N/A The Bank 91,411 10.20% 71,680 8.00% 89,600 10.00% Tier 1 Capital (to Risk Weighted Assets): The Company 82,489 9.23% $35,761 4.00% N/A N/A The Bank 81,636 9.11% 35,840 4.00% 53,760 6.00% Tier 1 Capital (to Average Assets): The Company 82,489 6.21% $39,825 3.00% N/A N/A The Bank 81,636 6.20% 39,526 3.00% 65,877 5.00% As of December 31, 2003: Total Capital (to Risk Weighted Assets): The Company $91,694 10.46% $70,146 8.00% N/A N/A The Bank 91,358 10.35% 70,637 8.00% $88,296 10.00% Tier 1 Capital (to Risk Weighted Assets): The Company 81,913 9.34% 35,073 4.00% N/A N/A The Bank 81,576 9.24% 35,319 4.00% 52,978 6.00% Tier 1 Capital (to Average Assets): The Company 81,913 6.24% 39,367 3.00% N/A N/A The Bank 81,576 6.22% 39,318 3.00% 65,530 5.00%
Liquidity Liquidity is the ability to provide sufficient resources to meet all current financial obligations and finance prospective business opportunities. The Company's liquidity position over any given period of time is a product of its operating, financing and investing activities. The extent of such activities is often shaped by such external factors as competition for deposits and demand for loans. The Company's most liquid assets are cash and cash equivalents. At March 31, 2004, the total of such assets amounted to $56.2 million, or 4.1%, of total assets, compared to $31.4 million, or 2.3%, of total assets at December 31, 2003. The increase in cash and cash equivalents was due largely to the sales of securities, deposit growth and loan prepayments, which produced funds that were placed in federal funds sold or interest earning deposits pending investment in loans and securities. Financing for the Company's loans and investments is derived primarily from deposits, along with interest and principal payments on loans and investments. At March 31, 2004 and December 31, 2003, total deposits amounted to $1.2 billion. In addition, the Company supplemented the more traditional funding sources with borrowings from the Federal Home Loan Bank of New York ("FHLB") and with securities sold under agreements to repurchase ("REPOS"). At March 31, 2004, advances from the FHLB 34 and REPOS amounted to $40.0 million and $13.2 million, respectively, as compared to $56.5 million and $15.6 million, respectively, at December 31, 2003. Net loans and leases at March 31, 2004 amounted to $821.7 million, an increase of $34.7 million, from $786.9 million at December 31, 2003. Another significant liquidity source is the Company's securities portfolio. Total securities at March 31, 2004 amounted to $388.2 million, a decrease of $63.9 million, from $452.1 million at December 31, 2003. At March 31, 2004 securities AFS amounted to $370.2 million, or 95.4%, of total securities compared to $433.0 million, or 95.8%, of total securities at December 31, 2003. In addition to the aforementioned sources of liquidity, the Company has available various other sources of liquidity, including federal funds purchased from other banks and the Federal Reserve discount window. The Bank also has a $96.3 million line of credit available through its membership in the FHLB. The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments, which include commitments to extend credit and standby letters of credit, involve, to a varying degree, elements of credit and interest rate risk in excess of the amount recognized in the Condensed Consolidated Balance Sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Company. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions. Commitments to extend credit and standby letters of credit are not recorded on the Company's condensed consolidated balance sheet until the instrument is exercised. At March 31, 2004 outstanding commitments to fund loans totaled $260.3 million and outstanding standby letters of credit totaled $2.5 million. The Company historically paid quarterly cash dividends and anticipates continuing paying quarterly dividends in the future. The Company could, if necessary, modify the amount or frequency, of dividends as an additional source of liquidity. There are imposed dividend restrictions on the Bank, which are described in Note 18 "Restrictions of Subsidiary Bank Dividends" in the Notes to Consolidated Financial Statements in the Company's 2003 Annual Report on Form 10-K. Management believes that the Company has sufficient cash flow and borrowing capacity to fund all outstanding commitments and letters of credit and to maintain proper levels of liquidity. 35 Item 4. Controls and Procedures In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), as of the end of the quarter ended March 31, 2004, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective. The Company maintains internal control over financial reporting. During the quarter ended March 31, 2004, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 36 PART II - OTHER INFORMATION Item 1. Legal Proceedings Reference is also made to Note 4 of the Company's Consolidated Financial Statements in this Form 10-Q. Item 2. Change in Securities and Use of Proceeds Total Number Maximum of Shares Number of Purchased as Shares That Part of the May Yet Be Total Number Average 2001 Stock Purchased of Shares Price Paid Repurchase Under the Period Purchased per Share Plan Plan -------------------------------------------------------------------------------- 2/1/04-2/29/04 84,786 $25.41 256,104 193,896 ========================================================= Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are furnished herewith: Exhibit. -------- 11 Statement re computation of per share earnings 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K During the quarter ended March 31, 2004, the Company filed the following Current Report on Form 8-K: Form 8-K filed January 23, 2004, reporting earnings for the year ending December 31, 2003. 37 Form 8-K filed March 31, 2004, reporting expected increase in net income for first quarter 2004 versus 2003 and expected decrease in diluted earnings per share for first quarter 2004 versus 2003. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Interchange Financial Services Corporation By: /s/ Charles T. Field -------------------------------------- Charles T. Field Senior Vice President and CFO (Duly Authorized Officer and Principal Financial and Accounting Officer) Dated: May 10, 2004 38