-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AmfYXCQPGN9/9AWHW/PmiOAZit901y8Dw5VLtnJSfFmjnxFfuLBaUuKHxPijRs1F bgBEAq3DAK9XtCQGTsxAww== 0000755933-06-000022.txt : 20060510 0000755933-06-000022.hdr.sgml : 20060510 20060510164354 ACCESSION NUMBER: 0000755933-06-000022 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060510 DATE AS OF CHANGE: 20060510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERCHANGE FINANCIAL SERVICES CORP /NJ/ CENTRAL INDEX KEY: 0000755933 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 222553159 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10518 FILM NUMBER: 06826830 BUSINESS ADDRESS: STREET 1: PARK 80 WEST PLAZA TWO STREET 2: ATTN INTERCHANGE STATE BANK CITY: SADDLE BROOK STATE: NJ ZIP: 07662 BUSINESS PHONE: 2017032265 MAIL ADDRESS: STREET 1: PARK 80 WEST STREET 2: PLAZA II CITY: SADDLE BROOK STATE: NJ ZIP: 07663 FORMER COMPANY: FORMER CONFORMED NAME: INTERCHANGER STATE BANK DATE OF NAME CHANGE: 19870416 FORMER COMPANY: FORMER CONFORMED NAME: INTERCHANGE FINANCIAL SERVICES CORP DATE OF NAME CHANGE: 19861209 10-Q 1 form10q033106.txt FORM 10-Q AS OF MARCH 31-2006 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, 2006 Commission File number 1-10518 INTERCHANGE FINANCIAL SERVICES CORPORATION (Exact name of registrant as specified in its charter) New Jersey 22-2553159 ---------- ---------- (State or other jurisdiction of (IRS Employer incorporation) Identification No.) Park 80 West/Plaza Two, Saddle Brook, NJ 07663 ---------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (201) 703-2265 Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (check one): |_| Large Accelerated Filer |X| Accelerated Filer |_| Non-accelerated Filer Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The number of outstanding shares of the Registrant's common stock, no par value per share, as of March 31, 2006, was 20,336,697. INTERCHANGE FINANCIAL SERVICES CORPORATION INDEX PART I FINANCIAL INFORMATION Page No. Item 1 Financial Statements Unaudited Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005..............................1 Unaudited Condensed Consolidated Statements of Income for the three months ended March 31, 2006 and 2005........................2 Unaudited Condensed Consolidated Statements of Changes in Stockholders' Equity for the three months ended March 31, 2006 and 2005...........................................3 Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005....................4 Notes to Unaudited Condensed Consolidated Financial Statements....5 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations..............................19 Item 3 Quantitative and Qualitative Disclosures About Market Risk.......31 Item 4 Controls and Procedures..........................................35 PART II OTHER INFORMATION Item 1 Legal Proceedings................................................37 Item 1A Risk Factors.....................................................37 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds......38 Item 3 Defaults upon Senior Securities..................................38 Item 4 Submission of Matters to a Vote of Security Holders..............38 Item 5 Other Information................................................38 Item 6 Exhibits.........................................................39 Signatures.......................................................40 PART I - FINANCIAL INFORMATION Item 1: FINANCIAL STATEMENTS
Interchange Financial Services Corporation - ----------------------------------------------------------------------------------------- CONDENSED CONSOLIDATED BALANCE SHEETS - ----------------------------------------------------------------------------------------- (dollars in thousands, except share data) (unaudited) March 31, December 31, 2006 2005 ------------- ----------- Assets Cash and due from banks $ 36,840 $ 42,620 Interest bearing demand deposits 4 4 ------------- ----------- Total cash and cash equivalents 36,844 42,624 ------------- ----------- Securities held-to-maturity at amortized cost (estimated fair value of $44,602 and $36,199 for March 31, 2006 and December 31, 2005, respectively) 44,484 35,714 ------------- ----------- Securities available-for-sale at estimated fair value (amortized cost of $317,449 and $324,548 for March 31, 2006 and December 31, 2005, respectively) 312,614 320,752 ------------- ----------- Loans available-for-sale 4,562 1,487 ------------- ----------- Loans and leases (net of unearned income and deferred fees of $6,482 and $6,786 for March 31, 2006 and December 31, 2005, respectively) 1,119,529 1,104,482 Less: Allowance for loan and lease losses 10,559 10,646 ------------- ----------- Net loans and leases 1,108,970 1,093,836 ------------- ----------- Bank owned life insurance 27,209 26,941 Premises and equipment, net 17,425 17,509 Foreclosed assets and other repossessed assets 74 122 Goodwill 68,922 68,910 Intangible assets 5,276 5,469 Accrued interest receivable and other assets 18,406 18,022 ------------- ----------- Total assets $ 1,644,786 $ 1,629,899 ============= =========== Liabilities Deposits Non-interest bearing $ 250,150 $ 260,151 Interest bearing 1,001,126 999,957 ------------- ----------- Total deposits 1,251,276 1,260,108 ------------- ----------- Securities sold under agreements to repurchase 13,154 3,939 Short-term borrowings 65,635 46,150 Long-term borrowings 100,331 110,333 Subordinated debentures 20,620 20,620 Accrued interest payable and other liabilities 11,986 11,234 ------------- ----------- Total liabilities 1,463,002 1,452,384 ------------- ----------- Commitments and contingent liabilities Stockholders' equity: Common stock, without par value; 33,750,000 shares authorized; 20,336,697 and 20,138,668 shares issued and outstanding for March 31, 2006 and December 31, 2005, respectively. 5,397 5,397 Capital surplus 96,756 97,238 Retained earnings 101,725 99,222 Accumulated other comprehensive loss, net of taxes of $1,885 and $1,497 for March 31, 2006 and December 31, 2005, respectively. (2,961) (2,310) ------------- ----------- 200,917 199,547 Less: Treasury stock 19,133 20,545 ------------- ----------- Total stockholders' equity 181,784 179,002 ------------- ----------- Total liabilities and stockholders' equity $ 1,644,786 $ 1,631,386 ============= =========== - ------------------------------------------------------------------------------------------ See notes to unaudited condensed consolidated financial statements.
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Interchange Financial Services Corporation - ----------------------------------------------------------------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF INCOME - ----------------------------------------------------------------------------------------------- For the Three Months Ended March 31, - ----------------------------------------------------------------------------------------------- (in thousands, except per share data) (unaudited) 2006 2005 --------------- ------------- Interest income Interest on loans and leases $ 18,826 $ 14,957 Interest and dividends on securities Taxable interest income 2,373 2,665 Interest income exempt from federal income taxes 687 323 Dividends 103 60 --------------- ------------- Total interest income 21,989 18,005 --------------- ------------- Interest expense Interest on deposits 6,292 3,922 Interest on securities sold under agreements to repurchase 34 23 Interest on short-term borrowings 442 180 Interest on long-term borrowings and subordinated debentures 1,434 316 --------------- ------------- Total interest expense 8,202 4,441 --------------- ------------- Net interest income 13,787 13,564 Provision for loan and lease losses 175 175 --------------- ------------- Net interest income after provision for loan and lease losses 13,612 13,389 --------------- ------------- Non-interest income Service fees on deposit accounts 892 883 Net gain on sale of securities 23 67 Net gain on sale of loans and leases 261 156 Bank owned life insurance 268 264 Commissions on sale of annuities and mutual funds 193 182 Other 1,047 642 --------------- ------------- Total non-interest income 2,684 2,194 --------------- ------------- Non-interest expense Salaries and benefits 5,437 4,955 Occupancy 1,586 1,463 Furniture and equipment 372 315 Advertising and promotion 236 395 Amortization of intangible assets 193 126 Other 2,008 1,900 --------------- ------------- Total non-interest expense 9,832 9,154 --------------- ------------- Income before income taxes 6,464 6,429 Income taxes 1,935 2,009 --------------- ------------- Net income $ 4,529 $ 4,420 =============== ============= Basic earnings per common share $0.22 $0.23 ===== ===== Diluted earnings per common share $0.22 $0.23 ===== ===== - ----------------------------------------------------------------------------------------------- See notes to unaudited condensed consolidated financial statements.
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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 Capital Treasury Income Earnings Income(Loss) Stock Surplus Stock Total ----------- --------- ----------- ------- --------- --------- --------- Balance at Jauary 1, 2005 $ 86,542 $ (633) $ 5,397 $ 73,320 $(14,471)$ 150,155 Comprehensive income Net Income $ 4,420 4,420 4,420 Other comprehensive losses, net of taxes Less: unealized losses on AFS debt securities (1,890) Less: net gains on disposition of securities (86) ----------- Other comprehensive losses, net of taxes (1,976) (1,976) (1,976) ----------- Comprehensive income $ 2,444 =========== Dividends on common stock (1,721) (1,721) Issued 17,111 shares of common stock in connection with Executive Compensation Plan 154 151 305 Exercised 11,675 option shares 11 96 107 Purchased 4,532 shares of common stock (76) (76) Payout of fractional shares resulting from the three-for-two stock split declared January 18, 2005 and paid on February 18, 2005 (7) (7) ---------- ----------- ------- --------- --------- -------- Balance at March 31, 2005 89,234 (2,609) 5,397 73,485 (14,300) 151,207 Comprehensive income Net Income $ 15,285 15,285 15,285 Other comprehensive losses, net of taxes Less: unealized losses on AFS debt securities 459 Less: net gains on disposition of securities (150) Minimum pension liability adjustment (10) ----------- Other comprehensive losses, net of taxes 299 299 299 ----------- Comprehensive income $ 15,584 =========== Dividends on common stock (5,292) (5,292) Issued 1,661 shares of common stock in connection with Executive Compensation Plan 20 11 31 Issued 1,323,181 shares of common stock in connection with the acquisition of Franklin Bank 23,738 23,738 Exercised 33,347 option shares (5) 287 282 Purchased 323,660 shares of common stock (5,827) (5,827) Payout of fractional shares in connection with the acquisition of Franklin Bank (5) (5) Reacquired 39,228 shares in settlement of lawsuit (716) (716) ---------- ----------- ------- --------- -------- ------- Balance at December 31, 2005 99,222 (2,310) 5,397 97,238 (20,545) 179,002 Comprehensive income Net Income $ 4,529 4,529 4,529 Other comprehensive losses, net of taxes Less: unealized losses on AFS debt securities (588) Less: net gains on disposition of securities (63) ----------- Other comprehensive losses, net of taxes (651) (651) (651) ----------- Comprehensive income $ 3,878 =========== Dividends on common stock (2,026) (2,026) Unvested restricted stock (220) (220) Amortization of deferred compensation of restricted stock 75 75 Exercised 136,220 option shares (337) 1,416 1,079 Purchased 227 shares of common stock (4) (4) ---------- ----------- ------- ------- --------- -------- Balance at March 31, 2006 $ 101,725 $ (2,961) $ 5,397 $96,756 $(19,133) $181,784 ========== =========== ======= ======= ========= ======== - --------------------------------------------------------------------------------------------------------------------------- See notes to unaudited condensed consolidated financial statements. All share data was restated to reflect a 3-for-2 stock split declared on January 18, 2005 and paid on February 18, 2005.
3
INTERCHANGE FINANCIAL SERVICES CORPORATION - ------------------------------------------------------------------------------------------- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months Ended March 31, - ------------------------------------------------------------------------------------------- (in thousands) (unaudited) 2006 2005 ------------- ----------- Cash flows from operating activities Net income $ 4,529 $ 4,420 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 583 502 Amortization of securities premiums 801 1,088 Accretion of securities discounts (123) (73) Amortization of loan premiums 19 23 Amortization of premiums in connection with acquisition 174 203 Provision for loan and lease losses 175 175 Increase in cash surrender value of Bank Owned Life Insurance (268) (263) Net gain on sale of securities (23) (67) Origination of loans held for sale (11,384) (2,490) Sale of loans held for sale 8,309 2,645 Net gain on sale of loans and leases (261) (156) Net gain on sale of fixed assets (3) - Write off of foreclosed and repossessed assets 68 13 Decrease (increase) in operating assets Accrued interest receivable 335 (113) Deferred taxes (132) (393) Other Assets (282) 1,236 Increase (decrease) in operating liabilities Accrued interest payable 28 313 Other 724 1,500 ------------- ----------- Cash provided by operating activities 3,269 8,563 ------------- ----------- Cash flows from investing activities (Payments for) proceeds from Net originations of loans and leases (15,514) (40,313) Purchase of loans and leases - (2,837) Sale of loans and leases 421 16 Purchase of securities available-for-sale (56,211) (14,560) Maturities of securities available-for-sale 49,678 23,585 Sale of securities available-for-sale 13,060 3,048 Maturities of securities held-to-maturity 3,370 984 Purchase of securities held-to-maturity (12,224) - Purchase of fixed assets (2,802) (304) Premium in connection with acquisition 6 19 Sale of fixed assets 2,380 - ------------- ----------- Cash used in investing activities (17,836) (30,362) ------------- ----------- Cash flows from financing activities Proceeds from (payments for) Net change in deposits (8,815) (14,740) Securities sold under agreements to repurchase and other borrowings 289,265 285,314 Retirement of securities sold under agreement to repurchase and other borrowings (270,567) (248,729) Dividends (2,026) (1,721) Common stock issued (145) 305 Payout of fractional shares resulting from 3-for-2 stock split - (7) Treasury stock (4) (76) Exercise of option shares 1,079 107 ------------- ----------- Cash provided by financing activities 8,787 20,453 ------------- ----------- Increase in cash and cash equivalents (5,780) (1,346) Cash and cash equivalents, beginning of period 42,624 33,110 ------------- ----------- Cash and cash equivalents, end of period $ 36,844 $ 31,764 ============= =========== Supplemental disclosure of cash flow information: Cash paid for: Interest $ 8,127 $ 4,323 Income taxes 250 38 Supplemental disclosure of non-cash investing and financing activities: Loans transferred to foreclosed real estate and other repossessed assets 20 7 - ------------------------------------------------------------------------------------------- See notes to unaudited condensed consolidated financial statements.
4 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 2006 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Interchange Financial Services Corporation and certain of its wholly owned subsidiaries (on a consolidated basis, the "Company") including its principal operating subsidiary, Interchange Bank (the "Bank") and Clover Leaf Mortgage Company, and have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and in accordance with the rules and regulations of the Securities and Exchange Commission. The Company has two wholly owned trusts which are not consolidated, see Note 13 "Subordinated Debentures" for a more detailed discussion of these subsidiaries. Pursuant to such rules and regulations, certain information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and schedules thereto included in Amendment No. 1 to the annual report on Form 10-K/A of the Company for the year ended December 31, 2005. The condensed consolidated financial data for the three month periods ended March 31, 2006 and 2005, are unaudited but reflect adjustments consisting of only normal recurring adjustments which are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the interim periods. The results of operations for interim periods are not necessarily indicative of results to be expected for any other period or the full year. Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates pertain to the allowance for loan and lease losses, the fair value of financial instruments, goodwill, intangibles, taxes and retirement benefits. New Accounting Pronouncements: In February 2006, the Financial Accounting Standards Board ("FASB") issued statement No. 155, "Accounting for Certain Hybrid Financial Instruments" ("SFAS No. 155"). Under current generally accepted accounting principles an entity that holds a financial instrument with an embedded derivative must bifurcate the financial instrument, resulting in the host and the embedded derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities to account for financial instruments with an embedded derivative at fair value thus negating the need to bifurcate the instrument between its host and the 5 embedded derivative. SFAS No. 155 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We expect that SFAS No. 155 will not have a material effect on our consolidated financial condition or results of operations. In March 2006, the FASB issued statement No. 156, "Accounting for Servicing of Financial Assets" ("SFAS no. 156"). SFAS No. 156 amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. SFAS No. 156 permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and serving liabilities is required to account for those derivative instruments at fair value. SFAS No. 156 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We expect that SFAS No. 156 will not have a material effect on our financial condition or results of operations. Stock Based Compensation: The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based Payment ("SFAS No. 123(R)"), on January 1, 2006 using the "modified prospective" method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS No. 123(R). Also under this method, expense is recognized for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). Prior to the adoption of SFAS No. 23(R), the Company accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related interpretations. Accordingly, the Company previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123(R) in 2005 (in thousands) (unaudited). 6 ----------------- For the three months ended March 31, 2005 ----------------- Net Income As reported $ 4,420 Less: Total stock-based compensation expense determined under the fair value method for all rewards, net of related tax effects 266 ----------------- Pro-forma $ 4,154 ================= Earnings per share: Basic: As reported 0.23 Pro forma 0.22 Diluted: As reported 0.23 Pro forma 0.21 On October 18, 2005, the Compensation Committee of the Board approved the accelerated vesting of all then outstanding unvested options to purchase common stock of the Company previously awarded to employees, officers and directors. No options were granted during the three months ended March 31, 2006. As a result of these actions there was no option expense or unrecognized costs recorded during the period. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions were used for option grants issued during the three months ended March 31, 2005: dividend yield of 2.01%, expected volatility of 23.05%; risk-free interest rate of 3.86%; and expected lives of approximately 7 years. Director Stock Compensation Program In 2000, the Company adopted a stock option plan, titled "Outside Director's Incentive Compensation Plan" (the "Director's Stock Plan") that covers those members of the Board of Directors of the Company who have not served as a full-time employee of the Company or any of its subsidiaries during the prior twelve-month period. Under this plan, options to purchase a maximum of 225,000 shares of Interchange common stock may be granted at fair market value at the date of grant. Options to purchase 157,000 shares (net of forfeitures) have been granted to date. Options granted expire if not exercised within ten years of date of grant and are exercisable according to a vesting schedule, starting one year from the date of grant. Only non-qualified stock options are granted under the Director's Stock Plan. 7 Employee Stock Option Plan The Company maintains two stock option and incentive plans: the Stock Option and Incentive Plan of 1997, as amended, and the 2005 Omnibus Stock and Incentive Plan (together "the Plans"), that covers certain key employees. The Compensation/Stock Option Committee administers the plans, reviews the awards and submits recommendations to the full board of directors for action. Options granted expire if not exercised within ten years of date of grant and are exercisable according to a vesting schedule, starting one year from the date of grant. Pursuant to the plans incentive stock options or non-qualified stock options may be granted to employees. In addition, the 2005 Omnibus Stock and Incentive Plan allows for other types of stock based awards to be issued including stock appreciation rights. The following table presents the activity related to options under all plans for the three months ended March 31, 2006 (in thousands) (unaudited). Weighted- Average Exercise Options Price ------------- ----------- Outstanding at January 1 1,407,919 $ 12.41 Granted - - Excercised (136,220) 7.93 Forfeited - - ------------- ----------- Outstanding at March 31 1,271,699 $ 12.89 ============= =========== All options are exercisable as of March 31, 2006. The weighted average remaining life of options outstanding at March 31, 2006 was 6.8 years. Restricted Stock Restricted Stock provides grantees with rights to shares of common stock upon completion of achievement of Company performance measures. During the restriction period, all shares are considered outstanding and dividends are paid on the Restricted Stock. The Restricted Stock vests over three years from date of grant. The Company recognizes compensation expense, measured as the quoted market price of the Restricted Stock on the grant date, on a straight-line basis over the vesting period for service period vesting. Restricted Stock is cancelled if an employee terminates prior to the vesting of the stock. As of March 31, 2006, unrecognized compensation cost related to unvested restricted stock totaled $1.3 million. The cost is expected to be recognized over a weighted average period of 2.8 years. The total grant date fair value of shares vested during the three months ended March 31, 2006 and 2005 was $263,000 and $253,000, respectively. 8 The following table presents the activity for restricted stock for the three months ended March 31, 2006. Number of Shares Weighted Average Grant-Date Fair Value (000) ------------------ ----------------- Unvested as of December 31, 2005 52,782 $ 680 Granted 62,036 1,181 Vested (24,694) (263) Forfeited (552) (10) ------------------ ----------------- Unvested as of March 31, 2006 89,572 $ 1,588 ================== ================= 2. Acquisitions On October 13, 2005 the Company completed its acquisition of Franklin Bank ("Franklin"), a one branch bank operating in Nutley, Essex County, New Jersey. The Company's acquisition of Franklin is intended to further enhance Interchange's presence in northern New Jersey. At October 13, 2005 Franklin had approximately, $87.0 million in total assets, $77.2 million in net loans and $76.0 million in deposits. Under the terms of the agreement, the total consideration received by Franklin shareholders in the merger is fixed at 1,323,575 shares of the common stock of the Company. Based upon the Company's average closing stock price three days prior to and after the date of announcement of the acquisition which occurred on June 23, 2005 of $17.94, the transaction represents total consideration of approximately $24.9 million, including approximately $1.2 million for the cash payment for option holders. Under the definitive agreement, each Franklin shareholder received 1.2264 Company shares for each Franklin share held immediately prior to the merger. The acquisition was accounted for as a purchase and the cost in excess of the fair value of net assets acquired was allocated first to net identified intangibles and then to goodwill. The goodwill is not tax deductible. The three months results of operations ending March 31, 2006 also include those of the acquired bank for the same period. 3. Earnings Per Common Share Basic earnings per common share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and restricted stock, and are determined using the treasury stock method. At March 31, 2006 and 2005 the weighted average diluted shares outstanding for the three months were approximately 20.7 million and 19.6 million, respectively. 9 The following table shows the computation of earnings per shares: (dollars in thousands, except per share amounts) (unaudited)
----------------------------------------------------------------- Three Months Ended, ----------------------------------------------------------------- March 31, 2006 March 31, 2005 ---------------------------------- ------------------------------ Weighted Per Weighted Per Average Share Average Share Income Shares Amount Income Shares Amount --------- ------------ ----------- --------- ----------- --------- Basic Earnings per Common Share Income available to common shareholders $ 4,529 20,231 $0.22 $ 4,420 19,134 $0.23 ========== ======== Effect of Dilutive Shares - 477 - 422 --------- ------------- --------- --------- Diluted Earnings per Common Share $ 4,529 20,708 $0.22 $ 4,420 19,556 $0.23 ========= ============= ========== ========= ========= ========
4. Commitments and Contingent Liabilities Legal Proceedings The Company is a party to routine litigations involving various aspects of its business, none of which, in the opinion of management, is expected to have a material adverse impact on the condensed consolidated financial condition, results of operations or liquidity of the Company. Commitments to Extend Credit At March 31, 2006, the Company had commitments to extend credit of approximately $293.3 million, of which approximately $4.3 million represents standby letters of credit. 5. Goodwill and Other Intangibles Goodwill is not amortized to expense, but rather is tested for impairment periodically. Goodwill is tested for impairment at least annually in accordance with the provisions of SFAS No. 142. There have been no events that have caused the Company to consider the need to test goodwill for impairment since the Company's last assessment. Other intangible assets are amortized to expense using straight-line methods over their respective estimated useful lives. At least annually, management reviews goodwill and other intangible assets and evaluates events or changes in circumstances that may indicate impairment in the carrying amount of such assets. If the sum of the expected undiscounted future cash flows, excluding interest charges, is less than the carrying amount of the 10 asset, an impairment loss is recognized. Impairment, if any, is measured on a discounted future cash flow basis. Net intangible assets are as follows: (in thousands) (unaudited) ---------------- ---------------- March 31, December 31, 2006 2005 ---------------- ---------------- Intangible assets $ 6,975 $ 6,975 Accumulated amortization (1,699) (1,506) ---------------- ---------------- Net intangible assets $ 5,276 $ 5,469 ================ ================ Intangible assets are a result of acquisitions and are primarily related to core deposit intangibles ("CDI") which have an estimated life of 10 years. For each of the three month periods ended March 31, 2006 and December 31, 2005, the CDI amortized were $193 thousand and $126 thousand, respectively. The CDI is periodically reviewed for impairment. At March 31, 2006 the scheduled amortization of the intangible assets is as follows (in thousands) (unaudited): 2006 for remaining period $ 560 2007 747 2008 747 2009 747 2010 747 Thereafter 1,728 ------------- Total $ 5,276 ============= 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. Cash Dividend On April 18, 2006, the Company declared a cash dividend of $0.10 per share payable on May 9, 2006, to holders of record as of May 1, 2006. 11 8. Securities Held-to-Maturity and Securities Available-for-Sale Securities held-to-maturity ("HTM") and securities available-for-sale ("AFS") consist of the following: (in thousands) (unaudited)
------------------------------------------------------------ March 31, 2006 ------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------------- ----------- ----------- -------------- Securities held-to-maturity Government-Sponsored Enterprises: Mortgage-backed securities $ 2,368 $ 7 $ 1 $ 2,374 Obligations of states & political subdivisions 42,116 324 212 42,228 ---------------- ----------- ----------- -------------- $ 44,484 $ 331 $ 213 $ 44,602 ================ =========== =========== ============== Securities available-for-sale Government-Sponsored Enterprises: Mortgage-backed securities $ 142,675 $ $ 33 $ 2,656 $ 140,052 Other debt 135,197 - 2,294 132,903 Obligations of states & political subdivisions 27,631 233 151 27,713 Equity securities 11,946 - - 11,946 ---------------- ----------- ----------- -------------- 317,449 266 5,101 312,614 ---------------- ----------- ----------- -------------- Total securities $ 361,933 $ $ 597 $ 5,314 $ 357,216 ================ =========== =========== ============== ------------------------------------------------------------ December 31, 2005 ------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------- ------------ ------------ -------------- Securities held-to-maturity Government-Sponsored Enterprises: Mortgage-backed securities $ 2,823 $ 15 $ 2 $ 2,836 Other debt 1,920 - - 1,920 Obligations of states & political subdivisions 30,971 481 9 31,443 ---------------- ----------- ----------- -------------- $ 35,714 $ 496 $ 11 $ 36,199 ================ =========== =========== ============== Securities available-for-sale Government-Sponsored Enterprises: Mortgage-backed securities $ 110,408 $ 79 $ 1,709 $ 108,778 Other debt 166,510 6 2,540 163,976 Obligations of states & political subdivisions 36,823 428 60 37,191 Equity securities 10,807 - - 10,807 ---------------- ----------- ----------- -------------- 324,548 513 4,309 320,752 ---------------- ----------- ----------- -------------- Total securities $ 360,262 $ 1,009 $ 4,320 $ 356,951 ================ =========== =========== ==============
12 At March 31, 2006, the contractual maturities of securities HTM and securities AFS are as follows: (in thousands) (unaudited)
Securities Securities Held-to-Maturity Available-for-Sale --------------------------- ------------------------ Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value ----------- ------------- ----------- ----------- Within 1 year $ 19,132 $ 19,140 $ 114,756 $ 113,658 After 1 but within 5 years 4,276 4,402 155,871 152,431 After 5 but within 10 years 13,757 13,809 26,952 26,552 After 10 years 7,319 7,251 7,924 8,027 Equity securities - - 11,946 11,946 ----------- ------------- ---------- ----------- $ 44,484 $ 44,602 $ 317,449 $ 312,614 =========== ============= ========== ===========
Proceeds from the sale of securities AFS amounted to $13.1 million and $3.0 million for the three months ended March 31, 2006 and 2005, respectively, which resulted in gross realized gains of $69 thousand and $67 thousand for those periods, respectively. Gross realized losses from the sale of securities AFS amounted to $46 thousand for the three months ended March 31, 2006. For the quarter ended March 31, 2005, there were no gross realized losses from the sale of securities. These amounts are included in net gain on sale of securities in the unaudited condensed consolidated statements of income. The investment portfolio is evaluated at least quarterly to determine if there are any securities with losses that are other-than-temporary. As of March 31, 2006, the Company has concluded that the unrealized losses are temporary in nature since they are primarily related to market interest rates and are not related to the underlying credit quality of the issuers of our investment portfolio. None of the investments are believed to be other-than-temporarily impaired. The Company has the ability and intent to hold the securities until maturity to recover the entire value. The following table summarizes all securities that have an unrealized loss and the duration of the unrealized loss at March 31, 2006: (in thousands) (unaudited) 13
----------------------- --------------------- ---------------------- 12 months or less 12 months or longer Totals ----------------------- --------------------- ---------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ---------- ----------- ---------- ---------- ---------- ----------- Securities AFS Government-Sponsored Enterprises: Mortgage-backed securities $ 72,936 $ 1,003 $ 62,083 $ 1,653 $ 135,019 $ 2,656 Obligations of U.S. agencies 10,936 163 121,968 2,131 132,904 2,294 Obligations of states & political subdivisions 3,996 68 4,875 83 8,871 151 --------- --------- --------- ---------- --------- ---------- $ 87,868 $ 1,234 $ 188,926 $ 3,867 $ 276,794 $ 5,101 ========= ========= ========= ========== ========= ========== Securities HTM Government-Sponsored Enterprises: Mortgage-backed securities $ 292 $ 1 - - $ 292 $ 1 Obligations of states & political subdivisions 15,628 212 - - 15,628 212 --------- --------- --------- ---------- --------- ---------- $ 15,920 $ 213 - - $ 15,920 $ 213 ========= ========= ========= ========== ========= ==========
The following table summarizes all securities that have an unrealized loss and the duration of the unrealized loss at December 31, 2005: (in thousands)
---------------------- --------------------- -------------------- 12 months or less 12 months or longer Totals ---------------------- --------------------- -------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses --------- ----------- --------- ----------- -------- ---------- Securities available-for-sale Government-Sponsored Enterprises: Mortgage-backed securities $ 42,556 $ 561 $ 53,118 $ 1,148 $ 95,674 $ 1,709 Other debt 6,058 89 153,227 2,451 159,285 2,540 Obligations of states & political subdivisons 3,423 33 2,512 27 5,935 60 --------- --------- --------- ---------- --------- ---------- $ 52,037 $ 683 $ 208,857 $ 3,626 $ 260,894 $ 4,309 ========= ========= ========= ========== ========= ========== Securities held-to-maturity Government-Sponsored Enterprises: Mortgage-backed securities $ 273 $ 2 $ 24 $ - $ 297 $ 2 Obligations of states & political subdivisions 2,577 9 - - 2,577 9 --------- --------- --------- ---------- --------- ---------- $ 2,850 $ 11 $ 24 $ - $ 2,874 $ 11 ========= ========= ========= ========== ========= ==========
Securities with carrying amounts of $98.2 million and $76.1 million at March 31, 2006 and December 31, 2005, respectively, were pledged for public deposits, Federal Home Loan Bank advances, securities sold under repurchase agreements and other purposes required by law. 14 9. Loans The composition of the loan portfolio is summarized as follows: (in thousands) (unaudited) --------------- --------------- March 31, December 31, 2006 2005 --------------- --------------- Real estate Residential $ 286,769 $ 291,448 Commercial 495,396 479,120 Construction 102,836 92,390 Commercial Commercial and financial 206,189 211,704 Lease financing 23,702 24,584 Consumer Lease financing 22 94 Installment 4,615 5,142 --------------- --------------- 1,119,529 1,104,482 Allowance for loan and lease losses (10,559) (10,646) --------------- --------------- Net loans and leases $ 1,108,970 $ 1,093,836 =============== =============== Loans are net of unearned income and deferred fees of $6.5 million and $6.8 million at March 31, 2006 and December 31, 2005, respectively. Nonperforming Loans Nonperforming loans include loans that are accounted for on a nonaccrual basis. Nonperforming loans are as follows: (in thousands) (unaudited) -------------- -------------- March 31, December 31, 2006 2005 -------------- -------------- Nonaccrual loans Residential real estate $ 814 $ 822 Commercial real estate 176 363 Commercial and financial 1,403 997 Commercial lease financing 1,047 1,290 Consumer 83 86 -------------- -------------- $ 3,523 $ 3,558 ============== ============== 15 10. Allowance for Loan and Lease Losses The Company's recorded investment in impaired loans is as follows: (in thousands) (unaudited)
---------------------- ---------------------- March 31, December 31, 2006 2005 ---------------------- ---------------------- Investment Related Investment Related in Allowance in Allowance Impaired for Loan Impaired for Loan Loans Losses Loans Losses ----------- ---------- ----------- ---------- Impaired loans With a related allowance for loan losses Commercial and financial $ 1,119 $ 299 $ 997 $ 281 Commercial real estate 176 4 380 4 Residential real estate 588 88 594 88 Without a related allowance for loan losses 285 - - - ----------- ---------- ----------- ---------- $ 2,168 $ 391 $ 1,971 $ 373 =========== ========== =========== ========== - ------------------------------------------------------------------------------------------------------------------- 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) (unaudited) ----------------------- Three months ended March 31, ----------------------- 2006 2005 ----------- ---------- Balance at beginning of period $ 10,646 $ 9,797 Additions (deductions) Provision charged to operations 175 175 Recoveries on loans previously charged-off 4 78 Loans charged-off (266) (174) ----------- ---------- Balance at end of period $ 10,559 $ 9,876 =========== ========== 11. Other Non-interest Expense Expenses included in other non-interest expense are as follows: (in thousands) (unaudited) --------------------- Three months ended March 31, --------------------- 2006 2005 ---------- ---------- Professional fees $ 362 $ 361 Legal fees 301 185 Directors' fees, travel and retirement 161 217 Data processing 261 265 All other 923 872 ---------- ---------- Total $ 2,008 $ 1,900 ========== ========== 16 12. Long-term Borrowings Long-term borrowings consist of the following FHLB advances: (in thousands) (unaudited) March 31, 2006 December 31, 2005 Maturity ------------------------- ------------------------ Date Balance Rate Balance Rate - --------------------- -------------- -------- ------------- ------- January 2007 (a) (b) $ - 4.22 $ 10,000 4.22 January 2007 (b) - 2.69 10,000 2.69 January 2010 (c) 15,000 3.66 15,000 3.66 October 2015 (d) 50,000 3.99 50,000 3.99 December 2015 (e) 25,000 3.94 25,000 3.94 February 2016 (f) 10,000 4.04 - - -------------- -------- ------------- ------- $ 100,000 3.93 % $ 110,000 3.84 % ============== ======== ============= ======= (a) The FHLB has an option to call this advance on a quarterly basis if the 3-month LIBOR resets above 7.50%. (b) Included in short-term borrowings as of March 31, 2006. (c) The FHLB has an option to call this advance in January 2008. (d) The FHLB has an option to call this advance quarterly after October 4, 2008. (e) The FHLB has an option to call this advance quarterly after December 30, 2007. (f) The FHLB has an option to call this advance quarterly after August 24, 2006. Included in long-term borrowings is a capitalized lease of $331 thousand and $333 thousand at March 31, 2006 and December 31, 2005, respectively. 13. Subordinated Debentures During June 2005, Interchange Statutory Trust I and Interchange Statutory Trust II (together the "Trusts") each issued $10 million of pooled trust preferred securities. In conjunction with the issuance of the trust preferred securities the Company issued subordinated debentures to the Trusts totaling $20.6 million. The rates of interest paid on the securities issued by the Trusts and the Company have been fixed for 5 years, at an average rate of 6.10%, after which time the rates will float at the 3-month LIBOR plus 1.71%. The Company has the right to call the debentures after 5 years on any of the interest payment dates. The final maturity date on the pool trust preferred securities and debentures is 2035. The Company does not meet the criteria as primary beneficiary for the Trusts in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46) and FIN No. 46(R), "Consolidation of Variable Interest Entities." As a result, these trusts are not consolidated. The Trusts have no independent operations. The obligations of the Trusts are fully and unconditionally guaranteed by the Company. The debentures are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of 17 the Company. Interest on the debentures is cumulative and payable in arrears. Proceeds from any redemption of debentures would cause a mandatory redemption of pooled trust preferred securities having an aggregate liquidation amount equal to the principal amount of debentures redeemed. 14. Benefit Plans In 1993, the Bank established a non-contributory defined benefit pension plan covering all eligible employees (the "Pension Plan"). In 1994, the Bank established a supplemental plan covering all eligible employees (the "Supplemental Plan") that provides for income that would have been paid out but for the limitation under the qualified Pension Plan. Also in 1994, the Company established a retirement plan for all directors of the Bank who are not employees of Interchange or of any subsidiary or affiliate of Interchange (the "Directors' Plan"). The following table shows the aggregated components of net periodic benefit costs for the periods noted: (in thousands) (unaudited) ---------------------------- Three Months Ended March 31, ---------------------------- 2006 2005 ------------ ------------- Service cost - $ 198 Interest cost $ 86 102 Expected return on plan assets (65) (55) Amortization of prior service cost - 1 ------------ ------------- Net periodic benefit cost $ 21 $ 246 ============ ============= During 2006, the Bank had not contributed to the Pension Plan. At December 31, 2005 the Pension Plan and the defined benefit portion of the Supplemental Plan and the Directors Plan were frozen. 15. Subsequent Events On April 13, 2006 the Company announced that it had entered into a definitive agreement whereby TD Banknorth Inc. would acquire the Company for approximately $480.6 million in an all cash transaction. The terms of the merger agreement call for each outstanding share of the Company's common stock to be converted into the right to receive $23.00 in cash per share. The transaction is subject to approval by shareholders of the Company, as well as customary regulatory approvals, and is expected to close early in the first quarter of 2007. 18 Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The following discussion is an analysis of the condensed consolidated financial condition and results of operations of the Company for the three month periods ended March 31, 2006 and 2005, and should be read in conjunction with the condensed consolidated financial statements and notes thereto included in Item 1 hereof. In addition, you should read this section in conjunction with Management's Discussion and Analysis and Results of Operations included in Amendment No. 1 to the Company's 2005 Annual Report on Form 10-K/A. Forward Looking Information In addition to discussing historical information, certain statements included in or incorporated into this report relating to the financial condition, results of operations and business of the Company, which are not historical facts, may be deemed "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When used herein, the words "anticipate," "believe," "estimate," "expect," and other similar expressions (including when preceded or followed by the word "not") are generally intended to identify such forward-looking statements. Such statements are intended to be covered by the safe harbor provisions for forward-looking statements contained in such Act, and we are including this statement for purposes of invoking these safe harbor provisions. Such forward-looking statements include, but are not limited to, statements about the operations of the Company, the adequacy of the Company's allowance for losses associated with the loan and lease portfolio, the quality of the loan and lease portfolio, the prospects of continued loan and deposit growth, and improved credit quality. The forward-looking statements in this report involve certain estimates or assumptions, known and unknown risks and uncertainties, many of which are beyond the control of the Company, and reflect what we currently anticipate will happen in each case. What actually happens could differ materially from what we currently anticipate will happen due to a variety of factors, including, among others, (i) increased competitive pressures among financial services companies; (ii) changes in the interest rate environment, reducing interest margins or increasing interest rate risk; (iii) deterioration in general economic conditions, internationally, nationally, or in the State of New Jersey; (iv) disruptions caused by terrorism, such as the events of September 11, 2001, or military actions in the Middle East or other areas; (v) legislation or regulatory requirements or changes adversely affecting the business of the Company; (vi) the impact of the proposed acquisition of the Company by TD Banknorth; and (vii) other risks detailed in reports filed by the Company with the Securities and Exchange Commission. Readers should not place undue expectations on any forward-looking statements. We undertake no obligation to update forward-looking statements or to make any public announcement when we consider forward-looking statements in this document to be no longer accurate, whether as a result of new information, what actually happens in the future or for any other reason. 19 Company Interchange Financial Services Corporation (the "Company"), a New Jersey business corporation, is a bank holding company registered with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. The Company was incorporated in the State of New Jersey on October 15, 1984. It acquired all of the outstanding stock of Interchange Bank (formerly known as Interchange State Bank), a New Jersey state chartered bank (the "Bank" or "Interchange"), in 1986. The Bank is the Company's principal operating subsidiary. In addition to the Bank, the Company has three other wholly owned direct subsidiaries: Clover Leaf Mortgage Company, a New Jersey corporation established in 1988, which is not currently engaged in any business activity; and Interchange Statutory Trust I and Interchange Statutory Trust II, which were formed for the sole purpose of issuing trust preferred securities. The Company does not qualify as the primary beneficiary for our wholly-owned trusts in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46) and FIN No. 46(R), "Consolidation of Variable Interest Entities." As a result, these trusts are not consolidated. The Company's principal executive office is located at Park 80 West/ Plaza Two, Saddle Brook, New Jersey 07663, and the telephone number is (201) 703-2265. As of March 31, 2006, the Company had consolidated assets of approximately $1.6 billion, deposits of approximately $1.3 billion and shareholders' equity of approximately $181.8 million. As a holding company, the Company provides support services to its direct and indirect subsidiaries. These include executive management, personnel and benefits, risk management, data processing, strategic planning, legal, and accounting and treasury. Banking Subsidiary The Bank, established in 1969, is a full-service New Jersey-chartered commercial bank headquartered in Saddle Brook, New Jersey. The Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"). It offers banking services for individuals and businesses through thirty (30) banking offices and one (1) supermarket mini-branch in Bergen and Essex Counties, New Jersey. The Bank maintains thirty-four (34) automated teller machines (operating within the StarTM , PlusTM, CIRRUSTM, VISATM, NYCETM, and MasterCardTM networks), which are located at thirty of the banking offices, a supermarket, and the Bank's operations center. Subsidiaries of the Bank include: FCBC, LLC established in 2004 to hold a 49% investment in Benjamin Title LLC, a title insurance company, Clover Leaf Investment Corporation, established in 1988 to engage in the business of an investment company pursuant to New Jersey law; Clover Leaf Insurance Agency, Inc., established in 1990 to engage in sales of tax-deferred annuities; Bridge View Investment Company, an investment company operating pursuant to New Jersey law; and Interchange Capital Company, L.L.C., established in 1999 to engage in equipment lease financing. All of the Bank's subsidiaries are organized under New Jersey law and are 100% 20 owned by the Bank. Clover Leaf Investment Corporation has 99% ownership of one subsidiary, Clover Leaf Management Realty Corporation, established in 1998 as a Real Estate Investment Trust ("REIT") which manages certain real estate assets of the Company. Bridge View Investment Company has one wholly owned subsidiary, Bridge View Delaware, Inc. ("BVDI"). BVDI is an investment company operating pursuant to Delaware law. Growth of the Company and the Bank On October 13, 2005 the Company completed its acquisition of Franklin Bank ("Franklin"), a one branch bank operating in Nutley, Essex County, New Jersey. At October 13, 2005 Franklin had approximately, $87.0 million in total assets, $77.2 million in total loans and $76.0 million in deposits. The acquisition was accounted for as a purchase and the cost in excess of fair value acquired was allocated first to net identified intangibles and then to goodwill. Based on the fair values the Company recorded goodwill of approximately $13.0 million. The Company's acquisition of Franklin is intended to further enhance Interchange's presence in northern New Jersey. As a result of the acquisition, the Bank now operates 30 banking offices. The acquisition of Franklin was accomplished through a merger of Franklin with and into the Bank. Critical Accounting Policies and Judgments The Company's consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in Amendment No. 1 to our 2005 Annual Report on Form 10-K/A, Note 1 "Nature of Business and Summary of Significant Accounting Policies" to our consolidated financial statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MDA"): "Critical Accounting Policies and Judgments." Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect the Company's reported results and financial position for the period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets and liabilities carried at fair value inherently result in more financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments primarily by using internal cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on the Company's future financial condition and results of operations. Allowance for Loan and Lease Losses: The allowance for loan and lease losses ("ALLL") is established through periodic charges to income. Loan losses are charged against the ALLL when management believes that the future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is 21 considered inadequate to absorb future loan losses on existing loans, based on, but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan and lease losses is increased. The Company considers the ALLL of $10.6 million adequate to cover estimated losses inherent in the loan portfolio, loan commitments and standby and other letters of credit that may become uncollectible based on management's evaluations of the size and current risk characteristics of the loan and lease portfolio as of the balance sheet date. The evaluations consider such factors as changes in the composition and volume of the loan portfolio, the impact of changing economic conditions on the credit worthiness of the borrowers, review of specific problem loans and management's assessment of the inherent risk and overall quality of the loan portfolio. For further discussion see the "Loan Quality" and "Allowance for Loan and Lease Losses" sections of the MDA, along with Note 1 "Nature of Business and Summary of Significant Accounting Policies"; Note 6 "Allowance for Loan and Lease Losses"; and Note 12 "Commitments and Contingent Liabilities" to the Consolidated Financial Statements in Amendment No. 1 to our 2005 Annual Report on Form 10-K/A. Business Combinations: Business combinations are accounted using the purchase method of accounting, the assets and liabilities of the companies acquired are recorded at their estimated fair value at the date of acquisition and include the results of operations of the acquired business from the date of acquisition. The excess of the purchase price over the estimated fair value of the net assets acquired is recognized as goodwill. Goodwill and Other Intangible Assets: Goodwill is not amortized to expense, but rather is tested for impairment periodically. Other intangible assets are amortized to expense using straight-line methods over their respective estimated useful lives. At least annually, and on an interim basis when conditions require, management reviews goodwill and other intangible assets and evaluates events or changes in circumstances that may indicate impairment in the carrying amount of such assets. If the sum of the expected undiscounted future cash flows, excluding interest charges, is less than the carrying amount of the asset, an impairment loss is recognized. An impairment is measured on a discounted future cash flow basis and a charge is recognized in the period that the asset has been deemed to be impaired. Based upon management's evaluation, no impairment loss is required to be recognized. Securities Held-to-Maturity and Securities Available-for-Sale: Debt securities purchased with the intent and ability to hold until maturity are classified as securities held-to-maturity ("HTM") and are carried at cost, adjusted for the amortization of premiums and accretion of discounts. Management determines whether the security will be classified as HTM at the time of purchase. All other securities, including equity securities, are classified as securities available-for-sale ("AFS"). Securities classified as AFS may be sold prior to maturity in response to, but not limited to, changes in interest rates, changes in prepayment risk or for asset/liability management strategies. These securities are carried at fair 22 value and any unrealized gains and losses are reported, net of taxes, in accumulated other comprehensive income (loss) included in the consolidated statement of stockholders' equity. The estimated fair value for securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments. Gains and losses from the sale of these securities are determined using the specific identification method and are reported in non-interest income. The Company does not acquire securities for the purpose of engaging in trading activities. Interest and dividends are accrued and credited to income as earned. Purchase premiums and discounts are recognized in interest income using the effective interest method over the term of the securities. On a quarterly basis, the Company makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; recent events specific to the issuer or industry; and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses). Pension Plan: The Bank maintains a qualified defined benefit pension plan (the "Pension Plan"), which covers all eligible employees and an unfunded supplemental pension plan which provides retirement income to all eligible employees who would have been paid amounts in excess of the amounts provided by the Pension Plan but for limitations under the qualified Pension Plan. In addition, the Company has an unfunded retirement plan for all directors of the Bank who are not employees of the Company or any subsidiary or affiliate. Our expected long-term rate of return on plan assets is 8.0% and was based on our expectations of the long-term return on the balanced mutual fund that we invest our plan assets which has had a return for the life of the fund of 8.4%. A 1.0% decrease in the long-term rate of return on plan assets would have increased the net periodic pension cost of the Pension Plan by approximately $28 thousand. The discount rates that we utilized for determining the future pension obligations of the plans ranged between 5.25% and 5.70% and were based upon comparing expected benefit payouts to yields on bonds available in the market place. A 1.0% decrease in the discount rate would have increased the net periodic pension cost by approximately $324 thousand. During 2005 the Company froze all future service benefits to be accrued under the plan. 23 THREE MONTHS ENDED MARCH 31, 2006 AND 2005 RESULTS OF OPERATIONS Summary For the first quarter of 2006, the Company reported earnings per diluted common share of $0.22, as compared to $0.23 for the same period in 2005. Net income for the three months ended March 31, 2006 was approximately $4.5 million. The earnings per share were primarily affected by increases in net interest income of 1.6% and non-interest income of 22.3% being offset by an increase in non-interest expense of 7.4% and the average diluted shares outstanding. The Company's return on average assets decreased to 1.11% for the three months ended March 31, 2006 as compared to 1.20% for the three months ended March 31, 2005. In addition, the Company's return on average stockholders' equity decreased to 10.05% for the first quarter 2006 versus 11.70% for the first quarter in 2005. The changes in return on average assets and equity were primarily the result of the decline in the net interest margin. Net Interest Income Net interest income is the most significant source of the Company's operating income. A portion of the Company's total interest income is derived from investments that are exempt from federal taxation. The amount of pretax income realized from those investments, due to the tax exemption, is less than the amount of pretax income realizable from comparable investments subject to federal taxation. For purposes of the following discussion, interest income exempt from federal taxation has been restated to a fully tax-equivalent basis using a corporate federal tax rate of 34% for the quarters ended March 31, 2006 and 2005. This was accomplished by adjusting this income upward to make it equivalent to the level of taxable income required to earn the same amount after taxes. Net interest income on a tax-equivalent basis increased $437 thousand, or 3.2%, to $14.2 million for the quarter ended March 31, 2006 as compared to the same quarter in 2005. The tax equivalent basis adjustments for the quarters ended March 31, 2006 and 2005 were $376 thousand and $162 thousand, respectively. The increase in net interest income was due mostly to an 11.0% growth in interest earning assets. This interest earning asset growth was funded by cash flows from the securities portfolio, deposit liabilities, and borrowings. The margin for the first quarter of 2006 was 3.84%, a decrease of 30 basis points as compared to the same quarter in 2005. Interest income, on a tax-equivalent basis, totaled $22.4 million for the first quarter of 2006, an increase of $4.2 million, or 23.1%, as compared to the same quarter in 2005. The increase was mostly attributed to the growth in interest earning assets and the shift in asset mix as average loans grew $162.6 million, while investments declined by $16.1 million. 24 Interest expense totaled $8.2 million for the first quarter of 2006, an increase of $3.8 million, as compared to the same period in 2005. The increase in interest expense was a result of the increase in rates paid on interest bearing deposits, an increase in borrowings and the issuance of $20.6 of subordinated debentures. The average rate paid on interest bearing deposit liabilities increased by 92 basis points to 2.49% for the quarter ended March 31, 2006 as compared to the same period in 2005. Interest bearing deposits grew on average $12.5 million, or 1.3%, for the first quarter of 2006 as compared to the same period in 2005. During June 2005, the Company issued $20.6 million of subordinated debentures to unconsolidated trust subsidiaries. The average rate paid on the subordinated debentures is 6.10% and is fixed for 5 years, after which time the rate paid on the subordinated debentures will be the 3-month LIBOR plus 1.71%. The subordinated debentures can be called at any of the interest payment dates following the fifth anniversary of their issuance. The final maturity on the subordinated debentures is 2035.
- ----------------------------------------------------------------------------------------------------------------------------------- Analysis of Net Interest Income - ----------------------------------------------------------------------------------------------------------------------------------- for the quarter ended March 31, (dollars in thousands) 2006 2005 ------------------------------------- ---------------------------------- (unaudited) Average Average Average Average Balance Interest Rate Balance Interest Rate ------------ ------------ ------- ----------- ---------- ------- Assets Interest earning assets: Loans (1) $ 1,109,004 $ 18,852 6.80 % $ 946,417 $ 14,985 6.33 % Taxable securities (4) 290,904 2,476 3.40 346,224 2,725 3.15 Tax-exempt securities (2) (4) 74,286 1,037 5.58 35,076 457 5.21 Federal funds sold and interest earning deposits 4 - - 64 - - ------------ ------------ ------- ---------- ---------- ------ Total interest-earning assets 1,474,198 22,365 6.07 1,327,781 18,167 5.47 ------------ ---------- Non-interest earning assets: Cash and due from banks 36,835 34,875 Allowance for loan and lease losses (10,671) (9,874) Other assets 133,253 115,435 ------------- ---------- Total assets $ 1,633,615 $1,468,217 ============= ========== Liabilities and stockholders' equity Interest-bearing liabilities Interest bearing deposits $ 1,009,666 6,292 2.49 $ 997,141 3,922 1.57 Borrowings and subordinated debentures 180,990 1,910 4.22 72,042 519 2.88 ------------- ------------ ------- ---------- ---------- ------ Total interest-bearing liabilities 1,190,656 8,202 2.76 1,069,183 4,441 1.66 ------------ ---------- Non-interest bearing liabilities Demand deposits 250,958 238,549 Other liabilities 11,790 9,433 ------------- ----------- Total liabilities (3) 1,453,404 1,317,165 Stockholders' equity 180,211 151,052 ------------- ---------- Total liabilities and stockholders' equity $ 1,633,615 $1,468,217 ============= ========== Net interest income (tax-equivalent basis) 14,163 3.31 13,726 3.81 Tax-equivalent basis adjustment (376) (162) ------------ ---------- Net interest income $ 13,787 $ 13,564 ============ ========== Net interest income as a percent of interest-earning assets (tax-equivalent basis) 3.84 % 4.14 % - ----------------------------------------------------------------------------------------------------------------------------------- (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 estimate of the amount necessary to bring the ALLL to a level that management considers adequate to reflect the risk of estimated losses inherent in the Company's loan and lease portfolio as of the balance sheet date. A more detailed discussion of the evaluation of the ALLL can be found in the section titled "Critical Accounting Policies and Judgments: Allowance for Loan and 25 Lease Losses" above. In the first quarter of 2006 and 2005, the Company's provision for loan and lease losses was $175 thousand. Non-interest Income For the quarter ended March 31, 2006, non-interest income totaled $2.7 million, an increase of $490 thousand, or 22.3%, as compared to the same period in 2005. The change was largely due to an increase in "other" non-interest income and net gains on sale of loans and leases of $405 thousand and $105 thousand, respectively. This was partly offset by a decline in net gains on sale of securities of $44 thousand. The increase in "other" non-interest income and gain on sale of loans was due in most part to an increase in referral income from and sales of Small Business Administration loans. Non-interest Expense For the quarter ended March 31, 2006, non-interest expense was $9.8 million, an increase of $678 thousand, as compared to the same period in 2005. This increase was largely due to the operating expenses associated with the acquisition of Franklin Bank, which was acquired on October 13, 2005, and an increase in "other" non-interest expense of $108 thousand. The increase in "other" non-interest expense was principally due to an increase in professional fees, including legal fees, of $117 thousand. The aforementioned increases were partly offset by a decrease in advertising and promotion expense of $159 thousand. Income Taxes Income tax expense as a percentage of pre-tax income was 29.9% for the three months ended March 31, 2006 as compared to 31.2% for the same period of 2005. The decline in the tax rate was partly attributable to the increase in non-taxable interest income. 26 FINANCIAL CONDITION Cash and Cash Equivalents At March 31, 2006, cash and cash equivalents was $36.8 million as compared to $42.6 million at December 31, 2005. Securities Portfolio Under Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), each security is classified as either trading, AFS, or HTM. The Company has no securities held in a trading account. The securities AFS are recorded at their estimated fair value. The after-tax difference between amortized cost and estimated fair value of securities AFS is recorded as "accumulated other comprehensive income" in the equity section of the balance sheet. The tax impact of such adjustment is recorded as an adjustment to the amount of the deferred tax liability. The securities HTM are carried at cost adjusted for the amortization of premiums and accretion of discounts, which are recognized as an adjustment to income. Under SFAS No. 115, securities HTM, with some exceptions, may only be sold within three months of maturity. The Company's U.S. Government-Sponsored Enterprises securities at March 31, 2006 and 2005 are not guaranteed by the U.S. Government; however, they are credit rated AAA or Aaa by nationally recognized statistical rating organizations. Substantially all obligations of states and political subdivisions are credit rated AAA or Aaa due to insurance, which guarantees the obligations against default, by private insurance companies. At March 31, 2006 and 2005, approximately $27.6 million and $12.2 million, respectively, are bond or tax anticipation notes from local municipalities, which are not rated. The Company uses its securities portfolio to ensure liquidity for cash flow requirements, to manage interest rate risk, provide a source of income, ensure collateral is available for pledging requirements and manage asset quality diversification. At March 31, 2006, investment securities totaled $357.1 million and represented 21.7% of total assets, as compared to $356.5 million and 21.9%, respectively, at December 31, 2005. Securities AFS comprised 87.5% of the total securities portfolio at March 31, 2006 as compared to 90.0% at December 31, 2005. At March 31, 2006, the Company had a net unrealized loss of $4.7 million as compared to a net unrealized loss of $3.3 million at December 31, 2005. The decrease in value was attributed to an increase in market interest rates during that period. Proceeds from the sale of securities AFS amounted to $13.1 million and $3.0 million for the three months ended March 31, 2006 and 2005, respectively, which resulted in gross realized gains of $69 thousand and $67 thousand for those periods, respectively. Gross realized losses from the sale of securities AFS amounted to $46 thousand for the three months ended March 31, 2006. For the quarter ended March 31, 2005, there were no gross realized losses from the sale of securities. These amounts are included in net gain on sale of securities in the unaudited condensed consolidated statements of income. 27 Loans Total loans amounted to $1.12 billion at March 31, 2006, an increase of $15.0 million from $1.10 billion at December 31, 2005. The growth was attributable to increases in commercial mortgage loans and construction loans of $16.3 million and $10.4 million, respectively. Nonperforming Assets Nonperforming assets are comprised of nonaccrual loans, restructured loans, foreclosed real estate and other repossessed assets. The Company's nonperforming assets at March 31, 2006 amounted to $3.6 million as compared to $3.7 million at December 31, 2005. The ratio of nonperforming assets to total loans and foreclosed real estate and other repossessed assets decreased to 0.32% at March 31, 2006 from 0.33% at December 31, 2005. The following table lists nonaccrual loans and foreclosed real estate and other repossessed assets at March 31, 2006, and December 31, 2005: (in thousands) --------------- -------------- March 31, December 31, 2006 2005 --------------- -------------- Nonaccrual loans $ 3,523 $ 3,558 Foreclosed and other repossessed assets 74 122 --------------- -------------- Total nonperforming assets $ 3,597 $ 3,680 =============== ============== Allowance for Loan and Lease Losses The ALLL is generally established through periodic charges to income through the provision for loan and lease losses. During the three months ended March 31, 2006, the ALLL decreased $87 thousand to $10.6 million. Loan losses are charged against the ALLL when management believes that the probable future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is considered inadequate to absorb future loan losses on existing loans, based on, but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan and lease losses is increased. The Company considers the ALLL of $10.6 million adequate to cover estimated losses inherent in the loan portfolio that may become uncollectible based on management's periodic evaluations of the loan portfolio and other relevant factors. The evaluations are inherently subjective as they require material estimates including such factors as potential loss factors, changes in trend of non-performing loans, current state of local and national economy, value of collateral changes in the composition and volume of the loan portfolio, review of specific problem loans and management's assessment of the inherent risk and overall quality of the loan portfolio. All of 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 and three months ended March 31, 2006 and 2005: (dollars in thousands) (unaudited) ----------------------- Three months ended March 31, ----------------------- 2006 2005 ----------- ---------- Average loans outstanding $ 1,109,004 $ 946,417 =========== ========== Allowance at beginning of period $ 10,646 $ 9,797 ----------- ---------- Loans charged-off: Commercial and financial 158 89 Commercial lease financing 107 81 Consumer loans 1 4 ----------- ---------- Total 266 174 ----------- ---------- Recoveries of loans previously charged-off: Real estate - 72 Consumer loans 4 6 ----------- ---------- Total 4 78 ----------- ---------- Provision for loan and lease losses 175 175 ----------- ---------- Allowance at end of period $ 10,559 $ 9,876 =========== ========== Allowance to loans (end of period) 0.94 % 1.01 % Ratio of net charge-offs to average Loans (annualized) 0.09 $ 0.04 % Deposits Deposits, which include non-interest bearing demand deposits, time deposits and other interest-bearing deposits, are an essential and cost-effective funding source for the Company. Other interest-bearing deposits, which include interest-bearing demand, money market and savings accounts, comprise the largest segment of the Company's total deposits. The Company emphasizes building core customer relationships by offering a variety of products designed to meet the financial needs of its customers based on their identifiable "life stages". At March 31, 2006 total deposits declined $8.8 million, or 0.7%, to $1.25 billion from December 31, 2005. The decrease was largely in non-interest bearing demand deposits, which declined $10.0 million, or 3.8%, to $250.2 million at March 31, 2006 from December 31, 2005. At March 31, 2006, non-interest bearing deposits amounted to $250.2 million, which equates to 20.0% of total deposits, which was down slightly from 20.6% at December 31, 2005. Other interest-bearing deposits increased $3.8 million to $691.3 million at March 31, 2006 and increased to 55.2% of total deposits compared to 54.6% of total deposits at December 31, 2005. Time deposits amounted to $309.9 million, or 24.8%, of total deposits at March 31, 2006, as compared to $312.5 million, or 24.8% of total deposits at December 31, 2005. 29 The following table reflects the composition of deposit liabilities: (dollars in thousands) (unaudited) -------------- ------------- March 31, December 31, 2006 2005 -------------- ------------- Non-interest bearing demand deposits $ 250,150 $ 260,151 Interest bearing demand deposits 469,116 466,436 Savings deposits 118,259 121,093 Money market deposits 103,898 99,907 Time deposits 309,853 312,521 -------------- ------------- Total $ 1,251,276 $ 1,260,108 ============== ============= 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 2006. The Company's real estate loan portfolio, concentrated primarily in northern New Jersey, is subject to risks associated with the local and regional economies. The Company's primary source of market risk exposure arises from changes in market interest rates ("interest rate risk"). Interest Rate Risk Interest rate risk is generally described as the exposure to potentially adverse changes in current and future net interest income resulting from: fluctuations in interest rates; product spreads; and imbalances in the repricing opportunities of interest-rate-sensitive assets and liabilities. Therefore, managing the Company's interest rate sensitivity is a primary objective of the Company's senior management. The Company's Asset/Liability Committee ("ALCO") manages our exposure to changes in market interest rates. ALCO attempts to maintain stable net interest margins by periodically evaluating the relationship between interest-rate-sensitive assets and liabilities. The evaluation, which is performed at least quarterly and presented to the board of directors, attempts to determine the impact on net interest margin from current and prospective changes in market interest rates. The Company manages interest rate risk exposure with the utilization of financial modeling and simulation techniques. These methods assist the Company in determining the effects of market rate changes on net interest income and future economic value of equity. The objective of the Company is to maximize net interest income within acceptable levels of risk established by policy. The techniques utilized for managing exposure to market rate changes involve a variety of interest rate, pricing and volume assumptions. These assumptions include projections on growth, prepayment and withdrawal levels as well as other embedded options inherently found in financial instruments. The Company reviews and validates these assumptions at least annually or more frequently if economic or other conditions change. At March 31, 2006, the Company simulated the effects on net interest income given an instantaneous and parallel shift in the yield curve of up to a 200 basis point rising interest rate environment and a 200 basis point declining interest rate environment. Based on that simulation, it was estimated that net interest income, over a twelve-month horizon, would not decrease by more than 2.4%. At March 31, 2006, the Company was within policy limits established by the board of directors for changes in net interest income and 31 future economic value of equity. The following table illustrates the effects on net interest income given an instantaneous and parallel shift in the yield curve of up to a 200 basis point rising interest rate environment and a 200 basis point declining interest rate environment: (unaudited) ------------------------------------------- Percentage Change in Estimated Net Interest Income over a twelve month horizon ------------------------------------------- March 31, March 31, 2006 2005 ---------------- ----------------- +200 basis points -1.1 % -4.7 % +100 basis points -0.2 -1.9 - -100 basis points -0.5 -2.1 - -200 basis points -2.4 * * Not simulated due to the historically low interest rate environment. The simulation described above does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape; prepayments on loans and securities; deposit decay rates; pricing decisions on loans and deposits; reinvestment/replacement of asset and liability cashflows; and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Further, as market conditions vary from those assumed in the simulation, actual results will also differ due to: prepayment/refinancing levels deviating from those assumed; the varying impact of interest rate changes on caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other internal/external variables. Furthermore, the simulation does not reflect actions that ALCO might take in response to anticipated changes in interest rates or competitive conditions in the market place. Capital Adequacy The Company is subject to capital adequacy requirements imposed by the Board of Governors of the Federal Reserve System (the "Federal Reserve"); and the Bank is subject to similar capital adequacy requirements imposed by the Federal Deposit Insurance Corporation (the "FDIC"). The Federal Reserve and the FDIC have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and 32 banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off balance sheet items. A banking organization's total qualifying capital includes two components: core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common shareholders' equity, qualifying perpetual preferred stock, trust preferred securities (subject to certain limitations) and minority interests, less goodwill and any unrealized gains or losses. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, trust preferred securities that exceed Tier 1 limits, certain other capital instruments and term subordinated debt. Total capital is the sum of core and supplementary capital. The Company's $20 million of trust preferred securities is considered Tier 1 capital by the Federal Reserve Board. At March 31, 2006, the minimum risk-based capital requirements to be considered adequately capitalized were 4% for Tier 1 capital and 8% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (non risk-adjusted) for the preceding quarter. At March 31, 2006, the minimum leverage ratio requirement to be considered adequately capitalized was 3%. The capital levels of the Company and the Bank at March 31, 2006, and the two highest capital adequacy levels recognized under the guidelines established by the federal banking agencies are included in the following table. The Company's and the Bank's ratios all exceeded the well-capitalized guidelines shown in the table. 33 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, 2006 (unaudited): Total Capital (to Risk Weighted Assets): The Company $ 143,020 12.02 % $ 95,198 8.00 % N/A N/A The Bank 143,644 12.05 % 95,392 8.00 % $ 119,240 10.00 % Tier 1 Capital (to Risk Weighted Assets): The Company 132,442 11.13 % 47,599 4.00 % N/A N/A The Bank 133,065 11.16 % 47,696 4.00 % 71,544 6.00 % Tier 1 Capital (to Average Assets): The Company 132,442 8.46 % 46,981 3.00 % N/A N/A The Bank 133,065 8.49 % 47,028 3.00 % 78,379 5.00 % As of December 31, 2005: Total Capital (to Risk Weighted Assets): The Company $ 139,560 11.93 % $ 93,595 8.00 % N/A N/A The Bank 140,863 11.98 % 94,042 8.00 % $ 117,553 10.00 % Tier 1 Capital (to Risk Weighted Assets): The Company 128,894 11.02 % 46,797 4.00 % N/A N/A The Bank 130,197 11.08 % 47,021 4.00 % 70,532 6.00 % Tier 1 Capital (to Average Assets): The Company 128,894 8.20 % 47,158 3.00 % N/A N/A The Bank 130,197 8.29 % 47,110 3.00 % 78,516 5.00 %
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, 2006, the total of such assets amounted to $36.8 million, or 2.2%, of total assets, compared to $42.6 million, or 2.6%, of total assets at December 31, 2005. Financing for the Company's loans and investments is derived primarily from deposits, along with interest and principal payments on loans and investments. At March 31, 2006 and December 31, 2005, total deposits amounted to $1.25 billion and $1.26 billion, respectively. In addition, the Company supplemented the more traditional funding sources with borrowings from the Federal Home Loan Bank of New York ("FHLB") and with securities sold under agreements to repurchase ("REPOS"). At March 31, 2006, short-term borrowings from the FHLB and REPOS amounted to $65.6 million and $13.2 million, respectively, as compared to $46.2 million and $3.9 million, respectively, at December 31, 2005. Another significant liquidity source is the Company's securities portfolio. Total securities at March 31, 2006 amounted to $357.1 million, an increase of $0.6 million, from $356.5 million at December 31, 2005. At March 31, 2006 securities AFS amounted to $312.6 million, or 87.5%, of total securities compared to $320.8 million, or 90.0%, of total securities at December 31, 2005. 34 In addition to the aforementioned sources of liquidity, the Company has available various other sources of liquidity, including federal funds purchased from other banks and the Federal Reserve discount window. The Bank also has a $101.8 million line of credit available through its membership in the FHLB of which $45.6 million was utilized at March 31, 2006. The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments, which include commitments to extend credit and standby letters of credit, involve, to a varying degree, elements of credit and interest rate risk in excess of the amount recognized in the unaudited Condensed Consolidated Balance Sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower if deemed necessary by the Company. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions. At March 31, 2006 outstanding commitments to fund loans totaled $293.3 million and outstanding standby letters of credit totaled $4.3 million. The Company has historically paid quarterly cash dividends and anticipates continuing paying quarterly dividends in the future. The Company's Board of Directors could, if they deemed it necessary, modify the amount or frequency, of dividends as an additional source of liquidity. There are imposed dividend restrictions on the Bank, which are described in Note 19 "Restrictions of Subsidiary Bank Dividends" in the Notes to Consolidated Financial Statements in Amendment No. 1 to the Company's 2005 Annual Report on Form 10-K/A. Management believes that the Company has sufficient cash flow and borrowing capacity to fund all outstanding commitments and letters of credit and to maintain proper levels of liquidity. 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, 2006, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management 35 necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Company maintains internal control over financial reporting. During the quarter ended March 31, 2006, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, those controls. 36 PART II - OTHER INFORMATION Item 1. Legal Proceedings In the ordinary course of business, the Company and it subsidiaries are involved in routine litigation involving various aspects of their business, none of which, individually or in the aggregate, in the opinion of management and its legal counsel, is expected to have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company. Item 1A. Risk Factors Except for the risk factors set forth below relating to the proposed acquisition of the Company by TD Banknorth Inc., there have been no material changes to any of the risk factors disclosed in Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005. Our business could be adversely affected by uncertainty related to the proposed merger and contractual restrictions while the proposed merger is pending. Uncertainty about when and whether the merger will be completed and the effects of the merger may have an adverse effect on us. These uncertainties could cause depositors and others that deal with to seek to change their existing business relationships with us, which could negatively affect our growth, revenues and results of operations. In addition, the merger agreement restricts us from taking specified actions without the buyer's approval. These restrictions could prevent us from pursuing attractive business opportunities that may arise prior to the completion of the proposed merger. Failure to complete the proposed merger could negatively impact our stock price, future business and financial results. Completion of the merger is subject to the satisfaction of various conditions, including the approval by our shareholders, as well as regulatory approvals. Although our board of directors will, subject to fiduciary exceptions, recommend that our stockholders approve and adopt the merger agreement, there is no assurance that the merger agreement and the merger will be approved, and there is no assurance that the other conditions to the completion of the merger will be satisfied. If the merger is not completed, we will be subject to several risks, including the following: o under certain circumstances, if the merger is not completed, we may be required to pay the buyer a termination fee of $20 million; 37 o the current market price of our common stock may reflect a market assumption that the merger will occur, and a failure to complete the merger could result in a negative perception by the stock market of us generally and a decline in the market price of our common stock; o certain costs relating to the merger, such as legal, accounting and financial advisory fees, are payable by us whether or not the merger is completed; o matters related to the merger may distract our management and employees from day-to-day operations and require substantial commitments of time and resources which could otherwise have been devoted to other opportunities that could have been beneficial to us; o we would continue to face the risks that we currently face as an independent company. Item 2. Unregistered Sales of Equity in Securities and Use of Proceeds Set forth below is certain information regarding repurchase of our common stock during the quarter.
Total Number of Shares Maximum Number of Total Number Purchased as Part of the Shares That May Yet Be of Shares Average Price 2005 Stock Repurchase Purchased Under the Period Purchased (1) Paid per Share Plan (2) Plan -------------------------------- -------------- ------------------------ ---------------------- 1/1/06 - 1/31/06 - - 321,737 626,340 2/1/06 - 2/28/06 227 $ 18.92 321,964 626,113 3/1/06 - 3/31/06 - - 321,964 626,113 ------------- -------------- ------------------------ ---------------------- Total for Quarter 227 $ 18.92 ============= ============== (1) Shares owned and tendered by employees and directors in accordance with the Stock Option and Incentive Plan of 1997, as amended, the 2005 Omnibus Stock and Incentive Plan and the Outside Directors Incentive Compensation. (2) Under the repurchase plan, the board of directors authorized the Company to purchase up to 950,000 common shares through July 31, 2006.
Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None 38 Item 6. Exhibits The following exhibits are furnished herewith: Exhibit ------- 11 Statement re computation of per share earnings 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 39 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, 2006 EX-11 2 exhibit11.txt EXHIBIT 11, STATEMENT RE: COMPUTATION Exhibit 11. Statement re computation of per share earnings (dollars in thousands, except per share amounts) (unaudited)
------------------------------------------------------------ Three Months Ended, ------------------------------------------------------------ March 31, 2006 March 31, 2005 ------------------------------- --------------------------- Weighted Per Weighted Per Average Share Average Share Income Shares Amount Income Shares Amount ---------- --------- ---------- -------- --------- -------- Basic Earnings per Common Share Income available to common shareholders $ 4,529 20,231 $0.22 $ 4,420 19,134 $0.23 ======== ======== Effect of Dilutive Shares - 477 - 422 ---------- --------- --------- --------- Diluted Earnings per Common Share $ 4,529 20,708 $0.22 $ 4,420 19,556 $0.23 ========== ========= ======== ========= ========= ========
All share and per share data were restated to reflect the 3-for-2 stock split declared on January 18, 2005 and paid on February 18, 2005. EX-31 3 exhibit31_1.txt CERTIFICATION OF CEO Exhibit 31.1 - Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 CERTIFICATION OF DISCLOSURE CONTROLS I, Anthony S. Abbate, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Interchange Financial Services Corporation for the quarterly period ended March 31, 2006; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 10, 2006 /s/ Anthony S. Abbate ----------------------------------------- Anthony S. Abbate President and Chief Executive Officer EX-31 4 exhibit31_2.txt CERTIFICATION OF CFO Exhibit 31.2 - Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 CERTIFICATION OF DISCLOSURE CONTROLS I, Charles T. Field, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Interchange Financial Services Corporation for the quarterly period ended March 31, 2006 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 10, 2006 /s/ Charles T. Field ------------------------------------------------- Charles T. Field Senior Vice President and Chief Financial Officer EX-32 5 exhibit32.txt CERTIFICATION OF CEO AND CFO Exhibit 32 - CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the Quarterly Report of Interchange Financial Services Corporation (the "Company") on Form 10-Q for the quarter ending March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"). The undersigned, Anthony S. Abbate, President and Chief Executive Officer of the Company, and Charles T. Field, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 10, 2006 /s/ Anthony S. Abbate ____________________________________ Anthony S. Abbate President and Chief Executive Officer /s/ Charles T. Field ____________________________________ Charles T. Field Senior Vice President and CFO -----END PRIVACY-ENHANCED MESSAGE-----