ITEM 1. BUSINESS
GENERAL
Interchange Financial Services Corporation (the "Company"), a New Jersey business corporation and bank holding company under Federal law, acquired all of the outstanding stock of Interchange State Bank, a New Jersey chartered bank (the "Bank" or "Interchange") in 1986.
The Bank, established in 1969, is a full-service commercial bank headquartered in Saddle Brook, New Jersey. It offers banking services for individuals and businesses through its twelve banking offices in Bergen County, New Jersey.
In addition to its commercial lending activities, the Bank offers a wide range of consumer banking services, including: checking and savings accounts, money-market accounts, certificates of deposit, individual retirement accounts, residential mortgages, home equity lines of credit and other second mortgage loans, home improvement loans, automobile loans, personal loans and overdraft protection. The Bank also offers a VISA(TM) credit card and Interchange Bank-Line--our telephone banking system. Certain Bank employees are also licensed insurance agents qualified to offer tax deferred annuities and related insurance products. The Bank also offers mutual funds to its customers through a third party vendor. Automated teller machines (MAC(TM), PLUS(TM), HONOR(TM), VISA(TM) and MASTERCARD(TM) networks) are located at nine of the banking offices and at two supermarkets.
The Bank is engaged in the financing of local business and industry, providing credit facilities and related services for smaller businesses, typically those with $1 million to $5 million in annual sales. Commercial loan customers of the Bank are businesses ranging from light manufacturing and local wholesale and distribution companies to medium-sized service firms and local retail businesses. Most forms of commercial lending are offered, including working capital lines of credit, small business administration loans, term loans for fixed asset acquisitions, commercial mortgages and other forms of asset-based financing.
In past years, the Bank has taken advantage of opportunities to purchase packages of loans. These loans were subjected to the Bank's independent credit analysis prior to purchase and were, in some cases, purchased with a limited buy-back obligation or other financial assurance from the sellers. In the Bank's experience, there are significant opportunities to sell the Bank's other products and services to the borrowers whose loans are purchased.
The Bank has expanded its service areas from one office in 1969 to the present twelve banking locations by opening new branches and, in 1991, acquiring branch locations formerly operated by other institutions. Management believes that the 1991 acquisition of the Park Ridge office of The Howard Savings Bank has allowed the Bank to increase its penetration of the affluent Pascack Valley area of Bergen County. The Company's acquisition in 1991 of the former Community Guardian Bank increased its penetration of the existing market area. A new branch was opened in Little Ferry in September, 1993, and in 1994, deposits of a failed thrift institution were acquired and added to the already growing deposits in that office. In June 1996, the Bank opened a new branch in Oakland, New Jersey. This expansion will increase the Bank's penetration in its contiguous market area. In September 1996, a mini-branch in Paramus, New Jersey, was closed. In December 1996, the branch in Clifton, New Jersey, was sold. These branches were eliminated in response to evaluations of prospective growth and earnings contributions of the branches. Since 1984, the Bank's assets have grown from $135 million to $505 million.
Deposits of the Bank are insured up to $100,000 per depositor by the Bank Insurance Fund administered by the FDIC.
The Company had 175 full-time-equivalent employees during 1996. Its principal executive office is located at Park 80 West/Plaza Two, Saddle Brook, New Jersey 07663, telephone number (201)703-2265. As used herein the term "Company" includes the Bank and wholly-owned subsidiaries of the Bank, unless the context otherwise requires.
The Bank's principal market for its deposit gathering activities covers major portions of Bergen County in the northeastern corner of New Jersey adjacent to New York City. The principal service areas of the Bank represent a diversified mix of stable residential neighborhoods with a wide range of per household income levels; offices, service industries and light industrial facilities; and large shopping malls and small retail outlets.
For many years Interchange State Bank has conducted periodic market research to keep aware of market trends. Much of this research affirmed that consumer financial needs are directly related to identifiable life stages. In response to these distinctive preferences, the bank has designed and marketed "packaged" products to appeal to these different segments. Product packages consist of offering several deposit, credit and other financial services together as a product unit. This encourages customers to use multiple products and allows the bank to establish stronger relationships.
The four product packages introduced to date include: GROW'N UP SAVINGS - --a passbook savings account which can be opened for a child of any age that teaches them the good habits of saving. MONEY PLUS ACCOUNT --geared to the 24-34 year age group. This is a checking account which includes additional financial benefits. MONEY MAKER ACCOUNT--created for the 35-54 year age group. This is an interest bearing checking account that offers higher rates automatically as the balance increases. PRIME TIME ACCOUNT--for the mature market which offers them a variety of financial and non-financial benefits available to them for a minimum balance only. Since the predominant age of the Interchange population is between 35-54 and 55+, the Money Maker and Prime Time Accounts offer a variety of products to accommodate any of their financial needs for that stage of their life. The Bank was among the first to offer such packaged financial products in its area and management believes they have been successful in attracting deposits and building a loyal client base.
COMPETITION
Competition in the banking and financial services industry in the Company's market area is intense. The Bank competes actively with national and state-chartered commercial banks and other financial institutions, including savings and loan associations, mutual savings banks, and credit unions. In addition, the Bank faces competition from less heavily regulated entities such as brokerage institutions, money management firms, consumer finance and credit card companies and various other types of financial services companies. Many of these institutions are larger than the Bank, some are better capitalized, and a number pursue community banking strategies similar to those of the Bank.
Management believes that opportunities continue to exist to satisfy the deposit and lending demands of small and middle market businesses. Larger banks continued to show an appetite for only the largest loans, finding themselves ill-equipped to administer smaller loans profitably. Interchange has the desire and the ability to give smaller businesses the treatment they deserve. We promise and deliver to this market the kind of preferential, first class attention that megabanks give megacompanies. Interchange meets this need through a unique program called Rapid Response Banking. The program provides commercial loans up to $50,000 with a streamlined approval process that borrows liberally from standard consumer lending practices. Naturally, in due course, many small businesses become midsize businesses, with a corresponding change in their financial requirements. But they do not outgrow Interchange because of our ability to be responsive to both constituencies. To continue serving companies throughout the various stages of their evolution, Interchange created Business Class Banking--a program that grows with the customer. Business Class Banking supports a spectrum of business-oriented financial products with value-added services. By designing progressive programs to accommodate the changing needs of growing businesses, Interchange is extending the longevity of valuable customer relationships.
In 1995, Interchange State Bank installed a relational database. This is powerful new technology, designed expressly for the banking industry and generally associated with only the largest and most forward thinking companies. From a marketing point of view, the implications of this technology are significant. We can now analyze account relationships, their activity and their relative value to the Bank in great detail.
Interchange has maintained an ambitious program of primary research to keep abreast of customer attitudes and preferences. Our sales quotas and incentives for employees are linked directly to bank-wide goals and are used to motivate employees to sell the "right" products to the "right" customers.
REGULATION AND SUPERVISION
THE COMPANY
The Company is a bank holding company under the Bank Holding Company Act of 1956, as amended (the "Holding Company Act"), and as such, is subject to supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As a bank holding company, the Company is required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require pursuant to the Holding Company Act and Federal Regulation Y. The Federal Reserve Board may conduct examinations of the Company or any of its subsidiaries. The Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank (although the Federal Reserve Board may not assert jurisdiction in certain bank mergers that are regulated under the Bank Merger Act), or ownership or control of any voting shares of any bank if after such acquisition it would own or control directly or indirectly more than 5% of the voting shares of such bank. Under certain circumstances, prior approval of the Federal Reserve Board is required under the Holding Company Act before a bank holding company may purchase or redeem any of its equity securities.
The Holding Company Act also prohibits a bank holding company, with certain limited exceptions, from itself engaging in or acquiring direct or indirect interest in or control of any company that is engaged in non-banking activities. Certain exemptions are available with respect to subsidiaries engaged in servicing or liquidating activities or companies acquired by a bank holding company in satisfaction of debts previously contracted. Another principal exception to this prohibition allows the acquisition, following an application or notice process, of interests in companies whose activities are found by the Federal Reserve Board, by order or regulation, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that have been determined by regulation to be closely related to banking are making or servicing loans, underwriting credit life insurance, performing certain data processing services, acting as an investment or financial advisor and providing discount securities brokerage services. Other activities approved by the Federal Reserve Board include acquisition of a savings association, consumer financial counseling, tax planning and tax return preparation, futures and options advisory services, check guaranty services, collection agency and credit bureau services, and real estate and personal property appraisals.
The provisions of Section 23A of the Federal Reserve Act and related statutes place limits on all insured banks (including the Bank) as to the amount of loans or extensions of credit to, or investment in, or certain other transactions with, their parent bank holding companies and certain of such holding companies' subsidiaries and as to the amount of advances to third parties collateralized by the securities or obligations of bank holding companies or their subsidiaries. In addition, loans and extensions of credit to affiliates of the Bank generally must be secured in the prescribed amounts.
CAPITAL ADEQUACY GUIDELINES
The Federal Reserve Board issued guidelines establishing risk-based capital requirements for bank holding companies and member banks. The guidelines established a risk-based capital framework consisting of (1) a definition of capital consisting of Tier I capital, which includes common shareholders' equity less certain intangibles and a supplementary component called Tier II, which includes a portion of the allowance for loan losses and (2) a system for assigning assets and off-balance-sheet items to one of the four weighted risk categories, with higher levels of capital being required for the categories perceived as representing the greater risks, and established a minimum risk-based capital ratio of 8% (of which at least 4% must be Tier I). An institution's risk-based capital ratio is determined by dividing its qualifying capital by its risk-weighted assets. The guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking institutions, take off-balance sheet items into account in assessing capital adequacy, and minimize disincentives to holding liquid, low-risk assets. Banking organizations are generally expected to operate with capital positions well above the minimum rates. Institutions with higher levels of risk, or which experience or anticipate significant growth, are also expected to operate well above minimum capital standards.
These guidelines focus principally on broad categories of credit risk although the framework for assigning assets and off-balance sheet items to risk categories does incorporate elements of transfer risk. The risk-based capital ratio does not, however, incorporate other factors that may affect a company's financial condition, such as overall interest rate exposure, liquidity, funding and market risks, the quality and level of earnings, investment or loan concentrations, the quality of loans and investments, the effectiveness of loan and investment policies and management's ability to monitor and control financial and operating risks.
In addition to the risk-based guidelines discussed above, the Federal Reserve Board requires that a bank holding company and bank which meet the regulator's highest performance and operational standards and which are not contemplating or experiencing significant growth maintain a minimum leverage ratio (Tier I capital as a percent of quarterly average adjusted assets) of 3%. For those financial institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be increased.
The Federal Reserve Board is vested with broad enforcement powers over bank holding companies to forestall activities that represent unsafe or unsound practices or constitute violations of law. These powers may be exercised through the issuance of cease and desist orders or other actions. The Federal Reserve Board is also empowered to assess civil penalties against companies or individuals who violate the Holding Company Act, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies and to order termination of ownership and control of non-banking subsidiaries by bank holding companies. Neither the Company nor any of its affiliates has ever been the subject of any such actions by the Federal Reserve Board.
THE BANK
As a New Jersey state-chartered member bank, the Bank's operations are subject to various requirements and restrictions of state law pertaining, among other things, to lending limits, reserves, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices and capital adequacy. The Bank is subject to primary supervision, periodic examination and regulation by the New Jersey Department of Banking and Insurance ("NJDBI"). If, as a result of an examination of a bank, the NJDBI determines that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the bank's operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the NJDBI. Such remedies include the power to enjoin "unsafe and unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to, among other things, direct an increase in capital, to restrict the growth of the Bank, to assess civil penalties and to remove officers and directors. The Bank has never been the subject of any administrative orders, memoranda of understanding or any other regulatory action by the NJDBI. The Bank also is subject to supervisory examination by the Federal Reserve Bank of New York.
The Bank's deposits are insured by the Bank Insurance Fund administered by the FDIC up to a maximum of $100,000 per depositor. For this protection, each bank pays a semi-annual statutory assessment to, and is subject to the rules and regulations of, the FDIC.
The Bank's ability to pay dividends is subject to certain statutory and regulatory restrictions. The New Jersey Banking Act of 1948, as amended, provides that no state-chartered bank may pay a dividend on its capital stock unless, following the payment of each such dividend, the capital stock of the bank will be unimpaired, and the bank will have a surplus of not less than 50% of its capital, or, if not, the payment of such dividend will not reduce the surplus of the bank. In addition, the payment of dividends is limited by the requirement to meet the risk-based capital guidelines issued by the Federal Reserve Board and other regulations.
FDIC IMPROVEMENT ACT OF 1991
The Federal Deposit Insurance Corporation Improvement of 1991, enacted in December 1991 ("FDICIA"), among other things, identifies the following capital standard categories for financial institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The FDIC has enacted regulations to implement the prompt corrective action provisions of FDICIA. These regulations establish five classifications based on the capital measures of an institution. Under the guidelines, a "well capitalized" institution is one with a total risk-based capital ratio of 10% or above, a Tier I risk-based capital ratio of 6% or above and a Tier I leverage ratio of 5% or above, and is not subject to a capital directive to meet a specific level for any capital measure; an "adequately capitalized" institution is one with a total risk-based capital ratio of 8% or above, a Tier I risk-based ratio of 4% or above, and a Tier I leverage ratio of 4% or above and which is not a well capitalized institution; an "under-capitalized" institution is one that does not meet the capital levels necessary to be an adequately capitalized institution; a "significantly undercapitalized" institution is one with a total risk-based capital ratio of under 6%, a Tier I risk-based capital ratio of under 3%, or a Tier I leverage ratio of under 3%; and a "critically undercapitalized" institution is one with a Tier I leverage ratio of 2% or less. The institution's primary regulator has the discretion to downgrade the institution by one classification level if the institution is found to be unsafe and unsound, or to be engaged in unsafe and unsound practices.
FDICIA imposes progressively more restrictive supervisory constraints on operations, management and capital distributions depending on the category in which an institution is classified. Pursuant to FDICIA, undercapitalized institutions must submit recapitalization plans, and a company controlling a failing institution must guarantee (subject to certain limitations) such institution's compliance with its plan in order for the plan to be accepted by the regulators. In addition, FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying a management fee to its holding company if the depository institution is, or would thereby become, undercapitalized. FDICIA also requires the various regulatory agencies to prescribe within one year from the date of enactment of FDICIA certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and permits regulatory action against a financial institution that does not meet such standards.
The Financial Institutions Reform Recovery and Enforcement Act of 1989 ("FIRREA") and FDICIA provide the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution.
The Bank's deposits are insured by the FDIC and the Bank is therefore subject to FDIC deposit insurance assessments. On September 15, 1992, the FDIC approved the implementation of a transition risk-based deposit premium assessment system under which each depository institution is placed in one of nine assessment categories based on certain capital and supervisory measures. The assessment rates under the new system range from 0.23 percent to 0.31 percent depending upon the assessment category into which the depository institution is placed. In 1995, the Federal Deposit Insurance Corporation reduced the lower tier of the assessment from 0.23 percent to 0.04 percent. The reduction of the assessment, effective as of the second quarter of 1995, resulted from the Bank Insurance Fund becoming fully capitalized. The Bank's assessment rate was 0.04 percent at December 31, 1995. Effective January 1, 1996, the FDIC further changed the rate structure for the BIF. Under the new rate structure, assessment rates will be between zero and 0.27 percent. However, institutions that have a zero assessment will be subject to a statutory minimum of $2,000 per year. In 1996, the Bank had a zero assessment, subject to the statutory minimum. A portion of the Bank's deposits (approximately 18 million) are Oakar deposits and are subject to the Savings Association Insurance Fund ("SAIF") assessment. The SAIF assessment rates were between 0.23 and 0.31 percent in 1996 and will range between zero and 0.27 percent in 1997. In 1996, the Bank had a 0.23 percent assessment rate.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases nine banking offices and one operations/support facility. The lease for the mini-branch located in Paramus, New Jersey, expired in September 1996 and was not renewed. It owns three banking offices and leases land on which it owns one bank building.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Interchange State Bank's (the "Bank"), a wholly owned subsidiary of the Company, was a party to a lawsuit commenced in April 1989 (Great American Mortgage Corp., et al, v. Robert Utter, et al.), filed in the Superior Court of New Jersey alleging that the Bank was statutorily liable for having paid checks which bore irregular endorsements. Various other legal proceedings related to the foregoing were also instituted and, in those actions, the Bank pursued various parties whom the Bank alleged were liable to it. On August 2, 1996, the Bank paid $120,000 plus prejudgment interest to resolve the final matter pertaining to these occurrences. The remainder of a reserve, which was established in 1992, was sufficient to cover this amount. All legal proceedings related to these occurrences, involving the potential liability of the Bank, have now been resolved.
The Company is also a party to routine litigation involving various aspects of its business, none of which, in the opinion of management and its legal counsel, is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the three months ended December 31, 1996, to a vote of the Company's security holders through the solicitation of proxies or otherwise.
EXECUTIVE OFFICERS
The following table sets forth the names, ages, and present positions of the principal executive
officers:
BUSINESS EXPERIENCE
ANTHONY S. ABBATE, President and Chief Executive Officer of the Bank since 1981; Senior Vice President and Controller from October 1980; President and Chief Executive Officer of Home State Bank 1978-1980. Engaged in the banking industry since 1959.
ROBERT N. HARRIS, Executive Vice President and Chief Financial Officer of the Bank since 1983; Senior Vice President and Chief Financial Officer of Bergen State Bank 1978-1983. Engaged in the banking industry since 1965. Mr. Harris retired effective December 31, 1996.
RICHARD N. LATRENTA, Senior Vice President-Lending of the Bank since 1984; Senior Loan Officer since 1982; Assistant Vice President since 1980; other positions with the Bank since 1976. Engaged in the banking industry since 1972.
FRANK R. GIANCOLA, Senior Vice President-Retail Banking since January 1, 1993; Senior Vice President-Operations of the Bank from 1984; Senior Operations Officer from 1982; Vice President/Branch Administrator from 1981. Engaged in the banking industry since 1971.
ANTHONY J. LABOZZETTA, Senior Vice President--Treasurer since January 1, 1997; Treasurer from 1995. Engaged in the banking industry since 1989. Formerly a senior manager with an international accounting firm.
Officers are elected annually and serve at the discretion of the board of directors. Management is not aware of any family relationship between any director or executive officer.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
The common stock is traded on the American Stock Exchange under the symbol "ISB." A cash dividend of $0.1675, $0.1725 and $0.185 was paid on each common share outstanding in each quarter during 1994, 1995 and 1996, respectively. The following table sets forth, for the periods indicated, the reported high and low sales prices:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section presents management's discussion and analysis of the consolidated results of operations and financial condition of Interchange Financial Services Corporation (the "Company"). The discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto on pages 36 through 60 and the summary consolidated data included elsewhere in this report.
OVERVIEW OF RESULTS
In 1996, the Company reported net income of $6.4 million or $2.26 per common share, as compared with $6.3 million or $2.19 per common share in 1995 and $5.6 million or $1.95 per common share in 1994.
Net income for 1996 was favorably affected by an increase in net interest income of $840 thousand or 3.8%, as compared to 1995 due largely to an improved net interest margin. The net interest margin increased 4 basis points in 1996, as compared to 1995, and was augmented by growth in average interest earning assets from 1995 levels. The growth occurred in loans which generally are the higher yielding assets for the Company. The net interest margin was also positively affected by growth in noninterest bearing liabilities of $6.2 million or 9.5%, from 1995 levels of $65.2 million. Furthermore, net interest income was positively affected by a favorable change in average rate paid on interest bearing liabilities resulting from a favorable shift in the mix of the Company's interest bearing liabilities.
In addition, net income for 1996 was beneficially affected by a decrease of $500 thousand in the provision for loan losses as compared to 1995. The decrease is mainly attributable to improved trends with respect to nonperforming loans and a decline in charge-off experience in 1996 as compared to 1995.
Net income for 1996 includes the effects of the following pretax gains: A net gain of $455 thousand resulting from the sale of the deposits of one of the Company's branch locations; a net gain of $235 thousand from the sale of available-for-sale ("AFS") securities; and, a gain of $261 thousand related to the collection of principal on a loan in excess of its carrying value. The aforementioned gains did not serve to increase net income for 1996 over 1995 mainly due to a net gain of $828 thousand in 1995 related to the sale of a portion of the subsidiary bank's loan servicing portfolio.
The benefits obtained from the improved net interest income and decrease in the provision for loan losses were partially offset by an increase of $731 thousand or 4.7% in operating expenses for 1996, as compared to 1995.
Net income for 1995 was favorably impacted by an increase in noninterest income of $1.0 million, or 28.2%, as compared to 1994. The increase was attributable to the sale of a portion of the subsidiary bank's loan servicing portfolio that generated a net gain of $828 thousand. Net income was also positively affected by an increase in interest income of $4.4 million resulting from an increase in average interest earning assets combined with an increase in average yields for those assets. The positive effect on net income derived from interest earning assets was mostly offset by a $4.1 million increase in interest expense in 1995 compared to 1994. An increase in interest bearing liabilities, specifically certificates of deposit, compounded by rising interest rates was primarily responsible for the increase in interest expense.
In 1995, net income also benefited from the nominal growth in noninterest expenses of $116 thousand, or .7%, as compared to 1994. The nominal increase was due to a $750 thousand, or 5.1%, increase in operating expenses offset by a $250 thousand reduction to a previously established litigation reserve and a $384 thousand decrease in the Federal Deposit Insurance Corporation ("FDIC") assessment. The assessment was reduced from 23 cents per thousand to 4 cents per thousand on qualified deposits as a result of the Bank Insurance Fund ("BIF") becoming fully capitalized. The reduction in the assessment became effective in the second quarter of 1995.
NET INTEREST INCOME
NET INTEREST INCOME IS THE DIFFERENCE BETWEEN THE INTEREST A COMPANY EARNS ON ITS ASSETS, PRINCIPALLY LOANS AND INVESTMENT SECURITIES, AND INTEREST IT PAYS ON ITS DEPOSITS AND BORROWINGS. WHEN EXPRESSED AS A PERCENTAGE OF AVERAGE ASSETS, IT IS REFERRED TO AS NET INTEREST MARGIN, OR SIMPLY INTEREST MARGIN. TABLE 3, WHICH PRESENTS CHANGES IN INTEREST INCOME AND INTEREST EXPENSE BY MAJOR ASSET AND LIABILITY CATEGORY FOR 1996 AND 1995, ILLUSTRATES THE IMPACT OF AVERAGE VOLUME GROWTH (ESTIMATED ACCORDING TO PRIOR YEAR RATES) AND RATE CHANGES (ESTIMATED ON THE BASIS OF PRIOR YEAR VOLUMES). CHANGES NOT DUE SOLELY TO CHANGES IN EITHER BALANCES OR RATES HAVE BEEN ALLOCATED TO SUCH CATEGORIES BASED ON THE RESPECTIVE PERCENTAGE CHANGES IN AVERAGE BALANCES AND AVERAGE RATES.
Figures are adjusted to a taxable equivalent basis to recognize the income from tax-exempt assets as if the interest was taxable, thereby allowing a uniform comparison to be made between yields on assets.
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Net interest income, on a taxable equivalent basis, totaled $22.7 million in 1996, an increase of $859 thousand or 3.9% from $21.9 million in 1995. Net interest income benefited from a $13.1 million or 3.0% increase in average interest earning assets from 1995 levels of $443.6 million. The benefits derived from the increased volume were partly offset by an unfavorable change in average yield on interest earning assets from 8.34% in 1995 to 8.17% in 1996, a decrease of 17 basis points. Net interest income also benefited from the marginal growth in interest bearing liabilities and the continued growth in noninterest bearing demand deposits. In 1996, average interest bearing liabilities increased $3.2 million or .9%, while noninterest bearing liabilities increased $6.2 million or 9.5%, from 1995 levels of $370.3 million and $65.2 million, respectively. Furthermore, net interest income was positively affected by a favorable change in average rate paid on interest bearing liabilities from 4.09% in 1995 to 3.91% in 1996, a decrease of 18 basis points.
The growth in interest earning assets stemmed largely from increased loans, particularly, commercial and commercial mortgage loans, as well as, consumer loans (comprised mostly of home equity loans). The average balances of commercial and commercial mortgage loans totaled $102.1 million and $46.1 million in 1996, respectively, compared to $91.3 million and $37.6 million in 1995, respectively, an increase of $10.8 million or 11.8% and $8.5 million or 22.6%, respectively. The average balances of consumer loans (comprised mostly of home equity loans) totaled $135.7 million in 1996, compared to $119.5 million in 1995, an increase of $16.2 million or 13.6%.
The growth in noninterest bearing demand deposits is attributable largely to the Company's marketing effort along with a more focused sales approach in the lending area. The loans resulting from this effort generally carry compensating balances in the form of noninterest bearing demand accounts. The favorable reduction in average rate paid on interest bearing deposits resulted, in part, from a planned business strategy which did not allow certain high cost certificates of deposits to renew at the high rates.
In 1995, net interest income, on a taxable equivalent basis, totaled $21.9 million, an increase of $238 thousand, or 1.1%, from $21.6 million in 1994. The increase was driven by a $21.7 million or 5.2% increase in average interest earning assets from 1994 levels of $421.9 million. In addition, net interest income was positively affected by an increase in average yield on interest earning assets from 7.74% in 1994 to 8.34% in 1995, an increase of 60 basis points. The benefits derived from the positive changes in average volume and average rate on interest earning assets were largely offset by the negative impacts of increases in average volume and average rate on interest bearing liabilities. Average interest bearing liabilities increased $16.5 million, or 4.7%, from 1994 levels of $353.7 million. More significantly, as illustrated in Table 3, the 98 basis point increase in the average rate paid on interest bearing liabilities, from 3.11% in 1994 to 4.09% in 1995, had a more adverse impact on net interest income.
In 1995, the growth in the average balance of certificates of deposits ("CDs") was largely responsible for the $913 thousand increase in interest paid due to volume growth. In 1995, the average balance of CDs increased $21.3 million or 17.1% and the average balance of savings accounts decreased $10.1 million or 8.3%. The increase in CDs was the result of higher interest rates in the second half of 1994 and the first half of 1995, increasing the popularity of CDs. Rising interest rates increased the costs of the Company's deposit liabilities, particularly time deposits, and was responsible for $3.2 million of the increase in interest expense.
Overall for 1995, the improved yields on interest earning assets, combined with the growth in average loans and investments, generated a rise in interest income of $4.4 million over 1994. Conversely, the increased costs of interest bearing liabilities, along with the increase in average balances, increased interest expense by $4.1 million, thereby, counteracting the positive benefits derived from interest earning assets.
LOAN LOSSES
The provision for loan losses represents management's determination of the amount necessary to bring the allowance for loan losses to the level it considers adequate to reflect the risk of future losses in the loan portfolio. Factors considered in the evaluation include: past loss experience; changes in the composition of nonperforming loans; the condition of borrowers facing financial pressure; the relationship of the current level of the allowance to the portfolio and to nonperforming loans; and existing economic conditions.
Loan loss provisions for 1996 amounted to $700 thousand, a decrease of $500 thousand from the previous year. In 1995, the loan loss provision amounted to $1.2 million, an increase of $256 thousand from 1994. The decrease in the provision for loan losses reflects, in part, the positive trends in nonperforming loans. In addition, it reflects the decrease in charge-off experience during 1996. Net loans charged-off against the allowance for loan losses in 1996 amounted to $694 thousand, down $698 thousand from $1.4 million in 1995.
See sections on Loan Portfolio and Loan Quality beginning on page 22 of this report for additional discussions pertaining to the allowance for loan losses.
The allowance for losses represented 106.8% of nonperforming assets at year-end up from 70.3% At the end of 1995.
The ratio increased as a result of a $1.8 million decrease in nonperforming assets in 1996 as compared to the end of the year in 1995. The decrease resulted largely from a third quarter 1996 sale of approximately $1.9 million of nonperforming loans which resulted in a charge-off of $380 thousand. The Company had valuation allowances on the nonperforming loans sufficient to cover the charge-offs.
The above allocation is intended for analytical purposes and may not be indicative of the categories in which future loan losses occur.
NONINTEREST INCOME
Noninterest income consists of all income other than interest and dividend income and is derived from: fees on bank transactions and credit cards; commissions on sales of annuities and mutual funds; rental of safe deposit space; net gains on sales of assets; and the accretion of discount in connection with an acquisition. Noninterest income totaled $4.3 million for 1996, a decrease of $307 thousand or 6.7% from $4.6 million for 1995. For 1995, total noninterest income increased $1.0 million or 28.2% from $3.6 million for the year ended December 31, 1994. The elements that significantly contributed to the changes in noninterest income are highlighted below.
In 1996, noninterest income was positively affected by a net pretax gain of $455 thousand resulting from the sale of the deposits of one of the Company's branch locations. The sale was in response to the Company's evaluation of the prospective growth and earnings contribution of the branch. Noninterest income also benefited from a $235 thousand net pretax gain from the sale of available-for-sale ("AFS") securities. The securities were sold as part of a securities portfolio restructuring plan aimed at improving the portfolio's return while reducing its risk. In addition, noninterest income benefited from a $261 thousand gain related to the collection of principal on a loan in excess of its carrying value. The benefits described above did not result in an increase to noninterest income in 1996 over 1995 largely because of a net pretax gain in 1995 of $828 thousand pertaining to the sale of a portion of the subsidiary bank's loan servicing portfolio. Consequently, noninterest income for 1996 decreased, in large part, because the discount connected with an acquisition of a failed financial institution has been fully accreted. Discount accretion contributed $249 thousand less to noninterest income in 1996 as compared to 1995.
The increase of $1.0 million in noninterest income for 1995 as compared to 1994 is due largely to the subsidiary bank selling a portion of its loan servicing portfolio which generated a gain of $828 thousand.
NONINTEREST EXPENSES
Noninterest expenses totaled $16.4 million for 1996. This represented an increase of $731 thousand or 4.7% from total noninterest expenses of $15.7 million for 1995. For 1995, total noninterest expenses increased $116 thousand or .7% from $15.5 million for the year ended December 31, 1994. The elements that significantly contributed to the changes in noninterest expenses are highlighted below.
Affecting the change in noninterest expenses for 1996 was an increase of $389 thousand or 5.4% in salaries and related expenses. For the most part, the increase resulted from promotions and normal annual salary adjustments. An increase of $244 thousand or 5.6% in other noninterest expenses also contributed to the change. The increase reflects a $250 thousand reduction of other noninterest expenses in 1995 for the reversal of a reserve related to a settled lawsuit. Furthermore, noninterest expenses were adversely affected by an increase of $198 thousand or 366.7% in foreclosed real estate expenses. For the most part, gains and losses from the disposition of foreclosed real estate contributed to the change in foreclosed real estate expense. In 1996, foreclosed real estate expense included net losses of $87 thousand pertaining to the disposition of foreclosed real estate as compared to net gains of $127 thousand for 1995. In 1996, noninterest expenses were favorably affected by a $343 thousand or 68.2% decrease in insurance premiums paid by the Company to the FDIC for deposit insurance. The decrease reflects the reduction in premium as the BIF attained target reserve levels.
The change in noninterest expenses for 1995 as compared to 1994 was minimal, largely because normal increases in noninterest expenses were offset by a $384 thousand or 43.3% decrease in insurance premiums paid by the Company to the FDIC for deposit insurance during 1995. In addition, noninterest expenses in 1995 were favorably affected by a $250 thousand reduction of a litigation reserve in connection with a settled lawsuit.
INCOME TAXES
In 1996, income taxes amounted to $3.5 million as compared to $3.3 million and $3.1 million for 1995 and 1994, respectively. The effective tax rate in 1996 was 35.0% as compared to 34.4% and 35.2% for 1995 and 1994, respectively. Detailed information on income taxes is shown in Notes 1 and 15 to the Consolidated Financial Statements.
NEW PRONOUNCEMENTS
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"). SFAS No. 125 establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial components approach that focuses on control. Under this approach, an entity, subsequent to a transfer of financial assets, must recognize the financial and servicing assets it controls and the liabilities it has incurred, derecognize financial assets when control has been surrendered, and derecognize liabilities when extinguished. Standards for distinguishing transfers of financial assets that are sales from those that are secured borrowings are provided in SFAS No. 125. A transfer not meeting the criteria for a sale must be accounted for as a secured borrowing with pledge of collateral.
SFAS No. 125 requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value, if practicable. It additionally requires that servicing assets and other retained interests in transferred assets be measured by allocating the previous carrying amount between the assets sold, if any, and retained interests, if any, based on their relative fair values at the date of transfer. Servicing assets and liabilities must be subsequently measured by amortization in proportion to and over the period of estimated net servicing income or loss and assessed for asset impairment, or increased obligation, based on their fair value.
SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. Earlier or retroactive application is not permitted. The Company is currently reviewing the impact of the implementation of SFAS No. 125 on its consolidated financial statements.
In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." SFAS No. 127 amends SFAS No. 125 by deferring for one year the effective date of paragraph 15 of SFAS No. 125 addressing secured borrowings and collateral, and for repurchase agreement, dollar roll, security lending and similar transactions, of paragraphs 9 through 12 and 237(b) of SFAS No. 125.
EFFECTS OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same magnitude as the prices of goods and services.
LOAN PORTFOLIO
Despite a surge in competition during 1996, the Company experienced strong growth in its loan portfolio. At December 31, 1996, total loans amounted to $351.8 million, up $40.6 million or 13.1% over the previous year. Promotional campaigns in conjunction with competitive loan rates and focused sales efforts were instrumental to the $18.7 million increase in the home equity loan portfolio. A team-sales approach implemented during 1996 helped meet the demands of our business customers and contributed to the $9.8 million and $15.3 million increases in commercial and commercial mortgage loans, respectively.
In 1995, total loans increased $20.5 million from the 1994 level. The increase was largely the result of promotional campaigns and competitive loan rates as well as the ability of the Company to identify and meet the needs of its business customers.
Commercial real estate mortgage loans amounted to $112.2 million at December 31, 1996, and represented 31.9% of total loans compared to $96.9 million or 31.2% of all loans at the end of 1995. These loans are secured primarily by first priority mortgage liens on owner-occupied commercial properties. While approximately 84% of all loans are collateralized by real estate located in northern New Jersey, the Company does not have any concentration of loans in any single industry classified under the Standard Industrial Classification Code which exceeds 4% of its total loans.
LOAN QUALITY
The lending activities of the Company are guided by the basic lending policy established by the Company's Board of Directors. Loans must meet the tests of a prudent loan, which include criteria regarding the character, capacity and capital of the borrower, collateral provided for the loan and prevailing economic conditions. The Company obtains an independent appraisal of real property, within regulatory guidelines, when it is considered the primary collateral for a loan.
The Company employs a full-time loan review officer who evaluates the credit risk for substantially all large commercial loans. This review process is intended to identify adverse developments in individual credits, regardless of whether such credits are also included on the watchlist discussed below and whether or not the loans are delinquent. The loan review officer reports directly to the President of the Company.
Management maintains a "watchlist" system under which credit officers are required to provide early warning of possible deteriorations in loans. These loans may not be delinquent currently, but may present indications of financial weakness, such as deteriorating financial ratios of the borrowers, or other concerns at an early stage to allow early implementation of responsive credit strategies.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccrual loans, restructured loans and foreclosed real estate. Foreclosed real estate, representing real estate collateral acquired by legal foreclosure procedures, is valued using independent appraisals and the Company's policy is to review such appraisals annually. The Company intends to dispose of each property at or near its current valuation. However, there can be no assurance that disposals will be made as soon as anticipated or at expected values.
Table 9 presents the detail of nonperforming assets and the aggregate of loans whose principal and/or interest has not been paid according to contractual terms. (See discussion of loan losses on page 17.) Other than the loans included in the table, there were no material potential problem loans, either individually or in the aggregate, at December 31, 1996.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
The Company identifies as "securities available for sale" securities used as part of its asset and liability management strategy, or securities that may be sold in response to, among other things, changes in interest rates and prepayment risk. See Notes 1 and 4 of Notes to Consolidated Financial Statements for additional information concerning securities.
Table 10 presents a summary of the contractual maturities and weighted average (adjusted to a taxable equivalent basis) of securities held to maturity and securities available for sale.
DEPOSITS
The Company traditionally relies on its deposit base to fund its credit needs. Core deposits, which include noninterest bearing demand deposits, interest bearing demand accounts, savings deposits, money market accounts and time deposits in amounts under $100,000, represented 96.0% of total deposits at December 31, 1996, and 97.3% at December 31, 1995.
Total deposits amounted to $430 million at December 31, 1996, a decrease of $6.4 million or 1.5% from year end 1995. The decrease was attributable to the departure of $9.7 million of deposits in connection with the sale of the Clifton Branch (See discussion pertaining to noninterest income on page 19). In addition, approximately $9.4 million of high cost certificates of deposits were not renewed as part of a planned business strategy. A new branch, opened in June 1996 with deposit balances of approximately $7.0 million at December 31, 1996, offset some of the planned outflows discussed above.
INTEREST RATE SENSITIVITY
FLUCTUATIONS IN MARKET INTEREST RATES CAN HAVE A SIGNIFICANT INFLUENCE ON NET INTEREST INCOME. THEREFORE, MANAGING THE COMPANY'S INTEREST RATE SENSITIVITY IS A PRIMARY OBJECTIVE OF THE COMPANY'S SENIOR MANAGEMENT. THE COMPANY'S ASSET/LIABILITY COMMITTEE ("ALCO") IS RESPONSIBLE FOR MANAGING THE EXPOSURE TO CHANGES IN MARKET INTEREST RATES. ALCO ATTEMPTS TO MAINTAIN STABLE NET INTEREST MARGINS BY PERIODICALLY EVALUATING THE RELATIONSHIP BETWEEN INTEREST-RATE SENSITIVE ASSETS AND INTEREST-RATE SENSITIVE LIABILITIES. THE EVALUATION ATTEMPTS TO DETERMINE THE IMPACT ON NET INTEREST MARGIN FROM CURRENT AND PROSPECTIVE CHANGES IN MARKET INTEREST RATES.
INTEREST RATE SENSITIVITY IS DETERMINED BY ANALYZING THE DIFFERENCE BETWEEN THE AMOUNT OF INTEREST EARNING ASSETS MATURING OR REPRICING WITHIN A SPECIFIC TIME PERIOD AND THE AMOUNT OF INTEREST BEARING LIABILITIES MATURING OR REPRICING WITHIN THAT SAME PERIOD OF TIME. THIS DIFFERENCE, OR "SENSITIVITY GAP," PROVIDES AN INDICATION OF THE EXTENT TO WHICH THE COMPANY'S NET INTEREST INCOME MAY BE AFFECTED BY FUTURE CHANGES IN MARKET INTEREST RATES. THE CUMULATIVE GAP POSITION AS A PERCENTAGE OF TOTAL ASSETS PROVIDES ONE RELATIVE MEASURE OF THE COMPANY'S INTEREST RATE EXPOSURE.
The cumulative gap between the Company's interest-rate sensitive assets and its interest-rate sensitive liabilities repricing within a one-year period was (12.22%) at December 31, 1996. Since the cumulative gap was negative, the Company has a "negative gap" position which theoretically will cause its assets to reprice more slowly than its deposit liabilities. In a declining interest rate environment, interest costs may be expected to fall faster than the interest received on earning assets, thus increasing the net interest spread. If interest rates increase, a negative gap means that the interest received on earning assets may be expected to increase more slowly than the interest paid on the Company's liabilities therefore decreasing the net interest spread.
Certain shortcomings are inherent in the method of analysis presented in Table 12 . Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while rates on other types of assets and liabilities may lag behind changes in market rates. In the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the table. The ability of borrowers to service their debt may decrease in the event of an interest rate increase. Management considers these factors when reviewing its gap position and establishing its ongoing asset/liability strategy.
LIQUIDITY
A FUNDAMENTAL COMPONENT OF THE COMPANY'S BUSINESS STRATEGY IS TO MANAGE LIQUIDITY TO ENSURE THE AVAILABILITY OF SUFFICIENT RESOURCES TO MEET ALL FINANCIAL OBLIGATIONS AND FINANCE PROSPECTIVE BUSINESS OPPORTUNITIES. LIQUIDITY MANAGEMENT IS CRITICAL TO THE STABILITY OF THE COMPANY. LIQUIDITY LEVELS OVER ANY GIVEN PERIOD OF TIME ARE A PRODUCT OF THE COMPANY'S OPERATING, FINANCING AND INVESTING ACTIVITIES. THE EXTENT OF SUCH ACTIVITIES ARE OFTEN SHAPED BY SUCH EXTERNAL FACTORS AS COMPETITION FOR DEPOSITS AND LOAN DEMAND.
Traditionally, financing for the Company's loans and investments is derived primarily from deposits, along with interest and principal payments on loans and investments. At December 31, 1996, total deposits amounted to $430 million, a decrease of $6.4 million or 1.5% over the prior comparable year. In 1996, 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 December 31, 1996, advances from the FHLB and REPOS amounted to $15.2 million and $11.1 million, respectively, as compared to $9.2 million and $1.7 million, respectively, at December 31, 1995.
In 1996, loan production continued to be the Company's principal investing activity. Net loans at December 31, 1996 amounted to $348.1 million, compared to $307.5 million at the end of 1995, an increase of $40.6 million or 13.2%.
The Company's most liquid assets are cash and due from banks and federal funds sold. At December 31, 1996, the total of such assets amounted to $24.3 million or 4.8% of total assets, compared to $25.2 million or 5.1% of total assets at year-end 1995.
Another significant liquidity source is the Company's available-for-sale ("AFS") securities. At December 31, 1996, AFS securities amounted to $55.3 million or 46.6% of total securities, compared to $67.5 million or 47.5% of total securities at year-end 1995.
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 $49.1 million line of credit available through its membership in the Federal Home Loan Bank of New York.
Management believes that the Company's sources of funds are sufficient to meet its funding requirements.
CAPITAL ADEQUACY
Stockholders' equity totaled $44.4 million and represents 8.8% of total assets at December 31, 1996, compared to $40.2 million and 8.2% of total assets at December 31, 1995. The $4.1 million increase was primarily attributable to net income of $6.4 million less cash dividends of $2.1 million.
Guidelines issued by the Federal Reserve Board and the FDIC establish capital adequacy guidelines for bank holding companies and state-chartered non-member banks. The guidelines establish a risk-based capital framework consisting of (1) a definition of capital consisting of Tier 1 capital, which includes common shareholders' equity less certain intangibles and a supplementary component called Tier II, which includes a portion of the allowance for loan losses, and (2) a system for assigning assets and off-balance-sheet items to one of the four weighted risk categories, with higher levels of capital being required for the categories perceived as representing the greater risks. An institution's risk-based capital ratio is determined by dividing its qualifying capital by its risk-weighted assets. The guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking institutions, take off-balance-sheet items into account in assessing capital adequacy, and minimize the disincentive to holding liquid, low-risk assets. Banking organizations are generally expected to operate with capital positions well above the minimum rates. Institutions with higher levels of risk, or which experience or anticipate significant growth, are also expected to operate well above minimum capital standards.
These guidelines focus principally on broad categories of credit risk, although the framework for assigning assets and off-balance sheet items to risk categories does incorporate elements of transfer risk. The risk-based capital ratio does not, however, incorporate other factors that may affect a company's financial condition, such as overall interest rate exposure, liquidity, funding and market risks, the quality and level of earnings, investment or loan concentrations, the quality of loans and investments, the effectiveness of loan and investment policies and management's ability to monitor and control financial and operating risks.
In addition to the risk-based guidelines discussed above, the Federal Reserve Board and the FDIC require that a bank holding company and bank which meet the regulators' highest performance and operation standards and which are not contemplating or experiencing significant growth maintain a minimum leverage ratio (Tier I capital as a percent of quarterly average adjusted assets) of 3%. For those financial institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be increased.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Independent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
a. Directors
The information contained in the Company's 1996 Proxy Statement is incorporated herein by reference in response to this item.
b. Executive Officers
Information required by this item is contained in Part I of this Form 10-K in the section entitled "Executive Officers."
c. Compliance with Section 16(a)
Information contained in the section entitled "Section 16 Compliance" of the Company's 1996 Proxy Statement is incorporated herein by reference in response to this item.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information contained in the section entitled "Executive Compensation" of the Company's 1996 Proxy Statement is incorporated herein by reference to this item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the section entitled "Amount and Nature of Beneficial Ownership" of the Company's 1996 Proxy Statement is incorporated herein by reference in response to this item.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the section entitled "Transactions with management" of the Company's 1996 Proxy Statement is incorporated herein by reference in response to this item.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K
a. Financial Statements and Schedules
The financial statements and schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules are filed as part of this Annual Report on Form 10-K
b. Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter ended December 31, 1996.
c. Exhibits
3.(a)Certificate of incorporation and amendments thereto (incorporated herein by reference to Registration Statement No.33-49840, exhibit 3 (a))
(b)By-laws (incorporated herein by reference to Registration Statement No. 33-49840, exhibit 3(b))
10. Material contracts
(a) Agreement for legal services between Andora, Palmisano & Geaney and the Company dated April 27, 1996.
(b) Lease for Washington Township, N.J., Branch Office, dated April 13, 1972 and amended December 21, 1972 (incorporated herein by reference to Registration Statement No. 33-49840, exhibit 10(h)).
(c) Lease for Lodi, N.J., Branch Office, dated January 25, 1985 (incorporated herein by reference to Registration Statement No. 33-49840, exhibit 10(i)).
(d) Lease for Elmwood Park, N.J., Retail Lending Processing Center, dated June 22, 1992 and amended June 28, 1994, (incorporated herein by reference to the Company's Annual Report on Form 10-K filed with the Commission for the year 1992).
(e) Amendment to lease for Elmwood Park, New Jersey, Retail Lending Processing Center, dated June 28, 1994 (incorporated herein by reference to the Company's Annual Report on Form 10-K filed with the Commission for the year 1994).
(f) Executive Compensation Plans and Arrangements
(1) 1989 Stock Option Plan is incorporated herein by reference to Registration Statement No. 33-49840, exhibit 10(j).
(2) Management Incentive Plan is incorporated by reference to Part III, Item 11, of the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders which will be filed with the Commission not later than 120 days after December 31, 1996
(3) Directors' Retirement Program (incorporated herein by reference to the Company's Annual Report on Form 10-K filed with the Commission for the year 1994).
(4) Executives' Supplemental Pension Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K filed with the Commission for the year 1994).
(5) Deferred Compensation Plan for Robert N. Harris (incorporated herein by reference to the Company's Annual Report on Form 10-K filed with the Commission for the year 1994).
11. Statement of Computation of Per Share Earnings
21. Subsidiaries of Registrant
23. Independent Auditors' Consent
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Interchange Financial Services Corporation
/s/Anthony Labozzetta --------------------------------- Anthony Labozzetta, Senior Vice President/Treasurer
March 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:
/s/Anthony S. Abbate /s/James E. Healey - ---------------------------------- ----------------------------------------- Anthony S. Abbate March 27, 1997 James E. Healey March 27, 1997 Director Director President and Chief Executive Officer
/s/Anthony D. Andora /s/Anthony Labozzetta - ---------------------------------- ----------------------------------------- Anthony D. Andora March 27, 1997 Anthony Labozzetta March 27, 1997 Director Senior Vice President and Treasurer Chairman of the Board
/s/Donald L. Correll /s/Nicholas R. Marcalus - ---------------------------------- ----------------------------------------- Donald L. Correll March 27, 1997 Nicholas R. Marcalus March 27, 1997 Director Director
/s/Anthony R. Cosia /s/Eleanore S. Nissley - ---------------------------------- ----------------------------------------- Anthony R. Cosia March 27, 199 Eleanore S. Nissley March 27, 1997 Director Director
/s/John J. Eccleston /s/Jeremiah F. O'Connor - ---------------------------------- ----------------------------------------- John J. Eccleston March 27, 1997 Jeremiah F. O'Connor March 27, 1997 Director Director
/s/David R. Ficca /s/Robert P. Rittereiser - ---------------------------------- ----------------------------------------- David R. Ficca March 27, 1997 Robert P. Rittereiser March 27, 1997 Director Director
/s/Benjamin Rosenzweig ----------------------------------------- Benjamin Rosenzweig March 27,1997 Director
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page No. in Form 10-K
Financial Statements
Independent Auditors' Report relating to the Consolidated Financial Statements and Notes thereto......................................... 36
Consolidated Balance Sheets at December 31, 1996 and 1995................. 37
Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994..................................... 38
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994................. 39
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994..................................... 40
Notes to Consolidated Financial Statements................................ 42
Schedules
Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable and, therefore, have been omitted.
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Interchange Financial Services Corporation Saddle Brook, New Jersey
We have audited the accompanying consolidated balance sheets of Interchange Financial Services Corporation and subsidiaries (the "Company") as of December 31, 1996 and 1995 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Interchange Financial Services Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP Parsippany, New Jersey January 20, 1997
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and practices within the banking industry. The following is a description of the Company's business and its significant accounting and reporting policies:
NATURE OF BUSINESS AND SIGNIFICANT ESTIMATES
Interchange Financial Services Corporation (the "Company"), a New Jersey business corporation, is a holding company whose principal subsidiary is Interchange State Bank (the "Bank"). The Bank is principally engaged in the business of attracting commercial and retail deposits and investing those funds into commercial business and commercial mortgage loans as well as residential mortgage and consumer loans. When demand for loans is low, the Bank invests in debt securities. Currently, the Bank conducts community banking operations in the northeast region of New Jersey (primarily Bergen county).
The Company uses certain accounting estimates in the preparation of its consolidated financial statements. As a result, actual results could differ from those estimates.
The most significant estimate pertains to the allowance for loan losses. The borrowers' ability to meet contractual obligations and collateral value are the most significant assumptions used to arrive at the estimate. The risks associated with such estimates arise when unforeseen conditions affect the borrowers ability to meet the contractual obligations of the loan and result in a decline in the value of the supporting collateral. Such unforeseen changes may have an adverse effect on the financial position of the Company.
Additionally, the Company is exposed to significant changes in market interest rates. Such changes could have an adverse effect on the earning capacity and financial position of the Company, particularly, in those situations in which a mismatch exists between the maturities or repricing of assets and supporting liabilities.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold.
SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
Debt securities which the Company has the positive intent and ability to hold until maturity are classified as held to maturity ("HTM") and are carried at cost, adjusted for the amortization of premiums and accretion of discounts on a level-yield method over the contractual maturity of the instruments. Investment securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale ("AFS") and are carried at market value. The unrealized gains and losses on these securities are reported, net of taxes, as a separate component of stockholders' equity. Management determines the appropriate classification of securities at the time of purchase.
Securities classified as AFS include securities used as part of the Company's asset and liability management strategy, or securities that may be sold in response to, among other things, changes in interest rates and prepayment risk. Gains and losses from the sale of these securities are determined using the specific identification method.
LOANS
Loans are stated at principal amounts outstanding, net of unearned discount. Interest income is accrued and credited at the applicable interest rates. Origination fees and certain direct origination costs have been deferred and are recognized over the life of the applicable loan as an adjustment to the yield. At December 31, 1996, approximately 84% of all loans are collateralized by real estate located in northern New Jersey, the Company's market area.
Loans are placed on nonaccrual status when, in the opinion of management, there is doubt as to the collectibility of interest or principal, or when principal or interest payments are in arrears 90 days or more, or if management considers collection of such amounts to be doubtful. Amounts accrued are evaluated for collectibility. Interest is subsequently recognized on nonaccrual loans only to the extent that cash is received and the ultimate repayment of principal is not in doubt. Loans are returned to accrual status when management deems that collection of principal and interest is reasonable and probable.
Mortgage loans available for sale are carried at lower of aggregate cost or market value.
In July 1991, the Bank acquired the assets and liabilities of a failed institution from the Federal Deposit Insurance Corporation (the "FDIC") which was accounted for using the purchase method of accounting. Consideration received from the FDIC was assigned to the fair value of the loans acquired, the allowance for loan losses and acquisition costs. Excess consideration was accreted into income over a five-year period which ended in August 1996.
Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114"), as amended by Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("SFAS No. 118"). Under SFAS No. 114, a loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to contractual terms of the loan agreement. The collection of all amounts due according to contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. SFAS No. 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral. The fair value of collateral, as reduced by costs to sell on a discounted basis, is utilized if a loan is collateral dependent or foreclosure is probable. All commercial and commercial mortgage loans are evaluated for impairment under SFAS No. 114. All nonaccrual commercial and commercial mortgage loans are considered impaired. The adoption of these rules did not have an impact on the Company's financial condition and results of operations.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through charges to income. Loan losses are charged against the allowance for loan losses when management believes that the collectibility of principal is unlikely. If, as a result of loans charged off or increases in the size or risk characteristics of the loan portfolio, the allowance is below the level considered by management to be adequate to absorb future loan losses on existing loans, the provision for loan losses is increased to the level considered necessary to provide an adequate allowance. The allowance is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible based on evaluations of the collectibility of the loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and economic conditions that may affect the borrowers' ability to pay.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Premises and equipment are depreciated over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the lease, if shorter. Estimated lives are 30 to 40 years for premises and 3 to 20 years for furniture and equipment. Expenditures for maintenance and repairs are expensed as incurred. The cost of major renewals and improvements is capitalized.
FORECLOSED REAL ESTATE
Real estate properties acquired through foreclosure are recorded at the lower of cost or estimated fair value, less estimated selling costs, at time of foreclosure. Subsequent valuations are performed periodically and the carrying value is adjusted by a charge to foreclosed real estate expense to reflect any subsequent declines in the estimated fair value. As a result, further declines in real estate values may result in increased foreclosed real estate expense. Routine holding costs are charged to expense as incurred.
INCOME TAXES
The Company utilizes the asset and liability method for accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current rates. The effect on deferred taxes of a change in tax rates is recognized in income in the period the change occurs. Deferred tax assets are reduced, through a valuation allowance, if necessary, by the amount of such benefits that are not expected to be realized based on current available evidence.
PER SHARE AMOUNTS
Earnings per common share is computed by dividing net income, less dividends on the preferred stock by the weighted average number of common shares outstanding of 2,838,161 during 1996 and 2,831,730 during 1995 and 1994. The potential dilution from the exercise of stock options is not material.
2. ACQUISITIONS
On February 25, 1994, the Bank assumed the deposit liabilities, amounting to $26,468,000, of Volunteer Federal Savings Association of Little Ferry, New Jersey. The Bank received $24,744,000 in cash representing the difference between the deposits assumed, net of $1,724,000 premium paid as part of the transaction.
The premiums paid to acquire the deposits in the Volunteer transaction and in a 1991 branch acquisition are being amortized over a period ranging from five to seven years. Amortization in 1996, 1995 and 1994, included in noninterest expenses, amounted to $444,000, $444,000, and $403,000, respectively.
3. RESTRICTIONS ON CASH AND DUE FROM BANKS
The subsidiary bank is required to maintain a reserve balance with the Federal Reserve Bank based upon the level of its deposit liability. The average amount of this reserve balance for 1996 and 1995 was approximately $8,164,000 and $6,803,000, respectively.
4. SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE
At December 31, 1996, the contractual maturities of securities held to maturity and securities available for sale are as follows: (in thousands)
Proceeds from the sale of securities available for sale totaled $38,349,000, $2,484,000, and $305,000 during the years ended december 31, 1996, 1995 and 1994, respectively. Gains of $452,000 and $16,000 were realized in 1996 and 1995, respectively, and losses of $217,000, $1,000 and $5,000 were realized in 1996, 1995 and 1994, respectively.
Proceeds from the sale of securities held to maturity (scheduled to mature within 3 months) totaled $6,008,000 during the year ended december 31, 1996. Gains of $7,000 were realized in 1996.
Securities with carrying amounts of $26.1 Million and $11.1 Million at December 31, 1996 and 1995, respectively, were pledged for public deposits, securities sold under repurchase agreements and other purposes required by law.
5. LOANS
Nonaccrual loans acquired in a 1991 transaction, with an estimated fair value of $452,000, and $1,060,000 at December 31, 1995 and 1994, respectively, are not included in the preceding table. At the acquisition date, these loans were not performing according to their original terms and were discounted from a face value of $978,000 and $2,773,000, respectively. There were no such loans at December 31, 1996.
Loans on which interest is accruing and included in income, but which were contractually past due 90 days or more as to principal or interest payments amounted to $25,000 at December 31, 1996. There were no such loans at December 31, 1994 and 1995.
Officers and directors of the Company and their affiliated companies are customers and are engaged in transactions with the Company in the ordinary course of business on substantially the same terms as those prevailing with other borrowers and suppliers.
The following table summarizes activity with respect to these loans: (in thousands)
6. ALLOWANCE FOR LOAN LOSSES
The Company's recorded investment in impaired loans is as follows:
Changes in the allowance for loan losses are summarized as follows: (in thousands) ------------------------ Years Ended December 31, ------------------------ 1996 1995 1994 ---- ---- -----
Balance at beginning of year ............... $ 3,647 $ 3,839 $ 3,905 Additions (deductions) Provision charged to operations ....... 700 1,200 944 Recoveries on loans previously charged off ...................... 208 118 114 Loans charged off ..................... (902) (1,510) (1,124) ------- ------- ------- Balance at end of year ..................... $ 3,653 $ 3,647 $ 3,839 ======= ======= =======
For years ended December 31, 1996, 1995 and 1994, the provisions charged to expense for federal income tax purposes amounted to approximately $694,000, $1,392,000, and $1,010,000, respectively.
7. PREMISES AND EQUIPMENT, NET
Premises and equipment are summarized as follows: (in thousands)
----------------------- December 31, ---------------------- 1996 1995 -------- ------
Land ........................................... $ 743 $ 743 Buildings ...................................... 1,062 1,062 Furniture, fixtures and equipment .............. 3,817 3,864 Leasehold improvements ......................... 4,954 4,715 ------- ------- 10,576 10,384 Less accumulated depreciation and amortization .............................. 5,425 4,874 ------- ------- $ 5,151 $ 5,510 ======= =======
8. DEPOSITS
Deposits are summarized as follows: (in thousands)
------------------------- December 31, ------------------------- 1996 1995 -------- ---------
Noninterest bearing demand deposits .............. $ 76,340 $ 69,213 Interest bearing demand deposits ................. 117,461 110,813 Money market deposits ............................ 39,815 38,716 Savings deposits ................................. 66,778 71,170 Time deposits .................................... 129,619 146,540 -------- -------- $430,013 $436,452 ======== ========
At december 31, 1996 and 1995, the carrying amounts of certificates of deposit that individually exceed $100,000 amounted to $17,153,000, and $11,674,000, respectively. Interest expense related to such deposits was approximately $692,000, $568,000, and $312,000 in 1996, 1995, and 1994, respectively.
9. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND SHORT-TERM BORROWINGS
Securities sold under agreements to repurchase and short-term borrowings are summarized as follows: (in thousands)
-------------------- December 31, -------------------- 1996 1995 ------ ------
Securities sold under agreements to repurchase ......... $11,050 $ 1,704 Federal funds purchased ................................ 5,200 4,200 Advances from the Federal Home Loan Bank of New York ................................... -- 5,000 ------- -------
$16,250 $10,904 ======= =======
The Bank has a $49.1 million line of credit available through its membership in the Federal Home Loan Bank of New York.
10. LONG-TERM BORROWINGS
Long-term borrowings are comprised of two Federal Home Loan Bank (the "FHLB") advances consisting of a $4.0 million advance with a 20-year amortization term, a fixed interest rate of 6.31% and matures in November 1998; and a $6.0 million advance, collateralized by U.S. Treasury securities, that has a fixed interest rate of 5.72% and matures in December 1999. The FHLB has an option to call the $6.0 million advance after December 1998.
11. BENEFIT PLANS
In 1993, the Company established a non-contributory defined benefit pension plan covering all eligible employees. The funding policy is to contribute an amount that is at least the minimum required by law. Retirement income is based on years of service under the plan and, subject to certain limits, on final average compensation. Effective January 1, 1994, the Company established a supplemental plan that provides for retirement income that would have been paid but for the limitation under the qualified plan.
Effective August 1, 1994, the Company established a retirement plan for all directors of the Company or the Bank who are not employees of the Company or of any subsidiary or affiliate of the Company. As a part of this Plan, the Company contributes annually to a life insurance policy or annuity contract as follows:
YEARS OF SERVICE AMOUNT CONTRIBUTED ---------------- ------------------ 6........ $5,000 7........ 6,000 8........ 7,000 9........ 8,000 10....... 9,000 11 or more 10,000
The life insurance policies or annuity contracts are owned by the Company. Retirement income to a director who has completed five years of service through ten years of service will be based on the cash value of the life insurance policy or annuity contract. After ten years of service, the retirement income will be the greater of the cash value of the life insurance policy or annuity contract or an amount determined by multiplying the standard annual retainer fees (currently $11,000) at the director's retirement day by the director's years of service.
The following table sets forth the funded status, as of December 31, of the plans and amounts recognized in the Company's Consolidated Balance Sheets and the major assumptions used to determine these amounts: (dollars in thousands)
The Company has a Capital Investment Plan (the "Plan") which permits employees to make basic contributions up to 4% of base compensation. Additional contributions up to 10% of compensation may be made when coupled with basic contributions. Under the Plan, the Company provides a matching contribution equal to 50% of the basic contribution of each participant. In addition, the Company makes a fixed contribution on behalf of each participant equal to 1% of such participant's base compensation. The Company's contribution to the Plan amounted to $119,000, $115,000, and $98,000 in 1996, 1995 and 1994, respectively.
12. STOCK OPTION PLAN
In 1989, the Company adopted a stock option plan covering certain key employees. Under this plan, as amended, a maximum of 283,500 shares of common stock may be granted at fair market value at the date of grant. Options granted expire if not exercised within ten years of date of grant and are exercisable starting one year from the date of grant.
In October 1995, the Financial Accounting Standards Board issued Statement No. 123. "Accounting for Stock-Based Compensation" (SFAS 123). SFAS 123 requires expanded disclosures of stock-based compensation arrangements with employees, and encourages, but does not require compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply Accounting Principles Board Opinion No. 25 ("APB 25"), which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB 25 to its stock-based compensation awards to employees.
If compensation cost for Plan awards had been determined based on fair value at the grant dates, net income and earnings per share would have been reduced to the pro-forma amounts below for the years ended December 31, 1996 and 1995: (no options were granted in 1995) (in thousands except share data)
------------------------- December 31, ------------------------- 1996 1995 ---------- ----------
Net income:
As reported .......................... $6,419 $6,280 Pro-forma ............................ 6,412 6,280
Net income per share:
As reported .......................... $2.26 $2.19 Pro-forma ............................ 2.26 2.19
The pro-forma effect of applying FAS 123 is not necessarily indicative of the effect on reported net income for future years.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the periods ending December 31, 1996: expected volatility, 22.26%; expected lives, 7 years; risk-free interest rate, 6.26%; expected dividend yield, 2.45%.
A summary of the Plan's status and changes during the years then ended is presented below: (in thousands except share data)
The following table summarizes information about options outstanding under the Plan at December 31, 1996:
13. CAPITAL
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the Bank's capital amounts and the Bank's classification under the regulatory framework for prompt corrective action, are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and Tier I capital to average assets. Management believes, as of December 31, 1996, that the Company and the Bank meet all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category.
14. OTHER NONINTEREST EXPENSES
Expenses included in other noninterest expenses which exceed one percent of the aggregate of total interest income and noninterest income in 1996, 1995 and 1994 are as follows: (in thousands)
15. INCOME TAXES
Income tax expense for the years ended December 31, is summarized as follows: (in thousands)
The effects of temporary differences that give rise to significant portions of the Company's deferred tax assets and liabilities as of December 31, are as follows: (in thousands)
Net deferred tax assets are included in other assets on the consolidated balance sheet. It is more likely than not that deferred tax assets of $1.5 million will be principally realized through carryback to taxable income in prior years and future reversals of existing taxable temporary differences and, to a lesser extent, future taxable income and tax planning strategies.
The provision for income taxes differs from the expected statutory provision as follows:
16. PREFERRED STOCK
On September 15, 1995, the Company exercised its right to redeem all of its preferred stock, not held as Treasury Stock, at $50 per share. At the same time the Company elected to cancel these shares together with the shares held as Treasury Stock. The cancellation included all of the 100,000 shares issued in 1987.
17. PARENT COMPANY INFORMATION (in thousands)
18. RESTRICTIONS OF SUBSIDIARY BANK DIVIDENDS
Under New Jersey state law, the Bank may declare a dividend only if, after payment thereof, its capital would be unimpaired and its remaining surplus would equal 50 percent of its capital. At December 31, 1996, undistributed net assets of the Bank were $43,001,000 of which $38,683,000 was available for the payment of dividends. In addition, payment of dividends is limited by the requirement to meet the capital guidelines issued by the Board of Governors of the Federal Reserve System.
19. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has outstanding commitments and contingent liabilities including agreements to extend credit which arise in the normal course of business and which are not shown in the accompanying financial statements.
Loan commitments are made to accommodate the financial needs of the Company's customers. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. They are issued primarily to support performance bonds. Both arrangements have credit risks essentially the same as that involved in extending loans to customers and are subject to the normal credit policies of the Company.
A summary of commitments to extend credit at December 31, are summarized as follows: (in thousands)
1996 1995 ------- ------
CREDIT CARD LOANS $ 6,631 $ 6,985 HOME EQUITY LOANS 43,204 41,089 OTHER LOANS 38,041 21,444 STANDBY LETTERS OF CREDIT 444 1,258 --------- ------- $88,320 $70,776 ========= =======
The minimum annual rental under non-cancelable operating leases for premises and equipment, exclusive of payments for maintenance, insurance and taxes, is summarized as follows: (in thousands)
1997 $ 868 1998 818 1999 714 2000 558 2001 346 THEREAFTER 822 -------
TOTAL MINIMUM LEASE PAYMENTS $4,126 =======
Rent expense for all leases amounted to approximately $1,024,000, $985,000 and $884,000 in 1996, 1995, and 1994, respectively.
In 1996, the Company leased certain real estate from two companies (three companies in 1995 and 1994) affiliated with directors of the company. Rental expense associated with such leases was $143,000, $157,000 and $167,000 for the years ended december 31, 1996, 1995, and 1994, respectively. The aggregate minimum rental commitments through 2003 under these leases was approximately $708,000 at december 31, 1996. A director of the Company also provided legal services through his affiliated firm. Fees paid for these services amounted to approximately $375,000, $323,000 and $427,000 in 1996, 1995, and 1994, respectively.
Interchange State Bank's (the "bank"), a wholly owned subsidiary of the Company was a party to a lawsuit commenced in April 1989 (Great American Mortgage Corp., Et al, v. Robert Utter, et al.), filed in the Superior Court of New Jersey alleging that the Bank was statutorily liable for having paid checks which bore irregular endorsements. Various other legal proceedings related to the foregoing were also instituted and, in those actions, the Bank pursued various parties whom the Bank alleged were liable to it. On August 2, 1996, the Bank paid $120,000 plus prejudgment interest to resolve the final matter pertaining to these occurrences. The remainder of a reserve, which was established in 1992, was sufficient to cover this amount. All legal proceedings related to these occurrences, involving the potential liability of the Bank, have now been resolved.
The Company is also a party to routine litigation involving various aspects of its business, none of which, in the opinion of management and its legal counsel, is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.
20. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA)
21. FAIR VALUE OF FINANCIAL INSTRUMENTS (in thousands)
Fair value estimates of the Company's financial instruments are made at a particular point in time, based on relevant market information and information about the financial instrument. Fair values are most commonly derived from quoted market prices. In the event market prices are not available, fair value is determined using the present value of anticipated future cash flows. This method is sensitive to the various assumptions and estimates used and the resulting fair value estimates may be significantly affected by minor variations in those assumptions or estimates. In that regard, it is likely that amounts different from the fair value estimates would be realized by the Company in immediate settlement of the financial instruments.
The methods and significant assumptions used to determine the estimated fair values of the Company's financial instruments are as follows:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. The estimated fair values of these financial instruments approximate their carrying values since they mature overnight or are due on demand.
INVESTMENT SECURITIES AND SECURITIES AVAILABLE FOR SALE
Estimated fair values are based principally on quoted market prices, where available, or dealer quotes. In the event quoted market prices are not available, fair values are estimated using market prices of similar securities.
LOANS
The loan portfolio is segregated into various categories for purposes of estimating fair value. Certain homogenous loan categories have been valued on a pool basis using quoted market prices for similar loans sold. The fair values of certain loans that reprice frequently and have no significant change in credit risk is assumed to equal their carrying values. The fair value of other types of loans is estimated by discounting the future cash flows using interest rates that are currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of nonperforming loans is estimated using methods employed by management in evaluating the allowance for loan losses.
DEPOSITS
The estimated fair values of deposits with no stated maturity, such as demand deposits, savings, NOW and money market accounts are, by definition, equal to the amount payable on demand at the reporting date. The fair values of fixed-rate certificates of deposit are based on discounting the remaining contractual cash flows using interest rates currently being offered on certificates of deposit with similar attributes and remaining maturities.
SHORT-TERM BORROWINGS
The fair value of short-term borrowings is assumed to equal the carrying value in the financial statements, as these instruments are short-term.
LONG-TERM BORROWINGS
Fair value estimates of long-term borrowings are based on discounting the remaining contractual cash flows using rates which are comparable to rates currently being offered for borrowings with similar remaining maturities.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
The fair values of commitments to extend credit and unadvanced lines of credit are estimated based on an analysis of the interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the commitments and the credit-worthiness of the potential borrowers. At December 31, 1996 and 1995, the estimated fair values of these off-balance-sheet financial instruments were immaterial.